OECD Releases Report on Improving Procedures for Tax Relief for Cross-Border Investors


On February 8, 2010, the Organisation for Economic Co-Operation and Development (OECD) released a public discussion draft of a report entitled "Possible Improvements to Procedures for Tax Relief for Cross-Border Investors: Implementation Package." The Report, prepared by the Pilot Group on Improving Procedures for Cross-Border Investors, provides draft documentation (Implementation Package) for implementing a streamlined procedure pursuant to which portfolio investors, including collective investment vehicles (CIVs, or in Canadian terminology, mutual funds), may claim reductions in withholding rates pursuant to tax treaties or the domestic law in the source country. The Pilot Group included representatives from the tax administrations of a number of OECD member states, including Canada, as well as representatives from the financial services industries representing, among others, managers and distributors of CIVs and global custodians. For the purposes of the Report, a CIV is a fund that is widely held, invests in a diversified portfolio of securities, and is subject to investor-protection regulation in the country in which it is established. The term includes "fund of funds" that achieve diversification by investing in other CIVs; it does not include private equity funds, hedge funds or REITs.

By way of background, in 2008, the OECD established an Informal Consultative Group on the Taxation of Collective Investment Vehicles and Procedures for Tax-Relief for Cross-Border Investors (ICG). The ICG prepared two reports released in early 2009, one relating to accessing treaty benefits by CIVs and the second relating to claims for treaty benefits more generally in intermediated structures.

A modified version of the first report of the ICG, which proposed changes to the commentary to the OECD Model Tax Convention, the basis on which approximately 3,000 bilateral tax treaties have been negotiated worldwide, was released by the OECD for public comment in December 2009 and was the subject of an article in McCarthy Tétrault’s Tax Update (Volume 2, Issue 1). It envisaged additional documentation relating to claims for treaty relief by CIVs, including Model Mutual Agreements (MOUs) to be entered into by Contracting States to address the entitlement of CIVs established in each Contracting State to claim treaty benefits and, where appropriate, to determine the basis on which proportionate benefits would be granted to CIVs not entitled to treaty relief in their own right. The Model MOUs are included in the Implementation Package.

The second report of the ICG envisaged a system for claiming treaty benefits that allows certain intermediaries — those that have entered into agreements with a source country — to make claims for treaty benefits on behalf of portfolio investors on a pooled basis in respect of income arising in the source country. Under these arrangements, an intermediary that "participates" in the system (an authorized intermediary) and deals directly with an investor would, if it obtains appropriate documentation and performs appropriate due diligence, be able to make a claim for treaty benefits (or reduced withholding pursuant to the source country’s domestic law) on behalf of the investor, including by passing certain information to the next intermediary in the chain, without identifying the investor. Intermediaries participating in the system would report investor-specific information to the source country. It was envisaged that source countries could provide information to the investor’s country of residence pursuant to exchange of information arrangements.

The proposed arrangements have some similarities to the current US "qualified intermediary regime" (QI), including the concept of financial intermediaries entering into contractual or other arrangements with the tax administration of a source country. There are important differences, including reporting to the source country of payments to non-residents rather than, in the case of a QI, reporting of US-source payments made to US accountholders. There are also important differences with the US regime contemplated by the Foreign Account Tax Compliance provisions (FATCA) under which foreign financial intermediaries that enter into an agreement with the IRS will be required to report to the IRS with respect to payments to US accountholders.

The Report is over 100 pages in length and includes the form of application by a financial intermediary to become an authorized intermediary, the form of agreement between the financial intermediary and the tax administration, forms to be used under the agreement, procedures for independent reviews and procedures for authorized intermediaries that accept primary withholding responsibilities. As noted, it also includes Model MOUs in relation to treaty entitlement of CIVs.

In a note such as this, it is not possible to comment on all aspects of the Implementation Package and only a number of highlights will be identified.

The Implementation Package requires close study by financial intermediaries because, even though the views and best practices reflected in the Implementation Package are not the views of OECD member states, they are clearly indicative of the direction that tax administrations are heading as a result of the recent financial crisis.

