Tax discrimination and trade in services: the search for a balance in Canada-U.S. relations.

Author:Brown, Catherine
 
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  1. OVERVIEW II. THE MOVE AGAINST DISCRIMINATION IN TRADE IN SERVICES A. General Agreement on Trade in Services 1. Overview 2. Most-Favoured-Nation Treatment 3. National Treatment B. The North American Free Trade Agreement 1. Overview 2. Taxation 3. Performance Requirements C. Canada-U.S. Treaty 1. Overview 2. Article V: Permanent Establishment 3. Article VII: Business Profits 4. Article XV: Income from Employment 5. Article XXV: Non-Discrimination III. TAXATION OF FOREIGN SERVICES AND SERVICE SUPPLIERS BY CANADA AND THE UNITED STATES A. The Case of Canada Hypothetical 1 (a) What are the tax consequences for Sam if he earns income in Canada as an independent contractor? How do these differ from those of a Canadian resident? (b) What additional Canadian tax issues arise if Sam requires employees or other subcontractors from the United States to deliver the services in Canada? What additional tax obligations, if any, are created for Sam and for Sam's employees? (c) What additional tax obligations will CanCo be subject to if it hires Sam as opposed to a Canadian resident service supplier? Hypothetical 2 Hypothetical 3 B. The Case of the United States Hypothetical 1 (a) What are the tax consequences for Cathy if she earns income in the United States as an independent contractor? How do these differ from those of a U.S. resident? (b) What additional U.S. tax issues arise if Cathy requires employees or other subcontractors from Canada to deliver the services? What additional tax obligations, if any, are created for Cathy and for Cathy's employees? (c) What additional tax obligations will USCo be subject to if it hires Cathy as opposed to a U.S. resident service supplier? Hypothetical 2 Hypothetical 3 IV. NON-DISCRIMINATION: THE BOTTOM LINE V. CONCLUSION I. OVERVIEW

    Canada and the United States are each other's largest trading partners. (1) Through NAFTA, they also form, along with Mexico, the largest free trade block in the world. (2) An important part of that trade is trade in services, which in large measure has been facilitated by trade agreements. Beginning with the Free Trade Agreement, (3) signed in 1988, the North American Free Trade Agreement (NAFTA), (4) signed in 1992, and the World Trade Organization (WTO) Agreement, (5) signed in 1994, both Canada and the United States have committed to reducing non-tariff barriers to trade in services between the two countries and to facilitate conditions of fair competition. (6) This includes significant commitments with respect to most-favoured-nation (MFN) treatment and national treatment (NT) for each other's service providers. (7)

    The potential benefits of these trade commitments to service providers may, however, be significantly undercut by broad exceptions for direct taxation measures, (8) which include matters involving potential tax discrimination. (9) The result is that differences in tax treatment between resident and nonresident service providers are entirely permissible under both tax and trade agreements, including measures that may negatively impact the cross-border service provider's ability to compete. (10)

    The issue of differences in tax treatment, particularly if those differences impact the ability of service providers to effectively compete in the other country, is especially important when examined against the reality that the domestic tax regimes in both Canada and the United States are rife with tax provisions that differentiate between resident and nonresident aliens, domestic and foreign corporations, and domestic and foreign activities. (11) Of specific importance to service providers may be a growing trend by both governments to enact tax legislation that might be regarded as protectionist or discriminatory. (12) Obvious examples in this regard are the findings by the WTO of trade violations by the United States in their tax legislation with the ultimate enactment of the American Jobs Creation Act in 2004. (13) Canada for its part has enacted legislation that provides both better tax rates and tax incentives for Canadian-controlled businesses and Canadian resident taxpayers. (14)

    Tax legislation is not the only factor that may affect conditions of competition. Administrative practices may also negatively impact cross border service providers. (15) The taxing agencies of both Canada and the United States are given broad discretion in establishing administrative practices that can increase the impact of tax provisions already negatively affecting a cross-border service provider. It is no surprise that the imposition of gross withholding taxes (16) on nonresident service fees may interfere with the ability of the service supplier to do business in the other country. Conversely, the ability to secure a waiver or exemption from withholding tax in circumstances where there is no ultimate tax liability in the other country will clearly benefit the service provider. (17)

