Is Preventing Treaty Shopping Worth Rethinking the GAAR? The Supreme Court’s Upcoming Decision in R v Alta Energy Luxembourg SARL
Paul Hildebrandt, 3L, Volume 79 Senior Editor
In the upcoming appeal of R v Alta Energy Luxembourg SARL (Alta Energy), the Supreme Court of Canada will have the opportunity to consider whether section 245 of the Income Tax Act (the “Act”), the General Anti-Avoidance Rule (“GAAR”), applies to a practice commonly known as “treaty shopping”. In deciding Alta Energy, the Tax Court of Canada and the Federal Court of Appeal concluded the GAAR did not prohibit treaty shopping [1].
The existing approach taken in GAAR jurisprudence imposes upon taxpayers a duty to avoid frustrating or defeating the object, spirit, or purpose of the relevant tax provisions (Copthorne Holdings Ltd v R, 2011 SCC 63 (CanLII) [Copthorne Holdings] at para 72); it is unlikely the GAAR could be used to prevent treaty shopping under this approach. Rather, invoking the GAAR to prevent treaty shopping would require an alternate approach that imposes upon taxpayers a new duty to act only in ways that are actively supported by the object, spirit, and purpose of the relevant provisions. This alternate approach is unlikely to be adopted, nor should it be. Indeed, although treaty shopping may be undesirable, it is unlikely that the Supreme Court will find that the GAAR provides a sufficient legislative basis to prevent treaty shopping without express statutory language. For this reason, if the government seeks to prevent treaty shopping, the GAAR is likely not the appropriate tool for doing so.
What is Treaty Shopping?
Treaty shopping occurs when a taxpayer structures a transaction in such a way as to obtain the advantages of a particular tax treaty. Such a situation allegedly arose in Alta Energy.
In Alta Energy, a United States LLC (“US Co”) owned the shares of a Canadian oil company (“Alta Canada”). Under the terms of the Canada-US Tax Treaty, if US Co sold the Alta Canada shares for a gain, Canada could tax that gain [2]. US Co considered this undesirable and undertook a reorganization where it transferred its Alta Canada shares to a related Luxembourg company (“Alta Luxembourg”). Under the new structure, the more favourable terms of the Canada-Luxembourg Tax Treaty (the “Can-Lux Treaty”) would apply. Under the Can-Lux Treaty, only Luxembourg could tax the gains that arose from the sale of the Alta Canada shares [3]. Thus, through the reorganization, US Co “shopped” for the more favourable terms of the Can-Lux Treaty.
Canada’s Minister of National Revenue (the “Minister”) objected to Alta Luxembourg’s use of the Can-Lux Treaty in this way and applied the GAAR, leading to the case in issue.
What is the GAAR?
At its core, the GAAR is a provision of the Act that states that even if a taxpayer is entitled to a certain tax treatment according to the “letter of the law”, the Minister may impose a different tax treatment if there has been a misuse or abuse of the “spirit of the law” [4]. Several requirements must be met before the Minister can apply the GAAR. In Alta Energy, the most contentious issue was whether the impugned transaction constituted a “misuse” or “abuse” of the treaty provisions. A two-step analysis is used to determine whether a misuse or abuse has occurred (Canada Trustco at para 55):
Determine the object, spirit, or purpose (collectively, the “objective”) of the relevant provisions, and;
If the impugned transaction has defeated or frustrated that objective, then there has been a misuse or abuse.
The Objective of the Can-Lux Treaty Provisions
The objective of the provisions is determined through a textual, contextual, and purposive analysis of the relevant provisions (Canada Trustco at para 41). The objective must be derivable from the provisions themselves. The provisions cannot be said to have the objective of preventing certain outcomes solely because those outcomes are considered “wrong” or “undesirable” from a moral or policy perspective [5].
