PART I

CANADA currently has 87 tax treaties in force. Each treaty reflects an individually negotiated "deal." In this respect, although Canada's tax treaties are generally based on the OECD's Model Convention on Income and Capital ("the OECD model"), they are all different. The absence or presence of a tax treaty between two countries and the inherent differences between tax treaties give rise to the tax-planning technique pejoratively known as "treaty shopping." This is the subject of this paper, which is an expanded version of the author's presentation at the 2009 IFA (Canadian Branch) International Tax Seminar ("the Seminar").

This paper first provides a tour d'horizon on the treatment of treaty shopping in Canada. It then examines in detail the decisions in Canada's second and most recent treaty-shopping case, Prevost Car Inc. v. Canada. ² Finally, it attempts to answer the question "What does the future hold?" in respect of Canada's approach to treaty shopping.

TREATY SHOPPING: A TOUR D'HORIZON

A. Overview

Although over the years the subject of treaty shopping has steadily been gaining exposure on the international scene,³ until now Canada has seen only very few developments in this area of tax law. Canada's first treaty-shopping case, MIL (Investments) S.A. v. Canada, ⁴ reached the courts in 2006. The Tax Court's decision in this case, affirmed by the Federal Court of Appeal (FCA) on June 13, 2007, was a clear victory for the taxpayer. In 2008 the Tax Court of Canada (TCC) held in favour of the taxpayer in its second treaty-shopping case, Prevost, and, most recently on February 26, 2009, the FCA affirmed that decision.

In the meantime, three days after the TCC's judgment in Prevost was rendered on April 22, 2008, the Advisory Panel on Canada's International Tax System ("the advisory panel")⁵ released a consultation paper ("consultation paper") aimed at eliciting submissions on how Canada's international tax system can be improved.⁶ One of the subjects of consultation was inbound treaty shopping. ⁷

In December 2008, the advisory panel issued its final report, which contains the advisory panel's recommendations on Canada's approach to treaty shopping. ⁸

The analysis in this paper proceeds in light of these Canadian developments.

B. What Is Treaty Shopping?

The expression "treaty shopping" was first used in Canada in the 1995 seminal tax treaty decision of the Supreme Court, Crown Forest v. Canada,⁹ which, however, did not deal with treaty shopping. Neither in Crown Forest nor in Canada's two treaty-shopping cases, MIL (Investments) and Prevost, did the courts seek to define that concept. It is the advisory panel that for the first time provided a formal Canadian definition of the notion:

The term "treaty shopping" refers to the situation where a person, who is resident in a given country (the home country) and who derives income or capital gains from another country (the source country), is able to gain access to a tax treaty in place between the source country and a third country that offers a more generous tax treatment than the tax treatment otherwise applicable. This situation could arise if the person is resident in a country that does not have a tax treaty with the source country, or if the tax treaty between the source country and the person's home country offers less generous tax treatment than the tax treaty between the source country and the third country. ¹⁰

This definition appropriately encapsulates the core elements of treaty shopping. It acknowledges that this kind of arrangement may be desirable either if the taxpayer is resident in a country that does not have a tax treaty with the source country, or if the tax treaty between the source country and the person's home country offers less generous tax treatment than the tax treaty between the source country and the third country. It also identifies the essence of treaty shopping as the ability to "gain access to a tax treaty in place between the source country and a third country that offers a more generous tax treatment than the tax treatment otherwise applicable." In this respect, because the benefits of a tax treaty are available only to residents of one or both of the contracting states, the key to treaty shopping is treaty residence.

The most obvious way to achieve treaty residence status and, hence, to gain access to a tax treaty is through the use of a corporation.¹¹ This is clear from the statement of the advisory panel that "[t]he most common way for a person resident in a given country to access the benefits under a tax treaty between a source country and a third country is to set up a corporation in the third country through which the income or capital gains will be channelled." Such a setup may be achieved either through incorporation, corporate continuance, or by the establishment of the corporation's place of management in the desired jurisdiction.

To be effective, a treaty-shopping structure must ensure that no material tax is incurred in the third country. This can be achieved either when income, profits, or gains are exempt or where an offsetting deduction is available in respect of payments made by the holding company.¹² In both cases, outbound payments should not be subject to any material withholding taxes in the intermediary state.

