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Taxable in Canada? Not a Black and White Situation

In Black v. The Queen (2014 TCC 12), Lord Conrad Black argued that he was not subject to tax in Canada on certain income and taxable benefits. Both Lord Black and the CRA agreed that he was a resident of both Canada and the U.K. in 2002, and that under Article 4(2)(a) of The Canada-United Kingdom Income Tax Convention (the “Convention”) he was a “deemed” resident of the U.K. for the purposes of the Convention.

Lord Black had filed his Canadian tax return for 2002 on the basis that some $800,000 of income from the duties of offices or employments performed by him in Canada was taxable in Canada. However, Lord Black did not include certain other remuneration and benefits totalling $5.1 million in his Canadian income, including some $2.8 million of income from the duties of offices or employments performed outside Canada, $326,177 of taxable dividends, $365,564 of shareholder benefits, and $1.3 million of benefits arising as a result of his use of an airplane owned by Hollinger International Inc.

At the Tax Court hearing, Lord Black argued that by virtue of his “deemed” U.K. residency these other amounts were not taxable in Canada. As it happens, since he was not domiciled in the U.K., Lord Black was subject to tax in the U.K. only on the portion of his non-U.K. source income that was remitted to or received in the U.K.

The CRA alleged that, notwithstanding Lord Black being deemed a U.K. resident for the purposes of the Convention, he was subject to Canadian tax on income and benefits that were not covered by the Convention.

The Tax Court dismissed Lord Black’s appeal and held that he could be a deemed resident of the U.K. for purposes of the Convention and also be a resident of Canada for purposes of the Canadian Income Tax Act. Chief Justice Rip noted that the arguments presented on behalf of Lord Black had no supporting authority and were contrary to the liberal and purposive approach that must be taken when interpreting a tax treaty.

In applying a liberal and purposive approach to Article 4(2) of the Convention, the Tax Court noted that the tie-breaker rule at issue merely provided a preference to the taxing authority of the U.K., but did not extinguish Canada’s claim to tax. Lord Black’s argument that there was an inconsistency between the Income Tax Act and the Convention was incorrect as it did not take into account the role of Article 4 in allocating taxing jurisdiction to avoid double taxation. As such, Lord Black was unable to point to any provision in the Convention that would result in double taxation if he were resident in Canada.

Lord Black also sought to rely on Article 27(2) of the Convention, which addressed the tax treatment of non-domiciled residents of the U.K. who are required to pay tax on foreign income only when received in the U.K. Article 27(2) essentially provides that where a person is subject to income tax in the U.K., and the Convention provides for tax relief in Canada, the tax relief will only be in respect of the amount of income that is actually taxed in the U.K. Thus, Lord Black argued that the Minister could not assess his non-Canadian income because none of the income was remitted or received in the U.K., and so there was no tax from which he could have been relieved in Canada.

Since the Tax Court had already determined that Lord Black was a resident of Canada for purposes of the Income Tax Act, the argument based on Article 27(2) could not succeed. The Tax Court agreed with the CRA that the Convention allocates the right to tax between Canada and the U.K. on an item-by-item basis, and any items not covered by the Convention were thus subject to tax on the basis of Lord Black’s residence in Canada. As a resident of Canada, Lord Black was subject to tax on his worldwide income, including income earned in the U.S.

We note that both parties agreed that subsection 250(5) of the Act, which deals with the deemed non-residency of a Canadian where the individual is deemed to be a resident in another country by virtue of a tax treaty, did not apply. This was because of the “grandfathered” application of subsection 250(5) (i.e., the provision is not applicable to a Canadian resident individual who was (i) a resident of two countries and (ii) deemed resident of one of those countries under a tax treaty at the time the subsection became effective in 1999). If subsection 250(5) had applied, then Lord Black would not be a resident of Canada for the purposes of the Income Tax Act.

On January 22, 2014, Lord Black filed his appeal in the Federal Court of Appeal (File No. A-70-14).

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Taxable in Canada? Not a Black and White Situation

CRA Provides Update on Audit Priorities and Activities

At the Canadian Tax Foundation’s recent Ontario Tax Conference (October 29-30), the Canada Revenue Agency provided an update on its current audit priorities and activities as part of the conference’s “Tax Administration Panel“.

The CRA was represented by Fiona Harrison, Manager of the Resources Section at the CRA’s Income Tax Rulings Directorate, and Jeff Sadrian, National Director of the CRA’s Large Business Audit Programs.