In Alta Energy FCA, the Minister argued that an objective of the Can-Lux Treaty was the prevention of treaty shopping. The Minister relied upon Iacobucci J’s comments in Crown Forest Industries Ltd v R, [1995] 2 SCR 802, 1995 CanLII 103 at para 52 that treaty shopping is an undesirable practice and should not be encouraged [6]. Webb JA, writing for the Federal Court of Appeal, dismissed the Minister’s argument. Webb JA held that, although Iacobucci J’s comments indicate treaty shopping is undesirable, this does not mean preventing treaty shopping is an objective of the treaty. A textual, contextual, and purposive analysis was required, and such an analysis did not indicate the provisions had this objective [7].
Webb JA’s conclusion is consistent with Rothstein J’s comment in Copthorne Holdings at para 118 that, when determining the objective of a provision, it is not permissible to “…bas[e] a finding of abuse on some broad statement of policy, such as anti-surplus stripping, which is not attached to the provisions at issue.” Similarly, accepting as true the holding in Crown Forest that treaty shopping is undesirable, the finding of an undesirable practice alone does not establish that the provisions in question seek to prevent that practice.
The Minister may have had a stronger argument if, for example, there were several anti-treaty shopping provisions in the Can-Lux Treaty and yet the taxpayer managed to treaty-shop anyway. In this hypothetical, the text, context, and purpose may have indicated that an objective of the provisions is the prevention of treaty shopping.
Webb JA concluded the objective of the relevant provisions was simply to produce the result described in the text: providing benefits to Luxembourg residents who own Canadian shares, the value of which is principally derived from Canadian immovable property used to carry on business (Alta Energy FCA at para 73). Given this objective, there was clearly no misuse or abuse because the benefits provided were precisely those contemplated (Alta Energy FCA at para 80). While I agree with Webb JA’s conclusion, there may be an additional, broader objective underlying the provisions.
A Potential Restatement of the Objective
It can be reasonably argued that a textual, contextual, and purposive analysis reveals the treaty provisions have an objective of the prevention of double taxation and the facilitation of cross-border business between residents of Canada and Luxembourg.
A textual analysis looks to what the relevant treaty provisions actually do (Copthorne Holdings at paras 88–90). The relevant treaty provisions allocate the right to tax certain amounts to only one of the two nations, thereby precluding the possibility of double taxation. A contextual analysis reveals that a number of other provisions in the Can-Lux Treaty also allocate taxing rights to one of the two nations, further indicating an objective of preventing double taxation [8]. Finally, a purposive analysis reveals that a purpose of the Can-Lux Treaty is the prevention of double taxation, as expressly stated in its preamble.
Given the clear objective of preventing double taxation, an objective of facilitating cross-border business between Canada and Luxembourg can be inferred. This is because where a possibility for double taxation exists, taxpayers will be more reluctant to engage in cross-border business. Reducing the potential for double taxation is thus a means of facilitating cross-border business between Luxembourg and Canada.
However, even if this broader objective were adopted, treaty shopping would not constitute a misuse or abuse under the approach currently taken in GAAR jurisprudence.
Does Treaty Shopping Constitute a Misuse or Abuse of the Restated Objectives?
A misuse or abuse occurs when the impugned transaction frustrates or defeats the objective of the relevant provisions (Canada Trustco at para 52). Treaty shopping does not frustrate or defeat the restated objectives as it neither results in double taxation nor prevents cross-border business from taking place. Thus, invoking the GAAR to combat treaty shopping would require a broader test for what constitutes a misuse or abuse.
The Alternate Approach
Using the GAAR to prevent treaty shopping would require a new test along the following lines: a transaction will constitute a misuse or abuse if it is not supported by the objective of the relevant provisions (what I call the “alternate approach”). To clarify the difference between the existing approach and the alternate approach, the former states “you cannot do what the provisions don’t want you to do,” the latter states “you can only do what the provisions want you to do.”
Under the alternate approach, if an objective of the Can-Lux Treaty is facilitating cross-border business between Canada and Luxembourg, treaty shopping is arguably a misuse or abuse because it is not undertaken to facilitate business between Canada and Luxembourg. In Alta Energy, for example, the Can-Lux Treaty was used as a structuring tool to facilitate business between the United States and Canada, not between Luxembourg and Canada. While the treaty’s objective is not the prevention of treaty shopping, treaty shopping is abusive because the objective indicates no support for using the treaty in such a way.
