Canada: Cross-Border Tax Structures And Tax Treaties

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) Rules

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 United States.

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 such treaties.

3. "Abuse of Treaties" Principle

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 shopping context.

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 similar) proceeds.

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 Tax Update.

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.