Canada: Appeal Court Finds Taxpayer to be "Beneficial Owner" Under Tax Treaty

On February 26, 2009 the Federal Court of Appeal unanimously dismissed the Crown's appeal in Prévost Car Inc. v. The Queen. The court held that a Dutch holding company was the "beneficial owner" of dividends received from its Canadian subsidiary for purposes of the Canada-Netherlands Income Tax Convention, despite having distributed substantially all of the dividends to its shareholders resident in other countries. The court thus affirmed that the Dutch company was not a mere conduit for its shareholders as had been alleged by the Crown. This is the first appellate decision in Canada to interpret the term "beneficial owner" in the tax treaty context.


The issue on appeal was whether the Dutch company, Prévost Holding B.V. (Holding), was the "beneficial owner" of dividends received from its wholly-owned Canadian subsidiary, Prévost Car Inc. (Prévost), for purposes of the Canada-Netherlands Income Tax Convention (Treaty). The reduced 5% withholding tax rate under the Treaty applied only if Holding was the beneficial owner of the dividends.

The Crown argued that Holding was merely a conduit or funnel for its corporate shareholders, Volvo Bussar Corporation (Volvo), a resident of Sweden, and Henlys Group PLC (Henlys), a resident of the United Kingdom. In its view, Prévost should have withheld tax from the dividend payments at the rates of 15% and 10%, pursuant to the Canada-Sweden and Canada-UK Income Tax Conventions, respectively.

The primary basis for the Crown's position was a shareholders agreement between Volvo and Henlys which provided (among other things) for not less than 80% of the profits of Prévost and Holding to be distributed to their respective shareholders. The Crown argued that this dividend policy required Holding to distribute dividends received by it to its shareholders, and that Holding had in fact distributed substantially all of the dividends it received. The Crown also argued that other factors suggested Holding was not the beneficial owner of the dividends. In particular, there was a lack of substance in the Netherlands (i.e., Holding did not have employees or maintain a physical office there, and was managed by a third party advisory firm). In addition, the Crown pointed to references in certain banking documents of Holding to the shareholders of Holding being "beneficial owners," the commonality of directors between Prévost and Holding, and certain inconsistencies in the corporate records of Prévost.

Decision of the Tax Court of Canada

Associate Chief Justice Rip (as he then was) acknowledged that the expression "beneficial owner" is not defined in the Treaty or in the Income Tax Act (Canada); however, Article 3(2) of the Treaty (similar to most tax treaties) 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 (in this case, Canada).

In view of Article 3(2), Justice Rip had recourse to several interpretive tools including Canadian and international jurisprudence, dictionary meanings of the relevant words in French, English and Dutch (the languages of the three official versions of the Treaty), the evidence of expert witnesses as well as the Commentary to the OECD Model Tax Convention on Income and on Capital (OECD Commentary). Justice Rip determined that "the 'beneficial owner' of dividends is the person who receives the dividends for his or her own use and enjoyment and assumes the risk and control of the dividend he or she received."

Despite the existence of the shareholders agreement (and the dividend policy therein), Justice Rip noted that since Holding was not a party to that agreement, neither Henlys nor Volvo could take action against Holding for failure to follow the policy. More importantly, the dividends were regarded as an asset of Holding that would be available to its creditors, if any, in the event of its insolvency. Holding was accordingly held to be the beneficial owner of the dividends received from Prévost, and was entitled to the reduced dividend withholding tax rate under the Treaty.

Decision of the Federal Court of Appeal

On appeal, the Crown argued that "beneficial owner" should have an international fiscal meaning (rather than its common law meaning in Canada) and, to give effect to the English, French and Dutch versions of the Treaty, "beneficial owner" should be construed as "the person who can, in fact, ultimately benefit from the dividend."

The Federal Court of Appeal rejected this approach, holding that the Tax Court's interpretation of "beneficial owner" had captured the essence of this concept and was in accordance with the views expressed in the OECD Commentary. The court found that the Crown's interpretation would open up a "myriad of possibilities which would jeopardize the relative degree of certainty and stability that a tax treaty seeks to achieve." Speaking for a unanimous bench, Justice Décary noted that the Crown was effectively urging upon the court, a "pejorative view of holding companies" which neither Canadian domestic law, the international community nor the Canadian government had previously endorsed. Accordingly, Justice Décary adopted the definition of "beneficial owner" as set out by the Tax Court, and dismissed the appeal in favour of Prévost.

In so doing, Justice Décary also observed that tax treaties should be interpreted with the benefit of the OECD Commentaries, including revisions to the Commentaries that are made after a particular tax treaty is signed (particularly where the revised Commentaries represent a fair interpretation of the words of the Model Convention and do not conflict with Commentaries in existence at the time the treaty was entered into, and where neither treaty partner has registered an objection to the revised Commentaries).

Implications of the Decision

The Canada Revenue Agency (CRA) has been inclined to contest taxpayers' entitlements to benefits under Canada's tax treaties in a myriad of ways. In MIL Investments S.A. v. The Queen, the CRA had relied on its ability to prevent perceived misuses or abuses of tax treaties through the Canadian domestic general anti-avoidance rule, which was amended in 2005 to explicitly apply to tax treaties, and had also argued that tax treaties contained an implied anti-abuse rule. The CRA was unsuccessful in that case both at the Tax Court and Federal Court of Appeal. Now in this case, the CRA has been unsuccessful in arguing that beneficial owner should be interpreted in a manner that would accord with the term being applied as a broad anti-treaty shopping provision.

Although Canada has limitation on benefits (LOB) provisions in approximately half of its tax treaties, its only comprehensive LOB provision is in the Canada-United States tax treaty. Given the CRA's lack of success to date in attacking treaty shopping under the general anti-avoidance rule, implied anti-abuse rules, and now through the meaning of beneficial owner, it is possible that Canada may seek to adopt more comprehensive LOB provisions in its tax treaty negotiations.

Despite the taxpayer's victory in Prévost Car Inc. v. The Queen, it remains critical to ensure that any international holding company structure is validly established and effectively maintained to ensure compliance with applicable tax treaty provisions. Otherwise, the desired treaty benefits may well be denied either on technical grounds or as a result of the application of the various rules that the CRA has previously used in attempting to limit perceived treaty shopping abuses.

The Crown has until April 27, 2009 to file an application for leave to appeal this decision to the Supreme Court of Canada.

Patrick Marley is a tax partner in the firm's Toronto office, where he advises on tax issues associated with international tax planning, domestic and cross-border mergers and acquisitions, corporate reorganizations, corporate finance, and various other tax matters. Pooja Samtani is an associate in the Tax Department in the firm's Toronto office.

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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