Support for the Alternate Approach
Support for the alternate approach may be found in Canada Trustco at para 66 where the Supreme Court stated a misuse or abuse will occur where “…it cannot be reasonably concluded that a tax benefit would be consistent with the [objective] of the provisions…” [9]. A requirement of “consistency” with the objective is different from a requirement simply not to frustrate or defeat that objective. The former, like the alternate approach, looks to whether the objective indicates support for the transaction, the latter looks to whether the transaction would prevent the objective from being achieved.
The term “misuse” in paragraph 245(4)(a) of the Act may also indicate support for the alternate approach. Most GAAR analyses focus on “abuses” rather than “misuses” [10], likely due to the statement in Copthorne Holdings at para 73 that “there is no distinction between an ‘abuse’ and a ‘misuse’”. While the merits of the focus on “abuse” are outside the scope of this post, I note that were “misuse” and “abuse” considered separate concepts, “misuse” would indicate support for the alternate approach. “Misuse” means “to use incorrectly” or “to use something in an unsuitable way or in a way that was not intended” [11]. “Abuse” means “to put to a wrong or improper use” or “to use something for the wrong purpose in a way that is harmful…” [12]. The existing approach seems to contemplate abuse by looking only to whether the taxpayer used the provisions for something that is “wrong” or “harmful”: frustrating the objective. A test that gave greater weight to the term “misuse” would arguably, like the alternate approach, look to whether the taxpayer used the provisions in a way other than that which was intended.
The Alternate Approach is Unlikely to be Adopted
While the alternate approach could be used to prevent treaty shopping, it is unlikely to be adopted for several reasons.
First, in Gwartz v R, 2013 TCC 86 (CanLII) at para 47, Hogan J held that “it is inappropriate, where the transactions do not otherwise conflict with the [objective] of the provisions…to apply the GAAR to deny a tax benefit resulting from a taxpayer’s reliance on a previously unnoticed legislative gap” [13]. This principle appears to reject the alternate approach as it suggests invoking the GAAR requires a “conflict” and rejects the notion that the GAAR prevents taxpayers from using a provision in way that is merely unforeseen.
Second, the alternate approach would limit the Duke of Westminster principle that “taxpayers are entitled to arrange their affairs to minimize the amount of tax payable” provided the provisions of the Act are complied with [14]. The core of the Duke of Westminster principle is that taxpayers are free to do as they wish within the bounds of the legislation. The core of the alternate approach is that taxpayers may only do what the drafters approve of.
Third, courts have consistently recognized that the GAAR is a tool to be used sparingly as it creates significant uncertainty for taxpayers [15]. By applying the GAAR in a greater number of situations, the alternate approach would cause greater uncertainty.
Finally, the GAAR was introduced to end the ‘cat and mouse game’ of “…action and reaction endlessly produced by complex, specific tax measures aimed at sophisticated business practices, and the inevitable, professionally-guided and equally specialized taxpayer reaction” [16]. The existing approach fulfils this goal by preventing taxpayers from frustrating the objective of ‘closing loopholes’ by finding another way to engage in the same undesired conduct. The alternate approach, on the other hand, uses the GAAR not to ‘keep loopholes closed’, but rather to retroactively implement policy by preventing outcomes not contemplated at the time of drafting but now considered undesirable. The GAAR is arguably not intended to be used this way.
Conclusion
While it can reasonably be argued that treaty shopping is a practice our tax system ought to prevent, it is not the type of issue the GAAR ought to remedy. The appropriate response is legislative change, not rethinking the GAAR.
Notes
[1] R v Alta Energy Luxembourg SARL, 2018 TCC 152 (CanLII); R v Alta Energy Luxembourg SARL, 2020 FCA 43 (CanLII) [Alta Energy FCA].
