Canada: Commercial Realities Shape The Interpretation Of Tax Treaties

Tax treaty benefits, like many other tax incentives, are often designed to encourage foreign investment in Canadian industry. However, gaps between the original intent of a policy and CRA's subsequent interpretations can result in uncertainty (and unwelcome tax bills) well after initial investment by a foreign company. The decision of the Tax Court of Canada in Alta Energy Luxembourg S.A.R.L. v R, released on August 22, 2018, reaffirms the right of a taxpayer to rely on the original intent behind a government policy and confirms that commercial realities should be considered in interpreting tax treaties. The decision makes clear that structuring ownership through a fiscal resident of a country with a favourable tax treaty is not, per se, an abuse or misuse of a tax treaty in the absence of some explicit further requirement in the treaty (such as a limitation on benefits provision).


In 2011, Alta Energy Partners LLC was formed as a U.S. LLC to acquire and develop oil and gas properties in North America. Alta Energy Partners formed a Canadian subsidiary, Alta Energy Partners Canada (Alta Canada), which acquired oil and gas properties in Canada. In 2012, the shares of Alta Canada were transferred to a Luxembourg holding company (Alta Energy Luxembourg S.A.R.L., or Alta Luxembourg). In 2013, the shares of Alta Canada were sold by Alta Luxembourg to an unrelated purchaser. The gain realized was over $380 million. Alta Luxembourg filed a Canadian tax return, claiming relief under article 13(5) of the Canada-Luxembourg Tax Treaty (Treaty) to exempt the gain from Canadian tax.

Article 13(5) of the Treaty allows the country in which a taxpayer is resident (which, in the case of Alta Luxembourg, was Luxembourg) to have the exclusive right to tax capital gains which are not specifically mentioned under Articles 13(1) through 13(4) of the Treaty. Luxembourg does not impose a tax on capital gains, which meant that Alta Luxembourg's capital gain from selling Alta Canada would not be taxed anywhere in the world if it was not taxed in Canada.

Decision of the Court

The primary issue before the court was whether or not Alta Luxembourg's capital gain would be taxable in Canada under article 13(4) of the Treaty. This provision specifies that the sale of shares of a company whose value derives from holding immovable property will be liable to tax in the country where the property is located (in this case, Canada), unless the property is "property in which the business of the company was carried on." Alta Luxembourg held substantial property in which it was not actively drilling, but where it intended to drill in future. The Crown argued that this was not "property in which the business of the company was carried on."

The court disagreed. Commercial realities of resource extraction indicate that a working interest consisting of numerous licenses cannot be developed and fully exploited all at once. First, a reserve must be accurately delineated. The resource owner must then prove that the resource can be extracted at a reasonable cost, having regard to the projected future commodity price. Significant drilling and extraction operations cannot be commenced until the economic value of the reserve is established. As a result, the fact that licenses representing a substantial portion of the appellant's land were not being actively developed did not exclude them from being property in which the business of the company was carried on. As such, this case stands for the proposition that, (1) tax treaties should be interpreted with reference to what the signatories intended (demonstrated either by extrinsic evidence or, as here, reasonable inference) and (2) normal commercial practices that taxpayers likely to be seeking benefits under a tax treaty carry out are highly relevant in interpreting what the treaty signatories intended and thus when treaty benefits should and should not be granted.

Interestingly, a government document (referred to only as "the position paper" by the court) came to the same conclusion in 1991, stating that excluded property could either be used or held for use in a company's business where that company was actively engaged in the exploration of a reserve. CRA then later cited and adopted the view from the position paper in a ruling issued in 2000. The court pointed out that CRA appeared to be repudiating its earlier position without admitting to doing so, and noted that taxpayers should be able to rely on stated positions that take into account how reserves are developed in Canada.

