Global Tax Alert | 18 December 2013
New protocol under Canada-Barbados Tax Convention enters into force
On 17 December 2013, the protocol amending the Agreement between Canada and Barbados for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital entered into force. The protocol was signed on 8 November 2011.
Although the protocol focuses on the replacement of the provisions in Article XXVIII dealing with the exchange of tax information, it would introduce a number of important additional changes to the convention.
In accordance with Article 6 of the protocol, its provisions generally have effect in Canada:
- • In respect of tax withheld at source on amounts paid or credited to nonresidents on or after 1 January 2014
- • In respect of other Canadian tax for taxation years beginning on or after 1 January 2014
However, the protocol's provisions on the exchange of tax information are effective from 17 December 2013 (the date of entry into force of the protocol), without regard to the taxation year to which a request for information relates.
This Tax Alert highlights the main revisions contemplated by the protocol.
Treaty residence and treaty benefits
The protocol would replace the main definition of “resident of a Contracting State” in paragraph IV(1) of the convention — to exclude from residence persons taxed only on a source basis, and to include the two contracting states and their political subdivisions or local authorities and their agencies or instrumentalities. These changes are intended to conform this definition with more modern formulations.
The protocol would also replace the residence tie-breaker rule for companies in paragraph IV(3) of the convention — defaulting to nationality — meaning place of incorporation in the corporate context, and would introduce a new tie-breaker rule (paragraph IV(4)) that would address persons other than individuals and companies, requiring competent authority determination, failing which the persons would be denied benefits under the convention. There would be no change to the tie-breaker for individuals in paragraph IV(2).
Although perhaps relevant in certain circumstances, these changes would not seem to have a significant impact as a practical matter on the determination of treaty residence for companies. Under Barbados domestic income tax law, companies are considered resident in Barbados only if their central management and control are located there. There is no general deemed residence rule for companies incorporated in Barbados. There is such a rule, for example, under section 3 of the Barbados International Business Companies Act, but this provision only applies for the purposes of that statute and does not affect the determination of the residence of such a company in general for Barbados income tax purposes. The effect of the Barbados International Business Companies Act — and of similar statutes — is merely to reduce the rate at which the relevant entities are taxable under the general Barbados Income Tax Act, not to substitute the fundamental basis of their taxation in Barbados, nor to limit that taxation only to income from sources in Barbados. Thus, a company that is incorporated in Barbados but managed in Canada would not be regarded as a treaty resident of Barbados. On the other hand, since there are presently no Barbados-resident companies that are subjected only to source-based taxation, the exclusion of source-based taxpayers should not affect the determination of the Barbados treaty residence of a company that is incorporated in Barbados.
In addition, the protocol would replace paragraph XXX(3) of the convention, which currently precludes the application of the convention to companies that are entitled to special tax benefits as Barbados International Business Companies (or similar special tax benefits). In its place, a more limited restriction would be introduced that would only exclude such companies (and other entities) from certain benefits under the convention — in particular, benefits under the “distributive” provisions in Articles VI to XXIV. This would affect any person or other entity entitled to any special tax benefit in Barbados under the International Business Companies Act, the Exempt Insurance Act, the Insurance Act, the International Financial Services Act, the Society With Restricted Liability Act or the International Trusts Act, or any substantially similar law subsequently enacted. This would also affect any person or other entity entitled to any special tax benefit in either country under a law of that country that has been identified in an Exchange of Notes between the two countries, although no such persons or entities have been identified at this time.
From a Canadian perspective, these revisions would have the effect of changing the analysis applicable to determining whether or not any such company that is a “foreign affiliate” of a person resident in Canada can be considered to derive “exempt earnings” in respect of its treaty-country income from an “active business.” However, these changes would not affect the conclusion typically reached under current rules.
- • A foreign affiliate can derive exempt earnings in respect of its treaty-country income from an active business if it is resident in a “designated treaty country” (DTC) as defined in subsection 5907(11) of the Income Tax Regulations, provided that it is not deemed to not be such a resident under Regulation 5907(11.2).
- • The DTC nonresidence deeming rule in Regulation 5907(11.2) applies to a foreign affiliate unless, under Regulation 5907(11.2)(a),
the affiliate “is a resident of that country for the purpose of the agreement or convention.” A companion rule in paragraph 5907(11.2)(c) is intended to preserve the ability of companies such as Barbados International Business Companies to derive such exempt earnings where the relevant agreement or convention entered into force before 1995, and the affiliate would be a resident of that country for the purpose of the agreement or convention but for a provision in the agreement or convention that has not been amended after 1994 and that provides that the agreement or convention does not apply to the affiliate.
- • Under the new protocol, a Barbados International Business Company (or a company enjoying similar tax benefits) could be regarded as a resident of Barbados, since new paragraph XXX(3) would not provide that the convention does not apply to such a company. Thus, although this provision would have been amended after 1994, the amendment would not have the effect of precluding such a company's treaty residence in Barbados, with the result that such a company could meet the conditions in Regulation 5907(11.2)(a), and would no longer need to rely on Regulation 5907(11.2)(c).
