As the regulation of international investment planning has become a topic of growing global importance, one of the issues which governments continue to consider is the use of tax treaties for inbound and outbound tax planning purposes; in particular, how to regulate the selection of particular tax treaties by taxpayers for the purpose of accessing preferential treaty benefits in the context of their particular investment structures.
This selective process, sometimes referred to as “treaty shopping”, has gained considerable attention with the coming into force of the OECD’s Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). One of the primary purposes of the MLI is to address “aggressive” international tax planning strategies that “artificially” shift profits to low or no-tax jurisdictions. Accordingly, the MLI modifies numerous bilateral tax treaties with a view towards preventing the perceived treaty abuse that may arise when taxpayers seek to avoid tax by engaging in planning with the principal purpose of accessing treaty benefits.
Accessing Treaty Benefits In Canada
Canadian courts have considered whether the practice of taxpayers structuring their affairs in order to select particular tax treaties may trigger the application of the “general anti-avoidance rule” (GAAR) contained in Canada’s Income Tax Act (Act).
Generally, the GAAR may apply to deny a tax benefit obtained by a person in a transaction which constitutes an “avoidance transaction” – in essence, a transaction undertaken primarily for the purpose of obtaining the benefit – that results, directly or indirectly, in a misuse or abuse of the provisions of, among other things, the Act or a tax treaty.
The issue of whether the GAAR may apply to deny treaty benefits obtained by taxpayers through “treaty shopping” was considered by the Tax Court of Canada (TCC) and subsequently, the Federal Court of Appeal (FCA) in Canada v. Alta Energy Luxembourg S.A.R.L. (Alta Energy). After the taxpayer’s success at the trial and appellate levels, Canada’s Minister of National Revenue (MNR) appealed the case to the Supreme Court of Canada (SCC), which heard oral submissions on March 19, 2021. When it is released, the SCC’s decision should provide guidance with respect to the ability of investors to engage in international tax planning which seeks to leverage the benefits of favourable tax treaties. This decision should be significant in light of the MLI becoming effective for many of Canada’s tax treaties in 2020.
The Facts In Alta Energy
In 2011, Alta Resources LLC and an affiliate of The Blackstone Group formed a US joint venture, Alta Energy Partners, LLC to acquire and develop oil and natural gas properties in North America. When Alberta’s Duvernay shale formation was selected as an investment property, Alta LLC incorporated Alta Energy Partners Canada as a wholly owned Canadian subsidiary to implement the project. Alta Canada’s working interest in the Duvernay formation consisted primarily of exploration, drilling, and extraction licenses and leases issued by the Alberta government.
To improve the tax efficiency of the corporate structure, in April 2012, affiliates of Alta Resources and Blackstone formed an Alberta partnership, Alta Energy Canada Partnership, which itself subsequently formed a wholly owned corporate subsidiary in Luxembourg, Alta Energy Luxembourg S.A.R.L. Alta LLC transferred all of the shares of Alta Canada to Alta Luxembourg in a taxable transaction, although no capital gain was realised on the transfer as the tax authorities accepted that the adjusted cost base of the property was equal to its fair market value at that time.
In 2013, Alta Luxembourg sold its shares of Alta Canada to Chevron Canada Ltd., giving rise to a capital gain of approximately US$382 million. While Canada generally does not tax non-residents on gains arising from the disposition of corporate securities, gains from the disposition of shares of a Canadian corporation that derive their value principally from Canadian real or resource property are subject to tax unless the shares are listed on a designated stock exchange.
Since Alta Canada’s interest in the Duvernay formation constituted Canadian resource property under the Act, the share sale would be subject to Canadian tax unless an exemption was available under the Canada-Luxembourg tax treaty, in which case the realised gain would only be taxable in Luxembourg. Alta Luxembourg contended that the shares were excluded from Canadian tax under Article 13(4) of the Treaty, which exempts shares of companies whose Canadian real or resource property consists of property “in which the business of the company was carried on”.
The Lower Court Judgments
At trial, the MNR contended that even if Alta Luxembourg technically qualified for the exemption, the GAAR should apply to deny the tax benefit received by Alta Luxembourg, being the exemption from Canadian tax on the disposition of the shares pursuant to the Treaty. Alta Luxembourg conceded that restructuring its activities from the US to Luxembourg gave rise to a tax benefit and constituted an “avoidance transaction” but claimed that the transaction was not abusive of the Treaty.
The MNR asserted that abuse of the Treaty arose from the fact that Alta Luxembourg was formed and became the owner of the Alta Canada shares for no purpose other than to avoid Canadian tax on the realised gain. The MNR also submitted that the reorganisation constituted “treaty shopping”, which it contended was an abuse of the Treaty by default.
The TCC found that Article 13(4) reflected the outcome of a negotiation between Canada and Luxembourg, under which the countries relinquished the right to tax gains on the disposition of certain types of property in order to stimulate foreign investment by residents of the other contracting state. Since the sale of the Alta Canada shares fell within the scope of this bargain, the TCC found that the transaction was not abusive of Article 13(4).
The TCC also dismissed the MNR’s “treaty shopping” argument, finding that tax planning undertaken in order to access treaty benefits that reduce the tax which would otherwise be payable on a transaction does not in and of itself constitute abuse under the GAAR. Accordingly, the TCC found in favour of Alta Luxembourg, determining that it qualified for the Article 13(4) exemption and that the resulting tax benefit was not denied by the GAAR.
