Copyright 2008, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Tax, April, 2008
On April 22, 2008, the Honourable Gerald J. Rip, Associate Chief Justice of the Tax Court of Canada, released his decision in the case of Prévost Car Inc. v. The Queen. This decision concerned whether a Netherlands holding company was the "beneficial owner" of dividends paid by its Canadian subsidiary for purposes of the reduced rate of withholding tax on dividends under the Canada-Netherlands Income Tax Convention (the Canada-Netherlands Treaty). The decision in Prévost has been eagerly awaited because of its implications to multinational corporate groups that include a holding company or a group financing or licensing company that would receive dividends, interest or royalties from other members of the group. In particular, there was a question as to whether the Tax Court would take a similar approach to that taken in the 2006 United Kingdom commercial case, Indofood International Ltd. v. JP Morgan Chase Bank N.A. London Branch, which also addressed the "beneficial owner" issue.
Taxpayers will be pleased that the Tax Court refused to pierce the corporate veil in order to conclude that the holding company's shareholders rather than the holding company should be considered to be the beneficial owner of a dividend for treaty purposes.
Facts of the Case
A Netherlands holding company, Prévost Holding B.V. (B.V.), was established by Volvo Bussar A.B. (Volvo), a corporation resident in Sweden and Henlys Group PLC (Henlys), a corporation resident in the U.K. Volvo was initially the direct owner of all of the shares of Prévost Car Inc. (Prévost Car), a Canadian corporation that built and customized buses and other vehicles. Volvo subsequently transferred the shares to B.V. and sold part of its shares of B.V. to Henlys, so that Volvo held 51% of B.V.'s shares while Henlys held the remaining 49%. B.V., in turn, held all of the shares of Prévost Car. B.V. had been established by Volvo and Henlys as a holding company that could be used to own North American projects that the two parties wished to participate in. As it turned out, B.V. was apparently used only to hold the shares of Prévost Car. The residency of B.V. in the Netherlands was not put in issue in the case.
From 1996 to 2001, Prévost Car made 12 dividend payments totalling $90 million representing 80% of its profit over that period. Eleven of those dividends totalling $78 million were assessed by the Canada Revenue Agency (the CRA) on the basis that sufficient non-resident tax had not been withheld and remitted. Prévost Car had withheld Canadian non-resident tax at the 5% rate pursuant to the Canada-Netherlands Treaty. On receiving such dividends from Prévost Car, B.V. would pay such amounts over to its shareholders, Volvo and Henlys, as dividends on the shares of B.V. The CRA took the position that B.V. was not the "beneficial owner" of such dividends paid by Prévost Car. In its reassessments, the CRA levied Canadian withholding tax at a rate of 15% on dividends that it stated were "beneficially owned" by Volvo pursuant to the Canada-Sweden Income Tax Convention and 10% on dividends that the CRA contended were "beneficially owned" by Henlys pursuant to the Canada-United Kingdom Income Tax Convention.
The Prévost Decision
The sole issue in the Prévost case was the meaning of the words "beneficial owner" in Article 10(2) of the Canada-Netherlands Treaty. Such phrase is not defined in that treaty; however, as Rip, A.C.J. acknowledged in his reasons, Article 3(2) of the Canada-Netherlands Treaty directs that, unless the context otherwise requires, undefined terms shall have the meaning attributed to them under the law of the state imposing the tax concerned, which in this case would be Canada. Rip, A.C.J. also considered the Commentary on the 1997 Organization of Economic Cooperation and Development Model Tax Convention on Income and on Capital (the OECD Model Convention) to be relevant to the analysis. He included consideration of the 2003 modifications to the Commentary and the OECD's report on conduit companies, even though the tax years at issue were 1996 to 2001 and the treaty in question was signed in 1986, and amended in 1993 and 1997.
The 2006 United Kingdom Indofood case was also discussed in the Tax Court decision, although it is not at all clear what weight, if any, the Tax Court gave to this case. The Indofood case involved an Indonesian company that set up a Mauritian special purpose vehicle to issue loan notes. Such structure was employed in order to take advantage of the withholding tax rates under the Indonesia-Mauritius Income Tax Convention. After the notes had been issued, Indonesia terminated that tax treaty, apparently because of concerns with conduit companies taking advantage of it. This change would increase the amount of withholding tax applicable to interest on the notes, and the issuer was obliged to gross up holders for any such withholding tax. The terms of the notes allowed the issuer to redeem them in such circumstances but only if such increased withholding tax could not be avoided by the issuer "taking reasonable measures available to it". Unrelated to the increased withholding tax cost, changes in foreign exchange and interest rates had made these notes very unfavourable from the issuer's perspective. When the issuer attempted to exercise its redemption right because of the termination of the Indonesia-Mauritius Income Tax Convention, the defendant in the case, acting on behalf of holders of the notes, refused to approve such redemption on the ground that it was not satisfied that the issuer had considered all of the measures available to it to avoid the increased liability for withholding tax. In particular, the defendant argued that the Indonesian parent could have interposed a Dutch entity and taken advantage of preferable withholding tax rates under the Netherlands-Indonesia Income Tax Convention. The U.K. Court of Appeal concluded that had such a Dutch company been interposed, it would have been acting as a mere "conduit" and would not have been the "beneficial owner" of interest received from the Indonesian parent and, thus, would not have been entitled to the reduced rate of withholding tax pursuant to Article 11 of the Indonesia-Mauritius Income Tax Convention.