C. What Is the Problem with Treaty Shopping?

The practice of treaty shopping has been the subject of diverging opinions by governments and taxpayers. On the one hand, taxpayers and their advisers tend to believe that, if it is not abusive, treaty shopping should be perfectly acceptable because it is "but a form of tax planning that happens to involve a tax treaty as part of the overall arrangement."¹³ In this respect, the advisory panel reported on the common use of treaty shopping to the effect that

businesses use treaties to mitigate the effect of delays in the negotiation or ratification of treaties when lower withholding rates are expected, to reduce the cost of capital on foreign investments, and to ease compliance burdens when treaty benefits are ultimately available … to reduce tax on capital gains and real estate, to minimize income tax on active business income, and to move such income within a group with no or lower withholding taxes.¹⁴

On the other hand, tax administrators seem to perceive inbound treaty shopping as inherently offensive.¹⁵ In essence, their objection seems to be founded on the argument that the benefits of a tax treaty are reserved for persons with material economic nexus to one or both contracting states. In this respect, as discussed next, the Canada Revenue Agency (CRA) has, in more recent times, been challenging treaty-shopping structures that it perceives objectionable.

D. Challenges to Treaty Shopping

Conceptually, challenges to treaty shopping may be pursued either based on domestic tax law or pursuant to the provisions of the treaty being shopped.

1. Challenges Under Domestic Law

Canada does not have specific domestic anti-treaty-shopping legislation. Instead, as noted by the advisory panel in its consultative report, Canada relies principally on the general anti-avoidance rule (GAAR) in s. 245 of the Income Tax Act¹⁶ to counter treaty-shopping situations. In this respect, in 2005, the GAAR was retroactively amended, effective from the initial enactment of s. 245 on September 12, 1988, to explicitly apply to tax treaties.¹⁷ The application of the amended GAAR in a tax treaty context was first judicially considered in 2006 in MIL (Investments).

MIL (Investments) dealt with a claim for an exemption from Canadian tax under article 13 of the Canada-Luxembourg tax treaty, on a capital gain of approximately Cdn $425 million realized by the taxpayer, MIL (Investments), on the sale of its shares in Diamond Field Resources Ltd. (DFR) on the 1996 takeover by mining giant, Inco, of DFR, which had discovered one of the world's largest nickel deposits at Voisey Bay in Newfoundland. MIL (Investments), a corporation owned by a non-resident of Canada, was initially incorporated in the Cayman Islands. Before June 1995, it owned 11.9 percent of DFR. On June 8, 1995, MIL (Investments) exchanged, on a tax-deferred basis, 703,000 DFR shares for 1,401,218 common shares of Inco, thereby reducing its shareholding in DFR to 9.817 percent. On July 17, 1995, MIL (Investments) was continued under the laws of Luxembourg. Between August 14 and 17, 1995, MIL (Investments) disposed of the 1,401,218 common shares of Inco for Cdn $65,466,895 and claimed an exemption from Canadian tax on the resulting capital gain under article 13 of the Canada-Luxembourg treaty. MIL (Investments) was not assessed in Canada on the gain, and it paid no tax in Luxembourg because the cost basis of the shares for Luxembourg tax purposes was their value at the time of the continuance, which exceeded the sale price. On September 14, 1995, MIL (Investments) disposed of 50,000 DFR shares for Cdn $4,525,000 and claimed an exemption from Canadian tax on the gain under article 13 of the Canada-Luxembourg treaty. Again, it was not assessed in Canada on the gain, and it paid no tax in Luxembourg. On May 22, 1996, the DFR shareholders approved the Inco takeover of DFR to take effect on August 21, 1996. MIL (Investments) received Cdn $427,475,645 for the disposition of its DFR shares. It claimed an exemption from Canadian tax on the resulting capital gain of Cdn $425,853,942 under article 13 of the Canada-Luxembourg treaty. This claim was the subject of the appeal.

In a lengthy, reasoned decision, the TCC held in favour of MIL (Investments) and rejected the government's claims that the transactions constituted treaty shopping and should be struck down either as being abusive tax avoidance under the GAAR or as violating an alleged inherent anti-treaty-shopping rule in the Canada-Luxembourg treaty.

With respect to the GAAR, the TCC found that none of the relevant transactions was an avoidance transaction under subsection 245(3) of the Act. Bell J stated that he accepted the taxpayer's contention that the continuation of MIL (Investments) from the Cayman Islands to Luxembourg was primarily for bona fide commercial reasons because Luxembourg was a better jurisdiction than the Cayman Islands from which to carry on a mining business in Africa. Hence, the court found that the GAAR had no application to the case.

