On Jan. 15, 2016, after 16 years of negotiations, the Trade and Economic Offices of Canada and Taiwan signed a tax arrangement (the "Treaty"). The Treaty could have a significant impact on many people and businesses in both Canada and Taiwan. The purpose of this article is to provide a brief summary of the main provisions of the Treaty that will be of interest to those residents in Canada or Taiwan who have, or are contemplating, personal or economic activity in the other territory. The first half of the article discusses the key "distributive rules" in the Treaty which allocate taxing rights of the particular income stream between the two territories. The second half of the article touches on some of the special provisions in the Treaty such as transfer pricing, exchange of information, mutual agreement procedure, dual residence and limitation of benefits.
The Treaty with Taiwan is another positive step by the Canadian government in updating or expanding its treaty network with central and south Asia.1 As the existing 1986 Canada‑China Treaty does not apply to residents of Taiwan, the Treaty is a welcome development for the residents of Taiwan who have social and economic ties with Canada. According to the Canadian Trade Office in Taipei:
- more than 200,000 people of Taiwanese descent reside in Canada and approximately 50,000 Canadians live in Taiwan; and
- Taiwan is Canada's 11th largest trading partner.2
As a result, the Treaty could have a significant impact on many people and businesses in both Canada and Taiwan.
For both political and legal reasons beyond the scope of this paper, Canada and Taiwan have officially described the Treaty as an "arrangement" and not as an "agreement", "convention" or "treaty". These political and legal reasons also appear to have influenced the wording of the Treaty in many respects. For example, the Treaty does not define the term "Canada" but instead uses the term "Territory" and defines it as the geographical area in which the Canada Revenue Agency ("CRA") exercises jurisdiction. Despite these nuances, the arrangement appears fully intended to have the practical effect of a typical tax treaty, and we have chosen to refer to it as such in this article.
Assuming that both countries ratify the Treaty in 2016,3 the Treaty will come into force in both Canada and Taiwan for any taxation year beginning on or after January 1, 2017. Once the Treaty is ratified by the respective governments, it will provide tax relief for residents of both jurisdictions and, more importantly, will help encourage inbound investments to Canada from Taiwan.
Overview and Analysis of Key Aspects of the Treaty
1. Reduced Withholding Tax Rates on Dividends, Interest and Royalties
One of the key impacts of the Treaty will be that many cross‑border payments, such as dividends, interest and royalties, between Canada and Taiwan residents will attract lower Canadian withholding tax rates under the Treaty. In effect, the Treaty should reduce the tax costs of repatriating income or profits from Canada to Taiwan, thereby stimulating cross‑border capital flow and foreign direct investment.
Under section 10 of the Treaty, dividends paid to residents of Taiwan by Canadian resident companies will now be subject to a maximum withholding tax rate of 15% rather than the 25% rate stipulated in subsection 212(2) of Canada's Income Tax Act (the "Tax Act"). Furthermore, where the beneficial owner of the dividend is a company resident in Taiwan that holds directly or indirectly at least 20% of the capital of the Canadian resident company paying the dividend, the withholding tax rate is further reduced to 10%.
With respect to interest payments, section 11 of the Treaty limits the withholding tax rate on such payments to 10% on arm's length and non-arm's length debt. Under the Tax Act, however, cross‑border interest payments, other than contingent or participating interest, between arm's length parties already do not attract any withholding tax in Canada. Therefore, with respect to interest arising in Canada, the Treaty will mainly benefit non‑arm's length parties as well as contingent interest arrangements.
Pursuant to section 12, the Treaty reduces the withholding tax rate on royalty payments to 10%. In contrast to some of Canada's other bilateral tax treaties, there is no elimination of withholding tax on royalty payments relating to the use of computer software, or the use of patents or information concerning industrial, commercial or scientific experience. This is unfortunate. However, subparagraph 212(1)(d)(vi) of the Tax Act may apply to exempt certain of these payments from withholding tax. This paragraph exempts certain royalties, such as those from the production or reproduction of literary, dramatic, musical or artistic work, in certain instances.
