Alta Energy: The Supreme Court of Canada rules on shopping under a tax treaty | Dentons
On November 26, 2021, the Supreme Court of Canada (âSCCâ) issued its long-awaited decision in The Queen v. Alta Energy Luxembourg SARL1 . The majority of the Court dismissed the Crown’s appeal and confirmed that, where Canada has agreed in a double taxation treaty to cede taxing rights to another country, it cannot use the general anti -avoidance (“GAAR”)2 to reconsider his agreement. In other words, an agreement is an agreement.
The case concerned the sale in 2013 (the âSaleâ) by Alta Energy Luxembourg SARL (âAlta Luxâ) of shares (the âSharesâ of Alta Energy Partners Canada Ltd. (âAlta Canadaâ) to Chevron. Alta Canada was a Canadian resident corporation that carried on a business of acquiring and developing oil and gas properties in Alberta. Alta Lux was formed and acquired the Shares solely for the purpose of completing the Sale and claiming a treaty exemption. on the resulting gain. On the sale, Alta Lux realized a gain of over $ 380 million. There was no doubt that the shares were “taxable Canadian property” in the absence of an exemption under of an applicable tax treaty, Alta Lux would have been subject to tax under the ITA on the taxable part of its gain.3
Articles 13 (4) and 13 (5) of the Canada-Luxembourg Convention of 1999 concerning the tax on income and on capital4 (the âTreatyâ) exempt from Canadian tax gains realized on the disposition of shares the value of which is derived primarily from real property located in Canada and in which the business of the Company has been carried on (the âExemption relating to business assets â). The only question before the SCC was whether, taking into account the GAAR, the Alta Lux gain was covered by the Business Property Exemption, given the lack of economic substance of the company in Luxembourg.5
The CRA’s concern
While the Canada Revenue Agency (the âCRAâ) admitted that Alta Lux was a âresidentâ of Luxembourg taking into account only the literal wording of Article 4 (1) of the Treaty, it argued that Alta Lux was not a âtrueâ resident of Luxembourg and that, therefore, he was not entitled to the commercial property exemption. In making this argument, the CRA attempted to invoke the GAAR to override sections 13 (4) and 13 (5). The ARC’s concern arose from two facts: (i) one year before the sale, Alta Energy Partners, LLC (âAlta LLCâ) transferred the Shares to Alta Lux and (ii) Alta Lux was unrelated substantial economic development with Luxembourg (no large office, no employees, no active bank account, etc.).
The transfer of the Shares by Alta LLC to Alta Lux did not qualify for a treaty exemption and was therefore a taxable transaction for purposes of the Tax Act. However, because it was at a much lower price than the product received a year later by Alta Lux on the sale, much of the overall gain realized since Alta Canada’s inception would be exempt from Canadian tax.
When undertaking a GAAR analysis, there is a three-part test6: (i) if there has been a “tax advantage”7 arising from a transaction, (ii) whether the transaction constituted an âavoidance transactionâ8 and (iii) whether the avoidance transaction was abusive.
Before the SCC, Alta Lux conceded that the transfer of the Shares by Alta LLC to Alta Lux not only created a tax benefit for Alta Lux, but was carried out primarily to confer that benefit, making it an âavoidance transactionâ. “. Therefore, the only question before the SCC was whether the transfer constituted abusive tax avoidance.
The CRA argued that because Alta Lux was just a holding company with no employees, it was abusing both the treaty residency rules and the business property exemption. Therefore, the position of the ARC was that Canada was not required to leave to Luxembourg the exclusive right to tax Alta Lux’s gain on the sale of the shares.
The majority decision
In a 6-3 decision, the majority of the SCC did not accept the CRA’s argument. Citing the principles of interpretation set out in Vienna Convention on the Law of Treaties9, the majority confirmed that the parties to a treaty must respect their end of the bargain and fulfill their obligations in good faith (or, as the old Latin expression goes, pacta sunt servanda: “every treaty in force is binding on parties and must be performed by them in good faith â). In the majority view, Canada entered into a binding agreement with Luxembourg knowing that the Grand Duchy did not tax capital gains, but did not insist on wording which would have resulted in the gain of the sale of the Shares would be taxable in Canada.
In undertaking the abuse analysis, the majority referred to certain guiding principles. It distinguishes between what is “immoral” on the one hand and “abusive” on the other hand and confirms its previous decision in Canada Trustco that the courts should not imbue the abuse analysis with a “value judgment of what is right or wrong, or theories of what tax law should be or should do”. Furthermore, the majority reiterated that the abuse analysis is not meant to be a “search for a policy. [ITA] which is not based on a unified, textual, contextual and teleological interpretation of the specific provisions in question â, but rather on the interpretation of the object, spirit and purpose of the specific provisions of the ITA or of a convention particular tax. The majority noted that the GAAR cannot be used to replace or modify clear wording in a tax or treaty provision simply on the basis of the underlying purpose of that wording.