Moreover, the Implementation Package reflects certain compromises that business may not be willing to support. For example, as noted below, the issue of liability where an intermediary has followed all necessary steps but has nonetheless under-withheld tax on a payment to a non-resident may need to be considered.

There is a lengthy comment period in relation to the Report, ending August 31, 2010. In addition, if there is sufficient interest, the McCarthy Tétrault Tax Group will put on a presentation to outline the Implementation Package in more detail to interested persons. Please indicate your interest in such a presentation by e-mail to [email protected].

Authorized Intermediary Regime

Authorized Intermediary

The Implementation Package contemplates that an "intermediary," being a person acting on behalf of others, such as a custodian, broker, nominee or other agent, will apply to the Competent Authority of a source country to become an "authorized intermediary" in relation to payments of dividends and interest arising in the source country. If the Competent Authority approves, it will enter into an agreement with that intermediary (AI Agreement) under which the intermediary becomes an authorized intermediary, is assigned an identification number, and agrees to follow certain procedures set out as an appendix to the agreement (Procedures). It is expected that the Procedures will be identical under all AI Agreements entered into by all source countries — modifications to the procedures will be made in the agreement itself.

The AI agreement will define "eligible countries," which are those countries in respect of whose residents the source country is prepared to have the reduced withholding procedures apply. They will be countries that the source country considers to have effective exchange of information relationships with the source country, adequate know-your-customer rules, and membership in a multi-lateral organization or grouping of countries that adopt common standardized approaches to issues of tax compliance including mutual assistance (such as the EU and OECD). Know-your-customer rules (KYC Rules) are defined to mean customer and due diligence requirements relating to the opening and maintenance of accounts with financial services firms that are based on the relevant principles established by the Financial Action Task Force, including in particular Recommendations 4-11 of the 40 Recommendations relating to measures to prevent money laundering and terrorist financing and the 9 Special Recommendations relating to terrorist financing as they relate to financial institutions found at http://www.fatf-gafi.org.

Investor Self-Declaration

The AI Agreement and the Procedures contemplate that an AI will obtain an investor Self-Declaration from each direct accountholder as part of the account-opening procedure. A direct accountholder is any person, including another intermediary, who has an account directly with the AI and in respect of which the AI is acting in its capacity as an authorized intermediary. The concept of designating accounts allows the AI to elect that only certain accounts are in the system. The Self-Declaration, in a specified form, will contain mandated information. For example, for an individual, the required information includes the individual’s name, address, taxpayer ID in his or her country of residence (if the country of residence issues taxpayer ID numbers); a certification that the individual is resident in the country of residence, is not acting as an agent, nominee or conduit with respect to income of the designated account, and is the beneficial owner thereof. The Self-Declaration includes a specific authorization to the AI to provide a copy of the form and additional information to any relevant tax authority and an acknowledgement that information relating to income paid or credited to the investor will be reported to the tax authority of the source state that may provide the information to the tax authority of the state in which the individual is resident. These express consents to disclosure should prevent assertions that disclosure is in breach of applicable privacy rules. The form also includes an undertaking to make the AI whole for any under-withholding and to update the Self-Declaration within 30 days of a change in circumstances. The Self-Declaration for entities is similar but requires classification of the entity into certain categories, including government, pension fund, charity, international organization and partnership.

The Procedures contemplate that the AI will review the Self-Declaration and other information in its possession, including information obtained as part of the account-opening process and application of KYC Rules, in order to determine if the Self-Declaration is unreliable or incorrect. An AI may not make claims on the basis of a Self-Declaration that the "AI knows, or should have known, that the information or statements contained … [therein] are unreliable or incorrect." The Procedures provide a non-exhaustive list of circumstances in which the AI is considered to have reason to know that a Self-Declaration is unreliable or incorrect, such as where the AI has other information that is inconsistent with the investor’s claim. A Self-Declaration is to expire on December 31 of the fifth year following the year in which it is signed. An AI must institute procedures to ensure that changes in an investor’s account information (e.g., change of address) that could affect the validity of the investor’s Self-Declaration, trigger a review and an updating if required.