In the course of the presentation, the CRA discussed a variety of issues (see the “Tax Administration Panel” conference slides), including “red tape” reduction, the CRA’s trust audit project, Regulation 105 waivers, ABIL claims, and omission penalties under s. 163(1). The CRA confirmed that it determines audit priorities based on the “highest risk”, and that it is continuing its “intelligence-based risk assessment” of taxpayers to determine which files will be selected for audit.

Other highlights included:

  • Folios – The CRA considers many existing Interpretation Bulletins to be out of date. The CRA intends to reorganize the information in the existing publications in new Folio chapters (i.e., all information relating to specific subjects will be “grouped” together). The CRA plans to update the Folios on an on-going basis, and the first 10-12 Folio chapters are likely to be published before the end of 2012.
  • Entity Classification - In a reversal of an earlier position (see, for example, CRA Document No. 2011-0415141E5 “Tax status of a German Family Trust” (August 4, 2011)), the CRA will once again accept requests for rulings on the classification of foreign entities.
  • Inter-Provincial Trusts – Where a trust claims to be resident, and pays tax, in one province, and the trust is later reassessed as resident in another province, the CRA will reassess the trust only for the difference between the tax paid in the first province and the tax owing in the second province.
  • U.S. LLCs – The CRA continues to disagree with the Tax Court’s decision in TD Securities (USA) LLC. v. The Queen (2010 TCC 186). The CRA’s view is that a fiscally-transparent U.S. LLC does not qualify as a resident of the U.S. for the purposes of the Canada-U.S. Tax Treaty, and is not a “qualifying person” under Article XXIX-A of the Treaty.
  • Section 56(2) – The CRA stated that it is aware of “elaborate arrangements” utilized to divert business income to family members. The CRA stated that, where such arrangements include the use of a trust, section 56(2) may be applied in respect of distributions from the trust provided the requirements of the provision are otherwise met (see Neuman v. The Queen (98 D.T.C. 6297 (S.C.C.)). In other words, the CRA may apply s. 56(2) to the actions of a trustee.

(The Tax Administration Panel conference slides are republished with permission of the Canadian Tax Foundation.)

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CRA Provides Update on Audit Priorities and Activities

New Guidance from the OECD on the Meaning of “Beneficial Owner” for Tax Treaty Purposes

Taxpayers and their advisors should be aware of a significant new development concerning the appropriate withholding tax rate on the payment of cross-border interest, royalties and dividends.

On October 19, 2012, the Organisation for Economic Cooperation and Development (the “OECD”) released a revised discussion draft concerning the meaning of “beneficial owner” for the purposes of Articles 10, 11 and 12 of the OECD’s model tax convention (the “OECD Model”). The discussion draft builds on the OECD’s prior discussion draft (released on April 29, 2011), which received widespread international criticism for its ambiguity and lack of meaningful guidance on this fundamental issue of international taxation.

Background

Canada’s Income Tax Act (the “Act”) requires that a Canadian company withhold 25 percent of dividends, interest and royalties paid to non-residents and remit this amount to the Canada Revenue Agency (the “CRA”) on behalf of the non-resident. However, Canada has entered into numerous bilateral tax treaties with various countries that reduce or eliminate the withholding tax. To benefit from these reductions or eliminations of Canadian withholding tax, the treaties generally require (among other things) that the recipient qualify as the “beneficial owner” of the amount paid.

Canada’s tax treaties are generally based on the OECD Model, which, together with its commentaries, generally provide that a resident of a contracting state will be the beneficial owner of an amount received from a resident of the other contracting state so long as the recipient was not acting in its capacity as an agent, nominee, fiduciary or administrator on behalf of a person not resident in that state.

However, there is surprisingly little additional insight into the intended meaning or possible interpretations of this term. There is a growing body of Canadian and international jurisprudence on the issue, with the Canadian case of Prevost Car, Inc. v. The Queen (2009 D.T.C. 5053 (F.C.A.), aff’g 2008 D.T.C. 3080 (T.C.C.)) currently serving as the high-water mark.  Nevertheless, inconsistencies remain in the manner in which different states interpret and apply “beneficial owner” (see also the earlier article by FMC’s Matt Peters on Velcro v. The Queen (2012 TCC 57)) .

