Précis April 2009 The Federal Court of Appeal has now upheld the

Document Sample
Précis April 2009 The Federal Court of Appeal has now upheld the Powered By Docstoc
                                                                              April 2009

The Federal Court of Appeal has now upheld the decision of the Tax Court of
Canada in Prévost Car. This recent pronouncement on treaty shopping affirms
that a holding company arrangement will not be denied treaty benefits on the
basis of beneficial ownership.



                                   The decision of the Federal Court of Appeal in
                                   Canada v. Prévost Car Inc. (“Prévost Car”)1 was
                                   released on February 26, 2009. Prévost Car is a
                                   landmark decision, since it is one of few
                                   Canadian cases to deal with the perceived
                                   abuse of “treaty shopping”2 and is the first case
    Krystle Ng-A-Mann              to judicially consider the meaning of the term
    Associate                      “beneficial owner” in the context of a Canadian
    Miller Thomson LLP             tax treaty.
    416.595.2962                Broadly speaking, Prévost Car represents an
                                attempt by the Canada Revenue Agency (“CRA”)
                                to apply an ‘innovative’, corporate veil-piercing
type of argument to crack down on holding company structures and to address
the issue of treaty shopping. In MIL (Investments) S.A. v. Canada (“MIL”), the
Minister of National Revenue (the “Minister”) was unsuccessful in utilizing the
general anti-avoidance rule (“GAAR”) in section 245 of the Income Tax Act
(Canada) (“ITA”)3 to achieve the same goal. In Prévost Car, the Minister instead
argued that treaty benefits under the Canada-Netherlands Income Tax
Convention (1986), as amended (the “Tax Treaty”)4, ought to have been denied
because the Dutch parent company was not the “beneficial owner” of dividends
paid to it by its Canadian wholly-owned subsidiary corporation, but rather, its
Swedish and U.K. shareholders were the true beneficial owners of the dividends.

  2009 FCA 57 [Prévost FCA].
  See e.g. MIL (Investments) S.A. v. Canada, 2007 FCA 236; aff’g 2006 TCC 460 [MIL]; Crown
    Forest Industries Ltd. v. Canada, [1995] 2 S.C.R. 802 [Crown Forest].
  R.S.C. 1985, c. 1 (5th Supp.), as amended [ITA].
  S.C. 1986, c. 48, Schedule 1.
Interposing a holding company—normally in a low tax rate jurisdiction with which
Canada has an income tax treaty—between a Canadian resident corporation and
its ultimate shareholder is a common tax planning technique that allows non-
residents to invest in Canada and enjoy reduced rates of withholding tax on
interest, dividends and other payments, among other treaty benefits. This has
consequently placed holding company arrangements on CRA’s radar as abusive
forms of treaty shopping. As a result, tax advisors and practitioners have waited
with somewhat bated breath for the release of the Federal Court of Appeal
decision in Prévost Car, since a negative outcome would have left a sizeable
number of similar structures on precarious footing and potentially open to
assessment by the CRA.


The facts are straightforward. Prévost Car Inc. (“Prévost Canada”) is a Canadian
resident corporation specializing in the manufacturing of buses whose shares
were transferred to Prévost Holding B.V. (“Prévost Holding”), a company
incorporated in the Netherlands. Volvo Bussar A.B. (“Volvo”) is a Swedish
resident corporation and Henlys Group PLC (“Henlys”) is a U.K. resident
corporation owning 51% and 49% of the shares of Prévost Holding, respectively.
At all relevant times, Prévost Holding neither had an office nor employees in the
Netherlands, nor did it have any investments other than the shares in Prévost
Canada. In addition, the Board of Directors of Prévost Holding was comprised of
the same members as the Board of Directors of Prévost Canada.

Pursuant to a shareholder agreement between Volvo and Henlys (the
“Shareholder Agreement”), Volvo and Henlys agreed that no less than 80% of
the profits of the companies under joint ownership (the “Corporate Group”) would
be distributed between them, subject to the Corporate Group having sufficient
financial resources to meet its normal working capital requirements at the time of

Prévost Canada paid dividends to Prévost Holding in the 1996 to 2001 taxation
years. Prévost Canada would have generally been required to withhold
Canadian taxes at a rate of 25% from the amount of such dividends unless the
withholding tax rate was reduced under a tax treaty. Prévost Canada withheld
Canadian taxes at rate of 5% (or 6% depending on the taxation year) from such
dividends on the basis that Prévost Holding was entitled to this reduced rate
under the Tax Treaty. Paragraph 2 of Article 10 of the Tax Treaty provides that a
corporation resident in the Netherlands that receives a dividend from a Canadian
resident company is entitled to this lower rate if it is the “beneficial owner” of such
dividend and owns at least 25% of the capital of, or controls directly or indirectly
at least 10% of the voting power in, the corporation paying the dividend. Prévost
Holding subsequently paid corresponding dividends to Volvo and Henlys in
accordance with the Shareholder Agreement.

