By Nicolas Baas, LL.B., LL.M. (Tax)
On May 12, 2008 we posted a blog entry commenting on the Tax Court decision of Prevost Car Inc. v. The Queen TCC 231. On February 26, 2009 the Federal Court of Appeal released its appeal decision in this case. The FCA endorsed the Tax Court’s decision in its entirety. The facts of this case are straightforward and can be found in our May 12, 2008 blog.
As in the Tax Court, the issue before the FCA was the interpretation of the term “beneficial owner” in Article 10(2) of the Convention between Canada and the Kingdom of the Netherlands for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income. In essence, one of the purposes of Article 10(2) of the Convention is to prevent tax evasion by making it so that the Treaty withholding rates will only apply when the dividend is paid to a resident of the Contracting State that is the “beneficial owner” of the dividend. If the recipient of the dividend is not the “beneficial owner” of the income, the Treaty rates will not apply. Thus, if a taxpayer in Country A interposes a Holding Corporation in Country B so as to benefit from the Treaty dividend withholding rates in Country B, but the actual “beneficial owner” of the dividend is in Country C, the taxpayer in Country A will have to apply the withholding rates in Country C not Country B.
The FCA does not delve in depth on the actual mechanics of the Convention, and the majority of the judgment is devoted to principles of Tax Treaty interpretation, more specifically the value of OECD documentation in interpreting the Tax Treaty. As such, this decision is more important for its guidance as to interpretation rather than its analysis of the actual text of the Tax Treaty. The Court makes certain comments with respect to the interpretation of Tax Conventions that are sure to interest practitioners of international taxation. In essence the Court recognizes the importance of the OECD Model Convention and other OECD documents.
However, the FCA does take a dim view of the Crown’s opinion that holding companies could be “looked through” to the ultimate beneficiary of the dividend:
Counsel for the Crown has invited the Court to determine that “beneficial owner”, “bénéficiaire effectif”, “mean the person who can, in fact, ultimately benefit from the dividend”. That proposed definition does not appear anywhere in the OECD documents and the very use of the word “can” opens up a myriad of possibilities which would jeopardize the relative degree of certainty and stability that a tax treaty seeks to achieve. The Crown, it seems to me, is asking the Court to adopt a pejorative view of holding companies which neither Canadian domestic law, the international community nor the Canadian government through the process of objection, have adopted.
This cited passage is the only significant analysis the FCA makes with respect to the actual Convention. Otherwise, the Court simply contents itself with reiterating verbatim the factual findings of the Tax Court and states that no palpable or overriding error was made by the Tax Court.
Giving the endorsement of the OECD Model Convention commentaries by the FCA, it is interesting to reproduce the commentaries passage which discusses the issue of “beneficial ownership”:
The requirement of beneficial ownership was introduced in paragraph 2 of Article 10 to clarify the meaning of the words “paid….to a resident” as they are used in paragraph 1 of the Article. It makes plain that the State of source is not obliged to give up taxing rights over dividend income merely because that income was immediately received by a resident of a State with which the State of source has concluded a convention. The term “beneficial owner” is not used in a narrow technical sense, rather, it should be understood in its context and in light of the object and purpose of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance.
When an item of income is received by a resident of a Contracting State acting in the capacity of agent or nominee it would be inconsistent with the object and purpose of the Convention for the state of source to grant relief or exemption merely on account of the status of the immediate recipient of the income as a resident of the Contracting State. The immediate recipient of the income in this situation qualifies as a resident but no potential double taxation arises as a consequence of that status since the recipient is not treated as the owner of the income for tax purposes in the State of residence. It would be equally inconsistent with the object and the purpose of the Convention for the State of source to grant relief or exemption where a resident of a Contracting State, otherwise than through an agency or nominee relationship, simply acts as a conduit for another person who in fact receives the benefit of the income concerned. For this reason, the report from the Committee on Fiscal Affairs entitled “Double Taxation Conventions and the Use of Conduit Companies” concludes that a conduit company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties. [Emphasis added]
In essence, the OECD commentaries state that an agent, nominee or “conduit” holding company should not be considered as the beneficial owner of the dividend. The wording of the OECD commentaries in the above passage should be noted: “…simply acts as a conduit for another person who in fact receives the benefit of the income concerned.” Contrast this passage with the FCA’s refusal to give effect to Crown’s contention that the beneficial owner “means the person who can, in fact, ultimately benefit from the dividend” (as reproduced above). Strangely, the FCA then goes on to state that there is no OECD documentation which supports the Crowns views. While the FCA may have disliked the Crown’s use of the wording “can […] ultimately benefit” versus the OECD’s wording of “who in fact receives the benefit” the Court does not explicitly say so and could have gone into a more in-depth and explicit analysis to offer more guidance to taxpayers.
The FCA upholds the Tax Court’s decision on the basis that the Tax Court had explicitly found as fact that the Holding Company was not an agent, nominee or conduit in this case. Thus, the OECD criteria for “beneficial ownership” (as reproduced above) would not apply.
This decision clearly stands for the proposition that dividends paid to Holding Companies that are not an agent, nominee or conduit will be entitled to benefit from the Treaty withholding rates, and as such is a clear “win” for taxpayers. However, in the event that the Crown could prove that a dividend was paid to an agent, nominee or conduit corporation, the Tax Treaty rates would not apply. Thus, each case will rest on its own facts and tax practitioners should be wary of structures that interpose a “shell corporation” to benefit from the Tax Treaty rates.
The FCA’s decision spans only 16 paragraphs and practitioners may have been better served by a more thorough analysis of the actual Treaty and the associated OECD documentation. It remains to be seen whether the Crown will appeal this decision to the Supreme Court of Canada. However, given the clear finding of fact by the Tax Court that the Holding Company was not an agent, nominee or conduit, it may be difficult for the Crown.