Multilateral Instrument May Make Treaty Relief More Generous
Posted in Tax


Canada has a series of bilateral tax treaties. These have evolved over time to include various anti-avoidance, and anti-treaty shopping rules. These rules include limitation on benefits provisions and purpose tests. The treaty between Canada and Hong Kong had one of the broadest rules.

Many countries, including Canada and Hong Kong, are now signatories to the Multilateral Instrument (“MLI”). This is designed as a multilateral overlay on bilateral tax treaties. The general aim of the MLI is to make treaties more robust and consistent. As of January 1, 2024 the MLI will apply to the tax treaty between Hong Kong and Canada (the “Treaty”).

The Principal Purpose Test

Hong Kong opted to implement the mandatory provisions of the MLI, including Article 7(1) – the “principal purpose test” (“PPT”). The PPT is an anti-avoidance measure that is based on the subjective purpose of a transaction. In applying the PPT, the question is whether it is reasonable to conclude that one of the principal purposes of the transaction is to obtain a treaty benefit. If the answer is yes, then that benefit will be denied. The purpose of the PPT is to prevent treaty abuse, such as a taxpayer attempting to access a lower withholding rate through treaty-shopping. The PPT has an important caveat. A saving provision applies where it can be established that granting the benefit would otherwise be in accordance with the object and purpose of the treaty.

The Treaty

Prior to the application of the MLI, the Treaty already contained a very broad purpose test. Under this test, a treaty benefit would be denied if anyone involved in the transaction’s main purpose was to obtain a treaty benefit. Unlike the PPT, there was no saving provision.

Canada Revenue Agency Interpretation

In a May 2023 IFA Roundtable, the Canada Revenue Agency (“CRA”) provided commentary on the application of the PPT to a particular fact pattern involving the Treaty. In this scenario, a Hong Kong resident individual transferred shares in a Canadian corporation to a Hong Kong corporation. Under Article 10:2(a) of the Treaty, this reduced the withholding tax rate on dividends from 15% to 5% (because that Article requires the recipient to be a “company”). But under the pre-MLI purpose test, the taxpayer would have been denied the benefit of the lower rate, since “one of the main purposes” of this transaction was to access a reduced rate of withholding.

By contrast, under the post-MLI purpose test, while the PPT may have applied to deny the Treaty benefit, the CRA explained that the Saving Provision would now apply, allowing the taxpayer to benefit from the reduced rate. This was likely because granting the lower rate to a company owned entirely by a resident individual of Hong Kong does not offend the purpose of the Treaty. Thus, for dividends paid after January 2024, a Hong Kong resident individual could access a lower rate by transferring their shares to a Hong Kong corporation.


The PPT and its saving provision are not limited in scope to Article 10 (the Dividends provision): they apply to the Treaty as a whole. Taxpayers should consider how the PPT interacts with the specific purpose tests in Articles 10 to 13 of the Treaty. This seems to be an example of the MLI operating to broaden treaty relief, rather than restrict it.

For any inquiries regarding this topic, please contact Gareth Williams or any other member of Lawson Lundell LLP’s Tax Group.


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