17 May 2023 IFA Roundtable Q. 7, 2023-0964521C6 - Application of Article 10, Canada-Hong Kong

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: Will Article 10(7) block access to treaty benefits in the circumstances described? Will the MLI's coming into effect with respect to the Canada-Hong Kong Agreement alter the results?

Position: 1. Article 10(7) will generally not apply in this situation. 2. Under Article 7(1) of the MLI, the same conclusion applies.

Reasons: see analysis below

2023 International Fiscal Association Conference
CRA Roundtable

Question 7– Article 10(7) Hong Kong- Canada Income Tax Agreement and Article 7(1) of the MLI

The Hong Kong-Canada Income Tax Agreement (Agreement) was signed on November 11, 2012 and is applicable in respect of withholding taxes from January 1, 2013.

Under Article 10 paragraph 2 (Article 10(2)) of the Agreement, where a dividend is paid by a Canadian resident company to a Hong Kong tax resident, the Canadian withholding tax will be reduced to either:

(a) 5% of the gross amount of the dividends if the beneficial owner is a company (other than a partnership) that controls directly or indirectly at least 10% of the voting power in the company paying the dividends (Article 10(2)(a)); and

(b) 15% of the gross amount of the dividends, in all other cases (Article 10(2)(b)).

Paragraph 7 of Article 10 (Article 10(7)) of the Agreement contains a main purpose test which states as follows:

“A resident of a Party shall not be entitled to any benefits provided under this Article in respect of a dividend if one of the main purposes of any person concerned with an assignment or transfer of the dividend, or with the creation, assignment, acquisition or transfer of the shares or other rights in respect of which the dividend is paid, or with the establishment acquisition or maintenance of the person that is the beneficial owner of the dividend, is for that resident to obtain the benefits of this Article.” (Emphasis Added).

Consider the following example:

Mr. A and his spouse (Taxpayers) have been residents of Hong Kong since prior to 2013 and have been resident there since. The Taxpayers are equal shareholders of a Canadian resident corporation (Canco). The Taxpayers plan to incorporate a new Hong Kong company (HKCo) and will each transfer their shares of Canco to HKCo. HKCo will own 100% of Canco after the transfer.

Questions:

(1) Will dividends paid by Canco to HKCo be eligible for the 5% reduced treaty rate in Article 10(2)(a)?

(2) Will the anti-avoidance rule under Article 10(7) of the Agreement apply to deny the benefit of Article 10(2)?

(3) If yes, will the withholding tax rate be 15% as available prior to the transactions or 25% as provided without the benefit of a tax treaty?

(4) Will the Multilateral Instrument (MLI) have any implications to the withholding tax rate applicable under the Agreement?

CRA Response

For dividends paid after January 1, 2024, Article 7(1) of the MLI identifies the circumstances in which a benefit under Article 10 of the Agreement may be denied.

“Article 7 MLI—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.” (Emphasis Added)

Generally, Article 10 of the Agreement provides, among other things, for a reduced rate of withholding tax in respect of dividends paid from a corporation resident in one of the agreeing jurisdictions to a resident of the other. Article 10(2) provides two different rates of withholding, the lower of which is available only to Hong Kong resident corporations which hold at least 10% of the voting power of the Canadian resident corporation paying a dividend (as defined at paragraph 3 of Article 10).

In the situation described in the question, dividends paid by Canco to HKCo would be subject to a 5% withholding rate according to Article 10(2)(a) of the Agreement. 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.

Based on the MLI notifications of the parties to the Agreement, Article 10(7) of the Agreement is applicable only to dividends paid before January 1, 2024. Although not specifically mentioned in the question, it is assumed that the main purposes of any person concerned with the acquisition or transfer of the shares of Canco by the Taxpayers did not include obtaining the benefits of Article 10 of the Agreement and that HKCo had the same purposes when acquiring the Canco shares . In the situation described in the question and in the absence of a main purpose by HKCo to gain access to Article 10 of the Treaty, Article 10(7) will generally not apply to deny the benefits of Article 10(2)(a) of the Agreement on such dividends paid by Canco to HKCo before January 1, 2024. If Article 10(7) of the Agreement had applied, the applicable withholding tax rate would have been 25%. The answer could be different depending on the facts and circumstances of a particular situation. The existence of a main purpose to obtain the benefits of Article 10 of the Treaty can only be answered in consideration of the specific situation.

Charles Taylor and Angelina Argento
2023-096452
May 17, 2023