Canada: Taxation Law @ Gowlings: April 11, 2011

Last Updated: April 15 2011

Edited by Mark L. Siegel


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By Pierre G Alary and Jim Wilson

One of the purposes of tax treaties is to encourage international trade and investment. Discriminatory taxation runs counter to that purpose. Hence, the prevention of discriminatory taxation is an important role of tax treaties. It is then surprising to think that until this year, a Canadian court had yet to rule on a case involving the non-discrimination article of Canada's bilateral tax treaties1.


Before looking at the language of some key paragraphs of the non-discrimination article of the Model Tax Convention on Income and on Capital of the Organization for Economic Co-operation and Development2 ("OECD" and the "Model") and how the article differs in Canada's tax treaties we will first describe two common concepts of non-discrimination found in international treaties in general.

The first concept is that of "national"3 treatment, whereby a State promises that it will give nationals of another State the same treatment that it gives to its own nationals in similar circumstances. By preventing locals from benefitting from an unfair advantage, this concept is widely seen as encouraging foreign investment.

Paragraph 1 of Article 24 of the Model reads as follows:

1. Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances, in particular with respect to residence, are or may be subjected. This provision shall, notwithstanding the provisions of Article 1, also apply to persons who are not residents of one or both of the Contracting States.

The first concept is clearly a principle heavily endorsed by the OECD under Article 24 of the Model. The same cannot be said for the second concept which relates to the "most favoured nation" treatment. Under this requirement, a State that is party to a treaty must grant to the parties of that treaty the same treatment it grants to third parties. A State must therefore treat its treaty partners as it treats other States. Despite what the name might seem to imply, "most favoured nation" treatment is really a promise to provide an equal treatment among treaty partners, not to provide better treatment than has been provided to other States. As alluded to above, the provisions of Article 24 were not intended by the OECD to be interpreted as to require most-favoured nation treatment.4 Countries in their bilateral negotiations would generally have to draft particular language into the treaty to achieve that concept.

Non-discrimination in Canada's tax treaties

We should first note that Canada has registered a reservation on the Article as a whole5, as it does not accept the broad principle of non-discrimination which is encouraged in the Model. For example, Canada's treaties do not generally include a provision equivalent to paragraph 4 of Article 24 of the Model because Canada is not prepared to give up its thin capitalization regime.6 Furthermore, paragraph 1 of the Non-Discrimination Article of Canada's tax treaties does not normally contain the last sentence of paragraph 1 of Article 24 of the Model. Based on this, it is evident that Canada is of the view that this Article should only apply to nationals covered by a particular treaty as it would be inappropriate to give a taxpayer the benefit of a Canadian treaty with a country in which the taxpayer is not a resident. Presumably, this is a bigger concern to Canada where the national is resident in a non-treaty country.

Paragraph 5 of Article 24 of the Model also provides that an entity of one of the Contracting States which is owned or controlled by residents of the other Contracting State may be treated no less favourably than entities owned or controlled by residents of the first-mentioned State. In other words, the Model requires national treatment for foreign–owned entities. Again, based on Canada's existing treaty network, it would appear that Canada is only prepared to accept a most-favoured nation rule. That is, the provision seen in many of Canada's treaties provides only that entities owned by residents of the treaty partner will be treated the same as any other foreign–owned entities. The intention is most likely to protect Canada's special tax regimes pertaining to small businesses in Canada and Canadian-controlled private corporations.

Nonetheless, Canada does accept the general principle of non-discrimination on the basis of nationality that is supported in the Model, albeit, as noted above, with the exception of a few of the principle's extensions as found in the Model. In the recent Saipem UK Limited decision, the application of paragraph 1 of Article 24 of the Model, as modified under Canada's tax treaties as described above, was the main issue before the Canadian court.

The Saipem UK Limited decision

In Saipem UK Limited v. The Queen7 ("Saipem"), the question before the Tax Court of Canada (the "Court") was whether the restriction in subsection 88(1.1) of the Income Tax Act (Canada)8 (the "Act") pertaining to "Canadian corporations" violated the taxpayer's rights to non-discriminatory treatment under Article 22 of the Canada-United Kingdom Tax Convention9 (the "Treaty"). The appellant ("Saipem UK"), a UK resident, carried on business in Canada through a permanent establishment ("PE") from 2004 to 2006. Saipem UK's subsidiary, Saipem Energy International Limited ("SEI"), also a resident of the UK, carried on business in Canada through a PE from 2001 to 2003. In 2003, SEI was wound up into its parent company (i.e. Saipem UK). In computing its income from its Canadian business for the 2004 to 2006 years, Saipem UK claimed deductions for the losses incurred by SEI in prior years. The Canada Revenue Agency disallowed the deductions for the SEI losses on the basis that Saipem UK and SEI were not "Canadian corporations" as required under subsection 88(1.1). Subsection 88(1.1) is a provision in the Act that allows the losses incurred by a Canadian corporation that was wound up to be carried forward and deducted by the parent company in circumstances where, among other criteria, not less than 90% of its issued shares are owned by another Canadian corporation (i.e. the parent company).

