Citation: 2012 TCC 3
Date: 20120103
Docket: 2008-2967(IT)G
BETWEEN:
FLSMIDTH LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Paris J.
[1]
The issue in this
appeal is whether GL&V/Dorr-Oliver Canada Inc. (“Dorr‑Oliver”), a
predecessor corporation of the Appellant, is entitled to a deduction under
subsection 20(12) of the Income Tax Act
for its share of U.S. income tax paid by a limited partnership of which it was
a member. The appeal relates to Dorr‑Oliver’s taxation year ending March
31, 2002.
[2]
Subsection 20(12)
allows a deduction for non-business income tax paid to a government of a
country other than Canada. The deduction is available in computing a
taxpayer’s income from a business or property.
[3]
Subsection 20(12) sets
out a number of conditions for the deduction. The relevant conditions for the
purposes of this appeal are that the foreign tax be paid in respect of the
taxpayer’s income from a business or property and that, in the case of a
corporation, the tax cannot reasonably be regarded as having been paid in
respect of income from the share of the capital stock of a foreign affiliate of
the corporation.
[4]
Subsection 20(12) reads
as follows:
In computing a taxpayer’s income for a taxation year from a business
or property, there may be deducted such amount as the taxpayer claims not
exceeding the non-business income tax paid by the taxpayer for the year to the
government of a country other than Canada (within the meaning assigned by
subsection 126(7) read without reference to paragraphs (c) and (e)
of the definition “non-business-income tax” in that subsection) in respect of
that income, other than such tax, or part thereof, that can reasonably be
regarded as having been paid by a corporation in respect of income from a share
of the capital stock of a foreign affiliate of the corporation.
[5]
The questions raised in
this appeal are:
i) whether the limited partnership, of
which Dorr-Oliver was a member, paid the U.S. income tax in respect of a
property source of income under the Act and, if so,
ii) whether the U.S tax could reasonably be
regarded as having been paid in respect of income from the share of the capital
stock of a foreign affiliate of Dorr-Oliver.
Overview
[6]
Dorr-Oliver
was incorporated in Ontario in 1990 as a wholly owned subsidiary of Groupe Laperrière &
Verrault (“GL&V”), a Quebec corporation.
[7]
In 1998, GL&V set up a
cross-border structure to finance the
acquisition of companies in the U.S. The kind of structure set up by GL&V is
known as a “tower structure.” Generally
speaking, a tower structure is a chain of holding entities (corporations or
partnerships) set up by a corporation to allow it to fund U.S. subsidiaries in a tax-efficient manner. This tax
efficiency is achieved by using entities that are classified differently under Canadian
and U.S. tax law. Such entities are referred to as
“hybrid entities” because, for tax purposes, one country treats the entity as a
flow-through vehicle like a partnership while the other country treats it as a
corporation, which is taxable in its own right.
[8]
As a result of the
different treatment of the hybrid entities in the GL&V structure, the
income of the limited partnership was calculated in a different manner for
Canadian tax purposes than for U.S. tax purposes. Under U.S. tax law, the income that was earned by the limited partnership
consisted of interest income earned from a U.S.
corporation. For Canadian tax purposes, it earned dividend income from a
Canadian corporation. This difference in treatment leads to the first issue in
this appeal: whether the U.S. tax paid on the interest income was paid
in respect of a property source of income under the Act.
[9]
With respect to the
second issue, the entity in the GL&V structure that paid the interest
income on which the limited partnership was taxed in the U.S. was a foreign affiliate of Dorr-Oliver. The question,
therefore, is whether the U.S. tax can reasonably be regarded as having
been paid by the limited partnership in respect of income from a share of a
foreign affiliate.
Facts
[10]
The following entities
were part of the GL&V structure:
GL&V and Peg Limited Partnership – the U.S. limited partnership of which Dorr-Oliver was a member.
It was constituted under the laws of the state of Delaware. Dorr-Oliver had a 98.9%
interest in the limited partnership, and GL&V had a 1% interest. The
general partner (another wholly owned subsidiary of GL&V) held a 0.1%
interest.
The limited partnership filed an election with the U.S. Internal Revenue
Service to be treated as a U.S. resident corporation. Under Canadian tax law, the limited partnership was
treated as a transparent entity.
GL&V Company: a Nova Scotia unlimited liability company (“NSULC”), all of the
shares of which were owned by the limited partnership. The sole activity of the
limited partnership was holding the shares of NSULC. NSULC was a disregarded
entity under U.S. tax law. It was treated as a corporation under Canadian
tax law and therefore subject to tax as a separate person.
GL&V Finance Inc.: a U.S. limited liability company (“LLC”) all of the shares
of which were owned by NSULC. LLC was a disregarded entity under U.S. tax law.
Under Canadian tax law, LLC was treated as a separate person subject to tax.
[11]
GL&V used the cross-border
structure to finance the its acquisition of U.S. companies in the following manner:
- the limited partnership subscribed for shares of
NSULC using, in part, borrowed funds;
- NSULC used the funds from the subscriptions made by
the limited partnership to subscribe for shares of LLC;
- LLC used the proceeds from the subscriptions to make
interest‑bearing loans (the “LLC loans”) to GL&V Holdings
(“Holdings”), a U.S. subsidiary of GL&V, and
- Holdings used the proceeds of the LLC loans to
provide capital and loans to indirectly wholly-owned subsidiaries of GL&V
to purchase U.S. companies.