Furthermore, the TCC stated that, in any event, it would not be able to find abusive avoidance under subsection 245(4). On this point, the government had argued that treaty shopping is an abuse of bilateral tax treaties and is recognized as such by the Supreme Court of Canada. In this respect, the government quoted from Crown Forest (see below) to argue that if the Supreme Court had access to section 245, it would have used that provision to deny a benefit from treaty shopping. Dealing with these arguments, Bell J stated as follows (paragraph 69):

I do not agree that Justice Iacobucci's obiter dicta can be used to establish a prima facie finding of abuse arising from the choice of the most beneficial treaty. There is nothing inherently proper or improper with selecting one foreign regime over another. Respondent's counsel was correct in arguing that the selection of a low tax jurisdiction may speak persuasively as evidence of a tax purpose for an alleged avoidance transaction, but the shopping or selection of a treaty to minimize tax on its own cannot be viewed as being abusive. It is the use of the selected treaty that must be examined.

On June 13, 2007, the Federal Court of Appeal unanimously affirmed the Tax Court's decision from the bench.

2. Challenges Under Tax Treaties

a. Treaty Residence

So far, in Canada there have been no reported court decisions where treaty shopping has been challenged on the basis that the holding entity is not a resident for the purposes of the treaty being shopped. This may be because the law in Canada on treaty residence has been settled since the Supreme Court's 1995 decision in Crown Forest. In that case the taxpayer, Crown Forest, rented barges from Norsk, a company incorporated in the Bahamas, whose sole office and place of business was located in the United States. Norsk filed income tax returns in the United States only, where it was considered a foreign corporation that was exempt from US income tax on the barge rentals under §883 of the Internal Revenue Code and, accordingly, paid no US tax on the barge rental payments. Crown Forest applied the reduced 10 percent rate to the rental payments under article XII of the Canada-United States tax treaty, rather than the 25 percent domestic withholding tax rate, on the basis that Norsk was a "resident of a Contracting State" for purposes of the treaty. ¹⁸

The Supreme Court of Canada ruled against the taxpayer and held that Norsk could not benefit from the reduced withholding tax rate because it was not a resident for purposes of the Canada-US tax treaty. But for reciprocal shipping profits legislation in the United States and the Bahamas, Norsk would have had a tax liability in the United States arising from the fact that it conducted a trade or business in the United States and derived income that was effectively connected with that business. Although the fact that its "place of management" was located in the United States was one factor contributing to the finding that it conducted a trade or business in the United States, the Supreme Court found that this did not constitute the basis for Norsk's tax liability in the first place. The only way for Norsk to benefit from residence status under the treaty was if source taxation of income that was effectively connected with a US trade or business constituted a criterion similar to the criteria enumerated in article IV. Iacobucci J held that source taxation is not similar because all the criteria in article IV constitute grounds for taxation on worldwide income, not just on source income. The court reasoned that the parties to the treaty intended that only persons who were resident in one of the contracting states and liable to tax in one of them on their "world-wide income" should be considered "residents" for purposes of the treaty.

Hence, on the basis of Crown Forest, so far it has been accepted that as long as a corporation is liable to full or worldwide taxation in its home country, it will be eligible for benefits under the treaty between Canada and that country, without regard to the residence of the corporation's shareholders or the degree of its economic nexus to that country. Accordingly, the reasoning in Crown Forest provides a firm legal basis for inbound treaty shopping in Canada. Yet, as mentioned above, it is notable that the notion of treaty shopping was considered in Crown Forest. Specifically, Iacobucci J stated the following regarding treaty shopping:

It seems to me that both Norsk and the respondent are seeking to minimize their tax liability by picking and choosing the international tax regimes most immediately beneficial to them. Although there is nothing improper with such behaviour, I certainly believe that it is not to be encouraged or promoted by judicial interpretation of existing agreements. …

In fact, under the respondent's interpretation, a foreign corporation whose place of management is in the U.S. would be a resident of the U.S. for purposes of the Convention notwithstanding that such a corporation may not have any effectively connected income to the U.S. and hence no U.S. tax liability at all. I find this possibility to be highly undesirable. "Treaty shopping" might be encouraged in which enterprises could route their income through particular states in order to avail themselves of benefits that were designed to be given only to residents of the contracting states. This result would be patently contrary to the basis on which Canada ceded its jurisdiction to tax as the source country, namely that the U.S. as the resident country would tax the income.¹⁹ [Emphasis added.]

b. General Anti-Treaty-Shopping Rules

It has been a longstanding US treaty policy to deal with treaty shopping by the inclusion in US tax treaties of a limitation-on-benefits (LOB) provision. Generally, Canada, like most other countries, has not followed in this path.²⁰ Currently, only Canada's treaty with the United States contains a LOB provision in article XXIX A. Before the coming into force of the fifth protocol, this provision was only for the benefit of the United States.²¹ Consistent with Canada's position, article XXIX A(7), which has been preserved in the updated bilateral LOB introduced in the fifth protocol, confirms Canada's right to apply the GAAR to deal with abusive treaty shopping.

