Correction Notice: On May 23, 2024, the final sentence in the fifth paragraph of this article was amended from the original publication. The amendment corrected the word “inappropriate” to “appropriate.”
Treaty Shopping Revisited
In a recently released internal TI (2019-0792651I7, June 16, 2020), the CRA considered whether UKco, by increasing its participation in Canco so as to reach the 10 percent ownership threshold the day before a dividend is paid, is entitled to the reduced withholding tax rate of 5 percent pursuant to article 10(2) of the Canada-UK tax treaty.
Article 10(2) allows UKco to claim a reduced withholding tax rate of 5 percent on a dividend paid by Canco if UKco “controls, directly or indirectly, at least 10 per cent of the voting power” in Canco, whereas article 10(8) prevents the application of the reduced withholding tax rate if “the main purpose or one of the main purposes of any person concerned with the creation or assignment of the shares or other rights in respect of which the dividend is paid to take advantage of this Article by means of that creation or assignment.”
The CRA, after reviewing the history of article 10(8) (in particular, the details concerning the expansion of the purpose test in 2003) and considering the OECD commentaries, concluded that “the intention of both Canada and the UK [was] that paragraph 8 of Article 10 of the Treaty not be limited to situations where the degree of connection of the ultimate dividend recipient with Canada is questioned.” The agency concluded, in other words, that the provision was not limited to situations of treaty shopping.
The reference to treaty shopping is puzzling in light of the wording of the provision and its limited application to dividend benefits. As the CRA emphasized, the predecessor of article 10(8) applied only when a dividend was paid by a UK corporation from income earned in a period ending 12 months (or more) before the Canadian shareholder attained a 10 percent ownership in the corporation. This provision was relevant in cases where—presumably because of our foreign affiliate system—such income was not taxed in Canada. The objective behind the predecessor provision was clearly to ensure that profits earned while a shareholder was below the 10 percent threshold could not benefit from the reduced withholding tax rate, unless the shares were acquired for bona fide commercial reasons and not primarily for the purpose of securing the benefit of article 10. The 2003 amendment supports this interpretation; the amendment focused on whether a shareholder’s participation is acquired primarily for the purpose of taking advantage of article 10 (as opposed to taking advantage of the treaty as a whole).
The treaty-shopping analysis seems to have been prompted by the applicant, who asked whether article 10(8) was “conditional on a lack of connection of the ultimate dividend recipient with Canada (treaty shopping).” Canco might have been arguing, in the course of an audit, that article 10(8) should not apply where no treaty-shopping intent exists. In any case, the CRA’s position seems inappropriate.
The CRA then considered whether the application of article 10(8) would subject UKco to a withholding rate of 25 percent (thereby denying any benefits under article 10) or to a rate of 15 percent. The CRA concluded, on the basis of what seems to be a strict reading of the provision, that the applicable rate was 25 percent.
This is a rather surprising outcome, considering the CRA’s position on the treaty-shopping issue and its reliance on the historical reasons for the inclusion of article 10(8) and on the OECD commentary, which both focus on the inappropriate manipulation of the 10 percent threshold. Had UKco not acquired an additional participation in Canco, it would have benefited from the 15 percent rate. It is perplexing that UKco ends up with a 25 percent rate, as if it were not a UK resident at all, thereby adding insult to the injury of article 10(8).
It is interesting to note that the TI is silent on the multilateral instrument (MLI), although, with respect to withholding tax, the MLI has applied to the Canada-UK treaty since January 1, 2020. The MLI has superseded article 10(8), and therefore the CRA’s analysis of 10(8) is now outdated.
The United Kingdom has not adopted the strict “one-year holding period” rule provided for in article 8 of the MLI, and it appears to have opted to rely on the principal purpose test (PPT) to determine whether the 5 percent reduced rate should be available in potentially abusive circumstances. Where the PPT applies, the “sanction” is to deny the specific treaty benefit, which may mean, in the situation at hand, that UKco should be entitled to the 15 percent rate for post-2020 periods. Canada, however, has declined to adopt the authority to provide discretionary benefits contemplated by article 7(4) of the MLI.
In addition, the TI does not address whether and in what circumstances the CRA would accept that the granting of treaty benefits, despite an acquisition by UKco of additional shares in order to qualify for a specific holding threshold, would be considered to be consistent with the “object” of the treaty, as contemplated in example E of the guidance in the commentaries on the PPT now incorporated into article 29 of the OECD model.
An updated TI that addresses the MLI and provides more detail regarding how the 10 percent threshold was attained (and whether the transaction was unwound subsequent to the payment of the dividend) would be helpful. In the meantime, the TI is of limited use to taxpayers facing similar situations.
Marie Emmanuelle Vaillancourt
Davies Ward Phillips & Vineberg LLP, Montreal
