Cross-border tax structures often optimize available tax treaty
benefits having regard to the differences between various bilateral
tax treaties. Structures that take advantage of such differences
(e.g., holding companies situated in advantageous or lower tax
jurisdictions) may, however, be susceptible to attack by tax
authorities under "treaty shopping" principles.
The Canada Revenue Agency (CRA) has commented that it considers
treaty shopping to include transactions that involve the
establishment of entities or residency in a particular jurisdiction
to permit a taxpayer to avail itself of the benefits of a
particular treaty for tax avoidance purposes.
Treaty shopping has developed a high profile, and the CRA has
indicated that it will target treaty shopping structures. The CRA
typically seeks to challenge treaty shopping on the basis of one or
more of the following five principles.
1. Specific Limitation on Benefit (LOB)
Limitation on benefit (LOB) provisions in tax treaties restrict
the entitlement to treaty benefits and are expressly designed to
counteract treaty shopping. Although Canada's bilateral tax
treaties do not generally contain detailed LOB provisions, the
Canada-US Tax Treaty was recently amended to create a reciprocal
LOB rule that denies the benefits of the Canada-US treaty to
certain US residents where they have an insufficient nexus with the
2. General Anti-Avoidance Rule (GAAR)
Following the 2004 federal budget, the GAAR was changed
retroactively to provide that the GAAR applies to tax treaties.
For the CRA to successfully attack an alleged treaty shopping
structure through the GAAR, it will have to demonstrate that a
particular transaction defeats the object, spirit and purpose of a
particular provision of a treaty. This may be difficult for the CRA
to establish in light of rules in most of Canada's treaties,
which already create a framework addressing who may benefit from
3. "Abuse of Treaties"
None of Canada's tax treaties contain an express "abuse
of treaties" principle. Any such principle would need to be
implied. As one has not been recognized by the Canadian courts to
date, it will be difficult for the CRA to sustain a treaty shopping
challenge on this basis.
4. Treaty Residence
A treaty shopping challenge may also be advanced by the CRA on
the basis that the treaty resident intermediary is not resident in
the particular state for treaty purposes and, therefore, not
entitled to treaty benefits. The issue of residence has yet to
receive any recent Canadian judicial consideration in the treaty
5. Beneficial Ownership
The CRA could also assert that the person claiming treaty
benefits in respect of a particular payment (e.g., dividends) is
not the beneficial owner of such payment so that it does not
qualify for treaty benefits, based upon the beneficial ownership
requirement in various provisions of Canadian tax treaties.
A taxpayer has successfully defended an attack founded on
beneficial ownership, and the reasoning of the court in that case
highlights the need for proper directors' meetings, minutes and
other corporate formalities so that it is clear the relevant
company assumes the risk and control of the property and exercises
its discretion to distribute or otherwise deal with dividend (or
McCarthy Tétrault Notes:
In light of the current state of Canada's LOB provisions,
the GAAR jurisprudence, and the Canadian and international
jurisprudence that has considered alleged treaty shopping
transactions, the current state of the law in Canada remains quite
favourable for transactions structured to efficiently utilize
Canada's array of bilateral tax treaties. In the context of
Canada-US transactions, proper consideration of the LOB provisions
will be essential, and in cross-border transactions involving the
United States and other countries, proper administration of such
structures will be vital to ensure residency and beneficial
ownership conditions are satisfied and to defend against possible
attacks on the basis of the GAAR.
For a more detailed discussion of this tax-structuring issue,
please see the
full article published previously in Volume 1, Issue 3 of our
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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