[12]
For the year ended March 31, 2002,
LLC earned interest income from Holdings on the LLC loans and used this income as
well as interest income it earned in the previous year to pay dividends to
NSULC. NSULC used the proceeds of the dividends from LLC to pay dividends to
the limited partnership.
[13]
During that year, the limited partnership
paid interest on money it borrowed to subscribe for the NSULC shares.
[14]
These transactions gave rise to
different tax results under U.S. and Canadian tax law.
[15]
For U.S. tax purposes NSULC and LLC
were treated as disregarded entities, and it was considered that:
-the limited partnership made the LLC loans to
Holdings directly,
-the interest earned on those loans was earned
directly by the limited partnership, and the LLC dividends and the NSULC
dividends were disregarded, and
-the interest paid by the limited partnership on the
money used to acquire the NSULC shares and ultimately fund the LLC loans was
incurred to earn the interest income on the LLC loans.
The
limited partnership filed an election with the U.S. Internal Revenue Service to
be treated as a U.S. resident corporation. In computing its net income, it
included the interest income from Holdings, and it deducted the interest it
paid on the money it borrowed to purchase the NSULC shares. The limited
partnership paid tax to the U.S. government on the resulting net income.
[16]
For Canadian tax purposes:
-LLC was treated as a foreign affiliate of NSULC, and
the interest income earned by LLC from Holdings was recharacterized as active
business income and was included in LLC’s exempt surplus.
-The LLC dividends paid to NSULC were paid out of
LLC’s exempt surplus. Since the dividends were paid out of exempt surplus, NSULC
was able to deduct the amount of those dividends in computing its taxable
income pursuant to paragraph 113(1)(a) of the Act and did
not pay tax on them.
-The limited partnership included the NSULC dividends
in its income and deducted the interest paid on the money it borrowed to subscribe
for the NSULC shares. It also deducted the U.S. tax it paid during the year, which is the deduction that
is disputed in this case.
-Dorr-Oliver included its share of the limited partnership’s
income in computing its income. The amount included in income by Dorr-Oliver
was net of its proportionate share of disputed deduction taken by the limited partnership
under subsection 20(12).
-In computing its taxable income, Dorr-Oliver deducted
its share of the NSULC dividends received by the limited partnership under
subsection 112(1). Therefore, Dorr-Oliver did not pay any tax on its proportionate
share of the NSULC dividends.
-LLC was a foreign affiliate of Dorr-Oliver.
It
is admitted by the parties that the U.S. tax that was paid by the limited partnership was paid
by it on interest income from the LLC loans and was non‑business income
tax as defined in subsection 126(7) of the Act. It is also admitted that
the limited partnership’s only source of income under the Act was its
shares in NSULC and that the only income it received in the year in issue was
the NSULC dividends.
First
Question: Was the U.S. tax
paid by the limited partnership in respect of income from a business or
property under the Act?
[17]
For the purposes of the first issue,
it is helpful to repeat the relevant portions of subsection 20(12), which read
as follows:
In computing a
taxpayer’s income . . . from a business or property, there may be
deducted . . . the . . . income tax paid by the taxpayer . . . to a government
of a country other than Canada . . . in respect of that income . . .
Respondent’s
position
[18]
The respondent submits that a
deduction under subsection 20(12) of the Act is only available for tax
paid to a foreign government in respect of income that arises from the same business
or property source as the income which is being computed by the taxpayer under
the Act. In this case, the limited partnership’s only source of income from
a Canadian tax perspective was its shares in NSULC. However, there was no amount
that could be deducted by the limited partnership under subsection 20(12) in
computing the limited partnership’s income from that source because the U.S. tax was not
paid by the limited partnership in respect of income from that source. The respondent
says that the U.S. tax was paid on interest income from the LLC loans,
which were not recognized as a source of income to the limited partnership under
the Act.
[19]
Since the income on which the U.S. tax was
paid was not considered to be income under the Act, there was no source
of income to the limited partnership against which the subsection 20(12)
deduction could be taken.
[20]
The respondent says that there
must be a “direct link” between the U.S. tax paid by the limited partnership and the dividend
income it received from NSULC and no direct link exists here. It is not enough
that interest income and dividends are both income from property under the Act.
The appellant cannot take deductions in respect of the interest income
attributed to the limited partnership under U.S. tax law, because that source did not exist under the Act.
Furthermore, since income from property is computed under the Act on a
property by property basis, only deductions that relate to the NSULC shares can
be taken in computing income from those shares.
[21]
The respondent also says that this
interpretation of the phrase “tax paid ….in respect of that income” is
consistent with the purpose of subsection 20(12), which is to ensure that
Canadian residents are not subject to international double taxation. There is
no double taxation of the limited partnership’s dividend income from NSULC
because those dividends were deductible by it under subsection 112(1) of
the Act, and therefore were not taxed under the Act. The only tax
paid by the limited partnership on the LLC interest income that flowed through
to the limited partnership was the U.S. tax.
Appellant’s
position
[22]
The appellant argues that the
phrase “tax paid … in respect of that income” in subsection 20(12) does not
require a causal or direct link between the U.S. tax and the dividend income from NSULC. It only requires
that the U.S. tax be paid in relation to the income which is
being computed under the Act or in connection with that income.
