Edwards v. The Queen, docket 2000-1183(IT)G

Date: 20020627

Docket: 2000-1183-IT-G

BETWEEN:

KELLY BRIAN EDWARDS,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasonsfor Judgment

Rip, J.

[1]            The issue in this appeal is whether income earned by a resident of Canada after June 30, 1997, in respect of his employment by a corporation resident in Hong Kong Special Administrative Region ("HKSAR" or "Hong Kong") is exempt from Canadian income tax by virtue of the Agreement for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income between Canada and the People's Republic of China ("Canada-China Tax Treaty", "Agreement", "Treaty", or "Convention").[1]

[2]            At all relevant times Mr. Kelly Brian Edwards was resident in Canada but did not earn any employment income in Canada. He was employed as a commercial airline pilot by Veta Ltd., a wholly-owned subsidiary of Cathay Pacific Airlines Ltd. ("Cathay Pacific"), a corporation incorporated under the laws of Hong Kong and resident in Hong Kong. Mr. Edwards appealed his assessment of income tax for 1997 on the basis that his income from employment during the period from July 1 to December 31, 1997 is exempt from income tax in Canada by virtue of the application of Article 15(3) of the Canada-China Tax Treaty.[2]

[3]            The appellant's position is that since July 1, 1997, the HKSAR has formed part of the People's Republic of China and therefore, the Treaty applies to persons resident in the HKSAR from July 1, 1997 onwards. By virtue of Article 15(3) of the Convention, remuneration paid by Cathay Pacific in respect of employment by the appellant aboard an aircraft operated in international traffic, as that term is defined in Article 3 of the Convention, is exempt from taxation in Canada. As the appellant received employment income from Cathay Pacific in 1997, by virtue of subparagraph 110(1)(f)(i) of the Act, he is entitled to a deduction in computing his income for 1997 in the amount of income paid by Cathay Pacific in respect of his employment for the period July 1 to December 31, 1997.

[4]            In assessing, the Minister of National Revenue ("Minister") deducted from Mr. Edwards' tax otherwise payable for 1997 a foreign tax credit pursuant to subsection 126(1) of the Act. The Minister's view is that the Treaty does not apply to Hong Kong.

Facts

[5]            The appeal proceeded by a Partial Statement of Agreed Facts, the testimony of Mr. Edwards, Mr. David K. Hollman, an officer of the Department of Foreign Affairs, and the reading in of evidence of the discovery of Ms. Karen Caspersen, a representative of the respondent.[3]

[6]            The Partial Statement of Agreed Facts[4] reads as follows:

          A.         Facts about the Canada-China Income Tax Agreement

1.        The Canada-China Income Tax Agreement Act, 1986 [Tab A] being Part III of S.C. 1986 c. 48 promulgates in Canada the Agreement between the Government of Canada and the Government of the People's Republic of China for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income [Tab B] (the "Canada-China Income Tax Agreement").

2.        The Canada-China Income Tax Agreement was signed on May 12, 1986 by the Prime Ministers of Canada and the People's Republic of China ("PRC") on behalf of their respective governments. The Canada-China Income Tax Agreement is generally patterned on the 1977 Model Double Taxation Convention prepared by the Organization for Economic Co-operation and Development ("OECD") (the "OECD Model Convention") [Tab C with the Commentary thereon at Tab D] and the Model Double Taxation Convention between Developed and Developing Countries adopted by the United Nations Ad Hoc Group of Experts in 1979 (the "UN Model Convention") [Tab E, with the Commentary thereon at Tab F].

3.        The Appellant relies upon Articles 1, 2, 3, 4(1) and 15(3) of the Canada-China Income Tax Agreement as being relevant to the determination of this appeal. Those Articles provide:[5]

          The Government of Canada and the Government of the People's Republic of China, desiring to conclude an Agreement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income, have agreed as follows:

          ARTICLE 1:                Personal Scope

          This Agreement shall apply to persons who are residents of one or both of the Contracting States.

          ARTICLE 2:                Taxes Covered

          1.           The existing taxes to which this Agreement shall apply are, in particular:

          (a)         in the case of Canada:

                       the income taxes imposed by the Government of Canada, (hereinafter referred to as "Canadian tax");

          (b)         in the case of the People's Republic of China:

                       (i)      the individual income tax:

                       (ii)    the income tax concerning joint ventures with Chinese and foreign investment:

                       (iii) the income tax concerning foreign enterprises; and

                       (iv)    the local income tax;

                       (hereinafter referred to as "Chinese tax").

         2.      This Agreement shall also apply to any identical or substantially similar taxes which are imposed after the date of signature of this Agreement in addition to, or in place of, those referred to in paragraph 1. The relevant authorities of the Contracting States shall notify each other of any substantial changes which have been made in their respective taxation laws within a reasonable period of time after such changes.

ARTICLE 3:     General Definitions

1. For the purposes of this Agreement, unless the context otherwise requires:

(a)         the term "Canada" used in a geographical sense, means the territory of Canada, including any area beyond the territorial seas of Canada which, in accordance with international law and under the laws of Canada, is an area within which Canada may exercise rights with respect to the sea-bed and sub-soil and their natural resources;

(b)         the term "the People's Republic of China", when used in a geographical sense, means all the territory of the People's Republic of China, including its territorial sea, in which the laws relating to Chinese tax apply, and all the area beyond its territorial sea, including the sea-bed and sub-soil thereof, over which the People's Republic of China has jurisdiction in accordance with international law and in which the laws relating to Chinese tax apply;

(c)         the terms "a Contracting State" and "the other Contracting State" mean Canada or the People's Republic of China, as the context requires;

(d)         the term "tax" means Canadian tax or Chinese tax, as the context requires;

(e)         the term "person" includes an individual, a company and any other body of persons;

(f)          the term "company" means any body corporate or any entity which is treated as a body corporate for tax purposes;

(g)         the terms "enterprise of a Contracting State" and "enterprise of the other Contracting State" mean respectively an enterprise carried on by a resident of a Contracting State and an enterprise carried on by a resident of the other Contracting State;

(h)         the term "nationals" means all individuals having the nationality of a Contracting State and all legal persons, partnerships and other bodies of persons deriving their status as such from the law in force in a Contracting State;

(i)          the term "international traffic" means any transport by a ship or aircraft operated by an enterprise of a Contracting State, except when the ship or aircraft is operated solely between places in the other Contracting State;

(j)          the term "competent authority" means, in the case of Canada, the Minister of National Revenue or his authorized representative, and in the case of the People's Republic of China, the Ministry of Finance or its authorized representative.

2.           As regards the application of this Agreement by a Contracting State any term not defined in this Agreement shall, unless the context otherwise requires, have the meaning which it has under the law of that Contracting State concerning the taxes to which this Agreement applies.

ARTICLE 4:     Resident

1. For the purposes of this Agreement, the term "resident of a Contracting State" means any person who, under the laws of that Contracting State, is liable to tax therein by reason of his domicile, residence, place of head office, place of management or any other criterion of a similar nature.

...

ARTICLE 15: Dependent Personal Services

...

3. Notwithstanding the provisions of paragraphs 1 and 2, remuneration in respect of an employment exercised aboard a ship or aircraft operated in international traffic by an enterprise of a Contracting State, shall be taxable only in that Contracting State.

...

B.          Facts about the Appellant

4.             At all material times Kelly Brian Edwards, (the "Appellant") was a resident only of Canada. As a resident of Canada, the Appellant was liable to tax in Canada on his worldwide income.

5.             The Appellant is a commercial airline pilot who at all material times was employed by Veta Ltd., a wholly-owned subsidiary of Cathay Pacific Airlines Ltd.

6.             At all material times, the Appellant performed the duties of his employment with Veta Ltd. aboard aircraft operated by Cathay Pacific Airlines Ltd. At all material times after July 1, 1997, the aircraft operated by Cathay Pacific Airlines Ltd. on which the Appellant exercised his employment provided air transport services between, inter alia, the Hong Kong Special Administrative Region ("HKSAR") of the PRC and Canada.

7.             The Appellant earned $265,739 of employment income in 1997 in the course of his employment as a commercial airline pilot on aircraft operated by Cathay Pacific Airlines Ltd.

8.             Under the terms of the subsection 8(1) of the Inland Revenue Ordinance, Ordinance 112, the Appellant was required to pay salaries tax to Hong Kong prior to July 1, 1997, and to the HKSAR of the PRC from July 1, 1997 on his income from employment with Veta Ltd., as a commercial airline pilot on aircraft operated by Cathay Pacific Airlines Ltd. The Appellant's income from employment with Veta Ltd. is sourced to the HKSAR of the PRC for the purposes of subsection 8(1) of the Inland Revenue Ordinance, Ordinance 112 for the reasons described in paragraphs 47 & 48 below. The Appellant paid salaries tax in the amount of (CDN) $40,665 in respect of the employment income described in paragraph 7.

9.             The Appellant included the amount of $265,739 described in paragraph 7, above, as income from employment in filing his Canadian tax return for the 1997 taxation year. The Appellant claimed a foreign tax credit of $40,665 under paragraph 126(1)(a) of the Income Tax Act (Canada) (the "Act") in respect of the salaries tax described in paragraph 8, above. The Appellant was initially assessed by the Minister of National Revenue (the "Minister") on the basis that the Appellant's employment income for Canadian tax purposes was $265,739 and permitting the foreign tax credit claimed under paragraph 126(1)(a) of the Act (the "Original Assessment").