The AI Agreement contemplates that an AI will provide Tax Rate Information to a Payor. A Payor is a person that makes a covered payment, generally any payment of interest or dividends arising in the source country received by the AI with respect to an account that has been designated by the AI as one for which it is acting as an AI. Tax Rate Information is pooled information provided by the AI with respect to the withholding rate to be applied to a payment. For example, if the AI has valid Self-Declarations from investors entitled to 40 per cent of a dividend payment at a 10 per cent withholding rate, the AI would advise the Payor to withhold at a 10 per cent rate from 40 per cent of the payment. The AI would not be required to provide copies of the investor Self-Declarations to the Payor nor the identity of the investors.

Where an AI is itself an accountholder with another upper-tier AI, the lower-tier AI is entitled to pass pooled information to the upper-tier AI that can combine this information with that relating to its own direct accountholders from which it has received Self-Declarations. The lower-tier AI must provide an appropriate declaration to the upper-tier AI.

The Self-Declaration procedures can be contrasted with current and proposed Canadian procedures. Information Circular 76-12R6, published by the Canada Revenue Agency (CRA), sets out procedures to be followed by persons paying or crediting amounts subject to Canadian withholding tax under Part XIII of the Income Tax Act (Canada) (ITA) to residents in countries with which Canada has a tax treaty. Under these procedures, it is not necessary to obtain a certificate or declaration from the payee in all cases. In particular, the payor can accept the name and address of the payee as being that of the beneficial owner unless there is reasonable cause to question whether the payee is the beneficial owner. A non-exhaustive list of circumstances in which there is reasonable cause to question whether the payee is the beneficial owner includes:

  1. the payee is known to act, even occasionally, as an agent or nominee (other than agents or nominees residing in Switzerland, which are subject to special arrangements);
  2. the payee is reported as "in care of" another person, or "in trust"; and
  3. the mailing address provided for payment of interest or dividends is different from the registered address of the "owner."

In doubtful cases, a certificate must be obtained from the payee. A sample certificate is provided by way of example. Where the payee is the beneficial owner, the recipient is required to certify that the payee is a resident of the relevant country, taxable in that country if required by the relevant treaty and the beneficial owner of the income from the property registered in the payee’s name. The payee also undertakes to advise the payor of any change in the payee’s country of residence.

In the case of an agent or nominee that provides financial intermediary service as part of its business, the agent must certify that the income from the property is, and will continue to be, held solely for the beneficial ownership of persons resident of — and, if required by the relevant tax treaty, taxable in — countries with which Canada has a tax treaty that provides for a specified Canadian withholding tax rate. The nominee also undertakes to replace the certificate should there be a change in the country of residence or holdings affecting the withholding requirements for a subsequent payment and to provide to the CRA, on request, such information as may be necessary to substantiate the accuracy of the information in the certificate. The agent or nominee will provide the certificate based on a review of names and addresses of its accountholders and, where it determines to question whether its accountholder is a beneficial owner, a certificate.

The Information Circular expressly contemplates providing pooled information to the payor of dividends and interest.

In early 2009, the CRA released for public comment draft certificates of residence for withholding tax purposes. The draft certificates were far more detailed but, again, use of the forms is not to be mandatory. Revised forms of certificate have not yet been released.

Contractual Intermediaries

The Procedures contemplate a second category of intermediaries that do not enter into AI Agreements with a source country. Such intermediaries are referred to as "contractual intermediaries." In order to be a contractual intermediary, the AI with which the intermediary deals must have received a valid intermediary declaration certifying that the intermediary is subject to KYC Rules, authorizing disclosure of the declaration to the relevant tax authorities and agreeing to procedures for the recovery of under-withheld tax. Contractual intermediaries will collect Self-Declarations from their own accountholders. However, a contractual intermediary cannot pass pooled information up the chain to an upper-tier intermediary. If the upper-tier intermediary is an AI, it can pool information provided by the contractual intermediary with other information if the contractual intermediary provides copies of the Self-Declarations for its accountholders in respect of which it seeks reduced withholding. The accountholder of the contractual intermediary will be treated as an "indirect account holder" of the AI. The AI is considered to know that relevant information or statements contained in documentation are unreliable or incorrect if a reasonably prudent person in the position of the AI would question the claims made. Unless the accountholder with the contractual intermediary is an accountholder with the AI, the AI will not have other information its possession and presumably will be required to make sure that the copy of the Self-Declaration provided to it is regular on its face.