OECD Guidance

Instead of clarifying the issue, the OECD’s prior discussion draft was roundly criticised for adding further uncertainty to the meaning of “beneficial owner”. In the prior draft, the OECD emphasized the desire to introduce a meaning that could be universally accepted and applied by all countries.  In this respect, the prior draft focused on assessing the recipient’s ability to have the “full right to use and enjoy” dividend, interest or royalty income and stated that a recipient will not be the beneficial owner if its powers are constrained by a contractual or legal obligation to pass the payment received to another person.  Many commentators suggested that this approach was too broad and ambiguous and left taxpayers with little certainty when structuring their affairs.  Moreover, the exact role of a country’s domestic law meaning of “beneficial owner” was left somewhat open.

The new draft attempts to clarify the issue by (i) more strongly abandoning the relevancy of any particular state’s domestic law meaning of “beneficial owner”; and (ii) providing further guidance as to what is meant by the right to use and enjoy an amount unconstrained by contractual or legal obligations.  The revised draft reviews in some detail the comments received by the OECD on it’s prior draft and explains in more detail (and through examples) the rationale behind its approach.

Next Steps

This is a controversial issue and the approach adopted by the OECD in its revised discussion draft will undoubtedly stir debate in the international tax arena.  The OECD has indicated that it will be accepting comments on the revised draft before 15 December, 2012, suggesting that another revised draft will likely be released in 2013.  Tax practitioners and their clients will need to carefully consider the approach that contained in the OECD’s revised draft and assess whether it presents any risks in their particular circumstances.

* Special thanks to Christian Orton, Articling Student, for his valuable contributions to this article. 

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New Guidance from the OECD on the Meaning of “Beneficial Owner” for Tax Treaty Purposes

Canada’s Sommerer Decision and Double Taxation

A recent decision of Canada’s Federal Court of Appeal provides insight on the application of the country’s tax treaties to income that is attributed to a Canadian resident taxpayer under the Income Tax Act (Canada). Also, the court made useful comments on the classification of an Austrian private foundation (privatstiftung) for domestic Canadian tax purposes.

In Peter Sommerer v. The Queen, 2012 FCA 207, the court affirmed the decision of the Tax Court of Canada (2011 TCC 212) finding that gains realized on dispositions of shares by an Austrian private foundation were not taxable in the hands of an individual beneficiary of the foundation on the basis that either (a) the gains could not be attributed to the Canadian individual under the ITA’s attribution rules or (b) the capital gains article of the Austria-Canada Income Tax Convention of 1976, as amended, prohibited Canada from taxing the gains.

To read the full article by Jesse Brodlieb, Matthew Peters, and Tony Schweitzer, as published in Tax Notes International, Vol. 67, Number 6, August 6, 2012, please click here. For our earlier blog post on the decision, please click here.

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Canada’s Sommerer Decision and Double Taxation

Federal Court of Appeal: Canada Cannot Tax Treaty Income Twice

It is trite law that one of the main purposes of tax treaties is to prevent double taxation of the same income. In Canada this principle has often been treated with a grain of salt since Canadian domestic rules do not bar double taxation and, in fact, the Canada Revenue Agency often resorts to double taxation where, for example, a shareholder appropriation is disallowed as a corporate expense while fully taxed in the shareholder’s hands.

The recent decision of the Federal Court of Appeal in The Queen v. Sommerer illustrates a refreshing approach to the concept of double taxation, at least in the context of Canada’s network of bilateral tax treaties based on the OECD Model Convention (and, to a lesser extent, the UN Model Convention).

Mr. Sommerer was at all material times a resident of Canada. He was a contingent beneficiary of an Austrian Privatstiftung (the “Sommerer Private Foundation”) created by his father in 1996. The Sommerer Private Foundation was at all material times a resident of Austria for the purposes of the Canada-Austria Tax Treaty. The facts that gave rise to the assessments under appeal are summarized by Sharlow JA as follows:

[30] On October 4, 1996, Peter Sommerer sold to the Sommerer Private Foundation 1,770,000 shares of Vienna Systems Corporation (the “Vienna shares”) for their fair market value of $1,177,050 (66.5¢ per share). The Sommerer Private Foundation paid $117,705 of the purchase price on the date of the agreement and was legally obliged to pay the remainder at a later date, with interest. The sale was unconditional. The cash portion of the purchase price was paid using part of the initial endowment from Herbert Sommerer (paragraphs 67 and 88 of Justice Miller’s reasons).

[31] In December of 1997, the Sommerer Private Foundation sold 216,666 of the Vienna shares for $4.50 per share to three individuals unrelated to the Sommerer family, realizing a capital gain. In December of 1998, the Sommerer Private Foundation sold the remaining Vienna shares to Nokia Corporation for $9.00 per share, realizing a further capital gain.