2. Business Profits
Under section 7 of the Treaty, Taiwan residents carrying on business in Canada will only be taxed on business income earned through a Canadian permanent establishment. Prior to the Treaty, any Canadian income earned by a Taiwan resident carrying on business in Canada was taxable in Canada. Section 5 of the Treaty provides a definition of "permanent establishment." Notably, however, unlike the new Canada‑Hong Kong Treaty, but like the Canada‑U.S. Tax Treaty, there is a special deemed service permanent establishment rule. In this regard, an enterprise of Taiwan will be deemed to have a permanent establishment in Canada if it furnishes services through employees or other personnel or persons engaged by the enterprise, but only where the service activities continue in Canada for the same or a connected project and for periods aggregating more than 183 days within any 12‑month period.
Issues may arise in allocating income from business operations between Canada and Taiwan. With respect to the allocation of economic profits between countries, including the deductibility of certain notional expenses, Article 7 of the 2010 OECD Model Tax Convention on Income and on Capital (the "OECD Model Treaty") and its Commentary (the "OECD Commentary") on Article 7 were amended to achieve a higher degree of symmetry on the taxation of a foreign entity's business profits regardless of whether that foreign entity operates a branch or uses a subsidiary that is a separate legal entity. However, Canada and Taiwan ignored the recommended wording from Article 7 of the OECD Model Treaty in drafting section 7 of the Treaty.
Given the general understanding that contracting states would negotiate or amend existing treaties to reflect the new wording of Article 7 of the OECD Model Treaty, this departure from the OECD Model Treaty is questionable in light of the OECD's work on this project. Therefore, in the absence of diplomatic notes or any public comment from the CRA confirming that the intention of the treaty negotiators was to adopt the full authorized OECD approach, taxpayers should proceed with caution in deciding whether to deduct certain notional expenses in computing income attributable to a permanent establishment. For larger scale business operations in Canada, Taiwan enterprises should speak to a Canadian tax advisor before deciding on a branch versus subsidiary structure to carry out its operation in Canada, especially if reducing the final Canadian tax liability is at all a concern.
The Treaty has a section dealing specifically with independent personal services. Under section 14 of the Treaty, individuals who are residents of Taiwan who provide professional services or other activities of an independent character in Canada will only be taxed on the income earned through a Canadian fixed base. This section is generally not seen in Canada's more recent tax treaties because Article 14 of the OECD Model Treaty was deleted in 2000 on the basis that there were never any intended differences between the concepts of permanent establishments, as used in Article 7, and fixed base, as used in Article 14. As a result, it is generally thought that Article 7, which deals with all forms of business profits, should be sufficient to cover income derived from professional services or other activities of an independent character carried out by individuals. One must therefore assume that this provision was added in the Treaty at the request of Taiwan for greater certainty.
Section 14 should work the same way section 7 does in that the concepts of what constitutes a permanent establishment should apply to the concept of fixed base. Furthermore, although there is no special deemed services "fixed base" rule in section 14, there is a special rule in section 14 that will maintain Canada's right to tax, regardless of the presence of a fixed base, where the Taiwan service provider is present in Canada for periods totalling at least 183 days in any 12‑month period commencing or ending in the relevant fiscal year.
3. Capital Gains
It is well known that there has been significant investment from Asia, including Taiwan, in Canadian real estate. Under section 13 of the Treaty, Canada reserves its right to tax capital gains arising from the disposition of immovable property in Canada, and from the disposition of shares whose value is derived principally from immovable property in Canada. This test applies, for example, even if the property being disposed consists of shares of a non‑Canadian corporation. As a result, Taiwan residents may still wish to consider structuring their investments in Canada through another treaty country (e.g. the Netherlands or Luxembourg) that has more favorable Article 13 provisions in its treaty with Canada and fairly non‑threatening limitation of benefits provisions.
However, the benefits of Taiwan residents utilizing an intermediary company in a jurisdiction with more favorable capital gains rules in its treaty with Canada may be short lived in light of possible changes that may come to Canada's treaty network as a result of the final recommendations released by the OECD on October 5, 2015 on Action 6 of its Base Erosion and Profit Shifting ("BEPS") Project. Action 6 "Preventing the Granting of Treaty Benefits in Inappropriate Circumstances", makes recommendations that, if enacted upon by Canada in its treaty network, would prevent the utilization by Taiwan residents of structures involving intermediary companies in third countries, for example the Netherlands or Luxembourg, for "treaty shopping" reasons. Canada's Department of Finance has also made it known that a domestic treaty shopping rule may be introduced into the Canadian tax system depending on how Canada decides to implement the final recommendations on Action 6. So Taiwan investors looking for a more tax‑efficient investment structure into Canada should talk to a Canadian tax advisor before finalizing any indirect structures.