Excluded Intermediaries

A third category of intermediary is the "excluded intermediary." No entity in the chain can rely on information originating with an excluded intermediary. An "excluded intermediary" is an intermediary that the Competent Authority of the source country determines, in its discretion, is likely to provide information that is by definition unreliable. The Procedures state that the determination should be based on objective evidence that information provided by the intermediary has repeatedly been unreliable or incorrect and has resulted in material under-withholding of tax that has not been promptly corrected. The source country may look at the intermediary’s conduct with respect to AI agreements that the intermediary has with other countries. In the case of a contractual intermediary, there should be objective evidence of failure to fulfill significant procedural obligations. Finally, if an AI Agreement is terminated for cause by the Competent Authority, the intermediary will normally be treated as an excluded intermediary for five years. The Competent Authority will "make available" to any person the name and address of any intermediaries designated as excluded intermediaries and may, if it chooses, publish that information. Note that in the AI Agreement, the intermediary agrees that the Competent Authority may disclose its status as an AI and, if applicable, its status as an excluded intermediary, or make such information publicly available.

Reporting to Source Country

An AI will be required to provide to the Competent Authority of the source country detailed information regarding payments paid, directly or through one or more contractual intermediaries, to its accountholders (direct and indirect) that are investors and other AIs during the calendar year. The report is due by April 30 of the following year. The report will include: the name, address and identification number of the AI; the name, address and taxpayer ID number of the accountholder (or other combination of information used by a Competent Authority to identify its residents) and country of residence; and information regarding the reportable payment, the date it was paid or credited to the accountholder, details of the securities in respect of which the payment was made and the amount of tax withheld. In the case of a payment to another AI, the same information is required except that the taxpayer ID number is to be the AI’s AI identification number.

Information provided to the Competent Authority of the source country can be provided to the Competent Authority of the accountholder’s country of residence on request or pursuant to automatic information exchange depending on the information exchange relationships in place.

Readers will note that it is conceivable that the proposed system could evolve to require reporting by an AI to the Competent Authorities of countries in which accountholders are resident.

Adjustments for Over- and Under-Withholding

The Procedures provide for adjustments to be made if an AI discovers that Tax Rate Information that has been provided to a payor, or withholding by the payor, was incorrect.

Independent Review and Compliance

The Procedures contemplate that an Independent Reviewer will be appointed although the Competent Authority retains the right to review directly the AI’s compliance with the Procedures and the AI Agreement. The initial Independent Reviewer will be named in the AI Agreement. The Competent Authority may require the delivery of an Independent Reviewer’s Report that will review the AI’s processing of covered payments including the application of withholding tax in accordance with the AI Agreement, the documentation secured (or to be secured) pursuant to the Procedures, and reporting to source country. The review procedures are set out in an Annex to the Procedures. The AI is to have the Independent Reviewer prepare an Independent Reviewer’s Report for the first full calendar year that the AI has in effect an AI Agreement with any country pursuant to which it acts as an AI in accordance with the Procedures. Thereafter, an Independent Reviewer’s Report is to be prepared only upon request by a Competent Authority under an AI Agreement, which shall be no more than every third year unless a Competent Authority has good cause for requesting a more frequent review. The request for a review must be delivered by the Competent Authority not later than December 31 of the year that is to be reviewed. If a review identifies failures by the AI for the year under review, the Competent Authority may require previous years that have not been reviewed to be reviewed if the AI would be liable for any under-withholding (i.e., a limitation period has not expired). If an intermediary is an AI with one source country and enters into an AI Agreement with a second source country, the AI is to provide the Competent Authority of the second source country with a copy of its most recent Independent Reviewer’s Report prepared for the first (or other) source country. If the first year of the AI Agreement with the second source country is not a year for which another independent review would be performed, the Competent Authority of the second source country may require such a review but on a limited basis — in general, limited to reviewing two covered payments arising in the source country.