On appeal, the MNR challenged the TCC’s finding that the GAAR did not apply to the share sale. The FCA upheld the TCC’s determination, however, finding that the MNR’s submissions amounted to an argument that Article 13(4) was only intended to benefit taxpayers who were Luxembourg investors (and not merely Luxembourg residents), entities with the potential to realise income in Luxembourg, and entities with commercial or economic ties to Luxembourg. Analysing the text of Article 13(4), the FCA found that none of these limitations existed in the provision which, by its terms, applied only to residents of a contracting state, as determined under the domestic law of the state of residence, being Luxembourg. As such, the FCA determined that the sale of the Alta Canada shares did not abuse Article 13(4).
With respect to the MNR’s “treaty shopping” submissions, the FCA cited Canadian jurisprudence[i] in which the TCC determined that selecting one foreign regime over another is neither inherently proper nor improper, and that while the existence of such a selection process may be relevant in determining whether a particular transaction constitutes an “avoidance transaction” under the GAAR, it does not indicate the existence of abusive tax avoidance. As such, the FCA agreed with the TCC’s finding that “treaty shopping” does not, by default, give rise to abuse under the GAAR, and found in favour of Alta Luxembourg.
The SCC Hearing
At the SCC, the MNR contended that the FCA erred by only considering the text of Article 13(4) in determining whether the GAAR was applicable and submitted that the purpose of Article 13(4) is to allocate taxing rights between Canada and Luxembourg based on the “economic connection” of income to a particular contracting state. Even though Alta Luxembourg was a Luxembourg resident for purposes of the Treaty, the MNR submitted that the company lacked substantial economic or commercial ties to the country, and that the reorganisation amounted to “treaty shopping” which abused the provisions of the Treaty.
In response, Alta Luxembourg’s position was that an analysis of the text, context and purpose of Article 13(4) did not indicate an intention on the part of Canada and Luxembourg to depart from the bargain reached between the countries. In addition, Alta Luxembourg contended that “treaty shopping” is merely a “pejorative label for selecting the most favourable available alternative in making an investment in a foreign jurisdiction”,[ii] and that the selection of a particular treaty regime for the purpose of minimising taxes is not inherently abusive: “To find that the selection of a treaty regime in order to minimise taxes is itself abusive is to conflate the concept of ‘avoidance’ with ‘abuse’. The GAAR does not support such conflation. If an abuse is to be found, it must lie in the use of a treaty, not in the selection”.[iii]
Alta Energy And The MLI
One of the central features of the MLI is the introduction of a “principal purpose test” (PPT) to treaties which are covered by the instrument, including the Treaty. Generally, the PPT will apply to disallow direct or indirect treaty benefits derived from an arrangement or transaction where it is reasonable to conclude that one of the principal purposes of the arrangement or transaction was to obtain the benefit, unless it is established that granting the benefit in the circumstances would be in accordance with the object and purpose of the relevant treaty provisions.
Given the similarities between the GAAR and the PPT, the SCC’s decision in Alta Energy will likely provide guidance as to how the PPT should apply in cases of alleged “treaty shopping” and, correspondingly, the ability of investors to utilise investment structures which seek to leverage the benefits of favourable tax treaties. While the PPT may make treaty benefits more difficult to obtain, particularly in light of the inclusion of an explicit anti-avoidance rule in the text of a treaty itself, if the SCC agrees with the analysis of the TCC and FCA, investors should be afforded a reasonable degree of comfort that they will continue to be able to structure international investments in a manner that most appropriately achieves their investment objectives.
Elie Roth is a partner at Davies Ward Phillips & Vineberg LLP in Toronto, Ontario, and Rhonda Rudick is a partner at Davies Ward Phillips & Vineberg LLP in Montreal, Quebec. The authors would like to thank Andrew Helsdon of Davies Ward Phillips & Vineberg LLP in Toronto, Ontario for his assistance.
[i] MIL (Investments) SA v. The Queen, 2006 TCC 460, aff’d 2007 FCA 236.
[ii] Factum of the Respondent (SCC), at para 91.
[iii] Factum of the Respondent (SCC), at para 92.
Elie S. Roth is a partner in the taxation law practice group in Toronto. Elie’s practice concentrates on all aspects of domestic and international tax planning, corporate taxation, and private client matters. He has also represented taxpayers in tax audits and tax litigation proceedings at all levels of Canadian courts including the Supreme Court of Canada. Elie is co-author of the textbook Canadian Taxation of Trusts (Canadian Tax Foundation, 2016), among other books and publications. He is a member of the IFA Canada council, a former governor of the Canadian Tax Foundation, a council member and member of the Taxes Committee of The International Academy of Estate and Trust Law, and an International Fellow of ACTEC.
Rhonda is a partner at Davies Ward Phillips & Vineberg LLP in Montreal, Quebec. Rhonda counsels clients on the tax aspects of mergers and acquisitions, corporate reorganisations and real estate transactions, both Canadian and cross-border, with a strong emphasis on estate planning. Publications include 'Canadian Tax Laws: A Review of 2019 and a Look Ahead to 2020' (Jan. 30, 2020); 'Letter to the Editor: Recent Changes to Canada’s Income Tax Laws Affecting Cross-Border Trusts and Estates: An Update' (Dec. 23, 2019); and 'Risks of Assigning a Trust Interest' (June 01, 2019). Rhonda's accolades include Best Lawyers Lawyer of the Year Trusts and Estates Montreal 2021.