Our previous article[i] was written in anticipation of the ruling from the Supreme Court of Canada (the SCC) in Canada v. Alta Energy Luxembourg S.A.R.L.[ii] (Alta Energy). Six of the nine SCC justices in Alta Energy held that the statutory general anti-avoidance rule (GAAR) did not deny treaty benefits under the Canada-Luxembourg Tax Treaty (Treaty). This milestone decision promises to be a leading authority in treaty shopping jurisprudence both within Canada and internationally. Further, the SCC’s decision provides important commentary on both the GAAR and the interpretation of tax treaties.
Treaty shopping generally refers to the selective process whereby a taxpayer of one country engages in tax arrangements designed to access preferential treaty benefits not readily available to the taxpayer in their home jurisdiction. Treaty shopping has been subjected to increased scrutiny in recent years, particularly since the coming into force of the OECD’s Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) in 2020. The MLI acts to modify bilateral tax treaties to address perceived abusive tax strategies where the principal purpose of the strategy is to access treaty benefits. The MLI has raised questions regarding the appropriateness of tax planning strategies which shift profits to low or no-tax jurisdictions.
The Facts In Alta Energy
In 2011, Alta Resources LLC and the Blackstone Group established a joint venture, Alta Energy Partners, LLC (Alta LLC), to acquire and develop oil and gas properties. Alta LLC incorporated a wholly owned subsidiary under the laws of Alberta (Alta Canada) to implement the activities of the joint venture. Alta Canada acquired the Duvernay Formation in Alberta and was given the right to explore, drill, and extract shale gas from the property.
In April 2012, the joint venture sought to improve the tax efficiency of its structure and incorporated Alta Energy Luxembourg S.A.R.L. (Alta Luxembourg) as a wholly owned corporate subsidiary of a partnership formed between affiliates of Alta Resources and Blackstone. Alta LLC then transferred all of the shares of Alta Canada to Alta Luxembourg in a taxable transaction, although no capital gain was realised as the adjusted cost base of the shares was equal to their fair market value at the time of transfer.
In 2013, Alta Luxembourg sold the shares of Alta Canada to Chevron Canada Ltd., realising a capital gain of US$382 million. Alta Luxembourg claimed an exemption from Canadian tax under the Treaty, taking the position that the shares were excluded from Canadian tax under Article 13(4) of the Treaty, which exempts gains on immoveable property situated in Canada “in which the business of the company was carried on”. The Minister of National Revenue (MNR) reassessed Alta Luxembourg on the basis that even if the treaty exemption technically applied, the GAAR should apply to deny the tax benefit and the sale of the shares should be subject to Canadian tax.
Both the Tax Court of Canada and the Federal Court of Appeal ruled in favour of the Taxpayer, determining the GAAR did not apply to deny to the exemption. The MNR was granted leave to appeal this decision to the SCC.
The SCC Decision
While application of the GAAR requires a taxpayer have obtained a “tax benefit” by entering into an “avoidance transaction” in a manner that “misused or abused” domestic tax legislation or a tax treaty, the only issue before the SCC was whether the transaction misused or abused the Treaty. The determination of misuse or abuse first requires a court to assess the object, spirit and purpose of the provision(s) alleged to have been misused or abused. The court must then determine whether the Taxpayer frustrated that object, spirit or purpose.
The MNR argued the purpose of Article 13(4) was to allocate taxing rights between Canada and Luxembourg based on the “economic allegiance” of income to either state, and that this purpose was frustrated as Alta Luxembourg lacked true commercial ties to Luxembourg as it was merely a conduit corporation established to obtain a benefit under the Treaty not otherwise available. The MNR also argued Alta Luxembourg had misused or abused the Treaty’s provisions on the determination of residence in Articles 1 and 4.
Alta Luxembourg argued the text, context and purpose of Article 13(4) did not indicate an intention by Canada or Luxembourg to depart from the bargain reached between the two countries. Alta Luxembourg also contended “treaty shopping” was merely a pejorative label for selecting the most favourable available alternative in making a foreign investment and selecting a particular treaty regime for the purpose of minimising taxes was not inherently abusive.
In rejecting the MNR’s arguments, a six-person majority noted the importance of affording consideration to the contractual nature of a treaty and that the GAAR analysis should focus on whether the transaction at issue was consistent with the compromises reached as the result of negotiations between contracting states.