[23]
The appellant says that in
economic terms the limited partnership’s profit from its shares in NSULC was
reduced by the U.S. tax that it paid and therefore that the U.S. tax was
paid in respect of the dividend income from NSULC. The appellant says that the U.S. tax
“reduced the profit from the sole and only undertaking of the limited partnership,
its investment in the NSULC shares.”
[24]
The appellant contends that the
words “In computing a taxpayer’s income from a business or property” and “tax
paid . . .in respect of that income” were added to subsection 20(12) simply for
the purpose of clarifying that the deduction was not available in respect of
foreign taxes paid on income from sources other than business or property and not
for the purpose of requiring that the foreign tax be paid on income from the
same source as that which is being computed under the Act. Since the U.S. taxes in
this case were paid in respect of a property source of income, the deduction
would fall within the intent of subsection 20(12).
[25]
In the alternative, the appellant submits
that the reference in subsection 20(12) to “income from a business or
property” is in fact a reference to a single unified source of income, again
because this wording is only intended to limit the deduction to foreign tax
paid in respect of income from business or property as opposed to other sources
of income. Therefore, the distinction made by the respondent between dividend
income earned by the limited partnership for Canadian tax purposes, and
interest income earned by it for U.S. tax purposes is irrelevant for the
purposes of subsection 20(12) since both types of income fall within the
category of “income from a business or property.”
[26]
In addition, the appellant says
that the interpretation proposed by the respondent is contrary to
administrative positions taken by the Minister in a number of CRA technical interpretations.
In those interpretations, the Minister has accepted that a subsection 20(12)
deduction was available in situations that were analogous to that of
Dorr-Oliver in this case.
[27]
The appellant also says that the respondent’s
interpretation of the phrase “in respect of that income” introduces a territorial
sourcing rule to subsection 20(12) that would deny a deduction where
income earned by a taxpayer is sourced in Canada under Canadian tax rules. The appellant submits that
nothing in subsection 20(12) suggests that the characterization of income
under Canadian and foreign tax law must be the same. The language of
subsection 20(12) does not refer to foreign source income on which the
foreign tax is paid.
Analysis
[28]
In order to determine whether the limited
partnership paid the U.S. tax in respect of income from a business or property
under the Act, it is necessary to determine the meaning of the phrases
“income . . . from a business or property” and “tax paid . . . in respect of
that income” found in subsection 20(12).
[29]
Firstly, I agree with the respondent
that the words “that income” in subsection 20(12) refer back to “income
from a business or property” found in the opening words of the provision. The appellant
did not challenge this point, and the language used is unambiguous.
[30]
Secondly, it is clear that the
phrase “income . . . from a business or property” is intended to refer to income
arising from each individual business or individual property of the taxpayer, rather
than income from all of a taxpayer’s business sources combined or property
sources combined or the combined business and property income of a taxpayer. The
phrase is used as part of the expression “in computing a taxpayer’s income for
a taxation year from a business or property” which has been held to require a
computation of income for each separate business or property. In Hickman
Motors Limited v. The Queen
Iacobucci J. wrote:
133 .
. . for tax purposes, when calculating income from business, a taxpayer may not
lump together the revenues and expenses from all of that person’s various
business enterprises. Rather, the taxpayer must compute, separately, his
or her income or loss from each individual business. This provides the
appropriate figure which the taxpayer then “plugs in” to the s. 3 formula for
computing income for the taxation year.
134 This
requirement to treat each business as a separate source arises from the wording
of the applicable statutory provisions. For example, s. 3(a) states
that a taxpayer must “determine the aggregate of amounts each of which is the
taxpayer’s income for the year . . . from each office, employment,
business and property” (emphasis added). Similarly, s. 4(1)(a)
provides:
. . .
a taxpayer’s income or loss for a taxation year from an office,
employment, business, property or other source, . . . is the taxpayer's income
or loss . . . computed in accordance with this Act on the assumption that he
had during the taxation year no income or loss except from that source....
[Emphasis added.]
Section
9(1) contains similar wording, as does s. 20(1), which lists a number of
deductions permitted from a taxpayer’s income “from a business or
property” (emphasis added).
135 This
need to segregate business income according to its various “sub-sources” has
been discussed in both academic writings and the jurisprudence. In Canadian
Income Taxation (4th ed. 1986), Edwin C. Harris says at p. 99:
. . .
the Act provides that a taxpayer's income for a taxation year is his income
from all sources, including but not limited to his income from each
office or employment, each business, and each property. His
income from each source-type is to be computed separately. [Emphasis added.]
[31]
At paragraph 138 of that decision,
Iacobucci J. went on to say:
The requirement to calculate income from each
“sub-source” separately is fundamental to the entire taxing scheme set up by
Parliament. To suggest otherwise, as my colleague does, is to ignore the
plain words of the Act.
[32]
These comments apply equally to
the calculation of property income under the Act. For this reason, I
reject the appellant’s arguments that the phrase “income . . . from a business
or property” in subsection 20(12) refers to a single unified source of
income, or to income from business or property generally. I find that the
wording of subsection 20(12) contemplates a calculation of income from a
specific business or property source of a taxpayer, and that the foreign tax
must be paid in respect of income from that source.