The majority then embarked on an analysis of the object, spirit and purpose of the conditions of residence provided for in Articles 1 and 4, paragraph 1, of the Treaty. It concluded that the underlying rationale for Article 4 (1) is to allow all persons who are residents under the laws of one or both of the Contracting States to claim benefits under the Treaty. , as long as their residency status could expose them to full liability tax (regardless of the existence or not of actual taxation). The majority noted that there was no reference to a âsufficient substantial economic linkâ in Articles 1 and 4 and that âthe inclusion of an unexpressed condition should be viewed with cautionâ.
Next, the majority analyzed the object, spirit and purpose of the commercial property exemption and concluded that it was intended to promote international investment in commercial assets embodied in real property, such as hotels and mines. By accepting the business goods exemption, Canada has sought to increase employment and economic investment in Canada by providing an incentive to foreign investors. If the drafters had wanted to impose limits on this objective, guarantees could have been included in the treaty. For example, Canada could have insisted that the business property exemption only apply if the relevant gain was taxable in Luxembourg (or only if the conventional resident had operated the business for a minimum period, etc.).
Ultimately, the majority concluded that the provisions of the Treaty worked the way the Contracting States intended them to do and, therefore, the transfer of the Shares to Alta Lux and the subsequent Sale did not abuse these provisions.
Importantly, the majority considered that, in the context of a treaty, the intentions of the two countries should be taken into account in any GAAR analysis. Luxembourg had negotiated for the exemption of commercial property to benefit its residents. Using the GAAR to override this exemption would unilaterally displace Luxembourg’s agreement and intentions.
The dissenting opinion
Unlike the majority, the three dissenting judges focused on the fact that many countries had seen their tax bases eroded as multinational corporations took advantage of loopholes and inadequacies in international tax rules. Consequently, they considered that Alta Lux’s tax benefit under the Convention was the result of abusive avoidance transactions which contradicted the logic underlying the relevant provisions of the Convention. They did not believe that neither the Tax Court of Canada nor the Federal Court of Appeal (or the majority of the SCC) had correctly identified the rationale for these provisions.
Further, they concluded that Parliament’s intention in enacting the GAAR was to allow the courts to have an unusual duty to look beyond the terms of a given provision and determine why it was enacted. Without such power, the GAAR would make no sense.
In the view of the dissent, the object, spirit and purpose of Articles 1, 4 and 13 of the treaty were akin to the theory of economic allegiance. This theory attributes the attribution of the powers of taxation to the state which has the closest fiscal link with the income concerned.
The dissent agreed that Article 13 (4) only grants Luxembourg the right to tax indirect gains of its residents from real estate located in Canada that is used in a business, but noted that Alta Lux does not had little or no real economic ties with Luxembourg. The dissent felt that this violated the rationale for this section. The dissent concluded that when taxing rights in a tax treaty are allocated on the basis of economic allegiance and the flow-through entities claim tax benefits despite the lack of any real economic link with the state of residence , treaty shopping is abusive.
Impact of the decision in the future
The majority’s conclusion that the GAAR cannot be used as a substitute for words in a provision is essential to our understanding of the GAAR. For example, in a recent decision, the Federal Court of Appeal asked the GAAR to read the word âcontrolâ in subsection 11 (1 (5) to mean âactual control.â The taxpayer in that case requested the leave to appeal The decision in Alta Energy should give it a much more solid basis for its application for authorization.
On the other hand, the transactions in question before the SCC predate the entry into force in Canada of the Multilateral Convention for the Implementation of Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the “MLI”) and the main object criterion contained therein. As a result, a future court may have to determine the impact of the MI on any subsequent transaction.
1 2021 CSC 49
2 Income Tax Act, RSC 1985, c. 1 (5th Supplement), as amended (the âITAâ), subsection 245 (2)
3 In accordance with subsections 2 (3) and 115 (1) of the ITA.
4 Convention between the Government of Canada and the Government of the Grand Duchy of Luxembourg for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital (the Treaty”).
5 In lower courts, the CRA also argued that the nature of the business operated by Alta Canada did not meet the technical requirements for the commercial property exemption to apply. The CRA did not raise this argument before the SCC.
6 See Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54 (âCanada Trustcoâ) and Copthorne Holdings Ltd. vs. Canada, 2011 SCC 63.
7 Within the meaning of subsection 245 (1) of the ITA.
8 Within the meaning of subsection 245 (3) of the ITA.
9 Vienna Convention on the Law of Treaties, Can. TS 1980 n Â° 37, art. 26, 31.