4. Income from Employment
Section 15 of the Treaty provides what could be a tremendous benefit to Taiwan residents, particularly to Taiwan companies sending their employees to temporarily work in Canada. Currently, in the absence of a bilateral tax treaty with Canada, any remuneration paid to a non‑resident employee for services performed in Canada is taxed under the Tax Act with no safe‑harbour rules. Section 15 includes the traditional OECD Model Treaty protection, which provides, for example, that remuneration derived by a resident of Taiwan in respect of an employment exercised in Canada will not be taxable in Canada if:
- the recipient is present in Canada for no more than 183 days in any 12‑month period commencing or ending in the relevant taxable period; and
- the remuneration is not paid by (or on behalf of) an employer who is resident in Canada or borne by a permanent establishment of the employer in Canada.
Generally, under the domestic tax laws of Canada, tax is totally or partially deferred on contributions to, and earnings in, pension schemes or on the accrual of pension rights, but is recovered when pension benefits are paid. Canada considers that a deduction for pension contributions is a deferral of tax on the part of the employment income that is saved towards retirement. When pension payments are made to non‑residents of Canada, such amounts are generally subject to a 25% Part XIII withholding tax. So another key element of the Treaty will be that periodic pension payments arising in Canada and paid to Taiwan residents will now attract lower Canadian withholding tax rates. For fixed income pensioners, this reduction in Canadian withholding tax can be significant, especially for those Taiwan residents who were not already taking advantage of certain elective treatment under the Tax Act.4
Under the Treaty, the reduced withholding rate on periodic pension payments arising in Canada and paid to a resident of Taiwan will not exceed the lesser of 15% of the gross amount of the periodic pension payment or the amount of tax that the recipient otherwise would have had to pay in Canada on such periodic pension payments had the individual been a resident of Canada when the payment was received. In many cases involving low income pensioners, Canada's effective tax rates for Canadian residents may be far less than a 15% withholding tax on the gross periodic pension payments.
6. Associated Enterprises (Transfer Pricing)
The avoidance of double taxation on income is a fundamental objective of any bilateral tax treaty. The most important section in the Treaty that deals with the avoidance of double taxation is Article 9 regarding transfer pricing adjustments. The negotiators of the Treaty have incorporated nearly all of Article 9 of the OECD Model Treaty, which creates an obligation on both parties to provide full relief on transfer pricing adjustments, as long as the party providing the relief agrees with the quantum of the adjustments. When such a commitment is included in a treaty, Canadian negotiators generally insist on including time limits in the treaty that limit the length of time during which a party is able to make a transfer pricing adjustment. In the Treaty, the time limit is eight years. Some of the benefits associated with such a provision include the comfort that the taxpayer generally cannot be audited beyond the eight‑year limit, as well as the obligation on the competent authorities to provide correlative relief to the extent they agree with the merits of the adjustment.
A similar eight‑year time limit has been added to the Mutual Agreement Procedure Section of the Treaty to prevent both governments from assessing other sources of income where there is potential for double taxation. For example, if a Taiwan enterprise carried on business in Canada through a branch (e.g. permanent establishment) and that enterprise was required to include all of its business profits in its tax base in Taiwan, the CRA would be prevented from raising an assessment increasing the income attributable to the enterprise's Canadian permanent establishment beyond the eight‑year period (see Business Profits above).
These eight‑year time limits will not come into play too often, at least from Canada's perspective, since Canada's tax system already has a shorter time limit in its domestic tax laws5 for CRA to raise reassessments on cross‑border transactions. However, it is common in complex transfer pricing cases and Canadian branch cases that are under review by CRA for CRA to request the taxpayer to sign waivers to keep these taxation years open for assessment. It should be noted that these domestic waivers will not override the government's obligations under the eight‑year time limit rules in the Treaty.6
7. Limitation of Benefits and Anti‑Treaty Shopping Provisions
Like many of Canada's tax treaties, the Treaty also includes a general limitation of benefits provision in Section 26. Generally, a limitation of benefits provision seeks to limit treaty shopping by requiring that persons, other than individuals, claiming treaty benefits be "true" residents of the respective treaty jurisdiction. The provision is typically included to thwart treaty shopping structures in which a person establishes residence in a jurisdiction without any significant or substantial ties to that jurisdiction for the purpose of taking advantage of specific treaty benefits.
