Originally Published in Blakes Bulletin on Tax, October 2007
In a case argued in the Tax Court of Canada in September 2007 but not yet decided (Prevost Car Inc. v. The Queen, Court Files 2004-2006(IT)G and 2004-4226(IT)G), the Canada Revenue Agency (the CRA) has taken the position that a Netherlands holding company was not the "beneficial owner" of dividends paid to it by its Canadian subsidiary for purposes of the reduced rate of withholding under the Canada-Netherlands tax treaty.
By way of background, 51% of the shares of Prevost Holding B.V. (B.V.), a Netherlands holding company, were owned by Volvo Bussar AB (Volvo), a corporation resident in Sweden and 49% by Henlys Group plc (Henlys), a corporation resident in the U.K. In turn, B.V. held all the shares of Prevost Car Inc. (Prevost Car), a corporation resident in Canada that was in the business of building and customizing motor coaches and other vehicles (B.V. had been incorporated in 1995 for the acquisition of Prevost Car by Volvo and Henlys).
From 1996 to 2001, Prevost Car made 12 dividend payments totalling CAD 90 million, representing 80% of its annual profit over that period. Of that amount, CAD 78 million was assessed by the CRA in respect of the 11 dividends at issue. Prevost Car withheld Canadian tax at the rate of 5% under the Canada-Netherlands tax treaty. Over the same period, B.V., in turn, paid dividends to its shareholders, Volvo and Henlys, in amounts equal to the dividends it received from Prevost Car.
In its reassessments, the CRA took the position that B.V. was not the "beneficial owner" of the dividends it received from Prevost Car. It imposed Canadian tax at a rate of 15% on dividends that it says were "beneficially owned" by Volvo and 10% on dividends that it says were "beneficially owned" by Henlys (the withholding rates under the Canada-Sweden tax treaty and the Canada-U.K. tax treaty, respectively).
The only issue at trial was whether B.V. was the "beneficial owner" of the dividends paid by Prevost Car during the relevant period.
According to the CRA, B.V. had been "interposed" between Volvo/Henlys and Prevost Car. On the CRA’s theory of the case, B.V. was an "intermediary" or "mere conduit". This conclusion was based largely on the fact that B.V. was simply a garden variety offshore holding company that did nothing more than hold shares in its Canadian subsidiary. In this regard, the Crown also relied on evidence that Volvo and Henlys had entered into a shareholders agreement which provided, among other things, that 80% of the annual profit of Prevost Car would be paid out as dividends. In addition, the affairs of B.V. were administered by a local trust company in the Netherlands which was duly authorized to do so by powers of attorney. Finally, some of the corporate resolutions and minutes of Prevost Car relating to dividends were not prepared in a meticulous manner and some of the banking documents of B.V. suggested that Volvo and Henlys considered themselves the de facto shareholders of Prevost Car.
In the Tax Court of Canada, the Crown’s legal argument was based on the proposition that the term "beneficial owner", as used in the Canada-Netherlands tax treaty, should be interpreted in accordance with its "ordinary meaning" rather than its legal meaning and in a manner consistent with the English, French and Dutch versions of that term. The Crown argued that all three versions, when read together, require that the recipient of the dividends must be the "real" beneficiary of the income.
At the end of the day, the Crown argued that the Court should "look behind the strict legal relationships to identify the person who, in fact, benefits from the dividend." This is an entirely novel proposition. But why, in principle, should the CRA have stopped at Volvo and Henlys? What about the shareholders of those corporations? And what about the shareholders of those shareholders? Taken to its logical conclusion, such an approach would lead to radical legal and financial uncertainty. In a typical holding company structure, corporations and individuals up the ladder will certainly "benefit from the income" generated by the Canadian operating company. However, that alone does not make the shareholders of a non-resident holding company the "beneficial owners" of dividends declared and paid by a Canadian operating company to that holding company.
Although the Commentary to the 1977 OECD Model Tax Convention and a subsequent OECD report suggest that holding companies acting as nominees or agents will not generally qualify as "beneficial owners" of dividends paid to them, that does not mean that garden variety holding companies are to be disregarded simply because they do nothing more than hold shares of a Canadian operating company.
Interestingly, the phrase "beneficial owner" is also used in provisions of the Canada-Netherlands tax treaty dealing with interest and royalties. Another case currently before the Tax Court of Canada presents the same question as Prevost Car but in respect of the beneficial ownership of royalty payments (Velcro Canada Inc. v. The Queen, Court File 2007-1806(IT)G). The Velcro case has not yet been scheduled for hearing.
It is hoped that the Tax Court of Canada will take the opportunity in Prevost Car to reassure non-resident investors that Canada will continue to respect the separate corporate existence of non-resident holding companies absent special circumstances (e.g., where they are merely nominees or agents). As the Federal Court of Appeal reminded the government of Canada in the recent MIL decision (see Kathleen Penny’s case comment at page 1), if the Canadian government wishes to change the rules of the game, it may do so on a country by country basis with the concurrence of its treaty partners. A limitation on benefits provision, for example, is an important feature of many of Canada’s current tax treaties, including its tax treaty with the United States, but is conspicuously absent from Canada’s tax treaty with the Netherlands.
If Canada wishes to deny treaty benefits in particular circumstances, then Canada and its treaty partners are obliged to renegotiate their bilateral agreements and make such changes clearly and unambiguously within the text of their tax treaties.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.