[33]
This interpretation, in my view,
accords with Parliament’s purpose in adding the phrases “from a business or
property” and “in respect of that income” to subsection 20(12) in 1992. Prior
to that time, subsection 20(12) did not contain any express restriction as to
the source of income against which foreign tax could be deducted and read as
follows:
Foreign
non-business income tax – In computing the income of a taxpayer for a
taxation year, there may be deducted such amount as the taxpayer [may ] claim
not exceeding the non-business income tax paid by the taxpayer for the year to
the government of a country other than Canada (within the meaning assigned [by
the definition “non-business-income tax”] in subsection 126(7) [if that
definition] read without reference to paragraphs (c) and (e) [thereof] other
than any such tax, or part thereof, that [may] reasonably be regarded as having
been paid by a corporation in respect of income from a share of the capital
stock of a foreign affiliate of the corporation.
(Emphasis added.)
[34]
The argument was made in the case
of Kaiser v. The Minister of National Revenue that subsection 20(12)
permitted the taxpayer to deduct foreign tax paid on employment income. Although
the Court in Kaiser held that a deduction under subsection 20(12) was only
available for the purposes of computing income from a business or property,
Parliament chose to amend the section in order to ensure that this limitation
was clear. However, Parliament also wanted to clarify that any amount claimed
under subsection 20(12) was to be deducted in computing income from the source
to which the foreign tax related. The Department of Finance Technical Notes set
out this purpose:
Subsection
20(12) permits non-business income tax paid to a foreign government to be
deducted in computing a taxpayer’s income, as an alternative to claiming that
tax as a foreign tax credit under section 126. This amendment, which applies to
1992 and subsequent taxation years, provides that a deduction under subsection
20(12) is available only with respect to foreign taxes paid in respect of
income from a business or property, and also clarifies that any amount claimed
under that subsection is to be deducted in computing income from the source to
which that tax relates.
[35]
Therefore, there is a clear
requirement in subsection 20(12) that the foreign tax be paid in respect of
income of a taxpayer from a particular business or property and that the tax is
only deductible in respect of that source.
[36]
In this case, the limited partnership’s
only source of income under the Act was its NSULC shares and the only
computation of income done by the limited partnership under the Act was
for that source. The requirement in subsection 20(12) that the foreign tax
be paid “in respect of that income” must be read as a requirement that the U.S
tax be paid in respect of the dividend income from NSULC.
[37]
The respondent’s position is that
since the U.S. tax was paid on interest income, it could not have
been paid in respect of the limited partnership’s NSULC dividend income. The respondent
is in effect arguing that the phrase “tax paid . . . in respect of that income”
should be read as “tax paid . . . on that income.”
[38]
This interpretation is too narrow.
[39]
In Nowegijick v. The Queen the Supreme Court of
Canada held that the words “in respect of” were “words of the widest possible
scope” and went on to say:
They import
such [meanings] as “in relation to”, “with reference to” or “in connection with.”
The phrase “in respect of” is probably the widest of any expression intended to
convey some connection between two related subject matters.
[40]
This statement has been quoted
frequently in Canadian tax cases, and I am not aware of any instance in which
the conclusion reached by the Supreme Court has not been followed. Therefore
the phrase “in respect of that income” in subsection 20(12) must be taken
to require some relationship or connection between the foreign tax and the
income being computed under the Act.
[41]
The respondent’s position that
there must be a direct link between the payment of the foreign tax and the
Canadian income also contradicts the position taken by the Canada Revenue
Agency (the “CRA”) in a number of its technical interpretations.
[42]
The first technical interpretation
involved an individual residing in Canada who owned all the shares of a Nova Scotia unlimited
liability corporation (ULC) which in turn owns all the shares of a U.S. limited
liability corporation (LLC). That individual paid U.S. tax on the
business or property income of LLC because both ULC and LLC were disregarded
under U.S. tax law. The CRA stated that the individual was entitled to a
deduction under subsection 20(12) for the U.S. tax paid even if he or she did not receive any dividend
from ULC. The material part of the technical interpretation reads:
. . . Although
what the taxpayer owns is the shares of ULC which is a Canadian corporation,
the U.S. taxes paid can be considered to be in respect of such shares such that
the deduction under subsection 20(12) . . . would not be denied . . . In this
situation the property is the shares of ULC. If the taxpayer did not own such
shares he would not have to pay the U.S. taxes and there is nothing in
subsection 20(12) of the Act which precludes the deduction from creating
a loss.
[43]
A similar example, from a 2008
technical interpretation, dealt with U.S. tax paid by a Canadian resident
taxpayer on his or her share of the income of a U.S. “S” corporation. An “S”
Corporation is disregarded for U.S. tax purposes and the income of the corporation is
attributed to its shareholders. Under Canadian tax law, the corporation is
treated as a separate person subject to tax. Therefore, the shareholder would
pay U.S. tax on income from the corporation’s activities, whereas in Canada he or
she would pay tax on dividends distributed by the corporation. The CRA stated
that a subsection 20(12) deduction was available for the U.S. tax paid
by the shareholder even where ULC did not pay a dividend to the taxpayer. In
other words, the CRA accepted that the 20(12) deduction was available where the
U.S.
tax was paid on income from a source that is different from the
taxpayer’s source of income under the Act. Presumably, the CRA accepted
that the U.S tax was paid in respect of the shareholder’s income from
property under the Act because the corporation’s income is paid out to
the shareholder eventually and taxed as income from property. The technical
interpretation states the view of the CRA that:
. . . a
deduction in a taxation year under subsection 20(12) of the Act for U.S. tax
paid by the taxpayer for the year in respect of his share of the income of an S
Corporation is not to be denied even though the taxpayer does not receive a
distribution from the S Corporation in the year. It should be noted that the
above view is not just an administrative position, as you indicated on your
memorandum, ignoring the words of the provision of subsection 20(12) but it is
a correct interpretation of that provision and is supported by the Department
of Finance.