The Crown advanced as an alternative argument that the general anti-avoidance rule (GAAR) in section 245 of the Income Tax Act (Canada) applied to the transaction. Alta Luxembourg conceded that it derived a tax benefit from the restructuring of its activities from the U.S. to Luxembourg and that there was an avoidance transaction. The parties disagreed about whether the avoidance transaction constituted an abuse or misuse, which would be required to invoke the GAAR. The Crown argued that the fact that the transactions resulted in double non-taxation constituted abusive tax avoidance. However, the court noted that Canadian treaty negotiators were aware of Luxembourg law at the time the treaty was negotiated (i.e., Luxembourg would not tax this gain), and had nonetheless departed from the OECD model treaty by allowing a carve-out for immovable property in which the business of a company is carried on. As such, the court declined to disturb the bargain between Canada and Luxembourg, which appeared to have been struck with a view to encouraging investment in Canada. Hogan J. noted that the Crown appeared to want to apply the GAAR to deal with an (allegedly) unintended gap in the Treaty, and held that it could not be applied this way.


There are two distinct aspects of this decision, both of which are relevant for taxpayers operating in an increasingly global world:

  1. Interpretation of tax treaties: Commercial realities and industry "best practices" should be considered when determining when treaty signatories intended tax treaty benefits to be granted, and a liberal interpretation given to tax treaty provisions. Tax incentives are generally intended to promote risk-taking by international investors and should apply during the early stages of resource investment.
  2. Government positions and GAAR: Where CRA changes its earlier administrative positions to taxpayers' detriment, it will have an uphill battle convincing the court that the later interpretation is the correct one, and at some level taxpayers should be able to rely on the CRA's earlier interpretations. The GAAR does not apply to retrospectively fill in gaps in legislation.

1. Interpretationof Tax Treaties

It is noteworthy that the court acknowledged that commercial realities of companies should be considered when interpreting tax treaties. The CRA position as to the interpretation of the "property in which the business of the company was carried on" exception appeared to be untenable given the practical realities of resource extraction, which requires slow and methodical investigation of a reserve. It is not practical to expect that a working interest would be developed all at once.

In that vein, the court also appeared to focus on the fact that this kind of investment and commercial practice was the intended result of Canada's tax treaty with Luxembourg. The appellant was conducting a genuine business, investing and developing Canadian resource property as encouraged to under the treaty. While the appellant used a holding company to garner more favourable treatment than it would have received as a US resident, the court held that there was nothing inherently abusive about doing so absent some evidence to the contrary in the relevant treaty (e.g., an explicit "principal purpose" test). Key to this analysis was the fact that both parties agreed that the shares were beneficially owned by the holding company that was fiscally resident in Luxembourg.

The court also focused on the choices made by the Canadian government in negotiating the Canada-Luxembourg Tax Treaty. The appellant qualified as a resident of Luxembourg because it met the requirements set out in Article 4 of the Treaty. The court noted that there was no limitation on benefits or "principal purpose" rule denying access to treaty benefits, which Canada has negotiated in other treaties and has agreed to incorporate into many of its existing treaties via the OECD multilateral convention on base erosion and profit shifting. Further, the OECD Model Treaty, which is used as a baseline in Canadian treaty negotiations, does not include a carve-out for immovable property in which the business of a company is carried on. It appeared to have been the explicit intention of Canadian treaty negotiators to give companies resident in Luxembourg more favourable treatment than companies resident in other countries, presumably in order to encourage further investment from Luxembourg. The court held that it was not in a position to intervene in this bargain.

II. The Use ofGovernment Documents in Tax Litigation

When the Crown attempted to distance itself from a 1991 position paper written by a government official which appeared to support the appellant's case, the court noted that it appeared CRA was repudiating an earlier position without admitting to doing so. The CRA had adopted the view in the position paper in a prior ruling, and it was inconsistent to resile from a prior view which informed the interpretation of the Treaty. This analysis is helpful for taxpayers in situations where the government initially designs legislation intended to encourage investment in specific industries, and changes its interpretation when the incentives seem to work too well.

The Crown is also not able to use the GAAR to retroactively fill gaps in legislation — whether or not such gaps are intended. The Department of Finance proposed a rule in 2014 to try to deal with double non-taxation in tax treaties for future years and the court noted that the Crown appeared to be applying the GAAR to have the same effect in past years. The court's holding that this is an inappropriate use of the GAAR promotes certainty for multinational taxpayers.

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