Separately, MIL (Investments) raised the issue of whether all tax treaties are implicitly governed by a general anti-treaty-shopping principle. In this case, the government presented an alternative argument to the effect that even if the GAAR did not apply to deny treaty benefits in the case, it would still be possible to deny the treaty exemption based on an anti-abuse rule inherent in the Canada-Luxembourg treaty. The government presented the 2003 revisions of the OECD commentaries and a confusing option of an expert as support for the existence of an inherent anti-abuse rule in tax treaties. The Tax Court rejected the Crown's arguments on this point. Bell J interpreted article 31(1)(c) of the Vienna Convention on the Law of Treaties to mean that one can consult only the OECD commentaries in existence at the time the treaty was negotiated without reference to subsequent revisions.

c. Specific Anti-Treaty-Shopping Rules

Canada's tax treaties provide reduced withholding tax rates only to the beneficial owners of payments subject to withholding tax.²² The Prevost decision, discussed in detail next, is the first case to reach Canada's courts where the CRA used the undefined treaty notion of "beneficial owner" as a weapon to combat treaty shopping.²³

THE PREVOST CASE

A. The Facts

The taxpayer in the case, Prevost Car Inc. (Prevost), was a Canadian manufacturer of motor coaches. In 1995, Volvo Bussar AB (Volvo), a Swedish company, and Henlys Group PLC (Henlys), a UK company, entered into a joint venture arrangement to acquire the shares of Prevost. Volvo acquired all the shares of Prevost and shortly thereafter transferred them to a wholly owned special-purpose Dutch subsidiary, Provost Holding BV (Dutchco), which had no employees or other activities. Volvo then sold 49 percent of the shares of Dutchco to Henlys.

There were several "bad facts" in the case. From the beginning, Volvo and Henlys had agreed in their shareholders' and subscription agreement that not less than 80 percent of the profits of Prevost and Dutchco would be distributed to the shareholders. In 1996, Volvo and Henlys, although not direct shareholders of Prevost, agreed to a dividend policy for Prevost "that following the completion of accounts for each quarter, and subject to adequate working and investment capital being available to the company, a dividend of 80 percent of the net retained profit after tax should be paid by the end of the following quarter." Moreover, there were errors in the corporate minute book of Prevost that confused Volvo and Henlys with its actual sole shareholder, Dutchco. Finally, in documentation provided to its banker, Dutchco had declared that the shares of Prevost were beneficially owned by Volvo and Henlys.

In 1996, 1997, 1998, 1999, and 2001, Prevost paid dividends to Dutchco according to the predetermined dividend policy and withheld and remitted tax at the rate of 5 percent (6 percent for 1996), which was the applicable rate under the Canada-Netherlands tax treaty. Dutchco then distributed the dividends received from Prevost to Volvo and Henlys.²⁴ The CRA reassessed the Canadian withholding tax for the years at issue without relying on the GAAR, but solely on the basis that Dutchco was not the beneficial owner of the dividends for purposes of article 10(2) of the Canada-Netherlands treaty; Prevost therefore should have withheld at the rates of 15 percent and 10 percent pursuant to the Canada-Sweden tax treaty and the Canada-UK tax treaty, respectively. Prevost appealed to the Tax Court of Canada.

B. Decision of the TCC

Rip ACJ (as he then was)²⁵ ruled in favour of Prevost. The Tax Court rejected the CRA's position that Dutchco was a conduit for Volvo and Henlys, and it found that Dutchco was the beneficial owner of the dividends paid by Prevost.