[44]
While these
interpretations are not binding, they can be taken into account in cases of
doubt. In Nowegijick, the Supreme
Court said that:
Administrative
policy and interpretation are not determinative but are entitled to weight and
can be an "important factor" in case of doubt about the meaning of
legislation: per de Grandpré, J Harel v The Deputy Minister of
Revenue of the Province of Quebec, [1978] 1 S.C.R. 851 at 859.
[45]
For these reasons, I find that
there is no requirement in subsection 20(12) that the foreign tax be paid on
the taxpayer’s income from a business or property, but that it is
sufficient that the payment of the tax be connected with or related to that
income. It seems to me, that, had Parliament intended to restrict the availability
of a deduction under subsection 20(12) to situations where the foreign tax was
paid on income from the same source as that which was being calculated it would
have simply used the words “paid on that income” rather than “paid in respect
of that income. ”
[46]
I accept the appellant’s
contention that the payment of the U.S. tax was related to or connected with
the dividend income received by the limited partnership from NSULC because the
indirect source of the dividend income received by the limited partnership was
the interest income received by LLC from Holdings and the payment of the tax
reduced the amount available to NSULC that could be paid out to the limited partnership
as dividends. Furthermore, as stated in the first CRA technical interpretation
cited above, if the appellant had not owned the NSULC shares, it would not have
had to pay the U.S. tax. This, in my view, is also sufficient to link the
payment of the U.S. tax and the dividend income received by the limited partnership
from NSULC for the purposes of subsection 20(12).
Second
question: Can Dorr‑Oliver’s share of the U.S. tax
paid by the limited partnership reasonably be regarded as having been paid by
Dorr‑Oliver in respect of income from a share of the capital stock of a
foreign affiliate of Dorr‑Oliver?
[47]
The parties agree that LLC was a
foreign affiliate of Dorr-Oliver during the period in issue. This is because
subsection 93.1(1) of the Act deemed Dorr‑Oliver to own a
proportionate share of the NSULC shares owned by the limited partnership equal
to its proportionate interest in the limited partnership, with the result that
Dorr-Oliver had an equity percentage in LLC equal to 98.7%.
[48]
The appellant and respondent disagree
whether Dorr-Oliver’s share of the U.S. tax paid by the limited partnership can reasonably be
regarded as having been paid with respect to income from the shares of LLC.
Appellant’s
position
[49]
The appellant says that the U.S.
tax cannot be reasonably regarded as having been paid by Dorr-Oliver in respect
of income from the shares of LLC because the shares of LLC was not a source of
income to Dorr-Oliver. The only potential source of dividend income for
Dorr-Oliver was the shares of NSULC owned by the limited partnership. Dividends
from those shares could not be considered income from the share of a foreign
affiliate, since NSULC was a Canadian corporation and not a foreign affiliate
of Dorr-Oliver.
[50]
The appellant also argued that the
phrase “may reasonably be regarded” does not authorize the Minister to ignore
the existence of NSULC and consider that the limited partnership received the
LLC dividends. Counsel stated that, absent a provision of the Act to the
contrary, or a sham, a taxpayer’s legal relationships must be respected.
[51]
The appellant also said that a reasonable
person could not conclude that the U.S. tax was paid in respect of dividend income from LLC
because the tax was payable even if LLC did not declare a dividend. The limited
partnership paid the U.S. tax on the interest income from Holdings that flowed
through to it because LLC and NSULC were disregarded entities for U.S. tax
purposes.
[52]
The appellant’s final argument was
that the respondent’s interpretation of the limitation in subsection 20(12) is
inconsistent with Canada’s obligation under the Convention between Canada
and the United States of America with respect to Tax on Income and on Capital (the “Treaty”). The
appellant says that Canada is obligated under Paragraphs XXIV (2) and (3) of the
Treaty to provide relief from the U.S. tax paid by the limited partnership in this case.
Respondent’s
position
[53]
The respondent submitted that the
words “other than any such tax, or part thereof, that can reasonably be
regarded as having been paid by a corporation in respect of income from a share
of the capital stock of a foreign affiliate of the corporation” are intended to
prevent a taxpayer from taking advantage of the foreign tax credit and
deduction regime under the Act if the taxpayer already benefits from the
foreign affiliate regime.
[54]
Counsel also said that since
dividends paid out of the exempt surplus of a foreign affiliate are not taxed
in Canada, it is only logical that foreign tax paid in respect of the income
giving rise to such dividends are not deductible under subsection 20(12).
Analysis
[55]
The appellant’s argument that Dorr-Oliver
could not have earned dividends from LLC and therefore that its share of the
U.S. tax paid by the limited partnership could not reasonably be regarded as
having been paid in respect of income from a share of LLC fails, in my view, to
take into account that Parliament has again used the words “tax that can
reasonably be regarded as having been paid . . . in respect of income
from a share of a foreign affiliate” rather than “tax paid on” such
income.