[32] In April of 1998, Peter Sommerer sold to the Sommerer Private Foundation, unconditionally, 57,143 shares of Cambrian Systems Corporation (the “Cambrian shares”) for $100,000 (approximately $1.75 per share). In December of 1998, the Sommerer Private Foundation sold the Cambrian shares to Northern Telecom Limited for $14.97 (US) per share, plus a further $4.12 (US) per share conditional on certain milestones being met in 1999. That sale resulted in another capital gain for the Sommerer Private Foundation.

CRA assessed Mr. Sommerer on the basis of subsection 75(2) of the Income Tax Act alleging that the proceeds from the sale of the shares by the Foundation could possibly revert to Mr. Sommerer. Both Justice Campbell Miller in the Tax Court of Canada and Justice Sharlow in the Court of Appeal rejected that interpretation holding that subsection 75(2) could not apply on a sale of property at fair market value.

Justice Sharlow did not stop there however. She went on to agree with Miller J. that the position advocated by CRA violated the Treaty’s fundamental principle of avoiding double taxation:

[66] The OECD model conventions, including the Canada-Austria Income Tax Convention, generally have two purposes – the avoidance of double taxation and the prevention of fiscal evasion. Article XIII (5) of the Canada-Austria Income Tax Convention speaks only to the avoidance of double taxation. “Double taxation” may mean either juridical double taxation (for example, imposing on a person Canadian and foreign tax on the same income) or economic double taxation (for example, imposing Canadian tax on a Canadian taxpayer for the attributed income of a foreign taxpayer, where the economic burden of foreign tax on that income is also borne indirectly by the Canadian taxpayer). By definition, an attribution rule may be expected to result only in economic double taxation.

[67] The Crown’s argument requires the interpretation of a specific income tax convention to be approached on the basis of a premise that excludes, from the outset, the notion that the convention is not intended to avoid economic double taxation. That approach was rejected by Justice Miller, correctly in my view. There is considerable merit in the opinion of Klaus Vogel, who says that the meaning of “double taxation” in a particular income tax convention is a matter that must be determined on the basis of an interpretation of that convention (Klaus Vogel on Double Taxation Conventions: A Commentary to the OECD –, UN –, and US Model Conventions for the Avoidance of Double Taxation on Income and Capital, 3rd ed. (The Hague: Kluweer Law International, 1997)).

[68] I see no error of law or principle in the conclusion of Justice Miller that Article XIII (5) applies to preclude Canada from taxing Peter Sommerer on the capital gains realized by the Sommerer Private Foundation.

Unless this case is reversed by the Supreme Court of Canada (at the date of this comment, no leave application has been filed), it is likely to be a very important precedent for tax practitioners plying their craft in the highly complex area of international tax treaties.

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Federal Court of Appeal: Canada Cannot Tax Treaty Income Twice

South African Tax Case Considers Application of Capital Gains Treaty Exemption to Deemed Disposition

A recent decision of the Supreme Court of Appeal of South Africa considered the application of the capital gains article in a double tax convention based on the OECD model to a deemed disposition of property occurring as a result of an “exit tax” imposed on an emigrating corporation. As the Court’s decision concerns capital gains exemption language that is similar to that used in most double tax treaties based on the OECD Model, it provides a helpful glimpse into how such provisions may be interpreted in other jurisdictions, including Canada.

In Commissioner for the South African Revenue Service v. Tradehold Ltd [2012] ZASCA 61, the Supreme Court of Appeal of South Africa (the “Court”) considered whether Article 13(4) of the Luxembourg-South Africa Tax Convention (the “Convention”) applied to exempt a deemed disposition arising under South Africa’s domestic “exit tax” from being subject to tax in South Africa.

The taxpayer, Tradehold Ltd. (“Tradehold”), was a publicly-listed holding corporation incorporated in South Africa. Under the domestic legislation, Tradehold was deemed to be a resident of South Africa by virtue of having been incorporated there. On July 2, 2002, the board of directors of Tradehold, at a meeting in Luxembourg, resolved that all further board meetings of the corporation would be held in Luxembourg. As a result, Tradehold became resident in Luxembourg under common law principles. Nonetheless, under South African legislation at the time, the corporation remained resident in South Africa.

As a dual resident corporation, the Convention’s “tie breaker” rule provided that Tradehold was deemed to be resident solely in Luxembourg for Convention purposes. A change to the definition of ‘resident’ under the South African domestic law to exclude a corporation that is “deemed to be exclusively a resident of another country for purposes of the application” of one of South Africa’s tax conventions, including the Convention, subsequently took effect on February 26, 2003.