The Minister reassessed Prévost Canada for additional Canadian withholding tax
on account of 11 dividends paid during its 1996, 1997, 1998, 1999 and 2001
taxation years. The Minister claimed that Prévost Holding was not the “beneficial
owner” of the dividends paid by Prévost Canada, as required under the Tax
Treaty. Instead, the Minister asserted that Volvo and Henlys were the true
beneficial owners of the dividends, and on that basis, the applicable withholding
tax rate ought to have been 15% and 10% on their respective portions of the
dividend payments under Canada’s tax treaties with Sweden and the United
Kingdom. Interestingly, the CRA later retracted from this position and claimed
that the 15% and 10% withholding tax rates were, in fact, a concession and the
applicable withholding tax rate should have been 25%.

Tax Court of Canada Decision

The Tax Court of Canada decision5 was delivered by Associate Chief Justice Rip
on April 30, 2008. Rip A.C.J. was not satisfied that Prévost Holding was a mere
conduit for Volvo and Henlys and was of the view that Prévost Holding was,
indeed, the beneficial owner of the dividends paid by Prévost Canada.

In reaching its decision to allow Prévost Canada’s appeal and vacate the
Minister’s assessments, the trial judge canvassed, at-length, the meaning of the
term “beneficial owner” (“bénéficiare effectif” in French), which was not defined in
the Tax Treaty. The trial judge noted that, pursuant to paragraph 2 of Article 3 of
the Tax Treaty, an undefined term shall have the meaning ascribed to it by the
domestic laws of the State imposing the taxes in question. Rip A.C.J. considered
Section 3 of the Canadian Income Tax Conventions Interpretation Act (the
“Treaty Interpretation Act”)6 which provides that, except to the extent the context
otherwise requires, a term that is not defined in a tax treaty should have the
meaning it has for purposes of the ITA at the time the term is interpreted rather
than the meaning it had at the time the treaty was entered into if the meaning of
that term has changed.

The trial judge noted the meaning of “beneficial owner” in domestic and
international case law, and its dictionary meanings. The Court examined the
1977 Organisation for Economic Co-operation and Development (OECD) Model
Tax Convention on Income and on Capital (the “OECD Model Tax Convention”)
on which the Tax Treaty was based and the Commentaries thereunder, as well
as later Commentaries to the OECD Model Tax Convention.7 In addition, the

  2008 TCC 231 [Prévost TCC].
  R.S., 1985, c.I-4.
  Of note, the Commentary to Article 10 of the OECD Model Income Tax Convention states that
    “under paragraph 2, the limitation of tax in the State of source is not available when an
    intermediary, such as an agent or nominee, is interposed between the beneficiary and the
    payer, unless the beneficial owner is a resident of the other Contracting State. States which
    wish to make this more explicit are free to do so during bilateral negotiations.” In negotiating

testimony of several expert witnesses on the interpretation of Dutch law and the
development of the OECD Model Tax Convention and Commentaries was also
heard in the Tax Court.

In the end, Rip A.C.J. rejected the “international fiscal meaning” of the term
“beneficial owner”8, preferring instead the definition under domestic law; and held
that the “beneficial owner” of the dividends is the “person who receives the
dividends for his or her own use and enjoyment and assumes the risk and control
of the dividend he or she received.”9

Federal Court of Appeal Decision

On appeal to the Federal Court of Appeal, the Minister alleged that the trial judge
used an incorrect approach to the interpretation of “beneficial owner” in giving the
term its meaning in common law and ignoring the civil and international law
definitions. The Court of Appeal, per Décary J.A. (Blais J.A. and Sharlow J.A.
concurring), found no palpable and overriding error was committed by the trial
judge and unanimously dismissed the appeal.


The Federal Court of Appeal decision was short and unfortunately did not include
much substantive analysis. However, the Court was able to succinctly address a
number of issues that were raised by the Minister on appeal.

