This article is co-authored by Monika Gammeter, Tax Partner AG.
On October 22, 2010 the Government of Canada and Swiss Federal Council signed a protocol (“Protocol”) to amend the 1997 Convention between Canada and Switzerland for the Avoidance of Double Taxation with Respect to Taxes on Income and on Capital (“Convention”).
The Protocol provides some significant amendments to the Convention. The more significant amendments include the following:
- replacement of Article 25, Exchange of Information, to bring it in line Article 26, Exchange of Information, of the OECD Model Convention with Respect to Taxes on Income and on Capital (“Model Convention”);
- changes to Article 10, Dividends, Article 11, Interest and Article 12, Royalties;
- changes to Article 18, Pensions and Annuities; and
- addition of an arbitration mechanism in Article 24, Mutual Agreement Procedure, for circumstances where the competent authorities are unable to resolve a dispute.
The Protocol will also introduce certain other changes, including changes to the provisions concerning capital gains, associated companies and residence.
Exchange of Information
Historically, Switzerland’s bilateral tax agreements have not provided for the exchange of information based on the Model Convention and have instead only provided for the sharing of “ancillary administrative assistance” with treaty partners as necessary to carry out the provisions of the treaty.
However, on March 13, 2009 the Swiss Federal Council announced to expand the assistance Swiss authorities would provide to treaty partners by providing provisions similar to Article 26 of the Model Convention to meet the standards of the OECD. This decision arose as a result of increasing international pressure in light of globalization of financial markets and the financial crisis.
Following the announcement, 23 OECD member states have declared interest in revising their double tax treaty with Switzerland to include the new information exchange provisions. Since then, Switzerland has negotiated new and revised treaties to include the new information exchange provision with more than two dozen States, half of which have already been approved by the two chambers of the Swiss federal parliament.
The changes to Article 25 will significantly expand the assistance and exchange of information between the Canada Revenue Agency and the Swiss Federal Tax Administration. Switzerland will, however, provide information to Canada on request basis only and the information provided under new Article 25 will be limited to relevant information concerning taxes covered by the Convention (no automatic or spontaneous information exchange will be granted by Switzerland). It is understood that the requesting State has pursued all reasonable means available under its internal taxation procedure to obtain the information and the requesting State must provide certain identifying information when making a request for information (no “fishing expeditions”).
The changes to Article 10, Dividends, will eliminate withholding tax on dividends paid to the Bank of Canada, Swiss National Bank and pension and retirement funds meeting certain conditions. Pension and retirement funds resident in the other contracting state will qualify for the exemption, where:
they are constituted and operated exclusively to administer or provide benefits under one or more pension or retirement plans; or
operated exclusively to earn income for the benefit of one or more residents of that other contracting state each of which satisfy the requirements of (a);
each pension or retirement plan provides benefits primarily to individuals who are residents of that other contracting state;
the dividends are not derived from carrying on a trade or a business or from a related person; and
the competent authorities of the contracting states agree that each pension or retirement plan generally corresponds to a pension or retirement plan recognized for tax purposes in the first-mentioned state.
This exemption from withholding tax on dividends paid to a qualifying pension or retirement plan is particularly significant since it encourages private equity investment in Canada and Switzerland. Regard should be had to the meaning of “pension or retirement plan” under domestic law.
Notably, former Article 10(2)(b), which provided that dividends paid by a non-resident owned investment corporation that is a resident of Canada to a beneficial owner that is a resident of Switzerland that holds at least 10 percent of the voting stock and of the capital of the dividend paying corporation, will be deleted.
Perhaps one of the most significant changes to the Convention is the elimination of withholding tax on interest payments to unrelated parties with the reservation to interest payable on an obligation that is contingent or dependent on the use of property is computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion or by reference to dividends paid or payable to shareholders of any class of shares of the capital stock of a corporation. The Convention currently limits withholding tax on interest payments to a rate of 10 percent in most cases.
Article 11, Interest, is also amended to provide a provision deeming parties to be “related persons” for the purposes of Article 11 “if either person participates directly or indirectly in the management or control of the other, or if any third person or persons participate directly or indirectly in the management or control of both.” This does not appear to be an exhaustive definition of “related persons” for purposes of the Convention and regard should also be had to the meaning of “related persons” under domestic law.
The Protocol will amend Article 12, Royalties, to expand the exemption from the general 10 percent rate of withholding tax, for royalties paid to a related party for the use of, or the right to use, any patent or any information concerning industrial, commercial or scientific experience (but not including any such information provided in connection with a rental or franchise agreement).
Pensions and Annuities
The Protocol will amend Article 18, to include payments under the social security legislation. The Convention currently excludes pensions from social security legislation from the limited source tax of 15 percent, which led to double taxation in the past.
Mutual Agreement Procedure
Finally, Article 24, Mutual Agreement Procedure, will also be subject to significant amendments. The Protocol provides for the addition of an arbitration mechanism for taxpayer disputes that remain unresolved by the competent authorities after three years (or a date agreed to between the competent authorities). However, tax disputes which are already before a court or tribunal in Canada or Switzerland will not be eligible for arbitration. The outcome of the arbitration will only be binding on the competent authorities if the taxpayer accepts the result.
Entry into force
The Protocol will enter into force after the implementation procedures of both States have been completed and on the later of notifications from Canada and Switzerland. The provisions of the Protocol will apply as follows with respect to:
- taxes withheld at source, on amounts paid or credited on or after January 1 of the year following the entry into force of the Protocol;
- other taxes, for taxation years beginning on or after January 1 of the year following the entry into force of the Protocol. Thus, the new provisions on exchange of information will be applicable to tax years beginning on or after January 1 of the year following the entry into force of the Protocol.
The Protocol will introduce some significant changes, particularly with respect to the exchange of information between Canada and Switzerland, as well as for payments of dividends, interest, royalties. It will also bring the Convention in line with the Swiss Federal Council’s March 2009 mandate to provide greater administrative assistance and will reduce some of the privacy Canadians enjoyed in respect of their tax affairs in Switzerland. It will also provide favourable tax treatment that will enhance private equity investment in Canada and Switzerland.