To answer the interpretational question before the court, Rip ACJ sought a "domestic solution" pursuant to article 3(2) of the Canada-Netherlands tax treaty.²⁶ Rip ACJ found that the expression "beneficial owner" is not alien to Canadian law and held that the beneficial owner 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. The person who is beneficial owner of the dividend is the person who enjoys and assumes all the attributes of ownership. In short the dividend is for the owner's own benefit and this person is not accountable to anyone for how he or she deals with the dividend income.²⁷

The judge reasoned that when corporate entities are involved, the corporation is the beneficial owner of its assets and the income therefrom 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.²⁸

Rip ACJ held that this was not the case with Dutchco. The fact that a few resolutions in Prevost's minute books contained references to Volvo and Henlys instead of Dutchco as the shareholders of Prevost and that Dutchco had no office or employees in the Netherlands was not sufficient to show that Dutchco was a conduit for Volvo and Henlys. Despite the provision in the shareholders' agreement to the effect that 80 percent of Prevost's income must be distributed, there was no predetermined or automatic flow of funds from Dutchco to its shareholders because Dutchco was not party to the shareholders' agreement and it was, therefore, not legally bound to pay dividends according to the policy set out in the agreement. Because Dutchco was free to use the dividends as it wished without being accountable to anyone, the dividends were beneficially owned by it. The Crown appealed the TCC's decision to the FCA.

C. Decision of the FCA

In a short, 19-paragraph decision rendered only nine days after the appeal was heard, Decary JA, on behalf of the FCA, dismissed the Crown's appeal. The FCA found no error of law with the conclusions of the TCC and accepted the TCC's characterization of the legal relationships, which it summarized as follows:

[16] The Judge found that:

a) the relationship between Prevost Holding and its shareholders is not one of agency, or mandate nor one where the property is in the name of a nominee (par. 100);

b) the corporate veil should not be pierced because Prevost Holding is not "a conduit for another person," cannot be said to have "absolutely no discretion as to the use or application of funds put through it as a conduit" and has not "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, for example a stockbroker who is the registered owner of the shares it holds for clients" (par. 100);

c) there is no evidence that Prevost Holding was a conduit for Volvo and Henlys and there was no predetermined or automatic flow of funds to Volvo and Henlys (par. 102);

d) Prevost Holding was a statutory entity carrying on business operations and corporate activity in accordance with the Dutch law under which it was constituted (par. 103);

e) Prevost Holding was not party to the Shareholders' Agreement (par. 103);

f ) neither Henlys nor Volvo could take action against Prevost Holding for failure to follow the dividend policy described in the Shareholders' Agreement (par. 103);

g) Prevost Holding's Deed of Incorporation did not obligate it to pay any dividend to its shareholders (par. 104);

h) when Prevost Holding decides to pay dividends, it must pay the dividends in accordance with the Dutch law (par. 104);

i) Prevost Holding was the registered owner of Prevost shares, paid for the shares and owned the shares for itself; when dividends are received by Prevost Holding in respect of shares it owns, the dividends are the property of Prevost Holding and are available to its creditors, if any, until such time as the management board declares a dividend and the dividend is approved by the shareholders (par. 105).

Leading up to its conclusion, the FCA cited the TCC's determination that "the ‘beneficial owner' of 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" (paragraph 13) and found that Rip ACJ's interpretation "captures the essence of the concepts of ‘beneficial owner,' ‘beneficiaire effectif' as it emerges from the review of the general, technical and legal meanings of the terms" (paragraph 14). It rejected the government's arguments in the following words (paragraph 15):

Counsel for the Crown has invited the Court to determine that "beneficial owner," "beneficiaire 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.²⁹ [Emphasis added.]

Significantly, the FCA also thought that the TCC's definition of "beneficial owner" accords with what is stated in the OECD commentaries and in the 1986 OECD conduit report. In this respect, at least half of the FCA's judgment deals with the potential role of later OECD materials, such as its 2003 commentaries, in interpreting a pre-existing treaty (this discussion is obiter in that it was not necessary to decide the case). Early in its decision, at paragraph 9, the FCA declared its agreement with counsel for both parties that a judge is entitled to "rely" on subsequent OECD documents. The FCA proceeded to refer to its decision in Cudd Pressure Control Inc. v. R,³⁰ where it qualified the relevance of the 1977 commentary³¹ to the interpretation of a treaty adopted in 1942 as being "somewhat suspect," but also noted that Robertson JA³² recognized that OECD commentaries "can provide some assistance" as to the 1942 Canada-US treaty. It then somewhat curiously indicated that "[t]o the extent that it might be said that a contrary view [it is unclear what is the "contrary view" referred to] was expressed by that Tax Court in MIL (Investments) S.A. v. The Queen … it does not appear that such a view was in the mind of this Court when it dismissed the appeal from the Bench." The FCA then qualified its position by stating, at paragraph 11, that later commentary may serve to guide the interpretation and application of bilateral conventions "when 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 and when, of course, neither treaty partners has registered an objection³³ to the new Commentaries" (emphasis added). Finally, the FCA concluded that, for purposes of interpreting the treaty, the conduit report and the 2003 commentary are a "helpful complement to the earlier Commentaries, insofar as they are eliciting, rather than contradicting, views previously expressed" (paragraph 12).

