Your Business News
Alta Energy: SCC confirms GAAR not applicable to treaty shopping
December 2, 2021
Authored by RSM Canada LLP
Cleo L. Melanson, CPA, CA, CMA shared this article
TAX ALERT |
In Canada v. Alta Energy Luxembourg S.A.R.L, the Supreme Court of Canada (SCC) upheld the lower courts’ decision that Alta Energy’s restructuring to avail itself of treaty benefits in the Canada-Luxembourg Tax Treaty (the Treaty) was not abusive tax avoidance and, therefore, the General Anti-Avoidance Rule (GAAR) did not apply.
The relevant facts are as follows: a US LLC owned shares of a Canadian corporation (Canco) that was engaged in oil and gas exploration. If the US LLC had sold the shares of Canco, the capital gain would have been taxable in Canada. The US LLC undertook a restructuring in which it transferred the shares of the Canco to Alta Energy, a corporation resident in Luxembourg. Alta Energy sold the Canco shares and took the position that the capital gain was not taxable in Canada due to Article 13(4) of the Treaty, which provides an exemption for residents of Luxembourg when the value of the shares is derived principally from immovable property that is situated in Canada, and in which the business of the company was carried on.
The government argued that the object, spirit and purpose of the relevant provisions – and of the Treaty as a whole – is that taxes should be paid on income, where the income has the strongest economic ties. This is referred to as the theory of ‘economic allegiance’, under which an economic connection between the state and the taxpayer serves as the basis for taxation. The government’s position was that accessing the Treaty exemption simply by incorporating a company in Luxembourg without any actual investment in, or economic connection to, Luxembourg, was treaty shopping that abused the above-noted object, spirit and purpose of the relevant Articles of the Treaty. Therefore, the GAAR applied to tax Alta Energy’s capital gain in Canada.
The majority of the SCC (six of the nine SCC Judges) dismissed the government’s argument and held that the GAAR did not apply. The majority’s decision outlined the following interpretive principles when considering the application of the GAAR to the Treaty:
- The GAAR invites courts to look beyond the text of a provision to determine the object, spirit and purpose of the provision, but the text of the provision cannot be ignored. Instead, “[t]he proper approach is one that unifies the text, context, and purpose, not a purposive one in search of a vague policy objective disconnected from the text.”
- The broad purpose of all treaties is to allocate taxing rights between the countries, and the principle that underlies this purpose is economic allegiance. However, economic allegiance is not the only principle or policy consideration that underlies each treaty provision. Therefore, when considering the application of the GAAR to specific treaty provisions, the principle of economic allegiance must be balanced against the principles that underlie the specific treaty provisions.
- The principles that underlie Article 13(4) of the Treaty are capital import neutrality, the concern to prevent tax base erosion and the desire to attract foreign investment. Due to these underlying principles, the theory of economic allegiance is not the dominating rationale underlying Article 13(4).
- Treaty shopping may be considered immoral but is not abusive.
What about the MLI?
At the time of the US LLC’s transfer of the Canco shares to Alta Energy, the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) was not in force. The MLI has measures to prevent treaty abuse, including treaty shopping. Specifically, the MLI has a Principal Purpose Test (PPT), which allows governments to deny treaty benefits to a business if the principal purpose of a business arrangement or transaction was to directly or indirectly obtain a tax benefit. Canada has been a signatory to the MLI since Dec. 1, 2019, meaning that, for Canada’s tax treaties with countries that are also signatories to the MLI, the SCC’s finding that treaty shopping did not abuse the Treaty may be of less significance because the government can use the PPT to challenge treaty shopping.
Evolution of the GAAR
This case instructs that when conducting a GAAR analysis, the text of the relevant provisions cannot be overlooked in favour of a broader purpose that underlies the provision but is wholly absent from the text itself. Instead, the broader purpose must be unified – balanced, if necessary – with the principles that underlie the text of the provision.
The government already stated that it is looking at ‘modernizing’ (strengthening?) the GAAR. The Minister’s loss in Alta Energy should augment the government’s aspiration to ‘modernize’ the GAAR.
Call us at 1 855 363 3526 or fill out the form below and we'll contact you to discuss your specific situation.
This article was written by Clara Pham, Yoni Moussadji and originally appeared on 2021-12-02 RSM Canada, and is available online at https://rsmcanada.com/our-insights/tax-alerts/alta-energy-scc-confirms-gaar-not-applicable-to-treaty-shopping.html.
The information contained herein is general in nature and based on authorities that are subject to change. RSM Canada guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM Canada assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
RSM Canada Alliance provides its members with access to resources of RSM Canada Operations ULC, RSM Canada LLP and certain of their affiliates (“RSM Canada”). RSM Canada Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM Canada. RSM Canada LLP is the Canadian member firm of RSM International, a global network of independent audit, tax and consulting firms. Members of RSM Canada Alliance have access to RSM International resources through RSM Canada but are not member firms of RSM International. Visit rsmcanada.com/aboutus for more information regarding RSM Canada and RSM International. The RSM trademark is used under license by RSM Canada. RSM Canada Alliance products and services are proprietary to RSM Canada.
FCR a proud member of RSM Canada Alliance, a premier affiliation of independent accounting and consulting firms across North America. RSM Canada Alliance provides our firm with access to resources of RSM, the leading provider of audit, tax and consulting services focused on the middle market. RSM Canada LLP is a licensed CPA firm and the Canadian member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM Canada Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.
For more information on how FCR can assist you, please call us at 1 855 363 3526