On March 22, 2016, the Minister of Finance tabled Canada's 2016 federal budget (the 2016 Budget). This was the first budget presented by the newly-elected Liberal government, which won a strong majority in the fall 2015 federal election after nearly a decade with the Conservative party in power. Although the 2016 Budget generally endorsed the Organisation for Economic Co-operation and Development's (OECD) Base Erosion and Profit Shifting (BEPS) action plans, it only addressed a limited number of the BEPS measures without proposing any legislative changes. This relatively limited initial response to BEPS by Canada can largely be explained by the fact that over the past decade successive Canadian governments have introduced significant changes to the domestic tax legislation to prevent certain perceived international abuses many of which are also targeted by BEPS. For example, Canada now has anti-avoidance rules that generally target planning to avoid the consequences of the thin capitalization and/or withholding tax rules through 'back-to-back' loan arrangements whereby a third party is interposed between the taxpayer and the ultimate lender, as well as rules aimed at stopping investments in foreign affiliates of corporations resident in Canada in circumstances where the Canadian corporations are foreign-controlled and simply fund their foreign affiliates in order to create interest deductions in Canada. Nevertheless, the 2016 Budget confirms Canada's commitment to address treaty shopping abuses and specifically endorses certain BEPS action plans of an administrative and procedural nature.
The 2016 Budget includes general comments on treaty abuse. The government notes that, under BEPS, there is a treaty abuse minimum standard that requires countries to include in their tax treaties an express statement that their common intention is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty shopping arrangements, and that Canada is committed to addressing treaty abuse in accordance with the minimum standard. This standard requires countries to adopt in their tax treaties one of two approaches to treaty anti-abuse rules. The first of these is a general anti-abuse rule that uses the criterion of whether one of the principal purposes of an arrangement or transaction was to obtain treaty benefits in a way that is not in accordance with the object and purpose of the relevant treaty provisions (so-called principal purpose test or PPT). The second approach is the use of a more mechanical and specific anti-abuse rule that requires satisfaction of a series of tests in order to qualify for treaty benefits (a limitation on benefits (LOB) rule).
Currently, only the Canada-U.S. Treaty has adopted a LOB rule, and several treaties have adopted a limited PPT. Going forward, Canada will consider either approach, depending on the particular circumstances and discussions with Canada's tax treaty partners. Amendments to Canada's tax treaties to include a treaty anti-abuse rule could be achieved through bilateral negotiations, the multilateral instrument, or a combination of the two. The multilateral instrument, which is to be developed in 2016, is a tax treaty that many countries could sign, modifying certain provisions of existing bilateral treaties. The 2016 Budget notes that Canada is actively participating in international work to develop the multilateral instrument, which the government expects will streamline the implementation of treaty-related BEPS recommendations, including treaty abuse.
Interestingly, the 2016 Budget makes no reference to the government's 2014 proposal to unilaterally implement a PPT. That proposed domestic measure was heavily criticized by the business and tax community and ultimately was withdrawn in August 2014.
Item 13 of the OECD action plan on BEPS, entitled "Transfer Pricing Documentation and Country-by-Country Reporting", contemplates multilateral or bilateral agreements between participating states providing for the collection and exchange by their respective tax authorities of standardized transfer pricing documentation and country-by-country (CbC) reporting for multinational enterprises (MNEs). Such CbC reporting would include information concerning revenue, profit, tax paid, stated capital, accumulated earnings, number of employees, tangible assets and the main activities of each of its subsidiaries. The stated purpose of the requirement to produce CbC reports and of the exchanges by countries of these reports is risk assessment, i.e. to enable the affected countries to assess perceived high-level transfer pricing risks and other BEPS-related risks.
The 2016 Budget proposes to implement CbC reporting, applicable to MNEs with total annual consolidated group revenue of €750-million or more. Where such an MNE has an ultimate parent entity that is resident in Canada (or, in certain cases, a Canadian resident subsidiary), it will be required to file a CbC report with the Canada Revenue Agency (CRA) within one year of the end of the fiscal year to which the report relates. The 2016 Budget indicates that, before any exchange with another jurisdiction, CRA will formalize an exchange arrangement with the other jurisdiction and will ensure that it has appropriate safeguards in place to protect the confidentiality of the reports.