D. Comments

Prevost is significant both in terms of its outcome and its discussion of whether commentaries to the OECD model issued following the negotiation and adoption of a particular treaty can be employed to interpret such treaty. The following comments briefly discuss the former point and then focus in detail on the latter matter, which, as discussed further below, may turn out to be determinative of Canada's approach to treaty shopping in the future.

1. "Beneficial Owner" Not a Treaty Anti-Abuse Weapon

The importance of Prevost cannot be overstated insofar as it confirms, at least in that case, the rejection of the CRA's attempts to challenge what it perceives to constitute objectionable tax treaty shopping by denying the status of "beneficial owner" for treaty purposes. In this respect, the author wholeheartedly agrees with the statement by tax treaty scholar Brian Arnold that "it is preferable for a basic tax rule such as beneficial ownership … not to be perverted into an anti-avoidance measure."³⁴ The TCC's convincingly reasonable and commonsense interpretation of the expression "beneficial owner" in Prevost, which was endorsed by the FCA, arguably reached the right result. Prevost exemplifies the fact that treaty shopping is not necessarily abusive. From both a commercial and a tax point of view, the transactions in Prevost could be seen as unobjectionable. Commercially, it is perfectly normal for two joint venturers to use a holding corporation for their common investment. Because Volvo and Henlys were based in different countries, forming a holding corporation in a neutral jurisdiction was understandable. From a tax standpoint, using a holding corporation resident in the Netherlands was an easy way to qualify for a dividend withholding tax rate that reflected Canada's most current treaty policy.³⁵

2. Using Later OECD Commentaries in Interpreting Pre-existing Treaties

Of great significance are the FCA's obiter statements in Prevost regarding the relevance of later OECD materials in interpreting a pre-existing tax treaty.³⁶

As outlined above, the FCA expressed the general view (but subject to the qualifications noted below) that later OECD commentaries may be "relied" on in interpreting a pre-existing tax treaty. In stating this position, the FCA departed from the previous holding of the TCC in MIL that "one can only consult the OECD commentary in existence at the time the Treaty was negotiated without reference to subsequent revisions" (paragraph 86), by suggesting, in a somewhat mysterious turn of phrase, that "it does not appear that such a view was in the mind of this Court when it dismissed the appeal from the Bench." In fact, the FCA, in dismissing the Crown's appeal in MIL, did not discuss this issue, and thus, perhaps, Decary JA was referring to what was in his own mind, because he sat on the MIL appeal.

In any event, it is not entirely surprising that the TCC's holding on this point in MIL would be weakened by subsequent decisions. The understandable tendency of a judge is well described by Special Commissioner John Avery Jones, in the 2008 UK decision Trevor Smallwood Trust v. Revenue & Customs:

The relevance of Commentaries adopted later than the Treaty is more problematic because the parties cannot have intended the new Commentary to apply at the time of making the Treaty. However, to ignore them means that one would be shutting one's eyes to advances in international tax thinking, such as how to apply the treaty to payments for software that had not been considered when the Treaty was made. The safer option is to read the later Commentary and then decide in the light of its content what weight should be given to it.³⁷ [Emphasis added.]

This "read and then decide" approach seems to be implicit in the FCA's subsequent qualification of its statements, to the effect that later commentaries may be used as a guide to interpretation only where they represent a fair interpretation of the words of the model convention, do not conflict with commentary in existence at the time a specific treaty was entered into, and when neither treaty partner has registered an observation to the new commentary.³⁸

The FCA did not elaborate further on this analytical approach to later OECD commentaries. It seems though that the FCA has borrowed (without specifically citing) substantially from David A. Ward et al., The Interpretation of Income Tax Treaties with Particular Reference to the Commentaries on the OECD Model.³⁹ In this book, the authors express their view on the relevance of later OECD commentaries as follows:

In our view, later commentaries that represent a fair interpretation of the Model and that clearly arise from the words of the Model (e.g. new amplification commentary) and that do not conflict with commentaries current at the time the tax treaty was negotiated can be given weight as persuasive interpretations by the CFA of the meaning of the particular Article of the Model, but they cannot be considered to have been adopted by the treaty negotiators for purposes of this particular tax treaty. [Emphasis added.]

