Research and Analysis

In this paper, the authors present corporate-level Marginal Effective Tax Rate (METR) estimates for direct investment from selected home countries (Canada, Australia, Germany, Sweden, UK, U.S.) to a group of selected host countries (Canada, Brazil, China, France, Ireland, UK, U.S.). The METR methodology provides estimates of the impact of corporate tax at the margin, i.e., for the last $1 of investment being made. METR estimates take into account many tax and non-tax parameters, in particular: corporate income taxes, value-added taxes (to the extent applicable to business inputs), capital taxes, withholding taxes, capital cost allowances, economic depreciation rates, and interest and inflation rates. In addition, some estimates take into account the impact of thin capitalization rules and of restrictions applicable to the deductibility of interest paid by a corporation to earn foreign business income.

This report identifies and assesses options for accessing a broader or full exemption tax system with regard to the taxation of outbound direct investment, if Canada were to move in such a direction. The report provides a general assessment of advantages and disadvantages, discussed within the academic and policy literature, of the two main approaches to taxing outbound direct investments, the worldwide tax system and the exemption tax system. It also examines the rules for taxing outbound direct investments in ten selected countries and evaluates the policy impact if Canada were to move to a full hybrid exemption tax system by reforming its tax laws and policies so that all foreign source active business income is exempt from Canadian tax. The report concludes with a brief discussion of possible reform approaches.

This paper reviews economic principles for optimality of the taxation of international profit, from both a global and national perspective. It argues that for systems based on residence or source, nothing less than full harmonisation across countries can achieve global optimality. The conditions for national optimality are more difficult to identify, but are most likely to imply source-based taxation. However, source-based taxation requires an allocation of the profits of multinational companies to individual jurisdictions; this is not only very difficult in practice, but in some cases is without any conceptual foundation. The taxation of interest income on a residence basis is also hard to justify if the aim of the tax system is to tax only economic activity in a given country.

This paper focuses on the broad economic principles that should guide tax policies that affect inbound foreign direct investment (FDI) in Canada. It provides a review and analysis of some basic economic models of the taxation of capital returns in a small open economy, and finds that these models ignore important issues in the taxation of FDI, in particular the ability of multinational enterprises (MNEs) to shift taxable income from high tax to low tax affiliates through transfer pricing and debt placement. Debt placement is the main focus of the remainder of the paper, starting first with a review of the main theories of the capital structure of the firm and the determinants of its debt level, followed by a review of the empirical literature on the determinants of the financial structures of MNEs foreign investments. The paper then looks at two empirical studies dealing with the effects of thin capitalization rules, considers the welfare effects of thin capitalization rules in an oligopolistic market, and discusses two proposals for extending the thin capitalization rules.

This report identifies the most significant policy issue regarding Canada’s thin capitalization rules as their extension to arm’s length debt. It characterizes the inclusion of arm’s length debt or a conversion to an earnings stripping approach as structural reforms, and considers their appropriateness for Canada in comparison with the current approach. To do so, this report reviews the tax treatment of interest expense as one aspect of the allocation of tax revenue from cross-border investment between a source state and a residence state; the use of thin capitalization rules as a transfer pricing technique as the rules attempt to protect the source-country tax base by only allowing the deduction of “reasonable” interest benchmarked against arm’s length standards; and the current Canadian approach. Various alternatives are presented: the introduction of a generalized rule of non-deductibility for interest on related party debt; an earnings stripping rule; the extension of thin capitalization rules to interest on arm’s length debt (including approaches to specifying a leverage ratio); and potential amendments to the existing thin capitalization rules to enhance their effectiveness in limiting the use of tax-driven debt.

The paper provides a review and analysis of the normative economic considerations, tax policy issues and options relevant to the tax treatment under an exemption system of expenses incurred to earn foreign source business income. Particular emphasis is placed on the tax treatment of interest expense incurred by domestic companies that earn exempt foreign source business income through foreign subsidiaries and foreign branches. The paper evaluates the efficiency properties of alternative expense deduction rules for countries in which expenses are incurred.

This paper examines some of the economic issues associated with the imposition of withholding taxes on cross-border income flows between Canada and other countries. Its primary focus is on the investment and revenue effects of eliminating, or reducing, withholding taxes on dividends, interest, rent and royalties.

This report identifies and compares types of treaty shopping, anti-treaty shopping policies and trends in Canadian and international jurisprudence to provide a general assessment of the law on access to tax treaty benefits. The report provides an overview of the OECD Model Tax Convention on Income and Capital, of Canada’s two systems of international taxation and of the purpose of tax treaties. It also provides an analysis of the beneficial owner provisions of tax treaties with reference to two OECD reports, Double Taxation Conventions and the Use of Conduit Companies and Double Taxation and the Use of Base Companies, and the evolving commentaries on the OECD Model. Through a survey of recent judicial decisions and writings on the abuse of rights principle in international law, the status of the principle and its application to tax treaties is examined, followed by a discussion of the application of Canada’s general anti-avoidance rule to tax treaties. This serves to distinguish between the abuse of rights principle in international law and the abuse of tax treaties concept under the general anti-avoidance rule in so far as either could be used to ascertain whether access to tax treaty benefits is appropriate. Finally, the report provides an analysis of the limitation on benefits articles that the United States has included in its tax treaties to deal with treaty shopping.

This report discusses the collection and management of taxpayer information by the government in the international tax area. It offers a preliminary review of certain issues that have been identified with respect to specific forms and returns and to specific systems or processes, and discusses certain options to address these issues.