The Commissioner assessed Tradehold on the basis that when Tradehold’s seat of effective management was relocated to Luxembourg, or when the domestic legislative change resulted in the corporation ceasing to be a deemed resident of South Africa, Tradehold was deemed to have disposed of its only relevant asset, namely, 100% of the shares of a subsidiary corporation, under South Africa’s departure tax. The result was a deemed capital gain in excess of R400,000,000.

At the Tax Court, the taxpayer argued that the deemed disposition was exempt from South African tax pursuant to Article 13(4) of the Convention, which designated the right to tax capital gains on most non-immovable property to the state of residence and not the source state. It was argued by Tradehold that the exemption was available because at the time of the deemed disposition the Convention tie breaker rule applied to deem Tradehold to be resident in Luxembourg only. The Tax Court rejected the Commissioner’s argument that the exemption in the Convention, which excluded “gains from the alienation of property” did not apply to a deemed disposition, as a deemed disposition was not an “alienation” for these purposes.

On appeal to the Supreme Court of Appeal, which is the highest court in South Africa for non-constitutional matters, the Commissioner again argued that the Convention did not provide an exemption for deemed dispositions, on the basis that a deemed disposition is not an “alienation”. The Commissioner argued that if Article 13(4) of the Convention applied, South Africa’s exit tax would be ineffective for corporations that migrate to a country with which South Africa has entered into a double tax treaty; it was argued that this could not have been the intention of the legislature. In addition, the Court considered the Commissioner’s argument that since the deeming provision in the domestic legislation provided that it applied “for purposes of this Schedule”, it could not apply to the Convention.

The Court held that the Convention modified South Africa’s domestic law and, as a result, it was necessary to determine whether the exit tax could be imposed consistently with the obligations entered into by South Africa when it signed the Convention. The Court noted that the Convention did not draw a distinction between capital gains arising from actual or deemed dispositions, despite the drafters of the Convention having been aware that the provisions of South Africa’s domestic taxing statute could result in deemed dispositions. The Court also found that there was no reason in principle why the parties to the Convention would have intended that Article 13(4) would apply only to taxes arising on actual capital gains arising from actual alienations of property. Accordingly, the Court found that the language of the Convention covered deemed dispositions and, therefore, the exit tax did not apply to Tradehold upon its ceasing to be resident in South Africa.

This decision has prompted the South African Minister of Finance, Pravin Gordhan, to state that he will consider whether legislative changes are necessary “to further clarify that a DTA does not apply to deemed or actual disposals while a taxpayer is resident in South Africa. Measures such as the immediate termination of a taxpayer’s year of assessment on the day before becoming non-resident, as is the practice in Canada, are being explored.” It is by no means clear however that the Canadian model would survive the analysis in Tradehold.

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South African Tax Case Considers Application of Capital Gains Treaty Exemption to Deemed Disposition

Argument concludes in Supreme Court of Canada in trust residence appeal (Garron)

Earlier today, the Supreme Court of Canada heard arguments in the Garron appeal.  The reasons for judgment of the Tax Court of Canada and the Federal Court of Appeal, as well as the factum of each party, may be found at our earlier post.

Appellants’ Oral Argument

Counsel for the Appellants argued that the Income Tax Act contemplates that the residence of a trust is to be determined by the residence of the trustee.  It does so through a combination of subsections 104(1) and 104(2).  As a trust itself has no legal personality, Parliament has created a ”deemed individual” character for trusts in the form of the trustee under subsection 104(2).  In the Appellants’ view, subsection 104(1) is critical as it provides the “linkage” between the trust and the trustee.

Justice Abella wondered whether the phrase “ownership or control” in subsection 104(1) suggests that Parliament intended that the “control” test apply in the context of determining the residence of a trust, as the Crown contends.

Justices LeBel and Karakatsanis wondered why one would look to the residence of the trustee when, under subsection 104(2), the trust is considered a separate person.

Justice Rothstein wondered why a trust should be treated differently than a corporation in the sense that both are created in similar ways and both have similar “locational attributes”.  In other words, why can’t we locate the trust outside the place the trustee resides?