Of greater significance, however, are the anti‑treaty shopping provisions in sections 10 to 12 of the Treaty. Anti‑treaty shopping provisions appear in many of Canada's tax treaties with other countries in various forms. These provisions will often deny the reduced withholding rates under a treaty when one of the main purposes of a transaction relating to a dividend, interest or royalty payment is to obtain treaty benefits. However, in the case of the anti‑treaty shopping provision in sections 10 to 12, the provisions are broadly worded and may potentially act to deny treaty benefits on many common structures. Therefore, in structuring any Canada‑Taiwan cross‑border transaction, special consideration must be given to the effect of these anti‑treaty shopping provisions and the manner in which they are or will be interpreted and applied by the relevant taxing jurisdiction.7
8. Exchange of Information
The Treaty includes an exchange of information section, which allows the competent authorities of Canada to request tax‑related information from Taiwan regarding Canadian residents, and vice versa. Therefore, for the purposes of administering and enforcing Canada's tax laws, the competent authorities of Canada will be able to obtain pertinent information from Taiwan relating to any Canadian resident's assets or investments held in Taiwan, or income earned in Taiwan. This exchange of information section in the Treaty will be an important tool against tax evasion, especially for Canada (which taxes its residents on their income earned in foreign countries), as the CRA will now have added powers to determine if Canadian residents have unreported income in Taiwan. However, it should be noted that under a Protocol of Understanding, it is understood that the provisions of section 26 do not require the territories to exchange information on an automatic or spontaneous basis.
9. Mutual Agreement Procedure (MAP)
Section 24 of the Treaty contains MAP provisions that allow the competent authorities from Taiwan and Canada to work together to resolve international tax disputes involving double taxation, and cases involving inconsistent application and interpretation of the Treaty.
By comparing the Treaty and a few other of Canada's more recently signed tax treaties to Canada's older tax treaties, a change in Canada's treaty policies regarding Canada's MAP provisions can be discerned. A "notwithstanding clause" has been inserted into paragraph 2 of section 24. This clause effectively frees the respective competent authorities from domestic statute of limitation requirements that may impose time limits on resolving tax disputes. Hence, the inclusion of the "notwithstanding clause" in the Treaty will benefit residents of Taiwan and Canada, as cases of "taxation not in accordance with" the Treaty, including juridical and economic double‑tax cases, presented to the competent authorities within the three‑year application period should be resolved notwithstanding domestic statute of limitation impediments in either Canada's or Taiwan's tax system. Until recently, this "notwithstanding clause," in the context of the MAP Article of Canada's treaty network, had historically only been seen in the tax treaty between Canada and the United States. However, based on the inclusion of this "notwithstanding clause" in several recent treaties, this would seem to signify a clear and welcome change in Canada's tax treaty policy which is now in line with the MAP Article of the OECD Model Treaty.
10. Dual Residency Provision and Definition of "Resident of a Party"
As alluded to above, because of the interesting questions regarding Taiwan's status as a sovereign state, the signing of this Treaty has led to certain departures from the more traditional language seen in Canada's other tax treaties. For example, section 1 of the Treaty refers to "residents of one or both of the Territories" as opposed to "residents of one or both of the Contracting States." There is no reference to a "national" in the Treaty, which is usually a term that is found throughout a typical Canadian tax treaty and often defined in Article 3 of such treaties. As a result, there are slight changes to the wording in certain provisions of the Treaty, such as the non‑discrimination section. All these subtle changes in typical tax treaty language seem relatively benign, intended mainly to finesse the diplomatic minefield.
The categorization of the Treaty as an "arrangement" as opposed to a "treaty", "agreement" or "convention" and the use of the term "resident of a Territory" as opposed to "resident of a Contracting State" will hopefully not adversely impact the application of Canada's foreign affiliate rules. For example, Canada's foreign affiliate rules generally provide that an affiliate's net earnings from an active business carried on by it in a designated treaty country will qualify as exempt surplus and may be distributed as a dividend free of Canadian tax to the Canadian corporation. Regulation 5907(11) of Canada's Tax Act defines designated treaty country to be "a sovereign state or other jurisdiction" in which Canada has entered into a comprehensive "agreement or convention" for the elimination of double tax. Therefore, it is not clear whether the fact that this is an "arrangement" will impact the tax‑free repatriation of dividends out of exempt surplus from a foreign affiliate located in Taiwan. Furthermore, the language in Regulation 5907(11.2)8 is slightly ambiguous in light of Taiwan being categorized as a "territory" as opposed to a "country," and the CRA may eventually be called upon to provide some clarification regarding the interpretation of that provision as well. Canadian companies may have to consider getting clarification from CRA regarding exempt surplus status in the event they have material business operations in Taiwan.