10.           The Appellant served a Notice of Objection [Tab G] to the Original Assessment in which the Appellant objected to the inclusion into income for Canadian tax purposes that portion of the employment income described in paragraph 7, above, which related to the period after July 1, 1997. The amount of this portion of the Appellant's employment income was $152,910. The Appellant also sought to correspondingly reduce his foreign tax credit claim to the extent of $26,653, being that portion of the foreign tax credit claim that related to the employment income described in paragraph 7, above, which related to the period after July 1, 1997. The Appellant objected on the basis that Article 15(3) of the Canada-China Income Tax Agreement applied to exclude from his income for Canadian tax purposes the portion of his income that related to employment exercised aboard aircraft operated by Cathay Pacific Airlines Ltd., after July 1, 1997, at which date Hong Kong became the HKSAR of the PRC. The Appellant also relied on subparagraph 110(1)(f)(i) of the Act which provides:

                110(1) Deductions permitted - for the purposes of computing the taxable income of a taxpayer for a taxation year, there may be deducted such of the following amounts as are applicable:

(f) deduction for payments -- ... or any amount that is

(i)            an amount exempt from income tax in Canada because of a provision contained in a tax convention or agreement with another country that has the force of law in Canada,

The Minister confirmed the Original Assessment by Notice of Confirmation dated December 2, 1999 [Tab H].

C. Facts about Cathay Pacific Airlines Ltd.

11.          At all material times, Cathay Pacific Airlines Ltd., and its subsidiary Veta Ltd., were incorporated, registered and resident in Hong Kong prior to July 1, 1997 and in the HKSAR of the PRC from July 1, 1997, where each had its place of head office.

12.          Cathay Pacific Airlines Ltd., at all material times, carried on the business of providing commercial air transport services to the public including, inter alia, air transport services between Canada and Hong Kong prior to July 1, 1997 and between Canada and the HKSAR of the PRC and Canada from July 1, 1997.

13.          Cathay Pacific Airlines Ltd. did not at any material time provide air transport services between places in Canada.

14.          At all material times Cathay Pacific Airlines Ltd. was liable to pay profits tax to Hong Kong prior to July 1, 1997 and to the HKSAR of the PRC from July 1, 1997 as calculated in accordance with Part IV of the Inland Revenue Ordinance, Ordinance 112, which is described in further detail at paragraph 49 below. In particular, Cathay Pacific Airlines Ltd. is subject to the terms of section 23C of the Inland Revenue Ordinance, Ordinance 112 which is described in further detail at paragraph 50 below. Cathay Pacific Airlines Ltd. was not liable to pay, and did not pay, tax to the Mainland of the PRC under the Provisional Regulations on Enterprise Income Tax of the Mainland of the PRC which is further described in paragraph 38 below.

15.          It is the position of the Appellant that from July 1, 1997, as a resident of the HKSAR of the PRC, Cathay Pacific Airlines Ltd. is a "resident of a Contracting State" as defined in Article 4(1) of the Canada-China Income Tax Agreement for the purposes of the definitions of "enterprise of a Contracting State" and "international traffic" in Article 3(1)(g) and (i) thereof. It is the position of the Respondent that the Canada-China Income Tax Agreement does not apply to the HKSAR of the PRC and therefore that, as a resident of the HKSAR of the PRC, Cathay Pacific Airlines Ltd. is not a "resident of a Contracting State" as defined in Article 4(1) of the Canada-China Income Tax Agreement for the purposes of the definitions of "enterprise of a Contracting State" and "international traffic" in Article 3(1)(g) and (i) thereof from July 1, 1997 or at any time.

              D. Facts about the HKSAR of the PRC

16.          The Sino-British Joint Declaration on the Question of Hong Kong [Tab I] (the "Joint Declaration") was signed at Beijing on December 19, 1984 by the Prime Ministers of the United Kingdom and the PRC.

17.          In the Joint Declaration, the Government of the PRC declared that it had decided to resume the exercise of sovereignty over Hong Kong with effect from July 1, 1997, and the Government of the United Kingdom declared that it would restore Hong Kong to the PRC effective July 1, 1997.

18.          On July 1, 1997 sovereignty over Hong Kong reverted to the PRC, at which time Hong Kong became the Hong Kong Special Administrative Region of the People's Republic of China. The Hong Kong Special Administrative Region has formed part of the PRC since July 1, 1997.

19.          Article 31 of the Constitution of the People's Republic of China [Tab J] authorizes the establishment of Special Administrative Regions on the terms prescribed by law enacted by the National People's Congress, as follows:

The state may establish special administrative regions when necessary. The systems to be instituted in special administrative regions shall be prescribed by law enacted by the National People's Congress in light of specific conditions.

20.            The constitutional structure of the HKSAR of the PRC is prescribed by the law adopted by the 7th National People's Congress on April 4, 1990 and promulgated by decree of the President of the PRC on that date and effective July 1, 1997, which law is known as the Basic Law of the Hong Kong Special Administrative Region of the People's Republic of China (the "Basic Law") [Tab K].

21.            Article 8 of the Basic Law provides for the maintenance of the laws of Hong Kong after the resumption of sovereignty by the PRC, and for the power of the legislature of the HKSAR to continue to amend such laws, provided that such laws are not in conflict with the Basic Law. Article 8 stipulates:

The laws previously in force in Hong Kong, that is, the common law, rules of equity, ordinances, subordinate legislation and customary law shall be maintained, except for any that contravene this Law and subject to any amendment by the legislature of the Hong Kong Special Administrative Region.

22.         The mechanism for the adoption of the laws of Hong Kong as laws of the HKSAR of the PRC is provided in Article 160 of the Basic Law, which stipulates:

Upon the establishment of the Hong Kong Special Administrative Region, the laws previously in force in Hong Kong shall be adopted as laws of the Region except for those which the Standing Committee of the National People's Congress declares to be in contravention of this Law.

23.         On February 23, 1997, the twenty-fourth session of the Eighth National People's Congress adopted the Decision of the Standing Committee of the National People's Congress on the Treatment of Laws Previously in Force in Hong Kong in accordance with Article 160 of the Basic Law of the Hong Kong Special Administrative Region of the People's Republic of China, [Tab L] (the "Standing Committee Decision") which provided that, with the exception of 24 Ordinances set out in Annex 1 and Annex 2 of the Standing Committee Decision, the laws previously in force in Hong Kong are adopted as laws of the HKSAR. Section 1 of the Standing Committee Decision provides:

The laws previously in force in Hong Kong, which include the common law, rules of equity, ordinances, subordinate legislation and customary law, except those which are in contravention of the Basic Law, are adopted as laws of the Hong Kong Special Administrative Region.

24.         The legislature of the HKSAR enacted the Hong Kong Reunification Ordinance, Gazette No. 110 of 1997, effective July 1, 1997, [Tab M] which declares in section 7(1) that:

The laws previously in force in Hong Kong, that is the common law, rules of equity, Ordinances, subsidiary legislation and customary law, which have been adopted as laws of the Hong Kong Special Administrative Region, shall continue to apply.

25.         Article 151 of the Basic Law provides:

The Hong Kong Special Administrative Region may on its own, using the name "Hong Kong, China", maintain and develop relations and conclude and implement agreements with foreign states and regions and relevant international organizations in the appropriate fields, including the economic, trade, financial and monetary, shipping communications, tourism, cultural and sports fields.

26.         Article 153 of the Basic Law provides:

The application to the Hong Kong Special Administrative Region of the international agreements to which the People's Republic of China is or becomes a party shall be decided by the Central People's Government, in accordance with the circumstances and needs of the Region, and after seeking the views of the government of the Region.

International agreements to which the People's Republic of China is not a party but which are implemented in Hong Kong may continue to be implemented in the Hong Kong Special Administrative Region. The Central People's Government shall, as necessary, authorize or assist the government of the Region to make appropriate arrangements for the application to the Region of other relevant international agreements.

27.           The HKSAR of the PRC and the Mainland of the PRC have an agreement for the avoidance of double taxation between the two Sides entitled "Memorandum for the Arrangement between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation on Income". This agreement was signed by representatives of the two governments of the HKSAR of the PRC and the Mainland of the PRC on February 11, 1998. [Tab N].

               E. Facts about the Tax Law of the Mainland of the PRC

28.           Tax is imposed by the Mainland of the PRC in accordance with two basic principles. Residents of the Mainland of the PRC are generally subject to tax on world-wide income. Non-residents of the Mainland of the PRC are generally subject to tax only on income sourced to the Mainland of the PRC. Taxes in the Mainland of the PRC are administered by the State Administration of Taxation.

29.           The taxes described in this Section E apply to the Mainland of the PRC. None of the taxes referred to in this Section E apply to the HKSAR of the PRC, nor is the Central People's Government entitled to levy taxes in the HKSAR of the PRC under Article 106 of the Basic Law.

30.           The "individual income tax" is referenced at Article 2(1)(b)(i) of the Canada-China Income Tax Agreement and was a tax imposed under the Individual Income Tax Law of the People's Republic of China [Tab O] (Adopted at the Third Session of the Fifth National People's Congress on September 10, 1980 and revised in accordance with the Decision on the Revision of the Individual Income Tax Law of the People's Republic of China adopted at the Fourth Meeting of the Standing Committee of the Eighth National People's Congress on October 31, 1993 and effective as of January 1, 1994).