[56]
As set out above, the phrase “in
respect of” is a broad expression intended to convey a connection between two
related matters. Here, the test would be whether it can reasonably be regarded
that the U.S. tax was paid in relation to, or in connection with,
income from the share of the foreign affiliate.
[57]
In this case, the tax was
connected with or related to the dividend income paid by LLC to NSULC because
it was paid on income that funded the payment of the dividends. It was admitted
that the dividends paid by LLC to NSULC were paid out of the interest paid to
LLC by Holdings, and that the LLC dividends in turn funded the dividends paid
by NSULC to the limited partnership.
[58]
The appellant argued, and I
accepted, on the first question in this appeal that the U.S. tax was
paid by the Partnership in respect of the dividend income received by
the Partnership from NSULC, although it was not paid on that income. The
appellant maintained that “when taxes affect a flow of income from a source,
with the result that the economic profit from that source is reduced, it is
reasonable to conclude that those taxes are paid ‘in respect of’ that source.”
I agree with this logic, and find that it also applies in relation to the
dividend income paid by LLC to NSULC. The U.S. tax paid by the Partnership on the interest income
paid by Holdings to LLC reduced the economic profit from that source that could
then be paid out to NSULC, and by extension reduced the amount that could be
paid by NSULC to the Partnership. The payment of taxes thereby affected the
flow of income at each step, from LLC through NSULC to the Partnership.
Therefore, I find that the U.S. tax was related to or connected with the dividend
income received by NSULC from LLC since both were part of the flow of funds
that originated with Holdings and ended up with the Partnership.
[59]
The appellant also argued that the
phrases “can reasonably be regarded” and “in respect of” in subsection 20(12)
do not allow the Minister to look through NSULC to conclude that the
Partnership paid the U.S. tax in respect of dividends from LLC. The Minister is
not entitled under that provision to disregard the existence of NSULC. The appellant
relies on the holding by the Supreme Court of Canada in Shell Canada Ltd. v.
R.
that, absent a specific provision of the Act to the contrary, or a sham,
a taxpayer’s bona fide legal relationships must be respected by the
Minister.
[60]
Counsel referred to sections 16
and 68 of the Act which specifically recharacterize certain agreements entered
into by a taxpayer.
[61]
Subsection 16(1), for example, deems
payments that can reasonably be regarded as interest or as another amount of an
income nature payable to a taxpayer to be income of the taxpayer regardless of
the legal form or effect of the agreement under which the payment was made to
the taxpayer. It reads:
Where, under a
contract or other arrangement, an amount can reasonably be regarded as being in
part interest or other amount of an income nature and in part an amount of a
capital nature, the following rules apply:
(a) the part
of the amount that can reasonably be regarded as interest shall, irrespective
of when the contract or arrangement was made or the form or legal effect
thereof, be deemed to be interest on a debt obligation held by the person to
whom the amount is paid or payable: and
(b) the part
of the amount that can reasonably be regarded as an amount of an income nature,
other than interest, shall, irrespective of when the contract or arrangement
was made or the form or legal effect thereof, be included in the income of the
taxpayer to whom the amount is paid or payable for the taxation year in which
the amount was received or became due to the extent it has not otherwise been
included in the taxpayer’s income.
[62]
Pursuant to section 68, where a taxpayer
receives an amount that can reasonably be regarded as part consideration for
the disposition of property and part consideration for services, the former
amount is deemed to be proceeds of disposition of property and the latter amount
to be an amount receivable in respect of those services, irrespective of the
legal form or effect of the contract under which the amounts were payable. It
reads:
Where an
amount received or receivable from a person can reasonably be regarded as being
in part the consideration for the disposition of a particular property of a
taxpayer or as being in part consideration for the provision of particular
services by a taxpayer,
(a) the part
of the amount that can reasonably be regarded as being the consideration for
the disposition shall be deemed to be proceeds of disposition of the particular
property irrespective of the form or legal effect of the contract or agreement
and the person to whom the property was disposed of shall be deemed to have
acquired it for an amount equal to that part; and
(b) the part
of the amount that can reasonably be regarded as being consideration for the
provision of particular services shall be deemed to be an amount received or
receivable by the taxpayer in respect of those services irrespective of the
form or legal effect of the contract or agreement and that part shall be deemed
to be an amount paid or payable to the taxpayer by the person to whom the
services were rendered in respect of those services.
[63]
I disagree with the appellant’s
position that the words “can reasonably be regarded” in subsection 20(12) do
not enable the Minister to look through NSULC. It seems to me that this phrase,
on its own, is a specific provision enabling the Minister to evaluate the
economic substance of a transaction regardless of its legal form. The words “irrespective
of . . . the form or legal effect thereof” found in subsection 16(1) and
“irrespective of the form or legal effect of the contract or agreement” found
in section 68 do not modify the phrase “can reasonably be regarded” but instead
relate to the deeming provision which follows in each case which deems certain
types of income to have been received by the taxpayer. There is no such deeming
provision in subsection 20(12).
