CRA indicates that the PPT object and purpose test is met where individuals in a Treaty country transfer their Canco shares to a Treaty-resident Holdco to reduce dividend withholding

Two long-time residents of Hong Kong (Mr. and Mrs. A) each transferred 50% of the shares of Canco to a new Hong Kong company. Leaving aside the avoidance provisions, this reduced the dividend withholding tax rate on dividends paid by Canco from the 15% general Treaty-reduced rate to a 5% rate (under Art. 10(2)(a) of the Canada-Hong Kong Treaty).

CRA noted that for dividends paid after 2023, it was no longer necessary to satisfy the “one of the main purposes” test in Art. 10(7) of the Treaty in order for such rate reduction to occur, and that instead the relevant test was the principal purpose test (PPT) in Art. 7(1) of the MLI.

CRA emphasized that even if the purpose test in Art. 7(1) was satisfied, Art. 7(1) nonetheless states that it does not apply to deny a Treaty benefit if “it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.” CRA then briefly stated:

Article 7(1) of the MLI will generally not apply to deny the benefits of Article 10(2)(a) of the Agreement on such dividends paid on or after January 1, 2024.

Accordingly, CRA appeared to accept that it would accord with the “object and purpose” of the Treaty for individuals resident in HK to access a lower withholding tax rate by transferring their shares to their HK corporation.

There was no similar object-and-purpose exception in Art. 10(7) of the Treaty so that, for dividends paid before 2024, it was necessary that one of the main purposes of transferring to the HK corporation was not accessing a rate reduction under Art. 10. If there was such a main purpose, the effect would be to increase the dividend withholding rate from 15% to 25%.

Neal Armstrong. Summary of 17 May 2023 IFA Roundtable, Q.7 under Treaties – Income Tax Conventions – Art. 10.