Last November, we told you about the new treaty shopping rules proposed by the Organisation for Economic Co-operation and Development (OECD) as part of the final report on Action 6 of the Action Plan on Base Erosion and Profit Shifting (BEPS Action Plan).

The main proposal in Action 6 was the amendment of the OECD model tax treaty to include “limitation on benefit” provisions. Two types of provisions were proposed: (i) specific provisions (LoB provisions) that limit the availability of treaty benefits to individuals, corporations, and other organizations that meet specific criteria that are intended to establish that business is actually carried on in a contracting state, and (ii) general provisions, (principal purpose provisions) that limit the availability of treaty benefits when one of the principal purposes of a transaction is to gain access to treaty benefits.

Both approaches have disadvantages. LoB provisions prevent an entity from accessing treaty benefits only if the specific criteria are not met, even where the only reason for the transaction is to access treaty benefits. Principal purpose provisions do not depend on any specific criteria, and instead rely on the interpretation of an entity’s “principal purpose”; as a result, the availability of treaty benefits may be uncertain to business and governments alike. In order to minimize the impact of these contrasting disadvantages, Action 6 recommends the inclusion of both provisions in tax treaties.

The implications of each type treaty shopping provision are significant for businesses that are looking to find a tax-efficient way to enter the Canadian market. On September 23, 2016, Canada entered into a new tax treaty with Israel (the Canada-Israel Treaty), Canada’s first treaty since the final report on Action 6 of the BEPS Action Plan. The text of the Canada-Israel Treaty provides important insight into Canada’s approach to treaty-shopping in the post-BEPS Action Plan environment.

Significantly, the Canada-Israel treaty does not include any LoB provisions as recommended by Action 6. Rather, the Canada-Israel treaty includes principal purpose provisions that deny the availability of treaty benefits with respect to dividends, interest, royalties, and capital gains if “one of the main purposes” of a transaction is to gain the benefit of the provisions relating to dividends, interests, royalties, or capital gains, respectively.

Similar principal purpose provisions have appeared in every tax treaty that Canada has entered into since 2010. In other words, Canada has not used its first opportunity to change its approach to treaty negotiation in light of Action 6 of the BEPS Action Plan. Instead, Canada has continued to insist on principal purpose provisions in an attempt to deny treaty benefits to entities that lack sufficient connections to Canada, while not insisting on LoB provisions that provide greater certainty as to the availability of treaty benefits.

Canada may yet alter its approach. However, the Canada-Israel Treaty is our first look at how Canada will look to combat treaty shopping. So far, Canada has chosen to take a broad approach that has the potential to create tremendous uncertainty for business looking for the most tax-efficient way to expand into Canada.

In addition, and simultaneous to ongoing treaty negotiations, the Government of Canada committed in its 2016 Budget to the development of a multilateral instrument to implement treaty-related recommendations in the BEPS Action Plan. Businesses must continue to consider what treaty shopping provisions are in place and what their implications will be as Canada enters into new tax treaties and renegotiates existing ones, as well as the potential impacts of the yet-to-be-completed multilateral instrument.

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