Canada now has more power to make sure companies pay their taxes

As part of an international effort to curb tax avoidance done through base erosion and profit shifting, Canada’s Multilateral Instrument came into force Dec. 1.

In 2017, Canada signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, also known as the Multilateral Instrument. Bill C-82, which ratified the agreement earned Royal Assent June 21, 2019. The MLI will begin impacting Canada’s tax treaties with other countries Jan. 1, 2020.

The MLI is to ensure that corporate profits are taxed in the jurisdiction where the “substantive economic activities” which brought them about took place and is necessary in response to the “aggressive international tax planning” that is denying revenue to governments around the world, said the MLI.

Canada has tax treaties in force with 93 other countries and the MLI revises those which are between Canada and a country that has also signed on to the MLI. The MLI adds a preamble to those agreements, which overrides certain provisions and may change the way the treaty is interpreted, says Dentons tax group partner Larry Nevsky.

Nevsky says one of the most significant changes to how Canada’s tax treaties will be interpreted due to the MLI, comes from the principal purpose test. This prevents tax-payers from enjoying a tax benefit through a tax treaty, if getting the benefit was “one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit,” states Article 7(1) of the MLI.

“So what it's trying to do is avoid treaty shopping by tax payers,” says Nevsky, whose practice involves transactional matters and international taxation. “If you're using the treaty to get the benefits under the treaty, but you don't have substance in the country, then the treaty benefits will be denied.”

The Multilateral Instrument originates in an effort by the Organisation for Economic Co-operation and Development to prevent multinational companies from minimizing their tax burden by “exploiting gaps and mismatches” between countries’ tax systems, states the OECD. Between approximately $133 billion and $319 billion is lost in tax revenue every year through these practices, accounting for from 4 to 10 per cent of global corporate income tax revenue, the OECD states. More than 90 countries have signed a Multilateral Instrument.

“The OECD countries have realized that with the mobility of corporations in modern times, there is a tendency to try and minimize taxes by moving to more favourable jurisdictions,” says Nevsky.

The MLI makes compliance “a little bit” more difficult, says Nevsky. As an added complexity, because the MLI applies to dozens of existing treaties with foreign governments, the MLI is going to be interpreted differently by different governments, he says.

“It will be interesting to see how the different countries navigate this going forward because it’s a new area where there's very little context so far,” he says.