Justice Moldaver wondered whether the phrase “unless the context otherwise requires” in subsection 104(1) suggests that Parliament did not want trustees to be set up as straw men outside Canada simply to avoid tax.  Counsel for the Appellants responded that the phrase “unless the context otherwise requires” means that in a provision where it makes no sense for “trust” to mean “trustee” it does not mean “trustee” (e.g. subsection 108(6)).  He also responded that Parliament addresses avoidance concerns elsewhere in the Income Tax Act, including section 94.  He submitted that the rule for the determination of residence of a trust is not the answer to tax avoidance.

Counsel for the Appellants drew to the Court’s attention the (a) affiliated persons rule and (b) qualified environmental trusts rule as both deal with the residence of trustees (as opposed to the residence of trusts).  This makes it clear that the residence of the trustees is what really matters and confirms the “linkage” between trust and trustee.

Counsel for the Appellants also noted that the plan undertaken in this case would not work today in light of the amendments to section 94 of the Income Tax Act and the provisions of the Income Tax Conventions Interpretation Act.

Justice Abella asked whether, in light of the fact that both corporations and trusts manage property, the test ought to be the same for each (i.e. the central management and control test) and where they manage the property should be determined in the same way for both.  Counsel for the Appellants characterized such an approach as “superficial”.

Finally, counsel for the Appellants argued that adoption of the “formalistic” central management and control test will not eliminate the possibility of manipulation.  One could arrange that all meetings at which substantive decisions are made occur outside Canada.  Accordingly, there is no reason to prefer that test over the traditional residence of the trustee test.

Crown’s Oral Argument

Counsel for the Crown argued that the central management and control test is the proper test for determining the residence of a trust for income tax purposes.  She argued that such a test is consistent with the legislative scheme.  She also argued that the rationale for the application of the test in the trust context is the same as the rationale for the application of the test in the corporate context.

Justice Moldaver asked, if Parliament intended the same rule to apply to trusts as to corporations, why the Income Tax Act did not provide that a trust is deemed to be a  corporation rather than an individual.  Crown counsel responded that someone has to be assigned responsibility for administrative functions, as noted by the Federal Court of Appeal, and that is the trustee under subsection 104(1).  Such administrative functions include filing returns, receiving assessments, filing objections and appeals and paying tax debts of the trust.

Citing De Beers Consolidated Mines, Justice Rothstein asked what the result would be if those who actually controlled the trusts met in Barbados and that is where they made all the substantive decisions (i.e. the key decisions affecting the trust property).  After noting that you can’t just leave Canada in order to “paper” such decisions if they were actually made in Canada, Crown counsel admitted that such a trust would be resident in the Barbados if indeed all substantive decisions were made in Barbados.

Justice LeBel asked whether one would have to perform a complete factual enquiry in order to make such a determination.  Crown counsel said yes, just as one would do in the case of a corporation in order to determine the place of central management and control.

Crown counsel listed a number of similarities between corporations and trusts particularly with respect to the managment of property as a function of each.  The question then becomes: where is that management exercised?

Justice Deschamps asked Crown counsel about the two statutory examples cited by counsel for the Appellants, namely, the affiliated persons rule and the qualified environmental trust rule.  She argued that those rules simply dictate where the trustees must reside and nothing else.

Counsel concluded by noting that the central management and control test has been applied for one hundred years and that test should now be adopted to determine where a trust is resident.

The Crown’s Alternative Arguments: Section 94 and GAAR

Junior counsel for the Appellants and the Crown spent approximately ten minutes each arguing the section 94 and GAAR points.  There were no questions directed to the Appellants on these points, but several questions were directed to the Crown.

The Crown contends that even if the trusts were resident in Canada (under either test), the trusts should be deemed not to have been resident in Canada under paragraph 94(1)(b) (the “contribution test”), as the Federal Court of Appeal concluded, on the basis that the trusts “acquired” property without actually “owning” it.  Junior counsel for the Crown was challenged on this point by Justice Rothstein.  He was also challenged when he argued that the GAAR applied.  Justice LeBel admitted that he had “some problems at this stage” with the application of the GAAR under the circumstances.  In addition, Justice Rothstein questioned whether there could be a GAAR case if all substantive decisions had actually made in the Barbados and, therefore, the trusts had satisfied the Crown’s central management and control test.  Junior counsel for the Crown responded by contending that there would be a GAAR case as such trusts, in light of the fact that they have no function to serve, would be artificial entities and devoid of economic substance.

After a very brief reply by counsel for the Appellants, judgment was reserved.