    Further, administrative practices are also subject to sudden change. For example, the Canada Revenue Agency (CRA) (18) abruptly changed its administrative policy in late 2003 regarding the amount and method of withholding for fees paid to nonresident directors of Canadian corporations. (19) Few would question the CRA's fight to make this change. No specific trade commitments extend to administrative practices other than that the practices must not constitute "arbitrary or unjustifiable discrimination" (20) or a "disguised restriction on trade in services." (21) However, because issues with respect to direct taxation largely fall outside the discipline of trade agreements, no international regulatory framework exists within which such administrative practices are monitored. (22)

    Tax measures will impact the competitive position of cross-border service providers. An important question, assuming that differences in tax treatment remain permissible despite commitments to non-discrimination made in trade agreements, is whether the potentially negative impact of such tax measures on cross-border service providers is acceptable in the context of the trade relationship between Canada and the United States. Put differently, is it time for Canada and the United States as trade partners to re-examine the question of what should he permissible and what should be considered tax discrimination in the trade in services? (23)

    This article answers these questions. It begins with an outline of the commitments to non-discrimination made by Canada and the United States in the WTO and the NAFTA Agreements with respect to nonresident and non-national service providers. These provide a benchmark against which to measure the extent of trade commitments to nondiscrimination in trade in services. The article then considers the articles of the Canada-U.S. Income Tax Treaty (Canada-U.S. Treaty) (24) that most impact cross-border service providers and the extent to which these provide protection against tax discrimination. The article next examines Canadian and U.S. federal tax legislation and administrative practices through a series of hypotheticals. As will be seen, in most cases, differences in tax treatment based on statutory provisions, including those that prima facie violate the NT and MFN treatment obligations adopted in trade agreements, are permissible under exceptions provided in those agreements. The answer is not always as obvious with respect to administrative practices. The article also considers whether additional steps should be taken to respond to the challenge of differences in tax treatment that may negatively impact the ability of service providers to compete in each other's markets, especially given our role as major trading partners.

  2. THE MOVE AGAINST DISCRIMINATION IN TRADE IN SERVICES

    What was promised: Non-discrimination

    Non-discrimination is one of the basic principles of most multinational trade agreements and the foundation for the MFN (25) and NT (26) obligations incorporated into such agreements. The need to include non-discrimination provisions with respect to trade in services was acknowledged in both the WTO Agreement and the NAFTA. (27) The MFN obligation, as applied to trade in services, requires that a host country tax foreign service providers from one country no less favorably than those from another. (28) The NT obligation requires that the host country treat foreign service providers and domestic service providers similarly or comparably, including the branches and subsidiaries of foreign investors. (29) The protection provided by the MFN and NT provisions in any trade agreement is, however, limited by the exceptions attached to them. (30)

    What was not promised: Permissible Tax Discrimination

    Canada and the United States undertook significant obligations in the WTO Agreement and the NAFTA with respect to non-discrimination with respect to each other's service providers and entered into a bilateral tax treaty. Each of these agreements plays a potentially significant role in the cross trade in services. Both the WTO Agreement and the NAFTA limit or exclude MFN and NT obligations with respect to direct taxation. (31) There are a number of stated reasons for so doing, ranging from the protection of tax sovereignty (32) to the issue of potential "free riders" under already negotiated tax treaties. (33) The signatories did not entirely ignore the possibility of discrimination with respect to direct taxes. Instead, the trade agreements largely defer to the tax treaties between individual countries in matters of tax discrimination. (34) In addition, a number of other specific exceptions and exclusions with respect to tax measures are included in both the WTO Agreement and the NAFTA. (35)

    The United States and Canada signed the current version of the Canada-U.S. Treaty in 1980. The treaty and its related protocols entered into force four years later, after it was ratified by the respective countries. (36) The Canada-U.S. Treaty has been subject to five protocols...

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