31.           Pursuant to the provisions of the Individual Income Tax Law of the People's Republic of China, as amended (the "Individual Income Tax Law") and the Regulations thereto (the "Implementing Regulations"):

(a)              Individuals not domiciled but who reside in the Mainland of the PRC for not more than 90 days in any one tax year and whose income is not borne by a permanent establishment in the Mainland of the PRC are not subject to tax in the Mainland of the PRC (Implementing Regulations, Article 7);

(b)             Individuals residing in the Mainland of the PRC for less than one year are subject to tax only on income derived from sources inside the Mainland of the PRC (Individual Income Tax Law, Article 1);

(c)              Individuals not domiciled but resident in the Mainland of the PRC for more than one year and less than five years are subject to tax on income derived from sources inside the Mainland of the PRC and from sources outside the Mainland of the PRC but only to the extent that the payor is inside the Mainland of the PRC (Implementing Regulations, Article 6); and

(d)             Individuals who reside in the Mainland of the PRC for more than five years are subject to tax on income from sources inside the Mainland of the PRC and from sources outside the Mainland of the PRC (i.e. on world-wide income) (Individual Income Tax Law, Article 1).

Tax under the Individual Income Tax Law is imposed at graduated rates from 5% to 45% on income from wages and salaries and at graduated rates from 5% to 35% on business income (Individual Income Tax Law, Article 3)

32.         The "income tax concerning joint ventures with Chinese and foreign investment" is referenced at Article 2(1)(b)(ii) of the Canada-China Income Tax Agreement and was a tax imposed prior to July 1, 1991 under the Income Tax Law of the People's Republic of China on Chinese-Foreign Equity Joint Ventures [Tab Q] adopted by the National People's Congress on September 10, 1980 and amended by the National People's Congress on September 2, 1983. In accordance with Article 3 of this law, the income tax was generally levied at a rate of 30% (subject to the reductions specified at Article 5 thereof) on world-wide income.

33.         The "income tax concerning foreign enterprises" is referenced at Article 2(1)(b)(iii) of the Canada-China Income Tax Agreement and was a tax imposed prior to July 1, 1991 under the Income Tax Law of the People's Republic of China on Foreign Enterprises [Tab R] adopted by the National People's Congress on December 13, 1981 and effective January 1, 1982. Income tax under this law was generally levied at graduated rates from 20% to 40% on income derived from sources in the Mainland of the PRC.

34.         The "income tax concerning joint ventures with Chinese and foreign investment" and the "income tax concerning foreign enterprises" were replaced, effective July 1, 1991 with the income tax on enterprises with foreign investment ("FIE"s) and on foreign enterprises ("FE"s) imposed under the Income Tax Law of the People's Republic of China on Enterprises with Foreign Investment and Foreign Enterprises [Tab S] adopted at the Fourth Meeting of the Seventh National People's Congress on April 9, 1991 and effective from July 1, 1991.

35.         The tax imposed under the Income Tax Law of the People's Republic of China on Enterprises with Foreign Investment and Foreign Enterprises ("Income Tax Law on FIEs and FEs") and the Detailed Implementing Rules thereto [Tab T] applies to the world-wide income of FIEs and to the income of FEs to the extent that such income is derived from sources in the Mainland of the PRC. This tax is levied at a maximum rate 30% of taxable income (Article 5).

36.         The tax rate under the Income Tax Laws on FIEs and FEs is reduced to 15% for FIEs with production activities in "special economic zones", and to 24% for FIEs in "coastal economic open zones" and certain other areas (Detailed Implementing Rules, Article 7 & Chapter 6 "Preferential Tax Treatment"). Subject to certain exceptions, FIEs with a term of operation of at least ten years engaged in production are exempt from tax for the first two profit-making years and granted a 50% reduction in tax in the third to fifth years (Detailed Implementing Rules, Article 8 & Chapter 6 "Preferential Tax Treatment"). Where a foreign investor in a FIE directly reinvests profits derived therefrom in the establishment or expansion of export-oriented or technologically advanced enterprises in the PRC, the investor may obtain a full refund of the enterprise income tax already paid on the reinvested amount in accordance with the relevant regulations of the State Council. (Detailed Implementing Rules, Article 81). Similarly, where a foreign investor in a FIE directly reinvests in profits derived therefrom in order to increase the registered capital in the FIE, or uses the same as capital investment for the establishment of another FIE, the investor shall obtain a refund of 40 percent of the income tax already paid on the reinvested amount, provided that the term of operation is not shorter than five years. If the reinvestment is withdrawn within five years, the refunded tax shall be paid back. (Income Tax Law on FIEs and FEs, Article 10). The after-tax profits derived from an FIE are not subject to withholding tax upon remittance to the shareholders thereof (Income Tax Law on FIEs and FEs, Article 19 and Implementing Regulations, Article 63).

37.         The "local income tax" is referenced at Article 2(1)(b)(iv) of the Canada-China Income Tax Agreement. Prior to July 1, 1991, a "local income tax" of 10% of the income tax otherwise payable was imposed under Article 3 of the Income Tax Law of the People's Republic of China on Chinese-Foreign Equity Joint Ventures [Tab Q] and Article 4 of Income Tax Law of the People's Republic of China on Foreign Enterprises [Tab R]. Effective July 1, 1991, a "local income tax" is imposed on FIEs and FEs under the Income Tax Law of the People's Republic of China on Enterprises with Foreign Investment and Foreign Enterprises [Tab S] at a rate of 3% of taxable income (Article 5), subject to reduction by the local authorities (Article 9).

38.         Effective January 1, 1994, an "enterprise income tax" is imposed on all enterprises other than foreign investment enterprises and foreign enterprises under the Provisional Regulations on Enterprise Income Tax [Tab U] (adopted at the 12th Executive Meeting of the State Council on November 26, 1993, promulgated by Decree No. 137 of the State Council of the PRC on December 13, 1993). This tax applies specifically to state-owned enterprises, collective enterprises, private enterprises, joint venture enterprises and joint stock enterprises. The enterprise income tax is imposed at a rate of 33% of taxable income, which is world-wide income (Article 1). No "local income tax" is imposed under the Provisional Regulations on Enterprise Income Tax.

39.         The Provisional Regulations on Enterprise Income Tax [Tab U] replaced as of January 1, 1994 the "state enterprise income tax", "state enterprise income regulatory tax", "collective enterprise income tax", "private enterprise income tax" and "household income tax" which had been imposed under the Draft Regulations of the People's Republic of China on State-Owned Enterprise Income Tax and Measures of Collection of State Owned Enterprise Adjustment Tax published by the State Council on September 1, 1984, the Provisional Regulations of the PRC on Collective Enterprise Income Tax published April 11, 1985 and the Provisional Regulations of the People's Republic of China on Private Enterprise Income Tax published on June 25, 1988.

40.         In addition to the individual income tax, the income tax for FIEs and FEs, the local income tax and the enterprise income tax, there are several other taxes imposed in the Mainland of the PRC, including a "value added tax" on the sale or import of goods or taxable services, a "consumption tax" on luxury items, a "business tax" on the provision of certain services and the transfer of immovable and intangible property, a "land value added tax", a "deed tax", a "stamp tax", a "vehicle and vessel license tax" and a "resource tax" [Tab V at 10.6].

             F. Facts about the Tax Law of the HKSAR of the PRC

41.         In the HKSAR of the PRC, there is no general system of taxing income or capital by reference to the residence of the taxpayer. For the purpose of determining taxable income, residents and non-residents are treated alike. Source of income, rather than residence status, is the single most important factor in determining a person's liability for taxation. A taxable person includes any person who has derived income in or from the HKSAR of the PRC. The following are chargeable income or profits: income from an office or employment, assessable profits from a trade, business or profession, and the assessable value of land and buildings. Income derived in or from the HKSAR of the PRC which falls under one of these three heads of taxation in the Inland Revenue Ordinance, Ordinance 112 is generally subject to tax in the HKSAR of the PRC. [Tab W at 11.2-11.4].

42.         Taxes in the HKSAR of the PRC are administered by the Department of Inland Revenue. None of the taxes described in this Section F apply to the Mainland of the PRC.

43.         Article 73 of the Basic Law provides:

The Legislative Council of the Hong Kong Special Administrative Region shall exercise the following powers and functions: ...

(3)            To approve taxation and public expenditure.

44.         Article 106 of the Basic Law provides:

The Hong Kong Special Administrative Region shall have independent finances.

The Hong Kong Special Administrative Region shall use its financial revenues exclusively for its own purposes, and they shall not be handed over to the Central People's Government.

The Central People's Government shall not levy taxes in the Hong Kong Special Administrative Region.

45.         Article 108 of the Basic Law provides:

The Hong Kong Special Administrative Region shall practice an independent taxation system.

The Hong Kong Special Administrative Region shall, taking the low tax policy previously pursued in Hong Kong as a reference, enact laws on its own concerning types of taxes, tax rates, tax reductions, allowances and exemptions, and other matters of taxation.