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Argument concludes in Supreme Court of Canada in trust residence appeal (Garron)

“Beneficial Owner” – CRA’s Assessment of Velcro Doesn’t Stick

The Tax Court has once again considered the meaning of the phrase “beneficial owner” for purposes of the tax treaty between Canada and the Netherlands (the “Treaty”).  It has also once again ruled in favour of the taxpayer in determining that a Dutch holding company was the “beneficial owner” of amounts received from a related Canadian company.

On February 24, 2012, the Tax Court of Canada released its eagerly-anticipated decision in Velcro Canada Inc. v. Her Majesty the Queen, which addresses the applicable Canadian withholding tax rate in respect of cross-border royalty payments within a multinational corporate group.  The decision comes almost four years after the Tax Court of Canada released its landmark decision in Prévost Car Inc. v. The Queen, which dealt with the identical treaty interpretational issue in the context of cross-border dividend payments.  The decision of the Tax Court was affirmed by the Federal Court of Appeal.

Both the Prévost Car Inc. and Velcro decisions are relevant to any multinational enterprise using a foreign holding company as an investment/financing vehicle and provide considerable comfort concerning the tax effectiveness of such structures.

The issue in Velcro was whether a Dutch holding company was the “beneficial owner” of royalties paid by a related Canadian company, and therefore entitled to a reduced rate of Canadian withholding tax under the Treaty in respect of the royalties.  Pursuant to the “beneficial owner test” described in Prévost Car Inc., this required that the Tax Court consider the following issues:

  • Did the Dutch holding company enjoy possession, use, risk and control of the amounts it received from the Canadian corporation?
  • Did the Dutch holding company act as a “conduit”, an agent or a nominee in respect of the amounts it received from the Canadian corporation?

The CRA’s position was that Dutchco was not the beneficial owner of the royalties generally because Dutchco was contractually required to remit a specific percentage of all amounts received from the Canadian corporation to its parent company located in the Netherlands-Antilles (which does not have a comprehensive tax treaty with Canada).  If the Canadian company had paid royalties directly to the Netherlands-Antilles company the royalty payments would have been subject to a 25% Canadian withholding tax.  In the CRA’s view, Dutchco was merely a collection agent for the Netherlands-Antilles company.

The Court rejected the CRA’s arguments and concluded that Dutcho was indeed the beneficial owner of the royalties.  The basis for the Court’s conclusion was that, even though Dutchco may have been contractually required to pay money onward to the Netherlands-Antilles company, it retained some discretion as to the use of the royalties while in its possession. Dutchco therefore possessed sufficient indicia of beneficial ownership while it held the royalties and could not be considered a conduit based on the “beneficial ownership test” outlined in Prévost Car Inc., which requires a lack of all discretion.

It is unclear at this time whether the CRA will appeal the Tax Court’s decision in Velcro to the Federal Court of Appeal. The tax community will continue to watch the progress of this case (if any) with great interest.

Please open the attached PDF for further information about the Velcro case.

Please visit the FMC website for prior coverage of Prévost Car Inc.

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“Beneficial Owner” – CRA’s Assessment of Velcro Doesn’t Stick

Tax Court Denies Deduction in Tower Financing Structure

Taxpayers that have implemented cross-border tower financing structures and that have claimed a Canadian tax deduction for any U.S. taxes paid should revisit their structures carefully in light of the Tax Court of Canada’s recent decision in FLSMIDTH Ltd. v. The Queen (2012 TCC 3), which is the Court’s first decision concerning tower structures.

For a more detailed review of this case, please click here.

The primary tax benefit of the typical tower structure is an interest deduction in both Canada and U.S. in respect of the same borrowing.  However, in certain tower structures, a spread is earned by a U.S. entity based on the amount of interest that is received by that entity from lower-tier entities in the structure and the amount of interest that is paid by the entity on external bank financing.  This spread is typically subject to U.S. federal income tax.

In FLSMIDTH Ltd. v. The Queen, the viability of the double interest deductions was not at issue; rather, the issue was whether an additional deduction under subsection 20(12) of the Income Tax Act (Canada) (the “Act”) was available under the Act with respect to the U.S. income tax that was paid on the spread.

Generally, the taxpayer would be entitled to the deduction under subsection 20(12) of the Act for the U.S. tax paid if two conditions were met:

1. the tax must have been paid in respect of a source of income under the Act; and

2. the U.S. tax must not reasonably be regarded as having been paid in respect of income from the share of a capital stock of a foreign affiliate of the taxpayer.