“Beneficial Owner”

As mentioned, it was the Crown’s contention that the trial judge gave an incorrect
interpretation to “beneficial owner” in ignoring the civil and international law
definitions. According to the Crown, the Court ought to interpret “beneficial
owner” to mean “the person who can, in fact, ultimately benefit from the
dividend.” However, the Court of Appeal rejected this approach, since the use of
the word “can” was overly broad and could jeopardize the degree of certainty and
stability that the treaty seeks to achieve. Further, the Court of Appeal found that
the trial judge’s formulation captured the essence of the concepts of “beneficial
owner” and “bénéficiare effectif” and was consonant with the OECD documents.

    the Canada-Netherlands Income Tax Treaty, this provision was not made more explicit, as
    contemplated by the Commentary. The 2003 modifications to this Commentary state that the
    term “beneficial owner” is not used in a “narrow technical sense, rather, it would be
    understood in its context and in light of the object and purposes of the Convention, including
    avoiding double taxation and the prevention of fiscal evasion and avoidance.”
  See e.g. Indofood International Ltd. v. JP Morgan Chase Bank N.A. London Branch, [2006]
    E.W.C.A. Civ. 158, S.T.L. 1195 (England and Wales Court of Appeal).
  Prévost TCC, supra note 5 at ¶ 100.

Interpretive Aids

On the issue of the documents that may be utilized by a court in interpreting a
treaty, a debate had previously arisen as to whether later OECD documents and
modifications to a Commentary under the OECD Model Tax Convention could be
referred to in interpreting a particular treaty provision, since they were not
necessarily contemporaneous with that provision. In endorsing the trial judge’s
reliance on later OECD documents, such as the 2003 amendments to the
Commentaries under the OECD Model Tax Convention and the 1986 OECD
Conduit Companies Report, the Court of Appeal took the opportunity to clarify its
position on the matter.

Despite the fact that the Court of Appeal appears to have espoused a contrary
view in MIL and had earlier characterized its reference to the 1977 Commentary
as being “somewhat suspect” in CUDD Pressure Control Inc. v. The Queen10,
Décary J.A. found that the Commentaries to the OECD Model Tax Convention
provide a “widely-accepted guide to the interpretation and application of the
provisions of existing bilateral conventions”11; and the same could be said with
respect to later Commentaries insofar as they represent “a fair interpretation of
the words of the Model Convention and do not conflict with Commentaries in
existence at the time a specific treaty was entered.”12 The Court of Appeal held
that later Commentaries are a “helpful complement to the earlier Commentaries”
to the extent that they elicit, rather than contradict, views previously expressed.13

Piercing the Corporate Veil

The Court of Appeal, like the lower court, determined that this was not an
appropriate case to look through Prévost Holding and pierce the corporate veil in
order to apply the higher withholding tax rate. On this issue, Décary J.A. cited
the statement of the trial judge with approval: “When corporate entities are
concerned, one does not pierce the corporate veil unless the corporation is a
conduit for another person and has absolutely no discretion as to the use or
application of funds put through it as conduit, or has agreed to act on someone
else’s behalf pursuant to that person’s instructions without any right to do other
than what that person instructs it…”14 Based on the facts, this was found not to
be the case.

   98 DTC 6630.
   Prévost FCA, supra note 1 at ¶ 10; see also Crown Forest.
   Ibid., at ¶ 11.
   Ibid., at ¶ 12.
   Prévost TCC, supra note 5 at ¶ 100.

Findings of Fact

The Court of Appeal endorsed a number of the trial judge’s findings of fact, which
proved to be determinative, namely:

          ·       the relationship between Prévost Holding and its shareholders was
                  not one of agency or mandate;

          ·       Prévost Holding was not a mere “conduit” for Volvo and Henlys,
                  and there was no automatic or predetermined flow of funds to Volvo
                  and Henlys;

          ·       Prévost Holding was not a party to the Shareholder Agreement;

          ·       neither Volvo nor Henlys could have taken action against Prévost
                  Holding for failure to pay out dividends, and Prévost Holding was
                  not obligated to pay any dividends to its shareholders; and

          ·       Prévost Holding was the registered owner of the shares in Prévost
                  Canada, and when dividends were received by Prévost Holding in
                  respect of the shares it owned, the dividends were the property of
                  Prévost Holding available to its creditors until such time as it
                  decided to declare a dividend to its shareholders.

On the whole, the Court of Appeal found that the Crown was 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.”15

Case Significance

The decision in Prévost Car provides some comfort to taxpayers since, despite
minimal substance being given to Prévost Holding (e.g. in the form of employees,
a board of directors with members resident in the Netherlands etc.), it was,
nevertheless, found not to be a mere conduit between Prévost Canada and its
shareholders. However, due to the lack of any comprehensive analysis by the
Federal Court of Appeal, it is not clear what constitutes enough substance for a
holding corporation to pass the smell test and how taxpayers can protect
themselves from re-assessment by the tax authorities in this regard. Taxpayers
wishing to invest in Canada through holding company structures should pay
particular attention to the finding of facts in Prévost Car in implementing these

     Prévost FCA, supra note 1, at ¶ 15.