Tax Discrimination and the Trade in Services between Canada and the United States: Deciphering the Landscape

• Author: Catherine Brown & Christine Manolakas
• Pages: 179-224

179

Chapter 9

Tax Discrimination and the Trade

in Services between Canada and

the United States: Deciphering the

Landscape

catherine brown & christine manolakas*

A. INTRODUCTION

1) Overview

A country’s sovereign right to levy tax is rarely questioned, and neither is the

fact that the i ncome tax systems of most nations regul arly treat taxpayers un-

equally. Different, and often less favourable, tax treatment is often based on

factors such a s nationality, residency, and the geographical location of activ-

ities. Canada, for ex ample, offers favourable tax rates to Canadian controlled

private corporations,1 as well as tax credits to research and development oc-

curring in Canada. The United States also provides many tax i ncentives to

domestic investment or act ivities.2 Discriminatory provisions are well docu-

mented and often justif‌ied by social policy and economic objectives.3

Historically, public international law efforts to limit tax discrim ination

were ineffective. Tax treaties, through bilateral concessions, served a modest

role in promoting non-disc rimination, usu ally based on nationality. Regu-

lating t ax d iscrimination against foreign serv ice providers ga ined import-

ance once trade in services began forming a signif‌icant part of global trade.

* The authors would li ke to thank Will Fiske for his resea rch assistance.

1 Inco me Tax Act, R.S.C. 1985 (5th Supp.), c. 1, s. 125 (as a mended) [ITA].

2 See the text below i n this chapter accompanying note s 150–233.

3 B. Ar nold, Tax Discrimination A gainst Aliens, Non-Re sidents and Foreign A ctivities: Canad a,

Australia, Ne w Zealand, The Unite d Kingdom and The Unite d States (Toronto: Canadian Tax

Foundation, 1991).

180 catherine brown & christine monol akas

The need for protection against non-tariff trade barriers was categorically

recognized in bot h the World Trade Organization Agreement (WTO)4 and

in the North American Free Trade Agreement (NAFTA).5

These trade agreements demand signif‌icant commitments of their sig-

natories with respect to market access and non-discrimi nation in the cross-

border supply of services. However, these multinational trade a greements6

have la rgely carved out commitments with respect to direct taxation (in-

come tax) measures from their provisions. This gap has a potentially nega-

tive impact on trade, especia lly concerning foreign service providers. The

primary tool to f‌ill this disciplinary role remains the bilateral tax treaty.7

Canada and the United States entered into such a bilateral agreement in

1942 (Canada-U.S. Treaty). The cur rent version, as enacted in 1980, has

been updated through four protocols, the latest being in 1997.8

This paper considers the ongoing effects upon Canadian and American

service providers when direct taxation measures are carved out from obli-

gations assumed under trade agreements and left to the jurisdiction of a

bilateral tax treaty by answering th ree questions. First, how do bilateral tax

and multinational trade agreements interact to discipline discriminatory

tax measu res affect ing these serv ice providers? Second, to what extent do

4 Final Act Embody ing the Results of the Ur uguay Round of Multilat eral Trade Negotiations, 15

April 1994, 33 I.L .M. 1125 (1994) [WTO Agre ement].

5 North A merican Free Trade Ag reement, U.S.-Can ada-Mexico, 17 De cember 1992, 32 I.L.M.

289 (1993) (entered into force 1 January 1994) [NA FTA].

6 General Agreeme nt on Tariff and Trade: General Ag reement on Trade in Serv ices, annex 1B, 33

I.L.M. 1168 (1994). The “ca rve out” was not without considerable cont roversy. It was widely

recognized th roughout the negotiations for the Ge neral Agreeme nt on Trade in Services

[GATS] that discr imination in direct ta xation could have just as deleter ious an effect on the

cross-border trade i n services as the non-tar iff barriers under rev iew. Nonetheless, in hotly

disputed negotiat ions resolved virtual ly on the eve of the deadline for sign ing the WTO

Agreement, di rect taxation was effe ctively removed from the GATS agree ment and remains

subject to bilatera l tax treaties. Discipli ne over direct taxation i ssues has also been largely

carved out of the NA FTA.