The Tax Court agreed that the U.S. tax was paid in respect of a source of income for purposes of the Act, even though that specific source of income (i.e., income that was characterized as interest for U.S. tax purposes) was not itself subject to tax under the Act; however, the Tax Court denied the deduction on the basis that the tax was in respect of income from the share of a foreign affiliate of the taxpayer.  Central to the Court’s decision was the broad interpretation that is to be given to the term “in respect of” for purposes of the Act.

Taxpayers that have implemented tower structures and that have claimed a subsection 20(12) deduction on any U.S. tax paid should reconsider their structures and contact a tax advisor to discuss the potential implications of this case in their particular circumstances.

At this time it is unclear whether the taxpayer will appeal this decision to the Federal Court of Appeal.

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Tax Court Denies Deduction in Tower Financing Structure

FCA Dismisses Saipem’s Appeal – No Discrimination for Purposes of the Canada-UK Tax Treaty

On September 6, 2011, the Federal Court of Appeal (Nadon, Trudel and Mainville, JJ.A.) heard an appeal by Saipem UK Limited (“Saipem UK”) against a decision of the Tax Court of Canada interpreting Article 22 of the Canada-UK Tax Treaty. The appeal was dismissed from the bench with costs.

The Tax Court had dismissed Saipem’s appeal and held that subsection 88(1.1) of the Income Tax Act does not discriminate on the basis of nationality since the determination of whether a corporation is a “Canadian corporation” is not dependent on a corporation’s nationality (i.e., a corporation incorporated outside Canada may be a Canadian resident based on the “management and control” test).

Mr. Justice Nadon delivered the following reasons for judgment:

[1] Notwithstanding Mr. Lefebvre’s forceful arguments, we have not been persuaded that the judge made any error which would allow us to intervene.

[2] More particularly, with regard to article 22(1) of the Canada – United Kingdom Tax Convention (the Tax Treaty), we are all of the view, substantially for the reasons given by the judge, that the provisions of the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.) as amended, at issue discriminate on the basis of residency and not nationality and, as a result, do not constitute discrimination against the Appellant under the Tax Treaty. With regard to article 22(2) of the Tax Treaty, we are all of the view, also for the reasons given by the judge, that the provisions at issue do not constitute less favourable treatment of the Appellant.

[3] In the end, Mr. Lefebvre’s argument, in effect, is that Canada should not be allowed, in the particular circumstances of this case, to discriminate against the Appellant on the basis of residency. Unfortunately, there is nothing in the Tax Treaty to support that view.

[4] Consequently, the appeal will be dismissed with costs in favour of the Respondent.

See our earlier post on the Saipem case.

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FCA Dismisses Saipem’s Appeal – No Discrimination for Purposes of the Canada-UK Tax Treaty

What Constitutes Discrimination for Purposes of the Canada-UK Tax Treaty? Saipem UK Limited v. The Queen

On September 06, 2011, the Federal Court of Appeal is scheduled to hear an appeal by Saipem UK Limited (“Saipem UK”) against a decision of the Tax Court of Canada interpreting Article 22 of the Canada-UK Tax Treaty.

Saipem UK was a UK-incorporated company and non-resident of Canada that carried on business in Canada through a PE. Saipem UK acquired Saipem Energy International Limited (SEI), another UK-incorporated company and non-resident of Canada that carried on business in Canada through a PE. SEI was wound-up into Saipem UK under section 88 of the Canada Income Tax Act, and Saipem UK  deducted certain non-capital losses of SEI pursuant to subsection 88(1.1). The Minister of National Revenue disallowed the deduction by Saipem UK on the basis that the corporations were not “Canadian Corporations” (i.e., incorporated or resident in Canada) as required by subsection 88(1.1).

Before the Tax Court, Saipem UK argued that subsection 88(1.1) violated Article 22 of the Canada-UK Tax Treaty, which prohibits a Contracting State from discriminating against a non-resident taxpayer on the basis of nationality.

The Tax Court dismissed Saipem UK’s appeal and held that subsection 88(1.1) does not discriminate on the basis of nationality since the determination of whether a corporation is a “Canadian Corporation” is not dependent on a corporation’s nationality (i.e., a corporation incorporated outside Canada may be a Canadian resident based on the “management and control” test).

For the appellant’s notice of appeal, see the Notice of Appeal of Saipem UK Limited.

For the written submissions of the appellant, see the Memorandum of Fact and Law of Saipem UK Limited.

For the written submissions of the respondent, see the Memorandum of Fact and Law of the Crown.

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What Constitutes Discrimination for Purposes of the Canada-UK Tax Treaty? Saipem UK Limited v. The Queen