46.         The Hong Kong Tax Law that was the Inland Revenue Ordinance of May 3, 1947 was adopted as Inland Revenue Ordinance, Ordinance 112 of the HKSAR of the PRC effective July 1, 1997, according to the process described in paragraphs 20-24 hereof. The text of the Inland Revenue Ordinance, Ordinance 112 of the HKSAR of the PRC on July 1, 1997 was identical to the text of the Inland Revenue Ordinance of May 3, 1947 on June 30, 1997.

47.         The Inland Revenue Ordinance, Ordinance 112 of the HKSAR of the PRC imposes a "salaries tax" in Part III thereof [Tab X]. The salaries tax is imposed upon individuals in respect of income arising in or derived from the HKSAR of the PRC from any office or employment or profit or any pension, pursuant to section 8(1). Section 8(1) will apply where an individual's employment is sourced in the HKSAR of the PRC and in such a case, all his income from that employment will be subject to the salaries tax even if only part of the services are performed in the HKSAR of the PRC. Section 8(1A) applies the salaries tax to employment which is not sourced in the HKSAR of the PRC but where the services are performed in the HKSAR of the PRC (CIR v. Geopfert (1987) HKTC 2, 210) [Tab W at 19.1-19.2]. The salaries tax is imposed at graduated rates from 2% to 17% [Tab W at 24.3].

48.         The Inland Revenue department of the HKSAR of the PRC has indicated that an employment will be sourced in the HKSAR of the PRC where the contract of employment is negotiated or entered into in the HKSAR of the PRC, the employer is resident in the HKSAR of the PRC, or the employee's remuneration is paid to the employee in the HKSAR of the PRC [Tab W at 19.2].

49.         The Inland Revenue Ordinance, Ordinance 112 of the HKSAR of the PRC imposes a "profits tax" in Part IV thereof [Tab Y]. Persons, (including corporations, partnerships, trustees and bodies of persons), both resident and non-resident, carrying on or deemed to be carrying on a trade, business or profession in the HKSAR of the PRC are liable to the profits tax on chargeable profits sourced to the HKSAR of the PRC. Certain income from sources outside the HKSAR of the PRC is deemed to arise from a source in the HKSAR of the PRC. Both actual receipts and amounts credited but not paid (i.e. accruals) are considered to be income liable to profits tax [Tab W at 12.1]. The rate of profits tax is 15% for individuals and 16% for corporate entities [Tab W at 22.1 & 24.1].

50.         Specific rules for the application of the profits tax to an aircraft owner resident in the HKSAR of the PRC are set out in section 23C of the Inland Revenue Ordinance, Ordinance 112 of the HKSAR of the PRC [Tab Y]. Section 23C deems a corporation resident in the HKSAR of the PRC that carries on a business as an owner of an aircraft to be carrying on that business in the HKSAR of the PRC. Section 23C of the Inland Revenue Ordinance, Ordinance 112 prescribes what proportion of the aircraft owner's worldwide income from carrying on business as an owner of an aircraft is to be apportioned to the HKSAR of the PRC for tax purposes.

51.         Part VII of the Inland Revenue Ordinance, Ordinance 112 of the HKSAR of the PRC [Tab Z] provides for the charging of tax under personal assessment. This Part provides for an effective merging of the heads of taxation under the Inland Revenue Ordinance, Ordinance 112 of the HKSAR of the PRC into a single assessment for an individual who is a permanent or temporary resident of the HKSAR of the PRC and who elects for personal assessment. The total income of the individual for the purposes of personal assessment consists of the net assessable value of land and buildings owned by the individual, the net assessable income from an office or employment of profit of the individual and assessable profits. Total income is reduced by approved charitable donations, business losses and certain interest in order to arrive at the individual's taxable amount. [Tab W at 21.2].

52.         The parties hereto agree, for the purpose of this appeal, to the facts as set out herein. Each party reserves the right to object to the relevance of any of the facts set out herein.

[7]              No evidence was adduced at trial concerning the constitutional, legal or political relationship of the Hong Kong Special Administrative Region to the People's Republic of China. Thus, I have no knowledge whether a Special Administrative Region is analogous, for example, to a Canadian province, one of the United States of America, a territory of Canada, a territory of the United States or a Crown Colony of the United Kingdom.

[8]              Mr. Edwards has worked often for Cathay Pacific since 1989. He usually flies aircraft for Cathay Pacific between Toronto and Hong Kong. He resides in Ontario. He pays tax on his salary to the HKSAR.

[9]              Mr. Hollman was cross-examined by appellant's counsel on his statutory declaration that was produced as an exhibit. He has worked as a foreign service officer for 33 years. At the time of trial, and since 1999, Mr. Hollman was Deputy Director of the China and Mongolia Division of the Department of Foreign Affairs and International Trade. He and three other officers are engaged with the management of Canada's political relations with the People's Republic of China. Canada has an Embassy in Beijing and a Consulate General in the HKSAR.

[10]            As a result of a request under the Access to Information Act, Mr. Hollman examined documents in possession of his Department relating to the negotiation of the Canada-China Tax Treaty. The documents mentioned in his declaration are included in the respondent's Supplementary List of Documents.

[11]            At the request of the Department of Justice and, I infer, for purposes of this appeal, Mr. Hollman arranged for a third person diplomatic note to be sent to the China Ministry of Foreign Affairs in November 2001 stating the Canadian government's position that the Convention does not apply to the HKSAR and requesting that the Government of China confirm that its position is the same as Canada's. The exchange of third person diplomatic notes corresponds to the "usual and accepted method by which the Government of Canada communicates with governments of other states", Mr. Hollman informed me. A similar note was sent to the Hong Kong Department of Justice. Mr. Hollman was aware that in an exchange of correspondence between Canadian and Chinese taxation authorities in March 2001, each government took the position that the Convention does not apply to the HKSAR. The Chinese government replied:

[TRANSLATION]

         Article No. 108 of the Basic Law of the Hong Kong Special Administrative Region of the People's Republic of China governs that HKSAR implements an independent taxation system. Therefore, the aforementioned agreement does not apply to the Hong Kong Special Administrative Region, and a company incorporated and resident in, and with its place of head office and place of management in, the Hong Kong Special Administrative Region, is neither a "resident of a Contracting State" nor an "enterprise of a Contracting State" within the meaning of Article 4 and Article 3, paragraph 1(g), respectively of the Agreement.

[12]            The reply from the Hong Kong Department of Justice also confirmed the Canadian government's position.

[13]            Appellant's counsel objected to evidence respecting the exchanges of diplomatic notes between Canada and China, since they took place after the taxation years in appeal. Copies of the notes were sent to counsel eight days before trial; however, respondent's counsel had informed appellant's counsel earlier of the exchange and that he would forward copies to appellant's counsel.

[14]            Appellant's counsel does not accept as the view of the Government of Canada expressed in a letter of March 13, 2001 from the Canada Customs and Revenue Agency ("CCRA") to the China tax authority. In the CCRA's view confirmed by the China tax authority, the Canada-China Tax Treaty does not apply to Hong Kong. According to the CCRA, Hong Kong can only be considered part of the PRC for purposes of the Treaty if the laws relating to Chinese tax apply to the HKSAR. The CCRA concluded in its letter that on review of paragraphs 1 and 2 of Article 2 of the Treaty, the term "China tax" does not include Hong Kong tax, for the following reasons:

         [T]he taxes listed in Article 2 paragraph 1(b) [of the Treaty], refer to taxes levied by the PRC at the time the Agreement was negotiated. Hong Kong's taxes would not qualify as "the local income tax" because, according to our notes from the negotiation of the Agreement, the local income tax was described by the PRC to be taxes that local governments have the right to levy, but only if allowed by and within the limits of, the People's Congress Tax Laws and it is our understanding that Hong Kong would not fall under those laws. Both the Basic Law of Hong Kong and the Sino-British Joint Declaration provide that tax laws of the PRC are not in force in Hong Kong. With respect to paragraph 2 of Article 2 (Taxes Covered), Hong Kong taxes are not identical or substantially similar taxes "imposed after the date of signature of this Agreement in addition to, or in place of", the existing taxes listed. They are neither in addition to the taxes listed nor do they replace the taxes listed.

[15]            The CCRA also referred to a publication of the Hong Kong Inland Revenue Department which also expressed the view that the Treaty will not apply to Hong Kong.[6]

[16]            The position of the Department of Finance was expressed at the 1997 Congress of the Association de planification fiscale et financi ère, Table Ronde sur la fiscalité fédérale. In an answer to question 3.7, "Could the Department of Finance indicate to us whether the Tax Convention between Canada and China applies to Hong Kong following unification?", the representative of the Department of Finance stated the following:

The tax treaty between Canada and China will not apply to Hong Kong despite unification, because under the terms of the unification agreement, it was agreed that Hong Kong would maintain its tax system, and therefore Chinese tax law would not apply to Hong Kong. As you may perhaps know, Canada did not have a tax convention with Hong Kong.

[17]            The portion of Ms. Caspersen's discovery evidence that was read in at trial related to the lack of public statements by the Canadian government that the Treaty did not apply to the HKSAR.