7 Organisation for Economic C o-operation and Development (OECD) C ommittee on Fiscal

Affairs, Mod el Double Taxation Conventi on on Income and Capital (Par is: OECD, 1977).

The OECD Model Treaty was rev ised in 1992 and updated in 1994 and 1995 and is now

published in loose-le af form. OECD Committee on Fisca l Affairs, Model Tax Conventi on on

Income and on Capit al (Paris: OECD, 2003).

8 Convention and Proto col between the Unit ed States and Canada f or the Avoidance of Doubl e

Taxation and the Pre vention of Fiscal Evasi on in the case of Income Taxes, 4 Marc h 1942. Con-

vention with R espect to Taxes on Income an d on Capital, U.S.-Cana da, 26 September 1980,

T.I.A.S. No. 11,087 [Ca nada-U.S. Treaty]; Protocol t o Amend Canada-U.S . Treaty, S.C. 1984,

c. 20; Protoco l to Amend Canada-U. S. Treaty, S.C. 1995, c. 34 (Royal assent given 8 Nove m-

ber 1995); as amended by the Protocols s igned on 14 June 1983; 28 March 1984; 17 March

1995 and 29 July 1997; Protoc ol to Amend Canada- U.S. Treaty, S.C. 1997, c. 38 (Royal assent

given 10 December 1997).

Tax Discriminati on and the Trade in Services be tween Canada and the Un ited States 181

interacting tax and trade agreements permit or result in tax discrimination?

Third, is the failure to discipline tax ation in trade agreements an issue that

should be addressed solely between the trade part ners? Before answer ing

these questions, it is useful to ref‌lect br ief‌ly on the principles underlying

non-discrimination in ta x and trade agreements.

2) Non-Discrimination

Non-discrimination is one of the basic principles of most mult inational

trade agreements, and, more specif‌ically, the root of “most favoured nation”

(MFN) treatment and “national” treatment (NT) incorporated into such

agreements. MFN treatment, as applied to trade in services, requires that a

host country tax foreign service providers from one country no less favour-

ably than those from a nother. NT treatment requires that the host country

treat foreign service providers and domestic serv ice providers sim ilarly or

comparably. The protection provided by the MFN and NT provisions in any

trade a greement is, however, limited by t he exceptions att ached to t hem.

As stated, almost all trade ag reements limit or exclude MFN and NT obli-

gations with respect to direc t taxation. Th is is accomplished most sign if‌i-

cantly by relegating d irect taxation matters to double taxation a greements

(tax treaties) between individual countr ies.

Tax treaties usua lly contain a non-discrimination clause that is modeled

on A rticle 24 of the Organization for Economic Cooperation and Develop-

ment Model Treaty (OECD Model Treaty). This is generally u nderstood to

be an NT clause and not an MFN clause. The f‌i rst objective of the non-dis-

crimination clause is to prevent a treaty part ner from subjecting foreign na-

tionals to treatment that is “other or more burdensome” than that of its own

nationals, provided that the former are in the same or substantially similar

circumstances as the latter. Its second objective is to ensure that companies

do not face less favourable ta x treatment based on whether capital is held by

its own nationals rather than the nationals of the other contracting country.

As will be discussed, the scope of the non-discrimination article in the OECD

Model Treaty is far narrower than the NT obligation found in both the WTO

and NAFTA. If the gap left by the direct ta xation “carve out” is f‌i lled with a

tax treaty providing a narrower N T protection, the possibility of discrimina-

tion remains, particularly as against non-residents. This void can be partially

f‌ill ed wit h an MFN obligat ion. How ever, th ere is no implied obligat ion to p ro-

vide MFN treatment in the OECD Model Treaty, although various tax treaties,

including the Canada-U.S. Treaty, do contain a limited MFN clause.9

9 Canada-U.S. Treaty, ibid., Article X XV(2). A signif‌icant issue under lying the discussion is

the scope of the non-d iscrimination clau se in the relevant tax treat y, and, in particular, t he