[2] Article 13(1) of the Canada-US Treaty allows Canada to tax gains derived by a US resident from the alienation of real property situated in Canada (US Co was a US resident). Article 13(3)(b)(ii) states that “real property situated in Canada” includes the shares of a Canadian-resident company, the value of which is derived principally from real property situated in Canada. Because Alta Canada was a Canadian-resident corporation and its value was derived principally from real property situated in Canada (Canadian oil and gas properties), Canada had the right to tax any gains US Co earned from its Alta Canada shares.
[3] Like Article 13(1) of the Canada-US Treaty, Article 13(1) of the Can-Lux Treaty allows Canada to tax gains derived by a resident of Luxembourg from the alienation of immovable property situated in Canada (Alta Luxembourg was a Luxembourg resident). However, Article 13(4) of the Can-Lux Treaty states “immovable property” does not include shares, the value of which is principally derived from immovable property in which the business of the company was carried on. Alta Canada’s shares principally derived their value from the oil and gas properties upon which Alta Canada’s business was carried on. Thus, Article 13(4) would not apply to allow Canada to tax the gain on the disposition of the Alta Canada shares and the gain on these shares would only be taxable in Luxembourg by virtue of the application of Article 13(5).
[4] See Canada Trustco Mortgage Co v R, 2005 SCC 54 (CanLII) (Canada Trustco) at para 16: “The GAAR's purpose is to deny the tax benefits of certain arrangements that comply with a literal interpretation of the provisions of the Act, but amount to an abuse of the provisions of the Act.”
[5] See Copthorne Holdings at para 70 where Rothstein J held “…determining the rationale of the relevant provisions of the Act should not be conflated with a value judgment of what is right or wrong nor with theories about what tax law ought to be or ought to do.”
[6] Note the GAAR was not in issue in Crown Forest. Iacobucci J’s comments were regarding an interpretation suggested by a taxpayer that could have allowed treaty shopping. Iacobucci J held that the taxpayer’s interpretation ought not be adopted partly because it could encourage the undesirable practice of treaty shopping.
[7] Alta Energy FCA at paras 78 - 80, citing MIL Investments SA v R, 2006 TCC 450 (CanLII) (aff’d 2007 FCA 236 (CanLII)).
[8] See Articles 6, 7, 8, 10, 11, 12, and 14 of the Can-Lux Treaty.
[9] See also, Canada Trustco at para 59 where the Court stated “The [misuse or abuse] analysis under s. 245(4) requires a close examination of the facts in order to determine whether allowing a tax benefit would be within the object, spirit or purpose of the provisions”. The term “within” here is similar to the term “consistent” used by the Court in Canada Trustco at para 66.
[10] See, for example, Copthorne Holdings at para 73 where the terms “misuse” and “abuse” were considered together under the umbrella term “abuse”; Alta Energy FCA where “abuse” was mentioned 25 times while “misuse” was mentioned only 5 times.
[11] See Merriam-Webster English Dictionary, sub verbo “misuse”; Cambridge English Dictionary, sub verbo “misuse”.
[12] See Merriam-Webster English Dictionary, sub verbo “abuse”; Cambridge English Dictionary, sub verbo “abuse”.
[13] See also Lehigh Cement Ltd v R, 2010 FCA 124 (CanLII) at para 37 (leave to appeal refused, [2010] SCCA No 273), holding “the Crown cannot discharge the burden of establishing that a transaction results in the misuse of an exemption merely by asserting that the transaction was not foreseen or that it exploits a previously unnoticed legislative gap”; Husky Energy Inc v Alberta, 2012 ABCA 231 (CanLII) at para 48.
[14] Canada Trustco at paras 11, 13, and 31 citing Inland Revenue Commissioners v Duke of Westminster (1935), [1936] AC 1 (UK HL).
[15] See Canada Trustco at para 21; Lipson v R, 2009 SCC 1 (CanLII) at paras 67, 104; and Copthorne Holdings at paras 66, 123.
[16] Canada, Department of Finance, The White Paper: Tax Reform 1987 (Ottawa: Department of Finance, June 18, 1987) citing Stubart Investments Ltd v R, [1984] 1 SCR 536, 1984 CanLII 20 (SCC) at 580.