No one would ever suggest international tax law is simple, but with Canada’s impending ratification of the OECD’s Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the “MLI“), a new layer of complexity has been added when determining whether a taxpayer is eligible to receive a particular treaty benefit. The recent decision in Alta Energy Luxembourg S.a.r.l v The Queen[1](“Alta Energy“) might be a new high-water mark for taxpayers in treaty interpretation, but it may also be their last win.

The decision in Alta Energy considered the application of the Canada-Luxembourg Tax Treaty (the “Luxembourg Treaty“), which along with the Canada-Netherlands Tax Treaty (and a few others), contains a distinctive provision that exempts capital gains on the disposition of shares of companies that derive more than half of their value from immovable property situated in Canada in which the business of the company is carried on.[2] In the context of inbound foreign investment into resource companies, private equity funds and other investors that structure their investments through offshore holding structures in Luxembourg, or the Netherlands, may benefit from the aforementioned exemption (the “Tax Act“).

In Alta Energy, the Tax Court had to determine whether such planning was an abuse of the Luxembourg Treaty. As required under Article 13(4) of the Luxembourg Treaty, in order for the above exemption to apply, it would have to be demonstrated that the immovable property was used in the underlying business. In this case, the Crown first argued that Article 13(4) should be interpreted narrowly and only permit the exemption where a resource license was actively used for exploitation, looking at it on a strict license by license basis.[3] The Court rejected the Crown’s arguments, stating that Article 13(4) was designed to attract foreign direct investment with a view to granting the exemption “in accordance with industry practices”.[4] Secondly, while it was acknowledged that the transaction could be considered an “avoidance transaction” which gave rise to a “tax benefit” for the purposes of s. 245 of the Income Tax Act,[5] the Court stated that previous decisions[6] established that the Luxembourg Treaty contained a narrow anti-avoidance provision based on the concept of beneficial ownership and that a Luxembourg holding company should not be denied the benefits of the Luxembourg Treaty solely because the shareholders are not themselves resident in Luxembourg.

While Alta Energy is a welcome judgment for many cross-borders investors, the next, and perhaps larger question that looms is the impact of the MLI on bilateral tax treaties, specifically in the implementation of treaty shopping provisions.

Simply put, the MLI is a multilateral treaty that operates to modify the terms of existing bilateral treaties.[7] Though there are many variations of how the MLI might affect a treaty, currently, all of Canada’s bilateral treaties modified by the MLI will contain two mandatory provisions: (i) a mandatory preamble (the “Preamble“); and (ii) a substantive principal purpose test (the “PPT“).

The Preamble provides that a particular treaty is intended to operate without creating opportunities to reduce taxation through tax evasion or avoidance, and specifically includes reference to treaty-shopping arrangements. The PPT operates so that regardless of any of the other provisions of a tax treaty (e.g., Article 13(4) of the Luxembourg Treaty) no benefit will be granted if it can be shown that obtaining that benefit was “one of the principal purposes” of any arrangement or transaction that resulted in that benefit. However, the PPT also includes a safe harbour provision where it can be demonstrated that the benefit was received in circumstances that were in accordance with the object and purpose of the relevant provisions.

Interestingly, in the context of Alta Energy, the Court’s interpretation of the object and purpose of Article 13(4) may be viewed as fitting into the PPT’s safe harbour as the Court explicitly stated that it was designed to encourage trade and investment. However, given that the Preamble directly targets treaty-shopping arrangements, it is unclear what the impact of Alta Energy will have on the application of MLI-modified tax treaties go forward.

[1] 2018 TCC 152

[2] Article 13(4) of the Luxembourg Treaty.

[3] Taking the Minister’s view, drilling or extraction activities would actually have to occur on the property covered by that specific resource license.

[4] Alta Energy, at para 68.

[5] The general anti-avoidance provision of the Income Tax Act (Canada).

[6] See Canada v Prevost Car Inc, 2009 FCA 57 and Velcro Canada v The Queen, 2012 TCC 57.

[7] Provided that both of the treaty’s signatory nations elect to have it apply to the particular agreement.

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