Taxpayers and their advisors should be aware of a significant new development concerning the appropriate withholding tax rate on the payment of cross-border interest, royalties and dividends.
On October 19, 2012, the Organisation for Economic Cooperation and Development (the “OECD”) released a revised discussion draft concerning the meaning of “beneficial owner” for the purposes of Articles 10, 11 and 12 of the OECD’s model tax convention (the “OECD Model”). The discussion draft builds on the OECD’s prior discussion draft (released on April 29, 2011), which received widespread international criticism for its ambiguity and lack of meaningful guidance on this fundamental issue of international taxation.
Canada’s Income Tax Act (the “Act”) requires that a Canadian company withhold 25 percent of dividends, interest and royalties paid to non-residents and remit this amount to the Canada Revenue Agency (the “CRA”) on behalf of the non-resident. However, Canada has entered into numerous bilateral tax treaties with various countries that reduce or eliminate the withholding tax. To benefit from these reductions or eliminations of Canadian withholding tax, the treaties generally require (among other things) that the recipient qualify as the “beneficial owner” of the amount paid.
Canada’s tax treaties are generally based on the OECD Model, which, together with its commentaries, generally provide that a resident of a contracting state will be the beneficial owner of an amount received from a resident of the other contracting state so long as the recipient was not acting in its capacity as an agent, nominee, fiduciary or administrator on behalf of a person not resident in that state.
However, there is surprisingly little additional insight into the intended meaning or possible interpretations of this term. There is a growing body of Canadian and international jurisprudence on the issue, with the Canadian case of Prevost Car, Inc. v. The Queen (2009 D.T.C. 5053 (F.C.A.), aff’g 2008 D.T.C. 3080 (T.C.C.)) currently serving as the high-water mark. Nevertheless, inconsistencies remain in the manner in which different states interpret and apply “beneficial owner” (see also the earlier article by FMC’s Matt Peters on Velcro v. The Queen (2012 TCC 57)) .
Instead of clarifying the issue, the OECD’s prior discussion draft was roundly criticised for adding further uncertainty to the meaning of “beneficial owner”. In the prior draft, the OECD emphasized the desire to introduce a meaning that could be universally accepted and applied by all countries. In this respect, the prior draft focused on assessing the recipient’s ability to have the “full right to use and enjoy” dividend, interest or royalty income and stated that a recipient will not be the beneficial owner if its powers are constrained by a contractual or legal obligation to pass the payment received to another person. Many commentators suggested that this approach was too broad and ambiguous and left taxpayers with little certainty when structuring their affairs. Moreover, the exact role of a country’s domestic law meaning of “beneficial owner” was left somewhat open.
The new draft attempts to clarify the issue by (i) more strongly abandoning the relevancy of any particular state’s domestic law meaning of “beneficial owner”; and (ii) providing further guidance as to what is meant by the right to use and enjoy an amount unconstrained by contractual or legal obligations. The revised draft reviews in some detail the comments received by the OECD on it’s prior draft and explains in more detail (and through examples) the rationale behind its approach.
This is a controversial issue and the approach adopted by the OECD in its revised discussion draft will undoubtedly stir debate in the international tax arena. The OECD has indicated that it will be accepting comments on the revised draft before 15 December, 2012, suggesting that another revised draft will likely be released in 2013. Tax practitioners and their clients will need to carefully consider the approach that contained in the OECD’s revised draft and assess whether it presents any risks in their particular circumstances.
* Special thanks to Christian Orton, Articling Student, for his valuable contributions to this article.