Interestingly, although these revisions would not preclude a Barbados International Business Company from deriving exempt earnings in respect of its treaty-country income from an active business, the protocol would replace the “exempt surplus” guarantee in current paragraph XXV(1)(b) of the convention with a more limited guarantee that “credit” for taxes payable in Barbados will be provided by Canada in respect of a dividend paid by a company that is a resident of Barbados to a company that is a resident of Canada and that controls directly or indirectly at least 10%
of the voting power in the first-mentioned company. The protocol would also eliminate the current “tax sparing” provision in paragraph XXV(4) of the convention. These provisions would not affect the analysis of the surplus treatment of a foreign affiliate's earnings under current rules.
The protocol would also introduce a rule (new paragraph XXX(5)) to restrict treaty benefits in respect of income that is subject to tax in one of the countries by reference to the amount of the income that is remitted to or received in that country (and not by reference to the full amount of the income). In such a case, treaty benefits to be granted by the other country would be allowed only to so much of the income as is taxed in the remittance country. This change could restrict treaty benefits available to taxpayers that are resident but not domiciled in Barbados.
Finally, the protocol would replace the “saving clause” in paragraph XXX(2) of the convention, which currently permits Canada to impose its tax on amounts included in the income of a resident of Canada according to section 91 of the Income Tax Act. This provision is limited to the taxation of a foreign affiliate's “foreign accrual property income.” New paragraph XXX(2) of the convention would permit a broader scope for taxation by Canada, extending to “amounts included in the income of a resident of Canada with respect to a company, partnership, trust, or other entity, in which that resident has an interest.”
Gains from taxable Canadian property
The protocol would replace the rule in paragraph XIV(3) that permits the source country to tax a gain derived by a resident of the other country from the disposition of the shares of a company (or an interest in a partnership or trust) where the property of the entity “consists principally of immovable property” situated in that country. This provision would be expanded to permit such taxation where the value of the relevant shares or other interests “is derived principally from immovable property” situated in the relevant country.
The intent of this change would appear to be to permit Canada to tax gains (indeed, the new provision would refer to “income or gains”) derived by a resident of Barbados from the disposition of the shares of a company, the assets of which consist of the shares of yet another company rather than direct holdings in Canadian immovable property, provided that the ultimate value is derived principally from Canadian immovable property.
The protocol would also replace the “claw back” provision in paragraph XIV(5) of the convention, permitting each country to tax its former residents in certain circumstances. The new provision would permit each country to tax gains from the alienation of property derived by an individual who is a resident of the other country and has been a resident of the taxing country at any time during the six years immediately preceding the alienation of the property, other than property to which the provisions of new paragraph XIV(6) would apply.
New paragraph XIV(6) would provide that, where an individual who ceases to be a resident of a country (the emigration country), and immediately thereafter becomes a resident of the other country (the immigration country), is treated for the purposes of taxation in the emigration country as having alienated a property (referred to as the “deemed alienation”) and is taxed in that country by reason thereof, the individual may elect to be treated for purposes of taxation in the immigration country as if the individual had, immediately before becoming a resident of that country, sold and repurchased the property for an amount equal to the lesser of its fair market value at the time of the deemed alienation and the amount the individual elects, at the time of the actual alienation of the property, to be the proceeds of disposition in the emigration country in respect of the deemed alienation. However, this provision would not apply to property any gain from which, arising immediately before the individual became a resident of the immigration country, may be taxed in that country, nor to immovable property situated in a third country.
Tax information exchange
The protocol would replace the provisions in Article XXVIII of the convention applicable to the exchange of tax information — in favor of provisions more in line with international standards developed by the Organisation for Economic Co-operation and Development. Current Article XXVIII addresses only the exchange of information “necessary for the carrying out of this Agreement” or “concerning taxes covered by this Agreement.” The scope of Article XXVIII would be expanded to address the exchange of information that is “foreseeably relevant for carrying out the provisions of this Agreement” or to the administration or enforcement of the domestic laws “concerning taxes of every kind and description imposed on behalf of the Contracting States,” insofar as that taxation is not contrary to the convention. In addition, new paragraphs XXVIII(4) and (5) would ensure that each country would be required to obtain and provide the requested information “even though [it] may not need such information for its own tax purposes,” and that a request could not be denied “solely because the information is held by a bank, other financial institution, nominee or person acting in an agency or a fiduciary capacity or because the information relates to ownership interests in a person.” As a result, it would seem that these provisions would apply to information concerning International Business Companies and other entities that may not enjoy full benefits under the convention.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (Canada), Toronto
- • Yi-Wen Hsu
+1 416 943 5310
- • Mark Kaplan
+1 416 943 3507
- • Heather Kerr
+1 416 943 3162
- • Trevor O'Brien
+1 416 943 5435
- • Linda Tang
+1 416 943 3421
- • Andy Tse
+1 416 943 3024
Ernst & Young LLP (Canada), Montreal
- • Albert Anelli
+1 514 874 4403
- • Angelo Nikolakakis
+1 514 879 2862
- • Nicolas Legault
+1 514 874 4404
- • Nik Diksic
+1 514 879 6537
Ernst & Young LLP (Canada), Calgary
- • Karen Nixon
+1 403 206 5326
- • Mark Coleman
+1 403 206 5147
Ernst & Young LLP (Canada), Vancouver
- • Eric Bretsen
+1 604 899 3578
Ernst & Young LLP, Canadian Tax Desk, New York
- • Andrea Lepitzki
+1 212 773 5415
- • Terry McDowell
+1 212 773 6332
EYG no. CM4045