Regarding treaty residence, the majority held that the object, spirit and purpose of Articles 1 and 4 were to allow all persons that are residents under the laws of one or both of the contracting states to claim benefits under the Treaty if their residence status could expose them to comprehensive tax liability in that contracting state. Residency for treaty purposes should be determined in accordance with the domestic law of the state in which residence is claimed. Given Luxembourg law conforms with the international norm of treating corporations as resident in the country in which they have their central management and control, and the drafters did not signal a contrary intention, the residency provisions were not abused.
Regarding Article 13(4), the majority indicated that the Treaty’s object, spirit and purpose was to foster international investment in Canada by exempting residents of Luxembourg from Canadian capital gains on immovable property used in carrying on their business. Article 13(4) is a reflection of Canada’s decision to intentionally cede its right to tax certain transactions entered into by Luxembourg residents in exchange for the international investment opportunities this exemption would attract.
The three-person minority judgment accepted the government’s argument that the object, spirit and purpose of the relevant provisions of the Treaty were to assign taxing rights to the state with the closest economic connection to the taxpayer’s income. The minority criticised the majority’s view that Canada would deliberately agree to a treaty creating conditions for potentially unlimited tax avoidance through use of Luxembourg conduit corporations.
Commentary On The GAAR
The majority provided helpful analysis regarding the application of the GAAR, noting that tax avoidance does not constitute, and should not be confused with, tax evasion. Transactions designed for tax avoidance purposes that lack a bona fide non-tax purpose may still be found not to be abusive.
The majority further took the position that the GAAR analysis should not be a value judgment, differentiating what may be perceived as “immoral” from what is considered “abusive” at law. The majority’s decision suggests taxpayers should be permitted to engage in planning strategies to minimise tax liability to the full extent of the law and should not be penalised where such strategies are not abusive.
This decision narrows the impact of the GAAR from a tax planning perspective, confirming that the GAAR cannot be used to effectively “rewrite” tax legislation to achieve a desired outcome.
The Future Of Treaty Shopping In Canada
The majority gave deference to the joint and common intentions of states party to the Treaty, acknowledging that tax treaties aim to stimulate investment amongst contracting states. While a government may re-negotiate existing treaties, courts should not be used as a tool for defaulting on, or otherwise altering, the obligations agreed upon by contracting states through unilateral application of the GAAR.
The majority’s emphasis on the contractual nature of treaties illustrates that in applying the GAAR to benefits obtained by way of treaty shopping, denial of such benefits must be tested against the bargain struck between the contracting states and not one country’s evolving views on treaty shopping. Further, the majority noted that parties to a tax treaty are presumed to understand the other state’s tax system. Implicit in this finding is that a state cannot later complain against treaty shopping opportunities it knew or must have known existed under a particular treaty. In this sense, it is important to reiterate the majority’s remarks that a broad moralistic assertion of treaty shopping is, alone, ineffective to warrant application of the GAAR absent evidence that the object and purpose of a specific provision of a treaty have been abused.
Application Of The MLI
This decision is also suggestive of how Canadian courts may apply the principal purpose test (PPT) under the MLI. The PPT applies to deny direct or indirect treaty benefits where one of the principal purposes of an arrangement or transaction is to obtain treaty benefits in a manner that is antithetical to the object and purpose of the relevant treaty provisions.
The holding in Alta Energy provides a useful precedent for future analysis of whether the PPT may apply to deny treaty benefits. While the PPT may arguably capture a broader range of transactions than the GAAR does, the ultimate question remains whether a tax benefit obtained by the taxpayer comports with the object and purpose of the relevant treaty provisions. In this regard, the analyses under the GAAR and the PPT are practically indistinguishable and should, in respect of the same set of facts, lead to identical conclusions. This suggests that Canadian investors should arguably be provided some assurance that the continued use of structures capitalising on international investment opportunities in a form that best aligns with their investment objectives, while maximising tax efficiency, should not attract application of the GAAR or the PPT.
The authors would like to thank Cory Soininen of Davies Ward Phillips & Vineberg LLP in Toronto, Ontario for his assistance.
[i] Elie Roth and Rhonda Rudick, “Supreme Court Of Canada To Render Treaty Shopping Decision” (May 21, 2021) in IFC Review.
[ii] Canada v Alta Energy Luxembourg S.A.R.L., 2021 SCC 49 (Alta Energy).
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.