As noted, the Competent Authority retains the right to review directly the AI’s compliance with the Procedures and the AI Agreement. Such review may take the form of spot checks pursuant to which the Competent Authority would request information regarding a certain percentage or number of accountholders receiving a specific payment to determine if the amount of withholding and any information required to be reported was correct. The Competent Authority may also cross-check with the Competent Authority of another country that an accountholder that asserts that it is resident in the other country is in fact resident in that country. More expansive examinations are also permitted.

Liability of the AI for Under-Withholding

While the Procedures contemplate specific steps to be taken by an AI, the risk of under-withholding of tax in relation to an investor remains with the AI. However, if the relevant payment is through a chain of intermediaries that includes more than one AI, it is the AI closest to the investor that is liable for any under-withholding. In contrast, under the ITA, each entity in the chain of intermediaries would be liable for any under-withholding of tax. The CRA states in Information Circular IC 76-12R6 that it is the payor’s responsibility to withhold and remit Part XIII tax at the appropriate rate and the payor is liable to the Crown for any deficiency. Following the procedures set forth in the Information Circular therefore technically does not afford a "due diligence defence" if there is an under-withholding.


An AI Agreement is for an indefinite term subject to the termination provisions contemplated by the Procedures. Either party may terminate the agreement on notice. However, the Competent Authority may not give notice of termination for seven years unless there is a "significant change in circumstances" or there is an event of default and the resolution procedures in the Procedures have been followed. The seven-year term is intended to recognize the substantial investment in systems and other costs to be incurred by an AI to participate in the system.

The resolution procedures contemplate that the Competent Authority will deliver a notice specifying an event of default that has occurred and proposing a date within 45 days for a meeting with the AI and, if necessary, the Independent Reviewer. The purpose of the meeting is to clarify and resolve the issues leading to the default. If the Competent Authority and the AI cannot reach a satisfactory resolution, or agree to continue discussions, the Competent Authority may deliver a notice of termination. Given the business consequences of termination, the Competent Authority will have extraordinary leverage in these discussions.

If the Competent Authority is proposing to designate the AI as an excluded intermediary, the meeting must be held within 15 days of the notice.

If an AI Agreement is terminated for cause by the Competent Authority, the intermediary will normally be treated as an excluded intermediary for five years and cannot participate in the system.

If the Independent Reviewer’s report identifies a default and the steps that the AI has taken to cure the default, the Competent Authority may decide that the cure is adequate, or, if not, issue a notice of default.

Issues for Business to Consider in Relation to the Authorized Intermediary Regime

As noted, there is a lengthy comment period in relation to the Report, ending August 31, 2010. Issues that should be considered by business include the following:

  1. If an authorized intermediary complies with the Procedures but there is nonetheless an under-withholding of tax, should the AI be liable for the deficiency? In other words, should there be a due diligence defence? Arguments can be made for and against the strict liability contemplated by the Procedures. In the Canadian context, Canada operates a system that is not dissimilar to the proposed system and has a strict liability regime in the ITA.
  2. The AI Agreement contemplates that one or more affiliates of an applicant for authorized intermediary status can, together with the applicant, be treated as authorized intermediaries. It is important to note that, as drafted, a reference to "the AI" in the Procedures means "the applicant and its affiliates designated as authorized intermediaries in the AI Agreement of which the procedures form part." This has a number of consequences. For example, the determination of whether an AI knows or should have known that a Self-Declaration is unreliable or incorrect will be made taking into account all of the information that "the AI" has in its possession. Therefore, if a parent corporation and subsidiary are designated as authorized intermediaries in the AI Agreement, each is treated as if it has in its possession the information held by the other even if there are privacy or other legal constraints on sharing that information. Business may want to argue again that only information actually in the possession of the entity is relevant. The issue might be finessed by having the applicant and each affiliate file separate applications and enter into separate agreements with a Competent Authority, but the Competent Authority could readily frustrate this planning by insisting on one agreement. If the AI were to operate by way of separate branches, any particular branch would be treated as possessing the information of all other branches.
  3. The system contemplates that Self-Declarations will be obtained from all investors that want to claim treaty relief. Should there be a transitional period in respect of existing investors? Should the duration of a Self-Declaration be limited to five years following the year it is signed?
  4. Should there be an affirmative obligation on a Competent Authority to publish lists of Authorized Intermediaries and excluded intermediaries on websites?
  5. Should there be additional limits on the ability of a Competent Authority to request Independent Reviews?

