Treaty Shopping Update


Treaty shopping has received a great deal of attention in Canada in recent years. Significant interest was initially generated by the federal government’s announcement in 2013 that it intended to adopt specific measures designed to curb the practice. Around the same time, the Organisation for Economic Co-operation and Development (OECD) released its Action Plan on Base Erosion and Profit Shifting (BEPS), which indicated that working groups would be tasked with formulating recommendations regarding certain issues or “actions,” including the prevention of treaty abuse (Action 6). Both the government’s and the OECD’s initiatives have undergone important developments over the past two and a half years. This article provides an overview of those developments and the current status of each initiative.

Canadian Government Initiative

As part of the 2013 Federal Budget, the Department of Finance (Finance) announced that it would be consulting with the Canadian tax community regarding possible measures that would “protect the integrity of Canada’s tax treaties while preserving a business tax environment that is conducive to foreign investment.” Later that year, it produced a consultation paper outlining several options in this regard, including both domestic and treaty-based measures designed to curb abusive treaty shopping (2013 Consultation Paper).[1] The 2013 Consultation Paper contained several arguments supporting the view that it would be legal under international law for Canada to adopt a domestic anti-treaty-shopping measure. Several of these arguments were drawn from the OECD’s commentary on its model tax treaty (the OECD Commentary).[2] The tax community was invited to comment on both the domestic and the treaty-based approaches discussed in the 2013 Consultation Paper; it was understood that the government would ultimately adopt one of the two options.

As part of the 2014 Federal Budget, and despite significant objections by taxpayer groups, Finance announced that it had decided to adopt a domestic rule, rather than a treaty-based approach. In summary, the rule would have denied treaty benefits to a person who, it was reasonable to conclude, had the intention of obtaining such benefits as one of the main purposes for undertaking a transaction or series of transactions.[3] The proposed rule also contained rebuttable presumptions in favour and against the application of the main purpose test and a relieving provision designed to permit the application of treaty benefits to the extent “reasonable having regard to all the circumstances.”

Shortly after the release of the 2014 Federal Budget, the Action 6 working group released its first draft report (March 2014 Draft).[4] The document adopted a different approach from that of Finance, focusing essentially on treaty-based measures for countering treaty abuse. It contained comments regarding the portions of the OECD Commentary relied upon by Finance in concluding that the adoption of a domestic treaty-shopping measure would not conflict with Canada’s international law obligations. It also suggested that future drafts would include further discussion on the issue. It was perhaps unsurprising, therefore, that on August 29, 2014, Finance announced that the government would “await further work by the Organisation for Economic Co-operation and Development and the Group of 20 (G-20) in relation to their Base Erosion and Profit Shifting initiative” before implementing the proposal set out in the 2014 Federal Budget.

The government has not made any significant comments regarding its treaty-shopping initiative since that time. That said, in the 2015 Federal Budget, Finance characterized its approach to the BEPS initiative as attempting to proceed “in a manner that balances tax integrity and fairness with the competitiveness of Canada’s tax system,” adding:

Improving business tax fairness and [competitiveness] has been a central element of the Government’s approach to fostering an environment in which businesses can thrive and compete in a global economy. Taxes are one of the main factors that drive investment decisions and the Government is committed to maintaining Canada’s advantage as an attractive destination for business investment.

This represents the first indication by Finance that it may not agree with or adopt all of the recommendations of the BEPS initiative, including, potentially, some relating to the practice of treaty shopping.

OECD BEPS Initiative

As mentioned above, the Action 6 working group’s initial recommendations were set out in the March 2014 Draft. In summary, the document contained three main proposals: (1) that the title and preamble of tax treaties should be amended to clarify that the contracting states wish to prevent tax avoidances and, more particularly, treaty shopping; (2) that a specific anti-avoidance rule be included in treaties based on the limitation on benefits (LOB) provision currently featured in most U.S. treaties; and (3) that in addition to the LOB provisions described in (2), treaties contain a general anti-avoidance rule that would deny benefits when it is reasonable to conclude that “one of the main purposes of arrangements or transactions is to secure a benefit under a tax treaty and obtaining that benefit in the circumstances would be contrary to the object and purpose of the relevant provisions of the tax treaty” (the “principal purpose test” or PPT). The March 2014 Draft included proposed language and treaty provisions implementing the above recommendations.

