On November 26, 2021, the SCC rendered its decision in Alta Energy Luxembourg SARL (2021 SCC 49). Six of the nine justices held that the Canadian statutory general anti-avoidance rule (GAAR) did not deny treaty benefits under the Canada-Luxembourg tax treaty (“the treaty”) in an apparent treaty-shopping scenario. The decision will likely become a leading authority on this controversial issue both in Canada and internationally, and it may influence the interpretation of the OECD-sponsored Multilateral Convention To Implement Tax Treaty Related Measures To Prevent Base Erosion and Profit Shifting (MLI).
The facts of the case are straightforward. A group of American investors set up a Canadian oil and gas exploration company (Alta Canada), using a Delaware LLC as the direct parent. Realizing that they would not be able to benefit from a treaty exemption on an ultimate sale of Alta Canada, the American group transferred the shares of Alta Canada to a newly formed Luxembourg company (Alta Luxco) at a time when those shares had not appreciated in value. Alta Luxco ultimately sold the Alta Canada shares at a significant capital gain, and claimed an exemption from tax in Canada under articles 13(4) and (5) of the treaty, which exempt from Canadian taxation gains on the sale of shares if the value of the shares disposed of is derived principally from immovable property situated in Canada in which the business of the company was carried on (known as the “business property exemption”).
The minister reassessed Alta Luxco on the basis that the property did not satisfy the business property exemption and, in the alternative, that GAAR applied to deny the exemption. Alta Luxco objected and ultimately appealed to the TCC, which sided with Alta Luxco. The GAAR issue was appealed to the FCA, which also ruled in favour of Alta Luxco. The Crown successfully sought leave to appeal to the SCC, but Côté J, writing for a six-person majority, rejected the government’s GAAR arguments.
The majority held that the purpose of articles 1 and 4 of the treaty is 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. Luxembourg’s domestic law is consistent with the international norm of treating corporations as being resident in the country in which they have their legal seat or central management. Had the parties to the treaty intended to deviate from this well-established notion, the drafters of the treaty would have explicitly signalled this intention. In fact, the inclusion of article 28(3) in the treaty, which denies treaty benefits to certain Luxembourg holding companies, suggests that when negotiating the treaty, Canada and Luxembourg specifically considered the question of what categories of Luxembourg-resident corporations should be denied access to treaty benefits. The majority thus concluded that the purpose of articles 1 and 4 is not to reserve the benefits of the treaty to residents that have “sufficient substantive economic connections” to their country of residence.
With respect to the business property exemption, the majority indicated that the treaty’s purpose is to foster international investment in Canada by exempting residents of Luxembourg from Canadian capital gains tax on shares that principally derive their value from immovable property used in carrying on the residents’ business. In enacting article 13(4), the drafters intended to deviate from the OECD model treaty, with Canada in effect giving up its right to tax certain transactions by Luxembourg residents in exchange for the economic opportunities that the business property exemption would provide to Canada. The majority noted that the use of Luxembourg conduit corporations was well known and foreseen at the time the treaty was signed. Canada could have limited access to the business property exemption by negotiating a subject-to-tax clause or including a beneficial owner requirement in the treaty, but it made a deliberate choice not to do so. Indeed, the majority left open the possibility that Canada may have intended the exemption to apply even in conduit scenarios.
In conclusion, the majority stated that a broad assertion of “treaty shopping” does not conform to a proper GAAR analysis; the application of GAAR must not be premised on a value judgment of what is right or wrong or on theories about what tax law ought to be or ought to do.
The three-person minority judgment, co-authored by Rowe and Martin JJ, forcefully endorsed the government’s view that the purpose of the relevant provisions of the treaty was to assign taxing rights to the state with the closest economic connection to the taxpayer’s income. That purpose had clearly been frustrated by Alta Luxco, since it had no genuine economic connection to Luxembourg and was “a mere conduit interposed in Luxembourg for residents of third-party states to avail themselves of a tax exemption under the Treaty.” The minority criticized the majority’s view that the government of Canada would deliberately agree to a treaty that created “the conditions for unlimited tax avoidance” by means of Luxembourg conduit corporations.
An important outstanding question is how Alta Energy will affect the application of the MLI and, more specifically, whether the outcome in this case would have been different under the MLI. The main feature of the MLI is the principal purpose test (PPT), which operates to deny treaty benefits when one of the principal purposes of an arrangement or transaction is to obtain treaty benefits in a way that is not in accordance with the object and purpose of the relevant treaty provisions. The PPT bears substantial resemblance to GAAR, especially in respect of the abuse analysis. Accordingly, the SCC’s holding in Alta Energy may strongly influence the analysis of when the PPT may apply to deny treaty benefits. Although the MLI contains a new preamble stating that the treaty is intended to eliminate double taxation without creating opportunities for non-taxation or reduced taxation (including through treaty-shopping arrangements), it is not clear that a court would apply such a broad statement of purpose to deny a treaty benefit that may very well have been intended to extend to conduit corporations—especially given that the MLI negotiators do not appear to have identified Alta Energy-like planning as a concern in their final report on BEPS action 6 or otherwise to have suggested that the business property exemption should be circumscribed. Put another way, OECD countries may notionally agree that treaty shopping is bad, but where a specific provision in a specific treaty was designed to foster treaty shopping for a specific purpose, GAAR and the PPT should arguably not apply to deny the resulting benefit.
It remains to be seen whether, as a result of Alta Energy, the Canadian government will actively pursue the inclusion of a limitation-on-benefits provision in key treaties.
Michael N. Kandev and John J. Lennard
Davies Ward Phillips & Vineberg LLP, Montreal