Federal Court of Appeal Upholds Treaty-Based Canadian Holding Structure

Written By Wade Ritchie, Jared Mackey and Greg Johnson

On February 12, 2020, the Federal Court of Appeal (FCA) in Canada v Alta Energy Luxembourg S.A.R.L., 2020 FCA 43 [Alta Lux] concluded that the Canada-Luxembourg tax treaty (Can-Lux Treaty) was not abused when a Luxembourg resident S.A.R.L. (Luxco) sold shares of a Canadian resource company in circumstances where a greater than $380-million capital gain realized on the sale was exempt from taxation in Canada. On appeal to the FCA, the Minister argued that the general anti-avoidance rule (GAAR) should apply to deny Luxco's treaty benefits in order to tax the gain in Canada. The facts of the case are more fully described in our earlier blog post on the Tax Court's 2018 decision—Tax Court Affirms Treaty-Based Canadian Holding Structure.

The FCA found that the object, spirit and purpose of the relevant Can-Lux Treaty provisions is reflected in the clear and simple text of the Treaty. Since the provisions operated as intended, the FCA concluded that the transactions at issue were not abusive and therefore dismissed the Minister's appeal. In reaching this conclusion, the FCA observed that Luxco was a resident of Luxembourg for purposes of the Can-Lux Treaty and refused to use the GAAR to read in additional requirements to claim treaty benefits. The FCA rejected the Minister's argument that Luxco lacked commercial or economic ties to Luxembourg, stating there "is no distinction in the [Can-Lux Treaty] between residents with strong economic or commercial ties and those with weak or no commercial or economic ties."

Alta Lux is consistent with previously decided Canadian tax cases involving treaty-based structures, and is particularly helpful for dispositions of taxable Canadian property by non-residents prior to the effective date of the OECD's Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). The MLI has introduced a broad anti-avoidance "principal purpose test" that will generally disallow a treaty benefit where obtaining the benefit is a principal purpose of a particular transaction or arrangement, unless granting the benefit would be in accordance with the object and purpose of the treaty provisions relied upon. Minimal guidance currently exists on how the principal purpose test will be applied, but it is expected that treaty benefits will be more difficult to obtain and a greater level of economic substance in the foreign country will be required. For more information on the MLI, please see the following Bennett Jones blog posts:

• New Ratifications of the OECD's Multilateral Instrument Put Canadian Resource Holding Structures at Risk; and
• Tax Treaty Benefits Threatened as Canada Completes Ratification of OECD's Multilateral Instrument.

Canada completed its domestic ratification of the MLI in August 2019. As a result, for Canadian holding structures that commonly rely on the Can-Lux Treaty or the Canada-Netherlands treaty, the MLI is now effective for withholding taxes and will come into effect for other taxes, including capital gains, for tax years beginning on or after June 1, 2020. Multinational enterprises and private equity firms investing in Canada through a Luxembourg or Netherlands holding structure should plan to ensure future compliance with the "principal purpose test" or to take advantage of current structures before the MLI becomes effective (e.g., through implementation of "step-up" transactions).

Contact any member of the Bennett Jones Tax group if you wish to discuss the implications of Alta Lux or the MLI on your Canadian investment.

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