15 May 2024 IFA Roundtable Q. 1, 2024-1007651C6 - Principal purpose test and the UK-Canada Tax Treaty

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: In the scenario described in 2019-0792651I7, in the CRA’s view, how would the principal purpose test (“PPT”) in paragraph 1 of Article 7 (“Article 7(1)”) of the Multilateral Instrument (“MLI”) apply if the dividend were paid in 2024? What if the UK-Canada Treaty did not contain Article 10(8)?

Position: In the circumstances outlined in the question, the 5% rate of withholding applies provided that granting a benefit in the circumstances would be in accordance with the object and purpose of Article 10. Example E in paragraph 182 of the OECD Commentary to Article 29(9) of the OECD Model Convention explains that in cases such as this, a relevant factor is whether the taxpayer “genuinely increases its participation in the company”. The benefit might not be granted if there is a manipulation of share ownership such as when the acquisition of additional shares is transitory or there are other facts and circumstances indicating that granting that benefit would not be in accordance with the object and purpose of the relevant provisions of the UK-Canada Treaty. An example could be where UK Co owned 8% of the shares of Canco, acquired an additional 2% of the shares of Canco prior to the dividend distribution, and sold the 2% ex-dividend, shortly thereafter.

Reasons: Example E in paragraph 182 of the Commentary to Article 29(9) of the OECD Model Convention provides for this exact situation.

2024 International Fiscal Association Conference
CRA Roundtable

Question 1: Principal Purpose Test and the UK-Canada Tax Treaty

In CRA Document 2019-0792651I7 (June 16, 2020) (“2019-0792651I7”), the CRA concluded that paragraph (8) of Article 10 (“Article 10(8)”) of the UK-Canada Income Tax Convention (“UK-Canada Treaty”) should deny a UK resident corporation the benefit of any reduction in the 25% withholding tax rate applicable to a dividend paid by a Canadian corporation, where the UK corporation owned less than 10% of the voting shares of the Canadian corporation, but acquired additional shares the day before the dividend was paid such that the UK corporation held 10% at the time the dividend was paid. The CRA provided detailed analysis which included its analysis of the history and context of Article 10(8) of the UK-Canada Treaty.

In the CRA’s view, how would the principal purpose test (“PPT”) in paragraph 1 of Article 7 (“Article 7(1)”) of the Multilateral Instrument (“MLI”) apply if the dividend were paid in 2024? What if the UK-Canada Treaty did not contain Article 10(8)?

CRA Response

Article 10(8) of the UK-Canada Treaty states as follows:

"8. The provisions of this Article shall not apply if it was 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." (Emphasis Added).

An earlier iteration of an anti-abuse provision in Article 10 of the UK-Canada Treaty had a carveout which read:

“Provided that this paragraph shall not apply if the shares were acquired for bona fide commercial reasons and not primarily for the purpose of securing the benefit of this Article (footnote 1) .”

In the absence of a similar exemption in the current version of Article 10(8) of the UK-Canada Treaty and given the facts in 2019-0792651I7, the conclusions therein logically followed.

Since the MLI is now effective in both Canada and the UK, and both countries have agreed that Article 7(1) of the MLI shall apply for purposes of the UK-Canada Treaty, Article 10(8) of the UK-Canada Treaty has effectively been replaced by Article 7(1) of the MLI, which reads as follows:

“Article 7 – Prevention of Treaty Abuse

1. Notwithstanding any provisions of a Covered Tax Agreement, a benefit under the Covered Tax Agreement shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless 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.”

The wording of Article 7(1) of the MLI is similar to the language in paragraph 9 of Article 29 (Entitlement to Benefits) (“Article 29(9)”) of the OECD (2017), Model Tax Convention on Income and on Capital: Condensed Version 2017, OECD Publishing, Paris, (“OECD Model Treaty”), which states as follows:

“9. Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.”

While the explanatory statement (footnote 2) that accompanies the MLI does not provide examples, both the OECD (2015), Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action 6 - 2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, (BEPS Action Report 6) (footnote 3) and the Commentary to Article 29(9) of the OECD Model Treaty (Commentary) added a number of examples which provide guidance on the application of Article 7(1) of the MLI.

Example E in paragraph 182 of the Commentary to Article 29(9) of the OECD Model Treaty (footnote 4) considers whether it would be contrary to the object and purpose of Article 10(2)(b) of the OECD Model Treaty where a shareholder, owning shares just below the threshold to receive the lower withholding tax rate under Article 10(2)(b) of the OECD Model Treaty, buys enough shares to reach the threshold:

“[A]lthough one of the principal purposes for the transaction through which the additional shares are acquired is clearly to obtain the benefit of Article 10(2) a), paragraph [29(9)] would not apply because it may be established that granting that benefit in these circumstances would be in accordance with the object and purpose of Article 10(2)a). That subparagraph uses an arbitrary threshold of 25 per cent for the purposes of determining which shareholders are entitled to the benefit of the lower rate of tax on dividends and it is consistent with this approach to grant the benefits of the subparagraph to a taxpayer who genuinely increases its participation in a company in order to satisfy this requirement.” (footnote 5)

The justification provided to conclude that granting the benefit of the reduced withholding rate in Article 10(2)(b) of the OECD Model Treaty would not be contrary to the object and purpose of Article 10 of the OECD Model Treaty appears to be that the 25% ownership threshold was met as long as the person “genuinely increases its participation in [the] company”. Although Example E outlines that the initial position was just below the threshold, there is no indication in the Commentary whether that element was viewed as being a relevant factor supporting the conclusion.

In the circumstances outlined in the question, the 5% rate of withholding applies provided that granting a benefit in the circumstances would be in accordance with the object and purpose of Article 10. Example E explains that in cases such as this, a relevant factor is whether the taxpayer “genuinely increases its participation in the company”. The benefit might not be granted if there is a manipulation of share ownership such as when the acquisition of additional shares is transitory or there are other facts and circumstances indicating that granting that benefit would not be in accordance with the object and purpose of the relevant provisions of the UK-Canada Treaty. An example could be where UK Co owned 8% of the shares of Canco, acquired an additional 2% of the shares of Canco prior to the dividend distribution, and sold the 2% ex-dividend, shortly thereafter.

Angelina Argento
2024-100765
May 15, 2024
Prepared in collaboration with the Treaty Abuse Prevention Committee

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Paragraph 7 of Article 10 of the UK-Canada Treaty as it read prior to the amendment introduced by Article IV, s. 4 of the 2003 Protocol.

2 See www.oecd.org/tax/treaties/explanatory-statement-multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-BEPS.pdf

3 www.oecd-ilibrary.org/taxation/preventing-the-granting-of-treaty-benefits-in-inappropriate-circumstances-action-6-2015-final-report_9789264241695-en. In particular, refer to pages 54-64 and especially paragraph 14 of the commentary.

4 This same example is in the BEPS Action 6 Report: see Example E, paragraph 14 on page 61 of the BEPS Action 6 Report.

5 At pages C(29)-92 to C(29)-93 of the Commentary on Article 29, available at: www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-2017-full-version_8cc997e9-en.