[64]
The appellant also submitted that
the words “can reasonably be regarded” were inserted into subsection 20(12) as an
objective test to apportion the foreign tax paid by the taxpayer among various
sources of income rather than to recharacterize the basis of the tax. Counsel
for the appellant drew a parallel in this regard between subsection 20(12), subsection
16(1) and section 68. However, both subsection 16(1) and section 68 are aimed
at amounts that contain more than one type of payment: subsection 16(1) refers
to “an amount . . . in part interest or other amount of an income nature and in
part an amount of a capital nature” and section 68 refers to an amount
part of which is consideration for the disposition of property and in part
consideration for the provision of services. There is no similar wording in
subsection 20(12) that would indicate an apportionment purpose.
[65]
For these reasons, I conclude that
the language of subsection 20(12) supports the respondent’s position that the
U.S. tax paid by the limited partnership were paid in respect of income from
the shares of LLC and that the tax could therefore reasonably be regarded as
having been so paid.
[66]
It is also necessary to consider
whether this result accords with the purpose of subsection 20(12), which is to
provide relief from foreign taxes paid in respect of income which is included
in a taxpayer’s income under the Act.
[67]
I agree with the proposition of
the respondent that the restriction in subsection 20(12) relating to foreign tax
paid in respect of income from the shares of a foreign affiliate of the
taxpayer is included because relief from foreign taxation on dividends from
foreign affiliates is dealt with comprehensively elsewhere in the Act.
[68]
The Act provides in
subsection 113(1) for relief from double taxation on dividends received from a
foreign affiliate: paragraph 113(1)(a) exempts dividends from tax when the
dividends are paid out of exempt surplus, and paragraphs 113(1)(b)
and (c) allow a deduction for the underlying foreign tax attributable to
the amount of the dividend when the dividends are paid out of taxable surplus.
(Add 113(a)(b)+(c)) It is reasonable to conclude that in
enacting these specific rules relating to foreign tax paid on dividends
received from foreign affiliates, Parliament intended to deal fully with the
relief from foreign tax for such dividends and that no further deduction under
20(12) is intended.
[69]
In this case, the dividend paid by
LLC to NSULC was deducted under paragraph 113(1)(a) and was thereby
exempt from tax in Canada. The dividends paid to the limited partnership by
NSULC were funded by the LLC dividends which had borne no Canadian tax.
[70]
The appellant also argues that the
respondent’s interpretation of the limitation in subsection 20(12) is
inconsistent with Canada’s obligation under the Treaty.
[71]
Paragraphs XXIV (2) and (3) of the
Treaty provide rules for reciprocal credits and exemptions with respect
to foreign tax in order to avoid double taxation on income that is taxable by
both Canada and the U.S.
[72]
Paragraphs XXIV (2) and (3) read as
follows:
(2) In the case of Canada, subject to the provisions of
paragraphs 4, 5 and 6, double taxation shall be avoided as follows:
(a) subject to the
provisions of the law of Canada regarding the deduction from tax payable in
Canada of tax paid in a territory outside Canada and to any subsequent
modification of those provisions (which shall not affect the general principle
hereof)
(i) income tax paid or
accrued to the United States on profits, income or gains arising in the United
States, and
(ii) in the case of an
individual, any social security taxes paid to the United States (other than
taxes relating to unemployment insurance benefits) by the individual on such
profits, income or gains
shall be deducted from any
Canadian tax payable in respect of such profits, income or gains;
(b) subject to the existing
provisions of the law of Canada regarding the taxation of income from a foreign
affiliate and to any subsequent modification of those provisions - which shall
not affect the general principle hereof - for the purpose of computing Canadian
tax, a company which is a resident of Canada shall be allowed to deduct in
computing its taxable income any dividend received by it out of the exempt
surplus of a foreign affiliate which is a resident of the United States; and
(c) notwithstanding the
provisions of subparagraph (a), where Canada imposes a tax on gains from the
alienation of property that, but for the provisions of paragraph 5 of Article
XIII (Gains), would not be taxable in Canada, income tax paid or accrued to the
United States on such gains shall be deducted from any Canadian tax payable in
respect of such gains.
(3) For the purposes
of this Article:
(a) profits, income or gains
(other than gains to which paragraph 5 of Article XIII (Gains) applies) of a
resident of a Contracting State which may be taxed in the other Contracting
State in accordance with the Convention (without regard to paragraph 2 of
Article XXIX (Miscellaneous Rules)) shall be deemed to arise in that other
State; and
(b) profits, income or gains of a
resident of a Contracting State which may not be taxed in the other Contracting State in accordance with the Convention (without
regard to paragraph 2 of Article XXIX (Miscellaneous Rules)) or to which
paragraph 5 of Article XIII (Gains) applies shall be deemed to arise in the
first-mentioned State.
[73]
The appellant says that Canada is
obligated under Paragraphs XXIV(2) and (3) to provide relief from the U.S. tax paid
by the limited partnership in this case. Counsel says that paragraph XXIV(2) of
the Treaty applies in this case because the limited partnership paid income
tax in the U.S. on U.S. source income which is subject to Canada’s taxing
power. The U.S. has taxed the limited partnership as its resident, which it is
allowed to do under the Treaty, and since Canada flows through the income
of the limited partnership to the partners, who are resident in Canada, the
foreign tax paid by the partnership should be allocated to the partners and
they should be entitled to foreign tax relief.
[74]
In arriving at this interpretation
of Paragraphs XXIV (2) and (3), the appellant relies on Articles 23A and 23B of
the OECD Model Treaty,
as well as the OECD Commentary on those provisions and the 1999 OECD report
entitled The Application of the OECD Model Tax Convention to Partnerships.
