The death of treaty shopping?

TORONTO – In the words of Angel Gurría, secretary-general of the Organisation for Economic Co-operation and Development (OECD), members of the OECD made “tax treaty history” this week in Paris, at the signing of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS MLI). 

Canadian Accountant reached out to David J. Rotfleisch of Toronto-based law firm Rotfleisch & Samulovitch for his view on the historic deal. 

Give us the big picture on treaty shopping.

Historically a large part of international tax planning, and a significant reason for establishing an offshore structure, was to take advantage of differences in national tax rates, frequently involving a multi-jurisdictional structure designed to take advantage of rate differences in bilateral tax treaties. This standard tax planning technique, called treaty shopping, was routinely carried out by tax lawyers and tax accountants doing cross border tax planning. 

While lucrative for the tax planning industry and beneficial for clients, for obvious reasons these techniques upset tax authorities in all jurisdictions.  

Treaty shopping often involved the flow-through of income through conduit or base companies in low-taxed treaty jurisdictions. Income was often not really earned in the low-rate jurisdiction but was taxed there. Another treaty shopping technique involved the use of hybrid entities that are characterized differently in two countries, again benefiting from a favourable tax rate. 

How will the new BEPS MLI affect Canada?

The new treaty is referred to as a multilateral instrument, or MLI, and in effect modifies bilateral treaties to which it applies. The effect in Canada, once implemented, will drastically alter cross-border tax arrangements and may well curtail treaty shopping. It is expected that [ultimately] some 100 countries will sign the treaty. However, each country can specify which bilateral treaties are subject to the MLI and the extent to which the required minimum rules will apply.

So, in the case of Canada, 75 of our 93 tax treaties are covered. This means that in theory treaty shopping could still be effective for the 18 treaties that are excluded. 

Much will depend on the will of governments to address treaty shopping and tax avoidance in general. What’s your prediction?

Recent years have seen the demise of bank secrecy. The Panama Papers leak and the prior so-called Offshore Leaks and the HSBC leaks showed that bank secrecy is now a mirage. But it also had the effect of bringing the murky world of offshore accounts to the attention of the public and of politicians, many of whom were implicated in Panama Papers.

While the OECD initiative predates the Panama Papers, it is reasonable to say that there has been an international focus on offshore abuse for some years now, and treaty shopping, while perfectly legal, doesn't really pass the smell test.

So while there may be gaps in the MLI, I am comfortable in predicting the imminent death of treaty shopping.

Colin Ellis is the editor-in-chief of Canadian Accountant.