[18]            Included amongst the exhibits produced at trial were correspondence between officials of the Departments of Finance and External Affairs during negotiations of the Canada-China Tax Treaty in 1984 and later years. The question of Hong Kong was discussed; in September 20, 1984, representatives of the United Kingdom and the PRC government initialed a draft text of an agreement anticipating the transfer of sovereignty over Hong Kong from the United Kingdom to the PRC on July 1, 1997. In the meantime Hong Kong authorities were not prepared to negotiate a tax Convention with Canada. Hong Kong had no tax Convention, with any government. Only when a firm of lawyers in Toronto raised the issue that the Convention would apply to Hong Kong after June 30, 1997 did the Departments of Finance and External Affairs begin seriously to consider the matter. In May 1995 the Department of External Affairs, Economic Law Division, was inclined to the view that the Treaty would not apply to Hong Kong after June 30, 1997 and by 1997, the Department of Finance and Revenue Canada (as it was then called), took the same position.[7]

Analysis

[19]            The leading Canadian authority on the interpretation of income tax treaties is the Supreme Court of Canada decision in Crown Forest Industries Ltd. v. Canada.[8] In that case, the corporate taxpayer rented certain barges from Norsk Pacific Steamship, a non-resident corporation incorporated in the Bahamas but carrying on business in the United States. Purporting to rely on paragraph 2 of Article XII of the Canada-United States Income Tax Convention (1980), the taxpayer withheld tax on its rental payments to Norsk at the rate of 10 per cent. The Court had to determine whether Norsk was a "resident of a Contracting State" -- in that case the United States -- within the meaning of Article IV of the Canada-United States Income Tax Convention (1980). The appeal was allowed. Writing for the Court, Iacobucci J. held that:

         In interpreting a treaty, the paramount goal is to find the meaning of the words in question. This process involves looking to the language used and the intentions of the parties. . . .[9]

[20]            With respect to the intention of the drafters of the Convention, Iacobucci J. observed as follows:

         Reviewing the intentions of the drafters of a taxation convention is a very important element in delineating the scope of the application of that treaty. As noted by Addy J. in J.N. Gladden Estate v. The Queen, [1985] 1 C.T.C. 163 (F.C.T.D.), at pp. 166-67:

Contrary to an ordinary taxing statute a tax treaty or convention must be given a liberal interpretation with a view to implementing the true intentions of the parties. A literal or legalistic interpretation must be avoided when the basic object of the treaty might be defeated or frustrated in so far as the particular item under consideration is concerned. [Emphasis added in the original]

. . .

         Clearly, the purpose of the Convention has significant relevance to how its provisions are to be interpreted. . . . [I]n ascertaining these goals and intentions, a court may refer to extrinsic materials which form part of the legal context (these include accepted model conventions and official commentaries thereon) without the need first to find an ambiguity before turning to such materials.[10]

[21]            Further, at page 827, Iacobucci J. reiterated that, when interpreting international taxation conventions, reference may be made to other types of extrinsic materials, such as other international taxation conventions and general models thereof. Iacobucci J. found an authority for this proposition in Article 31 of Section 3 of Part III of the Vienna Convention on the Law of Treaties ("Vienna Convention"),[11] which deals with the interpretation of treaties.

[22]            Articles 31 and 32 of the Vienna Convention read as follows:

ARTICLE 31

General rule of interpretation

             1. A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.

             2. The context for the purpose of the interpretation of a treaty shall comprise, in addition to the text, including its preamble and annexes:

(a) any agreement relating to the treaty which was made between all the parties in connexion with the conclusion of the treaty;

(b) any instrument which was made by one or more parties in connexion with the conclusion of the treaty and accepted by the other parties as an instrument related to the treaty.

              3. There shall be taken into account together with the context:

(a) any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions;

(b) any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation;

(c) any relevant rules of international law applicable in the relations between the parties.

4. A special meaning shall be given to a term if it is established that the parties so intended.

ARTICLE 32

Supplementary means of interpretation

              Recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the application of article 31, or to determine the meaning when the interpretation according to article 31:

              (a) leaves the meaning ambiguous or obscure; or

              (b) leads to a result which is manifestly absurd or unreasonable.

[23]          The Crown Forest decision has been applied by the Federal Court of Appeal in several cases.[12] In accordance with Crown Forest I shall first deal with the plain language of the Canada-China Tax Treaty and, then, with the intention of the drafters of the Convention.

The Plain Language

[24]          I agree with counsel for the appellant's suggestion that the proper method in applying an income tax convention was accurately summarized by Mr. Philip Baker in his book, Double Taxation Conventions and International Tax Law.[13] According to Baker, in interpreting a double taxation convention, one must first determine if the issue is within the scope of the Convention, then apply the relevant definitions, and then determine which of the substantive provisions apply.

[25]          Article 1 of the Treaty, the first of the preliminary articles dealing with the scope of the Treaty, states that the Treaty applies to persons who are residents of one or both Contracting States. There is no issue that the appellant, a resident of Canada, is within the personal scope of the Treaty.

[26] Article 2 determines the scope of the Treaty in the sense of defining those taxes that are covered by it. The appellant argues that, since he seeks relief from "the income taxes imposed by the Government of Canada", he satisfies the scope requirement of Article 2(1)(a) of the Treaty. Appellant's counsel argues that it is inaccurate to frame the issue as turning on whether the Treaty applies to the HKSAR. The language of the Treaty, he states, applies to the appellant. This submission is attractive. However, appellant's counsel acknowledged that if a Canadian resident were seeking relief under the Convention from one of the taxes imposed in the HKSAR, there properly would be a question of whether such tax would be within the scope of application of the Treaty. Indeed, taking into consideration the interests of the comity of nations, it would be unusual to treat a Canadian resident seeking relief from income taxes imposed by the Government of Canada as being within the scope of the Treaty where a Canadian resident seeking relief from one of the taxes imposed in the HKSAR would remain outside the scope of the same Convention.

[27]          As Baker points out, tax treaties are negotiated in the context of two existing tax systems, and therefore, Article 2 specifies the taxes to which the Convention applies. Thus, it appears to be a better view that, in applying Article 2 of the Convention, one must look not only at the taxes from which relief is sought but at the context of the two existing tax systems of the Treaty parties. Applying this approach, it would seem that the appellant is outside the scope of the taxes covered by the Treaty.

[28]          The appellant claims that pursuant to Article 15(3) of the Treaty he is entitled to a deduction in Canada in the amount of his employment income earned from Cathay Pacific because this employment income is taxable only in the Contracting State, the People's Republic of China. For Article 15(3) of the Convention to apply, the following two conditions must be satisfied:

i)               the remuneration in question must be in respect of an employment exercised aboard a ship or aircraft operated in "international traffic"; and

ii)              the remuneration in question must be in respect of an employment by an "enterprise of a Contracting State".

[29]          The expressions "international traffic" and "enterprise of a Contracting State" are defined at Article 3(1) of the Agreement. Again, there is no issue between the parties that the appellant's remuneration was in respect of an "employment exercised aboard an aircraft operated in international traffic". The parties disagree on whether Cathay Pacific was an "enterprise of a Contracting State" for the purposes of the Convention. This is the main issue of this appeal.

[30]          Article 3(1)(g) of the Convention defines "enterprise of a Contracting State" to mean "an enterprise carried on by a resident of a Contracting State". The expression "resident of a Contracting State" is defined at Article 4(1) of the Convention as follows:

For the purposes of this Agreement, the term "resident of a Contracting State" means any person who, under the laws of that Contracting State, is liable to tax therein by reason of his domicile, residence, place of head office, place of management or any other criterion of a similar nature.

[31]          To determine whether Cathay Pacific is an enterprise of the PRC, I must first determine whether Cathay Pacific is a person who:

                a) under the laws of that Contracting State,

                b) is liable to tax therein,

c) by reason of his domicile, residence, place of head office, place of management or any other criterion of a similar nature.

All three of these requirements are necessary for me to find that Cathay Pacific was an enterprise of the PRC in 1997.

(A)           Under the Laws of that Contracting State

[32]          Cathay Pacific's tax liability arises in the HKSAR under Part IV of the Hong Kong Internal Revenue Ordinance. [14]

[33]          The expression "laws of that Contracting State" is not defined in the Convention. With respect to this first criterion for residency under the Treaty, the appellant's submissions are twofold. First, the appellant argues that the Hong Kong Internal Revenue Ordinance is a "law of the People's Republic of China", this is denied by the respondent. Second, the appellant contends that the term "Contracting State" in the phrase "laws of that Contracting State" does not refer to the geographical definition of "the People's Republic of China" contained in Article 3(1)(b) of the Convention. Article 3(1)(b) defines the People's Republic of China "when used in the geographical sense".

[34]          The term "Contracting State" in the expression "the laws of that Contracting State" is not used in a geographical sense. Laws do not arise out of a geographical territory. They are a product of the institutions of a legal and political entity, in the appeal at bar, the State of the People's Republic of China. However, the Convention does not define the term "People's Republic of China" in a legal or political sense. The issue, then, is whether, for the purposes of the Treaty, the PRC includes the HKSAR in a sense other than a "geographical sense".

[35]          In support of the argument that the PRC includes the HKSAR for the purposes of the Treaty, the appellant refers to the Commentary on Article 2 of the OECD Model Tax Convention on Income and Capital [15] which reads as follows:

1. This Article is intended to make the terminology and nomenclature relating to the taxes covered by the Convention more acceptable and precise, to ensure identification of the Contracting States' taxes covered by the Convention, to widen as much as possible the field of application of the Convention by including, as far as possible, and in harmony with the domestic laws of the Contracting States, the taxes imposed by their political subdivisions or local authorities, to avoid the necessity of concluding a new convention whenever the Contracting States' domestic laws are modified, and to ensure for each Contracting State notification of significant changes in the taxation laws of the other State.