[75]
In this respect, the appellant’s
counsel cited the following excerpt from the 1999 OECD report (at para. 139):
The issue is
therefore whether State R (Canada), which taxes partner A on his share in the
partnership profits, is obliged, under the Convention to give credit for the
source tax that is levied in State P (United States) on partnership P, which
State P (United States) treats as a separate taxable entity. The answer to that
question must be affirmative. To the extent that State R (Canada) flows-through
the income of the partnership to the partners for the purpose of taxing them,
it should be consistent and flow-through the tax paid by the partnership [to
the partners] for the purposes of eliminating double taxation arising from its
taxation of the partners. In other words, if the corporate status given to the
partnership by State P (United States) is ignored for the purposes of taxing
the share in the profits, it should likewise be ignored for purposes of giving access
to the foreign tax credit,
[76]
The appellant argues that in this
case, “consistent with the OECD flow‑through approach for partnerships,
Canada must provide relief from U.S. tax as a result of the fact that the limited partnership’s
U.S. source income is taxed in the United
States.” The appellant says that subsection
20(12) is one of the measures adopted by Canada to provide relief from double
taxation, and therefore it should be interpreted in a manner that provides
relief to taxpayers in accordance with Canada’s treaty obligations.
Analysis
[77]
Firstly, I am not satisfied that
the appellant has shown that subsection XXIV(2) of the Treaty
imposes an obligation on Canada to provide a deduction in the form of paragraph
20(12) of the Act.
[78]
Under paragraph XXIV(2) of the Treaty,
Canada undertakes to avoid double taxation on profits, income or gains arising
in the U.S. by allowing specific types of relief, namely:
i) a deduction for any income tax paid or accrued to
the U.S. on U.S. source income from any Canadian tax payable in respect of that
income (subparagraph XXIV(2) (a)(i))
ii) a deduction for social security tax paid by an
individual to the U.S. (with certain limitations) on U.S. source income from
any Canadian tax payable in respect of that income. (subparagraph XXIV(2) (a)(ii))
iii) a deduction from taxable income for dividends
received by a Canadian resident company out of exempt surplus of a foreign
affiliate which is resident in the U.S. (paragraph XXIV(2)(b))
and
iv) a deduction for income tax paid or accrued to the
U.S. tax on certain gains from the alienation of property from Canadian tax
payable in respect of the gains (paragraph XXIV(2)(c)).
[79]
Paragraph XXIV(2) is made subject
to paragraphs XXIV(4), (5) and (6) which deal with U.S. citizens
resident in Canada. Those provisions are not relevant to the present
discussion.
[80]
It is apparent from paragraph
XXIV(2) that Canada is not required to allow a deduction for all U.S. tax paid on
income arising in the U.S., and that Canada’s obligation does not extend beyond
relief from double taxation. This is because in categories (i) (ii) and (iv)
above, the deduction is limited to the Canadian tax payable in respect of that
income. This obligation is met by the foreign tax credit provisions in subsection
126 of the Act which makes available a credit up to the amount of
Canadian tax payable in respect of that income.
[81]
Thus it seems to me that the Treaty
is not intended to provide for any relief for U.S. tax on U.S. source
income that is not taxed in Canada. In the present case, neither the U.S. source income
of the limited partnership that was taxed in the U.S. (and which is not
recognized as income of the limited partnership under Canadian law) nor the
dividend income which was received by the limited partnership from NSULC, and which
flowed through to the partners including the appellant, was taxed in Canada.
Furthermore, the LLC dividends received by NSULC (which were the source of the
dividends paid by NSULC to the Partnership) were not taxed in Canada because
they were paid out of the exempt surplus of LLC. On this basis, it seems clear
that no Canadian tax was payable “in respect of” the dividends received by the limited
partnership from NSULC.
[82]
Therefore, in my view, the appellant’s
contention that the Canada’s obligations under the Treaty require that
subsection 20(12) be interpreted to allow the appellant a deduction for its
share of the U.S. tax paid by the limited partnership is ill-founded.
[83]
With respect to the comments cited
by the Appellant from the OECD Partnership Report, it seems to me that the
position taken in that report (which would require the state in which the
partners are resident to flow through the tax paid in the state of source) is
predicated on the income on which the tax was paid being flowed through to the
partners. The report states:
To the
extent that State R (Canada) flows-through the income of the
partnership to the partners for the purpose of taxing them, it should be
consistent and flow-through the tax paid by the partnership to the partners for
the purposes of eliminating double taxation arising from its taxation of the
partners.
(Emphasis added.)
[84]
In the case at bar, however, the
income on which U.S. tax was paid by the limited partnership was not
flowed through to the partners. That income was not recognized by Canada.
[85]
Furthermore, since no Canadian tax
was paid on income derived from the income on which the U.S. tax was
paid by the limited partnership, there is no double taxation of the income that
was earned by the limited partnership in the U.S.
[86]
Therefore, I find that the
interpretation of subsection 20(12) which precludes the deduction taken by
Dorr-Oliver is not inconsistent with Canada’s obligations under the Treaty.
[87]
For these reasons, the appeal is
dismissed, with costs to the respondent.
Signed at Ottawa, Canada, this
3rd day of January 2012.
“B.Paris”
Email this Content