Considering this, it may be implied that the FCA has adopted Ward's detailed analysis on this point. In this respect, Ward's study was based on a classification, initially developed by Mike Waters (former chief of Working Party 1 at the OECD), which divides later commentaries into four categories: (1) those that fill a gap in the existing commentary by covering matters not previously mentioned; (2) those that amplify the existing commentary by adding new examples or arguments to what is already there; (3) those that record what states have been doing in practice; and (4) those that contradict the existing commentary.⁴⁰

According to Ward, there is "little or no legal justification for the use" of the first type of commentaries. Amplification commentaries of the second category can be given weight as persuasive interpretations by the OECD of the meaning of the particular article of the model. Concerning the third type of commentaries, Ward observes that state practice recorded in the OECD commentaries "may have effect under international law" as long as the relevant contracting states have adopted that practice, which establishes the agreement of the parties regarding its interpretation and is a genuine interpretation and not effectively a change in the treaty. However, the authors warn that OECD commentaries do not necessarily evidence a state practice adopted by one or more OECD member states. Finally, regarding Waters's fourth category, Ward indicates firmly that "later commentary contradicting previous commentary should never be taken into account in interpreting existing treaties."

Considering Ward's nuanced approach, it is quite unfortunate that the FCA in Prevost did not provide any clear guidance as to the weight to be accorded to the different types of later OECD commentaries. The FCA merely indicated that later commentary that meets the three requirements set out at paragraph 11 will constitute "a widely-accepted guide to the interpretation and application of existing bilateral conventions."

to be continued (PART II )

¹ This paper is dedicated in tribute to the late David A. Ward, who had provided the author with helpful comments with respect to this paper before passing away on January 13, 2010. All errors or omissions remain the responsibility of the author.

² 2009 DTC 5053 (FCA); aff'g. 2008 DTC 3080 (TCC).

³ For a recent article discussing various developments in the area of treaty shopping see Sander Bolderman, “Tour d'Horizon of the Term ‘Beneficial Owner,' ” Tax Notes International , June 8, 2009, at 881.

⁴ 2006 DTC 3307 (TCC); aff'd. 2007 DTC 5437 (FCA).

⁵ This government-mandated panel was struck by the minister of finance pursuant to the 2008 federal budget.

⁶ APCSIT, Enhancing Canada's International Tax Advantage: A Consultation Paper Issued by the Advisory Panel on Canada's System of International Taxation (Ottawa: APCSIT, April 2008). For further details, see Nathan Boidman, “Reforming Canada's International Tax: An Interim Report,” Tax Notes International , May 19, 2008, at 613.

⁷ See David A. Ward, Access to Tax Treaty Benefits: Research Report Prepared for the Advisory Pan el on Canada's System of International Taxation (Ottawa: APCSIT, September 2008).

⁸ APCSIT, Enhancing Canada's International Tax Advantage: Final Report (Ottawa: APCSIT, December 2008): http://www.apcsit-gcrcfi.ca/07/cp-dc/pdf/finalReport_eng.pdf (“Final Report”). See Nathan Boidman, “Reforming Canada's International Tax Regime: Final Recommendations, Part 1,” Tax Notes International , January 19, 2009, at 247 and Nathan Boidman, “Reforming Canada's International Tax Regime: Final Recommendations, Part 2,” Tax Notes International , January 26, 2009, at 345.

⁹ [1995] 2 SCR 802, 95 DTC 5389.

¹⁰ Consultation Paper, supra note 6, at paragraph 3.18.

¹¹ In some cases, the entity used may also be a partnership or a trust.

¹² See OECD, Double Taxation Conventions and the Use of Conduit Companies (Paris: OECD, November 27, 1986), at 3 (“the conduit report”).

¹³ Boidman, supra note 6, at 622.

¹⁴ Final Report, supra note 8, at paragraph 5.64.

¹⁵Notably, though understandably, governments are much less worried about outbound treaty shopping: see report by P. Marley and P. Macdonald, “Canada Revenue Agency Offers Views on Cross-Border Antiavoidance Rules,” Worldwide Tax Daily , May 15, 2005, 2005 WTD 92-3: “In her commentary at the IFA conference, [Patricia Brown, acting international tax counsel (treaty affairs) at the U.S. Treasury Department,] suggested that in the context of U.S. outbound investment, if a treaty can be shopped, it should be shopped.”

¹⁶ RSC 1985, c. 1 (5th Supp.), as amended (“the Act”).