[36]          In fact, the subsequent Commentary is even clearer in this respect:

2. This paragraph defines the scope of application of the Convention: taxes on income and on capital; the term "direct taxes" which is far too imprecise has therefore been avoided. It is immaterial on behalf of which authorities such taxes are imposed; it may be the State itself or its political subdivisions or local authorities (constituent States, regions, provinces, départements, cantons, districts, arrondissements, Kreise, municipalities or groups of municipalities, etc.).

[37]          However, the appellant's counsel ignores that the text of Article 2 of the OECD Model differs from that of Article 2 of the Canada-China Tax Treaty. In fact, Canada has expressly reserved its position on the part of paragraph 1 of the OECD Model which states that a tax treaty should apply to taxes of political subdivisions or local authorities. The relevant portion of the OECD Model, which is completely absent from the text of the Canada-China Tax Treaty, reads as follows:

Article 2. Taxes Covered - (1) This Convention shall apply to taxes on income and on capital imposed on behalf of a Contracting State or of its political subdivisions or local authorities, irrespective of the manner in which they are levied.

[38]          The above commentaries cannot apply to the Treaty.

[39]          The appellant also relies on Article 3(2) of the Treaty as well as on section 3 of the Income Tax Conventions Interpretation Act [16] and section 38 of the Interpretation Act [17] to argue, inconclusively, in my view, that for the period from July 1, 1997 onwards, the HKSAR was part of the People's Republic of China when this term is used in a sense other than a "geographical sense" in the Treaty. Section 38 of the Interpretation Act reads as follows:

The name commonly applied to any country, place, body, corporation, society, officer, functionary, person, party or thing means the country, place, body, corporation, society, officer, functionary, person, party or thing to which the name is commonly applied, although the name is not the formal or extended designation thereof.

[40]          Finally, the appellant invokes the solutions adopted in double taxation agreements between Canada and other countries for the proposition that the HKSAR is part of the People's Republic of China in the ordinary sense of that phrase as used in the Treaty.

[41]          One must apply the words of Article 31(1) of the Vienna Convention to interpret the term "People's Republic of China" in the context of the expression "the laws of the People's Republic of China". Then, the question which must be answered is whether Hong Kong's Internal Revenue Ordinance is a "law of the People's Republic of China" for the purposes of Article 4 of the Treaty.

[42]          The Internal Revenue Ordinance is an enactment of the Legislature of the HKSAR. Since July 1, 1997, the Legislature of the HKSAR has derived its powers from Section 3 of Chapter IV of the Basic Law of the Hong Kong Special Administrative Region. [18] The relevant provisions of the Basic Law for our purposes read as follows:

Article 66. The Legislative Council of the Hong Kong Special Administrative Region shall be the legislature of the Region. ...

Article 73. The Legislative Council of the Hong Kong Special Administrative Region shall exercise the following powers and functions;

(1) To enact, amend or repeal laws in accordance with the provisions of this Law and legal procedures;

(2) To examine and approve budgets introduced by the government;

(3) To approve taxation and public expenditure; ...

Article 108. The Hong Kong Special Administrative Region shall practise an independent taxation system.

[43]          I understand that the Basic Law is a law of the National People's Congress of the PRC. The Basic Law was enacted pursuant to Article 31 [19] and paragraph 13 of Article 62 of the Constitution of the People's Republic of China [20] which authorise the establishment of Special Administrative Regions, such as the HKSAR and Macao. Paragraph 13 of Article 62 reads as follows:

The National People's Congress exercises the following functions and powers: ...

13. to decide on the establishment of special administrative regions and the systems to be instituted there...

[44]          Appellant's counsel therefore agreed with the legal opinion of Mr. Alan Willis, a legal officer with the Department of External Affairs, at the time, who, on December 29, 1994, stated that "from July 1, 1997 onwards, the laws of the newly created Hong Kong Special Administrative Region of the People's Republic of China took their force and effect from the PRC" and that Articles 106 [21] and 108 [22] of the Basic Law "amount to a delegation of taxation authority from the central government to the local government".

[45]          I do not agree with Mr. Willis' opinion. The issue is whether the powers conferred upon the Legislative Council of the HKSAR by the Basic Law constitute a legislative delegation from the National People's Congress. Arguably, they do not. An example on point is that of Canada. [23] Technically, the principal instruments of the Canadian Constitution are enactments of the Imperial Parliament of Great Britain. [24] The Constitution Act, 1867 establishes the Parliament of Canada and the provincial legislatures and confers legislative authority upon them. However, it has been held that it is erroneous to regard powers conferred by the Constitution Act, 1867 on the provincial legislatures [25] or on the Parliament of Canada [26] as delegated powers. On the contrary, in Hodge v. The Queen, for example, it was held that provincial legislative power was "as plenary and as ample within the limits prescribed by section 92 as the Imperial Parliament in the plenitude of its power possessed and could bestow". [27] Similarly, the power of the Legislative Council of the HKSAR may be as plenary and as ample, by virtue of Article 73 of the Basic Law, as the National People's Congress possessed pursuant to Article 62 of the Constitution of the PRC. Thus, from a Canadian perspective, HKSAR's independent authority to enact taxation laws does not constitute a delegation of taxation authority from a central government to a local government. As I stated earlier in my reasons, there is no evidence of the constitutional or legal relationship between the central government of the PRC and the HKSAR.

[46]          The appellant also suggests that Article 160 [28] of the Basic Law supports his proposition that the laws of the HKSAR take their force and effect from the PRC. On February 23, 1997, the Standing Committee of the National People's Congress adopted the majority of the laws previously in force in Hong Kong, including the Internal Revenue Ordinance, as laws of the HKSAR. [29]

[47]          There is no evidence before me that the process described in the immediately preceding paragraph to adopt the laws of the Crown colony of Hong Kong constitutes an adoption of the laws of the HKSAR into the body of laws of the People's Republic of China. Nor does it appear that it is a legislative act by the National People's Congress. Rather, this process took place to ensure the continuity of the laws of the former Crown Colony of Hong Kong as laws of the newly created HKSAR as negotiated and agreed to by the PRC and the Government of the United Kingdom.

[48]          The Hong Kong Internal Revenue Ordinance is not a "law of the People's Republic of China" for the purposes of Article 4 of the Treaty. Therefore Cathay Pacific is not an enterprise of a Contracting State to the Treaty. On these findings alone, the appellant's primary argument would fail. However, in the event I am wrong in my finding that Cathay Pacific is not an enterprise of the PRC, I am considering the appellant's other submissions.

(B)           Liable to Tax Therein

[49]          The second criterion for residency in the People's Republic of China is that Cathay Pacific must be "liable to tax therein". This expression is not defined in the Treaty. The word "tax" is defined at subparagraph (1)(d) of Article 3 of the Treaty to mean "Canadian tax or Chinese tax, as the context requires". The expression "Chinese tax" is defined at subparagraph (1)(b) of Article 2 of the Treaty.

[50]          The appellant argues that the word "tax" in the expression "liable to tax therein" should not be given the meaning assigned to it by Articles 2 and 3 of the Treaty. The appellant contends that the purpose of Article 2 is to determine the scope of the Treaty in the sense of defining those taxes which are subject to double taxation relief. On the other hand, Article 4 is intended to define the meaning of the term "resident of a Contracting State", and thus to identify whether sufficient nexus exists between a person and a Contracting State.

[51]          Appellant's counsel illustrates his argument by contending that if the definition of "Chinese tax" were applied to the expression "liable to tax therein" in Article 4, no corporate entity subject to any of the corporate taxes in the Mainland of the PRC [30] would qualify for relief from Canadian taxes under the Treaty. In fact, counsel suggests, the definition of "Chinese tax" in Article 2 of the Agreement does not list any of the taxes imposed on corporate entities domestic to the Mainland of the PRC.

[52]          A literal or legalistic interpretation must be avoided when the basic object of a treaty might be defeated or frustrated in so far as the particular item under consideration is concerned. [31] Therefore, the appellant's argument that the word "tax" in the expression "liable to tax therein" should not be given the meaning assigned to it by Articles 2 and 3 of the Treaty is legitimate. Unfortunately, appellant' counsel does not suggest another interpretation for the word "tax" in this context.

[53]          The term "tax" must be interpreted against the background of the phrase "under the laws of that Contracting State, is liable to tax therein". Since Cathay Pacific's tax liability arises under Part IV of the Hong Kong Internal Revenue Ordinance and since I have decided that this Ordinance is not a "law of the People's Republic of China" for the purposes of Article 4 of the Convention, I must conclude that Cathay Pacific is not liable to tax in the People's Republic of China under the Treaty.

[54]          I find support for my conclusion when I consider the meaning of the word "therein" in the expression "liable to tax therein" in Article 4 of the Treaty. The word "therein" refers back to the expression "that Contracting State", which, in the present situation, is the People's Republic of China. Arguably, this is a reference to the geographical definition of the expression "People's Republic of China". The word "therein" means "in that place or thing". [32]

(C)           By a Reason of a Listed or Analogous Ground

[55]          With respect to the third criterion of residency, Article 4 of the Treaty requires that a person be liable for tax in a Contracting State "by reason of his domicile, residence, place of head office, place of management or any other criterion of a similar nature".