The 2016 Budget contemplates that CbC reporting will be required for taxation years that begin after 2015; most taxpayers that will be subject to these rules will be required to file their first CbC reports in Canada at the end of 2017. First exchanges between jurisdictions of CbC reports are expected to occur by June 2018. There were no draft legislative proposals included in the 2016 Budget, but these are expected to be released for comment in the coming months.
Revised Transfer Pricing Guidance
The 2016 Budget reiterates the principle that transfer prices for intra-group transactions within an MNE should meet the international arm's length standard, which principle is enshrined in domestic law in section 247 of the ITA and in Article IX of most of Canada's bilateral tax treaties. In Canada, the OECD Transfer Pricing Guidelines are endorsed in CRA's published administrative guidance on applying the arm's length principle. The Supreme Court of Canada has made clear that the OECD Transfer Pricing Guidelines are not law in Canada, but may provide relevant guidance in this regard (like other extrinsic interpretive aids).
The BEPS final reports include proposed revisions to the OECD Transfer Pricing Guidelines. The 2016 Budget describes these proposed revisions as clarifications, and states that they support CRA's current interpretation and application of the arm's length principle. The proposed revisions are thus being applied currently by CRA because they are consistent with CRA's current practices. Two exceptions to this position are the yet-to-be-finalized BEPS guidance on "low value-adding services" and "risk-free" as opposed to "risk-adjusted" returns for "cash box" entities.
While it is premature to offer substantive comment on the intended application of the proposed October 2015 revisions to the OECD Transfer Pricing Guidelines, it should be noted that there are likely to be legal issues that will need to be considered and addressed. For example, there may be legal impediments to the application of the revised guidance in audits of transactions that were completed before October 2015 or in the application of the provisions of a bilateral treaty concluded before any revision of the OECD Transfer Pricing Guidelines. The resolution of such issues may depend in part on whether the revisions are properly characterized as clarifications of prior rules or guidance or whether they go further. Another issue expected to be raised will be the resolution of conflicts between the proposed revisions and Canadian domestic law, including the legal principle that legal relationships are to be respected absent a sham or specific statutory authority to the contrary.
Spontaneous Exchange of Tax Rulings
The BEPS project developed a framework for the spontaneous exchange of certain tax rulings that could give rise to BEPS concerns in the absence of such exchange. The 2016 Budget confirms that the Canadian government intends to implement the BEPS minimum standard for the spontaneous exchange of certain tax rulings, and that CRA will commence exchanging tax rulings in 2016 with other jurisdictions that have committed to the minimum standard. CRA announced, contemporaneously with the introduction of the 2016 Budget, that its Income Tax Rulings Directorate will be updating its published guidance to outline the types of rulings potentially subject to this exchange, the process CRA will follow in performing the exchange and the additional information that it will require in respect of requests for rulings within the scope of the exchange initiative. Presumably CRA's processes will also need to have regard for its legislated privacy and confidentiality obligations to Canadian taxpayers.
Common Reporting Standard
Last year's federal budget (the 2015 Budget) had announced that Canada intended to implement another project initiated by the OECD, the development of a common reporting standard (CRS) for the automatic exchange of information among participating countries. While CRS may have its origins in the U.S. Foreign Account Tax Compliance Act (FATCA) rules, it is in many respects different from FATCA; one key difference is that CRS does not impose withholding obligations as a consequence of compliance failures or non-participation.
CRS will require CRA to collect information from Canadian financial institutions concerning financial accounts maintained by them for residents of participating countries, and to provide such information to the tax authorities of those participating countries. The goal stated in the 2015 Budget was to implement CRS as of July 1, 2017, with the first exchange of information occurring in 2018. The 2016 Budget reiterates the government's intention to proceed with CRS, but did not provide further details.