Model Mutual Agreements

The Report includes four Model MOUs that could be used under existing or future income tax conventions to allow CIVs established in a Contracting State to claim benefits with respect to income arising in the other Contracting State. They contemplate the following scenarios:

  1. Bilateral-Residents. This model contemplates a CIV established in a Contracting State that derives income from the other Contracting State and that provides relief in relation to residents of the Contracting State in which the CIV is established.
  2. Bilateral-Equivalent Beneficiaries. This model contemplates a CIV established in a Contracting State that derives income from the other Contracting State and relief is provided in relation to residents of the Contracting State in which the CIV is established and to investors (equivalent beneficiaries) who are residents of other States that would be entitled to a rate of tax in respect of an item of income that, under the source country’s domestic law or a treaty that the source country has with the relevant investor’s country of residence if the income were not received through the CIV, is at least as low as the rate provided in the treaty between the two Contracting States.

The Model MOUs also consider two analogous multilateral scenarios.

Each Model MOU contemplates that the competent authorities will agree that a CIV established in a Contracting State that is of a particular legal form is:

  1. Entitled to claim treaty benefits without regard to ownership of its shares or units (units) as a resident of the Contracting State in which it is established and is to be treated as the beneficial owner of such income. This treatment is subject to three principal caveats: (i) if the CIV would not be treated as a resident of the Contracting State because of a "generally applicable limitation on benefits clause," no treaty benefits will be available; (ii) whether the lower rate of withholding tax on dividends where the recipient holds more than a stated percentage of the payor corporation’s shares applies is to be agreed between the Contracting States; and (iii) the CIV will not be treated as a beneficial owner if a resident of the Contracting State that received the income in the same circumstances would not be regarded as the beneficial owner.
  2. Entitled to claim treaty benefits on a proportionate basis, having regard to the residence of investors. This claim is subject to the second and third caveat in (a) above. It is also contemplated that a CIV with separate classes of units may claim benefits as if the class were a separate CIV. The Contracting States may also agree that if the proportion of units held by investors entitled to treaty benefits exceeds a threshold amount, the CIV will be entitled to claim full treaty benefits; or
  3. Entitled to claim benefits at the rate applicable to owners of units in lieu of the owners claiming such deductions.

An abbreviated form of Self-Declaration is to be used by holders of units. The CIV itself would provide a Self-Declaration to an Authorized Intermediary or contractual intermediary setting out its status.

The Model MOUs contemplate that Contracting States can agree that a CIV may make certain assumptions in determining the ownership of its units:

  1. The annual determination for a year can be made based on an average of the proportion of units held by eligible investors at the end of the four quarters ending before the end of the preceding year.
  2. If distribution agreements between the CIV and distributors limit the distribution of units of the CIV, or of a class of units, to particular countries, the CIV can assume that units distributed by those distributors are held by residents of those countries provided that the units are not "freely transferable." Similar assumptions can be made if units of a CIV (or class) may only be distributed to certain types of investor (such as pension funds).

Issues for Business to Consider in Relation to the Model MOUs

From a Canadian perspective, most widely held mutual funds (including those governed by National Instrument NI 81-102 of the Canadian securities regulators) should be treated as CIVs entitled to claim benefits as a resident of Canada under the relevant treaty.

It is not obvious that a CIV that is not treated as a resident of a Contracting State because of a generally applicable limitation of benefits provision should not be treated as entitled to benefits on a proportionate basis.