[56]          The relevant sections of HKSAR's Internal Revenue Ordinance read as follows:

14 Charge of Profits Tax - (1) Subject to the provisions of this Ordinance, profits tax shall be charged for each year of assessment at the standard rate on every person carrying on a trade, profession or business in Hong Kong in respect of his assessable profits arising in or derived from Hong Kong for that year from such trade, profession or business (excluding profits arising from the sale of capital assets) as ascertained in accordance with this Part.

...

23C. Ascertainment of the assessable profits of a resident aircraft-owner - (1) Where a person carries on a business as an owner of aircraft and

(a) the business is normally controlled or managed in Hong Kong; or

(b) the person is a company incorporated in Hong Kong,

that person shall be deemed to be carrying on that business in Hong Kong.

[57]          These provisions confirm that Cathay Pacific is liable to tax under Hong Kong's Internal Revenue Ordinance by virtue of its "domicile, residence, place of head office, place of management or any other criterion of a similar nature".

[58]          Based on the above analysis, I conclude that Cathay Pacific was not "resident of a Contracting State" for the purposes of Article 4 of the Canada-China Tax Treaty. Therefore, it was not an "enterprise of a Contracting State" for the purposes of Article 15(3) of the Treaty.

What was the Intention of the Drafters of the Convention?

[59]          The broader question in this appeal is one of state succession. State succession is an area of public international law which is concerned with the situation where an area of territory falls under the sovereignty (or treaty making power) of a new or different state. [33] There are several forms of state succession: independence of a former colony, transfer of sovereignty, secession, merger of states (including annexation) or transfer of territory.

[60]          The transfer of sovereignty over Hong Kong is one of the most recent instances of state succession. Naturally, state succession has important implications for double taxation agreements. The question which is raised in the present appeal is whether the tax treaties of the successor state - in this case, the PRC - apply to the newly created Special Administrative Region of Hong Kong.

[61]          Generally, in the absence of evidence to the contrary, a treaty is binding on a state to the extent of the entirety of its territory. [34]

[62]          It is beyond any doubt that, since July 1, 1997, territorially and politically, the HKSAR has formed an inalienable part of the PRC. [35] The question remains whether the Treaty was intended to apply to the newly created HKSAR of the PRC. In order to determine this issue, Baker proposes two broad approaches: one that looks at public international law solutions and another one that examines solutions internal to the double taxation convention itself.

i)                      Public International Law Solutions

[63]          According to Baker, there is no well-established body of public international law on the issue of state succession. [36] State practice now relies very heavily upon "devolution agreements".

[64]          In the case of Hong Kong, in 1972, the United Nation's Decolonisation Committee accepted the assertion of the People's Republic of China, in which Britain acquiesced, that the settlement of the "Hong Kong question" was entirely within the PRC's sovereign right and was to take place in an appropriate way when conditions were ripe. [37] The first formal step in settling the "Hong Kong question" was taken when the Sino-British Joint Declaration [38] was concluded on 19 December 1984 and the ratifications were exchanged on 27 May 1985. This "devolution agreement", which was duly registered by both parties with the Secretariat of the United Nations, stipulated that sovereignty over Hong Kong would pass to the PRC on 1 July 1997. The PRC undertook to incorporate its basic policies regarding Hong Kong as developed in Annex I of the Joint Declaration into the Basic Law of the Hong Kong Special Administrative Region. The PRC further guaranteed that those basic policies would remain unchanged for fifty years.

[65]          Although the Joint Declaration and the Basic Law do not specifically address the issue of HKSAR's succession to PRC's treaties, it appears from the texts of these documents that Hong Kong will not be bound by PRC's international agreements and will, instead, be free to conclude its own treaties. For example, Article 2 of the Basic Law authorises the HKSAR to exercise a high degree of autonomy and enjoy executive, legislative and independent judicial power, including that of final adjudication. As stated previously, Articles 106 and 108 provide that the HKSAR will have independent finances and will practice an independent taxation system. Finally, Article 151 of the Basic Law stipulates that the HKSAR may on its own conclude international agreements. [39]

[66]          Mushkat reports that Hong Kong is under the regime of over two hundred multilateral treaties. [40] To date, the HKSAR has not concluded any comprehensive double taxation avoidance agreements except with the Mainland of the PRC. However, taking into consideration the text of Article 151 of the Basic Law, it reasonably may be concluded that the HKSAR is fully capable of entering into such agreements.

[67]          Mushkat, along with other authors, argues that, although the HKSAR is technically an "inalienable part" of the PRC and not an independent State, it possesses an independent legal personality. [41] Article 34 of the Vienna Convention contemplates the situation of the HKSAR:

A treaty does not create either obligations or rights for a third state without its consent.

[68]          The intention of the drafters of the Joint Declaration did not intend that the newly created HKSAR be bound by PRC's international agreements but, instead, to be free to develop its own international relations and to conclude its own treaties.

ii)                    Solution in Double Taxation Conventions

[69]          Baker suggests that, in the absence of any clear rules of public international law, there is a scope for a solution to the problem of state succession and double taxation conventions which is internal to the conventions themselves. The goals and intentions of the drafters of the Treaty must be reviewed in order to delineate its scope of application. [42] It was held in Crown Forest that in ascertaining these goals and intentions, a court may refer to extrinsic materials without the need first to find an ambiguity before turning to such materials.

(A)                General Objectives of the Convention

[70]          Tax treaties are negotiated in the context of two existing tax systems. This is obvious from the text of Article 2 of the Convention and of the OECD Model. Then, according to Baker, if the tax system remains substantially in place with regard to the successor states, it seems reasonable that the treaty should continue to be applied. If however, the state succession is followed by a major change of substance in the tax systems then it seems reasonable that the Treaty does not continue.

[71]          Although this is the subject of the appellant's alternative argument, which I consider later, if one adopts this general approach, it seems reasonable that PRC's Treaty with Canada would not apply to the newly created HKSAR by reason of the apparent dissimilarities between the tax systems of the Mainland of the PRC and the HKSAR.

(B)                 Administrative Practice

[72]          Counsel for the respondent argued and presented abundant evidence to the effect that the Government of Canada never intended the Treaty to apply to the HKSAR. With respect to the evidentiary weight to be given to the administrative practice of the Government of Canada, the respondent relied on the following comments of Iacobucci J. in Crown Forest:

[As] noted by La Forest, J. in Thomson v. Thomson, [1994] 3 S.C.R. 551, at p. 578:

It would be odd if in construing an international treaty to which the legislature has attempted to give effect, the treaty were not interpreted in the manner in which the state parties to the treaty must have intended.

This is also the view in American jurisprudence. The Supreme Court of the United States, in Sumitomo Shoji America, Inc. v. Avagliano, 457 U.S. 176 (1982), at pp. 184-85, held that ‘although not conclusive, the meaning attributed to treaty provisions by the Government agencies charged with their negotiation and enforcement is entitled to great weight.' [43]

[73]          This position is confirmed by subparagraph 3(b) of Article 31 of the Vienna Convention which states that in interpreting treaty provisions there must be taken into account, together with the context, any subsequent practice in the application of the Treaty.

[74]          Counsel for the appellant relied on the cases of Kubicek Estate and Canada v. Fiberco Export [44] in an attempt to discount the evidence of the administrative practice of the Government of Canada with respect to the Treaty, relying on the trial judge's comment in Fiberco that, among other things,

. . . when the government seeks to adduce evidence of its own previous practices to support the alleged correctness of its own interpretation of the law, the government seeks to breach the rule of law.

[75]          However, in the Federal Court of Appeal, Hugessen J.A., expressed his views with respect to the decision of the trial judge:

We also think that the Trial judge was wrong to do as he did and refuse to admit certain proffered evidence as to administrative practice and parliamentary history; while the law appears to us to be in a state of some uncertainty as to the use which may be made of such materials in the interpretation of statutes, it seems to us that the debate turns upon questions of weight rather than of admissibility, and that it is error for a Trial judge to exclude such evidence. [45]

[76]          It must also be noted that in Fiberco, the Federal Court had to consider whether a paper mill was a "certified property" within the meaning of subsection 127(9) of the Act. Arguably, since the Fiberco decision did not have to interpret a double taxation agreement, its authority is limited.

[77]          Evidence of the Government of Canada's administrative practice with respect to the Treaty is admissible and is entitled to great weight. I have reviewed the Canadian Government's views (and those of the PRC and the HKSAR) and practice earlier in these reasons. The general administrative practice of the Canadian Government - as well as the governments of the PRC and HKSAR - is that a corporation that is resident in Hong Kong and is subject to Hong Kong's Internal Revenue Ordinance is not considered a resident of the PRC under the Treaty.

(C)                 Position Expressed in Doctrinal Texts

[78]          Doctrinal texts are also important in ascertaining the rules of international law. Article 38 of the Statute of the International Court of Justice states that:

The Court, whose function is to decide in accordance with international law such disputes as are submitted to it, shall apply: ...

(d) ... the teachings of the most highly qualified publicists of the various nations, as subsidiary means for the determination of rules of law.