¹⁷ Budget Implementation Act, 2004, No. 2, SC 2005, c. 19, ss. 52 and 60.

¹⁸ Article IV of the Canada-US tax treaty provides that a “resident of a Contracting State” is any person or entity who, under the laws of that state, is liable to tax therein by reason of domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature.

¹⁹Crown Forest , supra note 9, at 5397 (DTC).

²⁰ Canada's position is that it is preferable to rely on the GAAR to counter treaty shopping than to include detailed LOB provisions in its tax treaties.

²¹ Although of apparent limited necessity, it was added by the 1995 protocol at the insistence of the United States to counter treaty shopping.

²² All but one of Canada's 87 tax treaties use the term “beneficial owner” in this context. Canada's treaty with Australia uses the term “beneficially entitled” instead.

²³ For detailed comment see M. Kandev, “Prévost Car: Canada's First Word on Beneficial Ownership,” Tax Notes International , May 19, 2008, at 526; N. Boidman and M. Kandev, “News Analysis: Canadian Taxpayer Wins Prévost Appeal,” Tax Notes International , March 9, 2009, at 862; M. Kandev and B. Wiener, “Some Thoughts on the Use of Later OECD Commentaries After Prévost Car,” Tax Notes International , May 25, 2009, at 667.

²⁴ Presumably, the dividends received by Dutchco were eligible for the Dutch participation exemption and, further, were exempt from any Dutch withholding tax, pursuant to the EC Parent-Subsidiary Directive, on further distribution by Dutchco to Volvo and Henlys.

²⁵ On July 15, 2008, Rip J was appointed chief justice of the Tax Court of Canada.

²⁶ Article 3(2) of the treaty provides that terms not defined in the treaty must, unless the context otherwise requires, be given their domestic tax meaning in the state applying the treaty.

²⁷Prévost (TCC), supra note 2, at paragraph 100.

²⁸Ibid.

²⁹ The FCA's reference to “process of objection” is not altogether clear in this context.

³⁰ 98 DTC 6630 (FCA).

³¹ Actually, these were OECD commentaries adopted in 1994.

³² Actually, it was McDonald JA.

³³ Presumably, the court meant “observation.”

³⁴“Tax Treaty News” (2008) 7 Bulletin for International Taxation , at 263.

³⁵ This strategy was acknowledged in the final report. In this respect, Canada's traditional approach had been to oppose the low 5 percent rate on non-portfolio intercorporate dividends. This approach was reflected in the Canada-Sweden tax treaty that was in force at the time the relevant transactions were contemplated. In the early 1990s, however, Canada changed its treaty policy and began the time-consuming process of renegotiating its treaties to provide the low 5 percent rate. The choice of the Netherlands as a holding company location was obvious because, at the time the acquisition of Prévost was planned, the Canada-Netherlands treaty had already been renegotiated. The inoffensive nature of the tax planning is demonstrated by the fact that, effective December 23, 1997, the Canada-Sweden tax treaty was also changed to provide the low 5 percent rate for non-portfolio intercorporate dividends. At the time of the relevant transactions, the Canada-UK tax treaty already provided a (low) 10 percent rate on such dividends; this rate was reduced to 5 percent in the protocol signed on May 7, 2003. It is notable that this protocol had been under negotiation since 1995.

³⁶ The trouble with the FCA's decision in Prévost is its attempt (tenuous as it is) to make a link between its reasons for judgment and its observations on the interpretational value of later OECD commentaries, both generally and in this case. This is because the FCA endorsed the TCC decision, but that decision did not, in fact, rely on the conduit report or the 2003 commentaries, as explained next. See Kandev and Wiener, supra note 23.

³⁷ [2008] UKSPC SPC00669 (February 19, 2008) at paragraph 99.

³⁸ In fact, it is notable that, despite that it cited paragraph 35 of the introduction to the OECD commentaries (added in 1992) for its position on the relevance of later OECD documents, the FCA did not endorse the OECD's broad statement that changes to the commentaries are normally applicable to the interpretation of conventions concluded before their adoption “because they reflect the consensus of the OECD Member countries as to the proper interpretation of existing provisions and their application to specific situations.”

³⁹ Kingston, ON: IFA, 2005, at chapter 6.

⁴⁰ M. Waters, “The Relevance of the OECD Commentaries in the Interpretation of Tax Treaties,” in Praxis des Internationalen Steuerrechts, Festschrift für Helmut Lukota , M. Lang and H. Jirousek, eds. (Wien, Austria: Linde Verlag Wien, 2005), at 680.