The Tax Court in the Prévost decision reviewed the Indofood case, but neither explicitly accepted nor rejected the conclusions therein other than to suggest that it seemed to be in conflict with certain other cases. The Indofood case, however, does not seem to have played a major role in the Tax Court's decision in Prévost. This may be appropriate for a number of reasons. The first is that Indofood is a United Kingdom commercial decision that because of the terms of the notes involved, required the court to interpret the meaning of a phrase in a tax treaty. Furthermore, that analysis required a U.K. court to ascertain what meaning would be given to the term "beneficial owner" by an Indonesian court under Indonesian law, which is a civil and not a common law jurisdiction.
Rip, A.C.J. began his analysis of the phrase "beneficial owner" by referring to the OECD Commentary on Article 10(2) the OECD Model Convention which explains that one should look behind an agent or nominee in order to determine the beneficial owner of a payment and that a conduit company is also not a beneficial owner. He noted that an agent, nominee or conduit company "never has any attribute of ownership of the dividend" received. "Conduit companies" have been a source of concern to tax authorities and the OECD, resulting in the release by the OECD of a report on the use of conduit companies which led to the revision of the Commentary to the OECD Model Convention.
In Prévost, Rip, A.C.J. concluded that the "beneficial owner" of a dividend is the person who assumes and enjoys all of the attributes of ownership of such dividend, including "control" of the dividend received. He stated further that the dividend must be for the person's own benefit and the person must not be accountable to anyone for how the dividend income is dealt with. The Supreme Court of Canada decision in Jodrey Estate v. Nova Scotia (Minister of Finance) which concluded that the beneficial owner of a particular property is the person who "ultimately" exercises the rights of ownership of such property, was referred to. Rip, A.C.J. concluded that, when making the determination of who is the person who can ultimately exercise the rights of ownership in property, the Supreme Court of Canada in Jodrey did not intend that one should strip away the corporate veil to conclude that the shareholders of the corporation are the beneficial owners of its assets, including income earned by the corporation. A possible exception would arise if "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 a conduit, or has agreed to act on someone else's behalf pursuant to that person's instructions". However, that was not in his view the relationship between B.V. and its shareholders. Accordingly, the taxpayer succeeded, as B.V. was considered to be the beneficial owner of dividends paid by Prévost Car and entitled to the benefits of the Canada-Netherlands Treaty.
The Tax Court's refusal to ignore the legally effective relationships and existence of separate legal entities is very welcome. That being said, the analysis in Prévost does leave some questions as to what decision the court would have made had the facts been slightly different, particularly with respect to the role that a shareholders' agreement between B.V.'s shareholders played in the decision. This shareholders' agreement provided for distributions of 80% of the profits through the corporate group that included both Prévost Car and B.V. The court noted that this agreement did not obligate B.V. to pay its dividends on that basis because B.V. was required to pay its dividends in accordance with Dutch law. The court seemed to place some weight, however, on the fact that B.V. was apparently not a party to the shareholders' agreement. Thus, if the dividend policy described in the shareholders' agreement was not carried out, then one shareholder would have an action under such agreement against the other shareholder, but no shareholder would have an action against B.V.
One is left to wonder how Rip, A.C.J. would have concluded if B.V. had been a party to the shareholders' agreement and therefore had contractual obligations to pay dividends. Where possible, any commitments by a corporation to pay dividends to its shareholders should be subject to exercise of some true discretion by the directors of the corporation. The Prévost case does not address a situation in which a corporation receiving dividends, interest or royalties has binding contractual obligations to flow those income items through to another person, for example as back-to-back dividends, interest or royalties. However, it is apparent from the Tax Court's decision that there would be a potential concern in the event of a "predetermined or automatic flow of funds" through a corporation, or a situation in which income is "ab initio destined for" another person with the corporation receiving the income acting "as a funnel" or "a conduit" to flow the income through to the other person. Another factor mentioned by the Tax Court would be whether the income received by the corporation is its asset and available to its creditors, if any. It should be kept in mind that the OECD Commentary suggests that where a "formal owner", as a practical matter, has very narrow powers, such a situation could render such person not to be the beneficial owner in relation to the income concerned, as its role is a mere fiduciary or administrator acting on account of the true beneficial owners.
It is also interesting to note that the CRA did not assert that the general anti-avoidance rule (GAAR) should be applied to deny B.V. the benefit of the reduced withholding tax rate under the Canada-Netherlands Tax Treaty. Although GAAR was not an issue in the case, Rip, A.C.J. nonetheless seemed to go out of his way to include in the description of the facts comments to the effect that there were valid non-tax reasons for having established B.V. in the Netherlands rather than another jurisdiction. Given such discussion, it would seem unlikely that the court would have found that GAAR could have been successfully applied in these circumstances. In any event, the MIL Investments case decided by the Canadian Federal Court of Appeal in 2007 is good authority for not applying GAAR in a "treaty shopping" context.
The Prévost case is a welcome reaffirmation that legally effective transactions will not be lightly ignored by the courts. Nonetheless, the analysis in the decision and developments concerning conduit companies generally mean that attention must be paid when establishing foreign holding companies, intra-group financing companies or companies licensing intellectual property to other members of the corporate group. In addition to "beneficial owner" concerns, changes to the foreign affiliate rules, GAAR and limitation on benefits provisions in tax treaties must be considered. To date, most Canadian tax treaties do not have comprehensive limitation on benefits provisions. It is noted that the recent protocol to amend the Canada-United States Treaty adds such provisions for Canadian tax purposes.
As of this writing, it is not yet known whether the Crown will be appealing Prévost to the Federal Court of Appeal.
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