Over the past few years, the issue of “tax avoidance” has dominated agendas at both Canadian and international tax conferences. The issue has also received considerable news coverage as a result of the actions of certain large companies with complicated tax structures that were seen not to be paying their fair share of taxes. Many countries, including Canada, have been waiting to receive guidance on how to deal with this and other issues from the Organization for Economic Co-operation and Development (OECD), the premier supranational organization that helps governments implement international tax principles.
On September 16th, the OECD released a series of much-anticipated reports containing recommendations for ensuring the profits of corporations with entities or operations in more than one country are taxed appropriately. Charities and not-for-profit lawyers took note of these new reports since the recommendations also address the use of tax-exempt organizations as a means of avoiding tax.
What prompted the OECD to study this issue was the potential for companies to abuse international tax rules by setting up entities, including not-for-profit organizations, for the purpose of avoiding tax. By way of background, international tax rules generally consist of treaties entered into between the national governments of two countries. Canada’s tax treaties (of which there are 92 currently in force) typically provide that Canada will not tax certain types of income if that income is taxed by the other signatory to the treaty, and vice versa. This ensures that income is not taxed twice (i.e., by both Canada and the other country). The potential for the same income to be taxed in two separate jurisdictions is commonly referred to as “double taxation”. In the case of not-for-profit organizations, tax treaties contain rules that ensure Canadian not-for-profit organizations, for example, are not inappropriately subject to tax in other jurisdictions.
Generally speaking, in order to qualify for treaty benefits, a company must be a “resident” of a country that is a party to a tax treaty. For example, under the Canada-U.S. Tax Treaty, Canadian not-for-profit organizations are “residents” of Canada and will therefore qualify for U.S. tax relief in certain circumstances where they may derive income in the U.S. However, the OECD is now recommending that only “residents” that are “qualifying persons” should be entitled to treaty benefits. Its specific recommendation is that those not-for-profit organizations that qualify for treaty benefits should be listed in the treaties themselves. This rule would likely make it more difficult for not-for-profit organizations to be eligible for treaty benefits by virtue of the fact that they would have to be mentioned (at least by category) in a tax treaty.
It is unclear whether Canada will incorporate this particular OECD recommendation into its existing tax treaties, or on a going-forward basis in any new treaties. However, in the past, Canada has typically modeled its tax treaties based on OECD recommendations. Moreover, the federal Department of Finance (which is responsible for implementing tax policy in Canada) had indicated that it was waiting for the OECD to release these reports before making any final decisions with respect to how it planned to deal with certain aspects of the “tax avoidance” issue. We will continue to follow developments in this area, including reactions from the Department of Finance, and report on them as necessary.