Perhaps one of the key benefits of the Treaty is the introduction of the standard dual resident tie‑breaker rules for individuals, which are common in most of Canada's tax treaties. In light of the significant number of Taiwan residents who have moved to Canada, or have had dependent family members move to Canada, the inclusion of these tie‑breaker rules should help dual resident individuals ascertain, with a significant degree of certainty in most cases, the territory in which they would be considered resident for purposes of the Treaty. In reference to subsection 250(5) of the Tax Act, dual resident individuals who are found to be residents of Taiwan under the tie‑breaker rules will be deemed to be non‑residents of Canada provided that they were not resident in Canada prior to February 25, 1998. Again however, as subsection 250(5) refers to "tax treaties" and not "arrangements", one should seek clarification from CRA before assuming subsection 250(5) will apply where a tie‑breaker rule in the Treaty is settled in favor of Taiwan. In tax policy terms, one would hope that a broad definition of treaty will be taken by CRA in applying subsection 250(5).
Corporations that incorporated in Canada but have central management and control in Taiwan, or vice versa, should be aware that Section 4 of the Treaty does not include a definitive corporate tie‑breaker rule. A dual resident corporation would be dependent on the competent authorities of Canada and Taiwan to mutually agree to resolve the issue of dual residence or resulting double tax. Also, similar interpretive issues could arise in subsection 250(5), as described above, to dual resident corporations where the competent authorities settle the tie in favor of Taiwan. So again, CRA may be called upon to provide some assurances on the application of subsection 250(5) to dual resident corporations in light of the categorization of this Treaty as an "Arrangement".
The Treaty is another step that reinforces Canada's strong relationships in the Asia‑Pacific region. The Treaty also reflects the larger trend of western countries increasing ties and fostering relationships with Asian countries. As trade and investment flows continue to increase between Canada and Asia, the Treaty should reduce tax barriers and encourage increased bilateral trade and investment between Canada and Taiwan. In the long term, increased trade and investment should lead to economic growth and more jobs in both countries.
Jim Wilson is a Partner at Gowling WLG (Canada) LLP in Ottawa. He may be contacted by email at firstname.lastname@example.org
Nathan Piche is an articling student at Gowling WLG (Canada) LLP in Ottawa. He may be contacted by email at email@example.com.
1 For example, in 2012 the Government of Canada signed a tax treaty with the Government of the Hong Kong Special Administrative Region of China and announced that they had reached an agreement in principle with the Chinese government to update the 1986 Canada‑China Treaty.
2 See Canada.org.tw
3 In light of the political sensitivity with the Chinese government as a consequence of Canada signing an "arrangement" of this nature with Taiwan, there is always a possibility that the Treaty will not be ratified in 2016.
4 Because pensions are commonly dealing with smaller overall income figures, Canada's Tax Act does allow non‑resident pensioners, in lieu of paying a withholding tax on gross pension payments, to make a section 217 election and file a Canadian tax return reporting their Canadian pension income. This election generally results in a lower overall Canadian tax liability than a withholding tax on gross pension payments, particularly since Canada's tax rates for individuals is on a progressive basis and pensions are commonly lower income amounts.
5 Typically seven years from the date of the original notice of assessment-see subparagraphs 152(4)(b)(iii) and (iii.1) of the Tax Act.
6 See paragraph 152(4)(a)(ii) of the Tax Act and Form T2029.
7 The potentially significant ramifications of these anti‑treaty shopping provisions have been analyzed in a separate paper by Jim Wilson and Eric Koh, titled "New Limitation on Benefits Provisions in Canada's Tax Treaties: A Step Too Far?" that was published in Canadian Tax @ Gowlings.
8 Regulation 5907(11.2) deems a foreign affiliate not to be resident in a country with which Canada has entered into a comprehensive agreement or convention for the elimination of double tax unless, generally, the foreign affiliate is a resident of that country for the purposes of the agreement or convention.