The new Canada-U.S. tax treaty and the limitation on benefits provision: a justifiable compromise?


University of British Columbia

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Master of Laws - LLM




On November 9, 1995, Canada and the United States ratified the Third Protocol to the Canada-US. Income Tax Convention. The Protocol will benefit Canadians engaged in cross-border business as it eliminates many pre-existing tax barriers to trade and investment. However, the Protocol also includes a controversial Limitation on Benefits ('LOB') Article, intended to prevent treaty shopping by Canadian resident entities. This thesis will analyze the LOB Article and examine its problems and the potential pitfalls which Canadian taxpayers should be aware of when conducting cross-border trade and investment. These problems fall into five categories. First, the LOB Article is difficult to apply in practice because it contains complex tests and several undefined and vague terms. Second, the LOB Article has the potential to deny treaty benefits to entities engaged in bona fide non-treaty shopping activities. Third, Canadian resident entities which have, or plan to have, U.S. source income will be required to take into account the LOB Article's extremely complex rules and plan appropriately whenever there is a change in the share ownership of their Canadian businesses or an increase in the level of expense payments to third country residents. They will have to conduct regular reviews to ensure that they are in compliance with the LOB Article. Fourth, the LOB Article could have the unplanned effect of re-directing tax revenues from Canada to the U.S. Finally, the LOB Article violates two of the three goals of tax treaty policy: the prevention of double taxation and the promotion of stability. This thesis concludes that the inclusion of the LOB Article in the Protocol was politically and bureaucratically motivated by U.S. tax authorities' zeal to halt treaty shopping at all costs. The inclusion of the LOB Article demonstrates the preoccupation of the U.S. with eliminating treaty shopping. This preoccupation appears to take precedent over the basic goal of international tax treaties, which is the facilitation of trade and investment through the removal of tax barriers to the free exchange of capital, goods and services. Further, this thesis concludes that Canada should not have conceded to the inclusion of the LOB Article in the Protocol because its negative impact on some Canadian entities and the Canadian economy will outweigh the Protocol's potential benefits for Canada.


Intergovernmental tax relations -- Canada; Intergovernmental tax relations -- United States; Intergovernmental tax relations -- Treaties

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