In September 2014, a revised report was published by the Action 6 Working Group (September 2014 Draft).[5] The most significant change introduced by the document was arguably the statement that it was no longer considered necessary for states to adopt both a LOB provision and PPT. Although this “combined approach” was clearly judged ideal by the working group, it indicated that states should be given a degree of flexibility in the matter, and would be expected only to adhere to a “minimum standard” consisting of (1) making the changes suggested by the March 2014 Draft to the title and preamble of treaties, and (2) adopting either (a) a PPT or (b) a LOB provision, together with a new rule aimed at “conduit arrangements.” The new anti-conduit rule would apply when a resident of a treaty country received an amount in respect of which treaty benefits were claimed, if “all or substantially all” of the amount was paid “directly or indirectly” to a person who was not a resident of a contracting state, and one of the principal purposes of the transaction or series of transactions that resulted in the availability of treaty benefits was to obtain such benefits. Other important items included with the September 2014 Draft were draft text to be inserted in the OECD Commentary on the LOB provision and PPT, the addition of important features to the LOB provision, such as a derivative benefits clause, and a series of new treaty-based specific anti-avoidance rules.

In November 2014, the Action 6 working group released a document containing a list of 20 issues associated with the September 2014 Draft that remained to be addressed, and it invited comments from members of the tax community.[6] A response to these comments and discussion of the 20 issues was provided in a report released by the group in May 2015 (May 2015 Draft).[7] The May 2015 Draft is considerably shorter than the September 2015 Draft. The most significant change introduced by the document relates to the LOB provision. Rather than providing a model LOB provision, the document proposes that the OECD model treaty contain only a “skeleton.” It then suggests that the OECD Commentary provide alternative formulations that states may adopt according to their particular circumstances. The text of a “simplified” LOB is provided in the May 2015 Draft, for example, as an option for countries that have adopted a PPT and will consequently not need to rely as much on an LOB. Other smaller changes have also been proposed, including, most notably, the possibility of having states establish special committees (analogous to the Canadian GAAR committee) charged with approving the application of the PPT prior to the issuance of any assessment. Finally, the May 2015 Draft also introduces changes to the anti-conduit rule previously described in the September 2014 Draft. Rather than providing proposed text for the rule, it suggested that states be left to craft the rule as they see fit. To guide them, however, the May 2015 Draft contains a series of examples of situations that should or should not be caught by the anti-conduit provision that the Action 6 working group proposed to include in the OECD Commentary (most concerned “back-to-back” payments involving third-party intermediaries of the type covered by subsection 18(6.1) and 212(3.1)-(3.3) of the Income Tax Act (Canada)).


Finance’s decision to wait for the work of the OECD to be completed before adopting any definitive strategy regarding treaty shopping is to be welcomed. The result of that decision, however, is that it is even more important for tax practitioners to be aware of the status of the Action 6 working group’s draft recommendations. Indeed, tax practitioners may be advising clients on the establishment of structures that will be subject to the rules adopted in accordance with such recommendations. Hopes for a lengthy implementation process may be misplaced because negotiations are underway on the adoption of a multilateral instrument designed to permit the recommendations stemming from the BEPS initiative to be implemented in as many treaties as possible, as quickly as possible (this process is the subject of its own BEPS action item – Action 15). It remains to be seen whether Canada and the countries typically implicated in treaty-shopping strategies will sign any such instrument.

[1] Department of Finance Canada, "Consultation Paper on Treaty Shopping – The Problem and Possible Solutions."

[2] Organisation for Economic Co-operation and Development, Articles of the OECD Model Tax Convention on Income and Capital (Paris: OECD, July 2010).

[3] See Stephanie Morand, "Treaty Shopping Proposals – A Review of 2013 and 2014 Developments" (May 8, 2014), McCarthy Tétrault International Tax Newsletter (Taxnet Pro Corporate Tax Centre), for a detailed review of the measure proposed by Finance.

[4] Public Discussion Draft, BEPS Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, 14 March 2014–9 April 2014.

[5] Preventing the Granting of Treaty Benefits in Inappropriate Circumstances: Action 6: 2014 Deliverable (Paris: OECD, 2014).

[6] Public Discussion Draft, Follow Up Work on BEPS Action 6: Preventing Treaty Abuse, 21 November 2014–9 January 2015.

[7] Revised Discussion Draft, BEPS Action 6: Prevent Treaty Abuse, 22 May 2015–17 June 2015.