Saipem UK argued that the limited application of subsection 88(1.1) of the Act to Canadian corporations violated Saipem UK's right to non-discrimination in accordance with Article 22 of the Treaty. The Tax Court of Canada was asked to consider both paragraphs 1 and 2 of Article 22. With respect to paragraph 1 of Article 22, it concluded that Saipem UK was not being treated "less favourably" and that subsection 88(1.1) does not discriminate based strictly on nationality. For example, the phrase "Canadian corporation" is defined in subsection 89(1) of the Act as a corporation that was either incorporated in Canada, or resident in Canada since June 18, 1971. The Court concluded that the proper approach would be to compare Saipem UK "with a Canadian national that is a non-resident of Canada and that has a non-resident wound-up subsidiary. That non-resident Canadian national would not qualify as a "Canadian corporation" under subsection 89(1) and therefore would not have access to its wound-up subsidiary's losses under subsection 88(1.1) of the Act." With respect to paragraph 2 of Article 22, the Court also concluded that the "equal treatment principle only applies to the taxation of the PE's own activities. It does not therefore extend to provisions that take into account the relationship between an enterprise and other enterprises and that allow the transfer of losses." This conclusion is consistent with Article VII of the Treaty which deals with the determination of profits of a permanent establishment situated in a contracting state.

Interestingly, this was the first Canadian court case materially dealing with the non-discrimination article of one of Canada's tax treaties. Therefore, this case is significant as it offers the first judicial guidance in Canada on the matter. More importantly, the Court, in applying and interpreting the expression "in the same circumstances"10, confirmed that the residence of the taxpayers is one of the factors that must be taken into account when determining whether the taxpayers are placed in similar circumstances for the non-discrimination provision to apply.

Even though the Court ruled against the appellant11, the Court did describe certain situations where the non-discrimination provisions of the Treaty could apply. One interesting situation, while not raised by the Court, is the case where a foreign company is resident of Canada from the date of its incorporation12. In light of the definition of "Canadian corporation" in subsection 89(1) of the Act, discussed above, a corporation created after 1971 would always have to be incorporated in Canada to be considered a Canadian corporation, and be allowed benefits offered in the Act, such as rollovers under section 88 since mere residence in Canada would not be sufficient. Thus, the definition of "Canadian corporation" is clearly discriminatory. Regardless, the Court's analysis in Saipem should be helpful for future cases of non-discrimination.


1.Canadian courts have previously ruled on minor issues regarding the non-discrimination article. See for example Crawford v. The Queen, 51 DTC 99 and Ramada Ontario Ltd v. The Queen, 94 DTC 1071. However, we view the recent Saipem UK Limited decision as the first ruling of substance on the article.

2. OECD, Model Tax Convention on Income and on Capital, Condensed Version (OECD Publishing, 2010) [Model].

3. The term "national" is defined in Article 3 of the Model as, in relation to a Contracting State, any individual possessing the nationality or citizenship of that Contracting State and any legal person, partnership or association deriving its status as such from the laws in force in that Contracting State.

4. See paragraph 2 of the commentary on Article 24 of the Model.

5. See paragraph 85 of the commentary on Article 24 of the Model.

6. Where a Canadian treaty does include paragraph 4 of the Model, Canada will generally ensure that its thin capitalization regime is protected under a special overriding provision of the treaty (see, for example, paragraph 7 of Article 25 of the Canada-U.S. Treaty).

7. Saipem UK Limited v. The Queen, 2011 TCC 25 (decision rendered on January 14, 2011).

8. Income Tax Act, RSC 1985, (5th Supp), c 1 [ITA].

9. Convention Between the Government of Canada and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains, as amended.

10. As found in paragraph 1 of Article 24 of the Model and Canada's treaties in general.

11. Saipem UK Limited has appealed the decision to the Federal Court of Appeal (docket #A64-11, filed February 9, 2011).

12. For example, a corporation created in a foreign jurisdiction, after June 18, 1971, but had its central management and control in Canada and subsection 250(5) of the Act did not apply to deem the corporation to be a non-resident of Canada

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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