Multilateral Convention to Implement Tax Treaty related Measures to Prevent Base Erosion and Profit Shifting
The OECD’s Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the multilateral instrument or “MLI”) is now law in Canada. The MLI was Action 15 of the Base Erosion and Profits Shifting (BEPS) Project. With respect to taxpayers claiming benefits under Canadian bilateral treaties the MLI is effective January 1, 2020 with respect to withholding under 28 bilateral treaties and effective for tax years beginning June 1, 2020 with respect to all other taxes levied by Canada or one of these bilateral treaty countries.
The MLI uses a “reservation” process whereby either Canada and the bilateral treaty partner can reserve with respect to certain provisions in the MLI, in either case the particular MLI provision may not apply or may apply in modified form with respect to that particular bilateral treaty.
Article 7 of the MLI (Prevention of Treaty Abuse) introduces a blanket “principal purpose test,” which can only be reserved against “on the basis that it intends to adopt a combination of a detailed limitation on benefits provision and either rules to address conduit financing structures or a principal purpose tax, thereby meeting the minimum standard for preventing treaty abuse under the OECD/G20 BEPS package.” Pursuant to its ratification instrument deposited with the OECD on August 29, 2019 Canada stated the following: “Canada hereby expresses a statement that while Canada accepts the application of Article 7(1) alone [the principal purpose test] as an interim measure, it intends where possible to adopt a limitation on benefits provision, in addition to or in replacement of Article 7(1), through bilateral negotiation.”
Article 8 of the MLI provides a holding period requirement to benefit from reduced withholding rates on dividends. Article 9 provides a 365-day look-back to test whether shares or other equity interests principally derive their value from real or immovable property for purposes of allocating taxing jurisdiction with respect to capital gains.
Canada reserved on the entirety of Articles 10 through 15 of the MLI dealing with anti-abuse rules for triangular permanent establishments (Article 10), application of a treaty to a country’s own residents (Article 11), commissionaire arrangements and similar strategies (Article 12), specific activity exemptions to permanent establishment status (Article 13), unbundling contracts (Article 14) and definition of person closely related to an enterprise (Article 15).
The MLI also provides procedural frameworks for the mutual agreement procedure and mandatory binding arbitration that will apply to Canada’s bilateral treaties if the other jurisdiction has also opted into the binding arbitration provisions.
Not all contracting states have adopted the MLI, and some like the United States will never adopt the MLI. Of the contracting states that have adopted the MLI, in order to know how much of the MLI would apply to its particular bilateral treaty with Canada one needs to consult the reservations of both Canada and the other contracting state. Simply to identify what the applicable rules are in a particular country is now an exercise in itself, let alone parsing, interpreting and applying the multitude of new rules. The OECD has developed a matching tool (in beta release) in order to determine what provisions of the MLI apply between two countries with a bilateral treaty. This tool is available here: https://www.oecd.org/tax/beps/mli-matching-database.htm.
Tax-deferred partnership contributions – final regulations issued under section 721(c) of the Code.
On January 17 the Department of the Treasury issued final regulations under the regulatory grant provided at section 721(c) of the Code. This grant of regulatory authority had been in the Code since 1997; temporary and proposed regulations were issued in January 2017 and these are the regulations that became final this year. These regulations cause certain transfers of appreciated assets by US persons to a partnership in exchange for partnership interests to trigger taxable capital gains when the transferee partnership has foreign partners related to the US person transferor.
Section 721(a) of the Code is the US analogue to subsection 97(2) of the Act, allowing certain transfers of appreciated assets to a partnership in exchange for partnership interests to be transacted on a tax-deferred basis. The Canadian analogue to the 721(c) regulations is the definition of “Canadian partnership” under the Act. From a tax policy perspective, the Canadian fisc is worried about gains eluding the Canadian tax net when transferred to a partnership on a rollover basis, therefore the rollover is bluntly only available if all of the partners are Canadian residents. The US Department of the Treasury has taken a more nuanced approach to this valid tax policy concern.
Very broadly, under the general rule of the charging provision at Treas. Reg. § 1.721(c)-2, the tax deferral provided by section 721(a) of the Code is not available in cases of contributions of “section 721(c) property” to a “section 721(c) partnership”. Section 721(c) property is appreciated property contributed to a partnership by a US person transferor other than cash equivalents, most appreciated securities, tangible property with a book value exceeding adjusted tax basis by no more than $20,000 or with an adjusted tax basis in excess of book value, and an interest in a partnership that directly or indirectly derives 90% or more of its value from the aforementioned excluded assets. (In case you were not aware, the US partnership rules are complex.)
A section 721(c) partnership in turn is defined as a foreign or domestic partnership if there is a contribution of section 721(c) property to the partnership and after the contribution and related transactions a related foreign person with respect to the US person transferor is a direct or indirect partner in the partnership, and the US person transferor and related persons own 80 percent or more of the interests in the partnership capital, profits, deductions or losses.
There is a gain deferral method available to transfers that would otherwise be subject to gain recognition if certain substantive and procedural requirements under Treas. Reg. § 1.721(c)-3 are met.
© Thomson Reuters Canada Limited. Originally published in Vol. 6, no. 1 of Arbitrary Assessment, February 2020
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