[79]          The doctrinal materials before me support the respondent's contention that the Convention does not apply to the HKSAR. For example, from a United Kingdom perspective, Baker expresses the following opinion:

Similarly, the convention with China defines "China" as "all the territory...in which the laws relating to Chinese tax are in force..."; Chinese tax is defined to cover only those taxes in force in the Mainland (so as to exclude Hong Kong, Macao and Taiwan - thus avoiding a difficult diplomatic issue in making it relatively clear that China's treaties will not apply to Hong Kong after June 30, 1997). [46]

(D)                 Avoidance of Internal Inconsistencies

[80]          It is well established that a literal or legalistic interpretation must be avoided when the basic object of a treaty might be defeated or frustrated. [47]

[81]          If the Canada-China Tax Treaty applied to the HKSAR a practical inconsistency would arise within the Treaty with respect to the definition of "competent authority" in subparagraph 1(j) of Article 3. This provision specifically designates PRC's Ministry of Finance as the Chinese competent authority for the purposes of the Convention. [48] At the same time, the Internal Revenue Department of the HKSAR administers Hong Kong's taxation system independently from the Mainland Ministry of Finance.

[82]          This inconsistency has important practical implications for the Treaty. D.R. Davies points out that an important feature of all double taxation treaties is the machinery for administrative co-operation between the revenue authorities of the treaty countries. [49] This machinery for administrative co-operation is established through Article 23 of the Treaty which covers the mutual agreement procedure, and Article 24 which deals with exchange of information. Uncertainty as to the relevant competent authority risks to jeopardise the functioning of these provisions. Accordingly, the Treaty should be interpreted to avoid such inconsistency. This is another indication that the Convention does not apply to the HKSAR.

(E)                  Other Extrinsic Materials

[83]          In Crown Forest, Iacobucci J. stated that, when interpreting international taxation conventions, reference may be made to a variety of extrinsic materials, including other international taxation conventions. [50] The appellant has not submitted any material to establish that any double taxation convention entered into by the PRC, in particular a Convention entered into after July 1, 1997, has been considered expedient to explicitly exclude the HKSAR from the ambit of the agreement.

[84]          There is little guidance from third countries as to the appropriate interpretation of their double taxation treaties with the PRC with respect to the HKSAR. (I was more reluctant to accept the evidence of an officer of the CCRA in respect of such evidence). According to Baker, it seems to be accepted in the United Kingdom that because United Kingdom's Convention with China defines "China" as "all the territory...in which the laws relating to Chinese tax are in force..." and because Chinese tax is defined to cover only those taxes in force in the Mainland, it is "relatively clear" that the treaty will not apply to Hong Kong, Macao and Taiwan. [51]

Conclusion on the Appellant's Principal Argument

[85]          Cathay Pacific was not an "enterprise of a Contracting State" because it was not liable to tax therein under the laws of the People's Republic of China. Therefore, the employment income earned by the appellant from July 1 to December 31, 1997 in respect of his employment by Cathay Pacific is not exempt from income tax in Canada by reason of the application of Article 15(3) of the Treaty.

Appellant's Alternative Argument

[86]          The appellant's alternative argument is that, to the extent that the definition of the People's Republic of China, as found in Article 3(1)(b) of the Treaty, is relevant to the determination of whether the appellant is entitled to the protection afforded by Article 15(3), certain taxes imposed under HKSAR's Internal Revenue Ordinance meet the definition of "Chinese tax" as found in Article 2 of the Treaty. Therefore, the appellant argues that the definition of "People's Republic of China" in the Treaty includes the HKSAR from July 1, 1997 on.

[87]          Appellant's counsel acknowledges that none of the four types of taxes set out in subparagraph (1)(b) of Article 2 of the Treaty apply in the HKSAR. Counsel notes that the types of taxes referred to in Article 2(1) of the Treaty were imposed under laws which were in force in the Mainland of China in 1986 and have all been substantially amended or replaced since that time.

[88]          Paragraph 2 of Article 2 of the Treaty, provides that the Treaty shall also apply to any "identical or substantially similar taxes" which are imposed after the date of signature of the Agreement "in addition to, or in place of, those referred to in paragraph 1". The parties agree that this provision is necessary to prevent the Treaty from being inoperative in the event that of one of the Contracting States modifies its tax laws, as governments are wont to do. Appellant argues correctly that Article 2(2) extends the definition of "Chinese tax" to include taxes, such as the Income Tax Law of the People's Republic of China on Enterprises with Foreign Investment and Foreign Enterprises. This, however, does not mean that the categories provided in paragraph 1 of Article 2 should be extended to the taxes imposed by the HKSAR. In this respect, the appellant reiterates his reliance on the Commentary on Article 2 of the OECD Model Convention. However, as I have previously stated, the Commentary referred to by the appellant cannot apply to the text of the Treaty because it refers to a portion of the OECD Model, which is completely absent from the text of the Canada-China Tax Treaty.

[89]          Counsel for the appellant also argued that, pursuant to paragraph 2 of Article 2 of the Treaty a tax imposed in the HKSAR would need to satisfy three conditions in order to be included in the definition of "Chinese tax". The tax would have to be:

(a)         imposed after the date of signature of the Agreement;

        (b)         be in addition to, or in place of the taxes referred to in paragraph 1 of        Article 2; and

(c)              be identical or substantially similar to those referred to in paragraph 1.

(d)            

[90]          With respect to the "imposition" requirement of Article 2(2), the appellant relies primarily on the fact that all of the laws of Hong Kong were re-enacted as laws of the HKSAR of the PRC on July 1, 1997. Counsel for the appellant notes that it is fundamental to the structure of a double taxation convention that the listed taxes in Article 2 be imposed, respectively, by one or the other Contracting State. In that respect, counsel contends, again, that taxes imposed by the HKSAR after July 1, 1997 are so imposed under authority delegated from the PRC. I have previously concluded that this is not so, because HKSAR's independent authority to enact taxation laws does not constitute a delegation of taxation authority from a central government to a local government and the appellant's alternative argument fails.

[91]          This should conclude my consideration of appellant's argument. However, if I were required to determine whether the taxes imposed in the HKSAR are "identical or substantially similar" to the four taxes listed in paragraph (1)(b) of Article 2 of the Treaty, I would find that there was no identity or substantial similarity between the taxes of the HKSAR and the PRC. First of all the tax bases differ: Hong Kong has a territorial base and the PRC taxes on world-wide income. In the HKSAR, there is no personal system of taxing income or capital gains by reference to the taxpayer's residence. [52] Source of income usually determines a person's liability in the HKSAR. The taxes imposed under Parts II, III and IV of the HKSAR's Internal Revenue Ordinance, are property tax, salaries tax and profits tax, respectively. The application of the taxes is generally limited to assessable income or profits which arise in, or are derived from, Hong Kong sources.

[92]          Liability for tax in the PRC is generally established by reference to the taxpayer's residence; individuals and enterprises in the PRC are taxed on their world-wide income.[53] Non residents of the PRC are taxed only on income derived from sources in the PRC.[54] There is no withholding tax in the HKSAR but there is such a 20 per cent withholding tax on the Mainland of the PRC. This, appellant's counsel argues, may be one reason other states do not require a tax treaty with the HKSAR.

[93]          Tax rates between the HKSAR and PRC are also quite different. Section 2 of the Internal Revenue Ordinance nets out the HKSAR's tax rates for the years of assessment 1998/99 and for each year after that year:

(a)            Upon the first $35,000:                                             2%

(b)           Upon the next $35,000:                                            7%

(c)            Upon the next $35,000:                                             12%

(d)           Upon the remainder:                                                                17%

[94]          The structure for tax rates for the PRC is more complex. Under the PRC's Individual Income Tax Law, for example,tax on employment income varies from 5 per cent to 45 per cent. Investment income is taxed at a flat rate of 20 per cent. Chinese-foreign equity joint ventures are taxed at a flat rate of 30 per cent plus a local tax of 3 per cent. Tax rates for joint ventures established in coastal regions may be lower because there are various incentive programs reducing the rates. There are also tax holidays and other deductions. Normally, tax rates in the HKSAR are substantially less than in the Mainland of the PRC.

[95]          Therefore, taxes imposed by the HKSAR do not fall within the definition of "Chinese tax" for purposes of Article 2 of the Treaty and the Treaty's definition of People's Republic of China does not include the HKSAR. Cathay Pacific is not an enterprise of the PRC for purposes of the Treaty.

[96]          The appeal is dismissed with costs.

Signed at Ottawa, Canada, this 27th day of June, 2002.

"Gerald J. Rip"

J.T.C.C.

COURT FILE NO.:                                                 2000-1183(IT)G

STYLE OF CAUSE:                                               Kelly Brian Edwards and

                                                                                                Her Majesty The Queen

PLACE OF HEARING:                                         Ottawa, Ontario

DATE OF HEARING:                                           January 22, 23 & 24, 2002

REASONS FOR JUDGMENT BY:      The Hon. Judge Gerald J. Rip

DATE OF JUDGMENT:                                       June 27, 2002

APPEARANCES:

Counsel for the Appellant: Roger E. Taylor &

                                                                                Edward C. Rowe

Counsel for the Respondent:              Donald G. Gibson

COUNSEL OF RECORD:

For the Appellant:                                                 DONAHUE LLP

                                                                                Barristers & Solicitors

Address:                          100 Queen Street

                                          Suite 1600

                                          Ottawa, Ontario K1P 1K1

For the Respondent:                             Morris Rosenberg

                                                                                Deputy Attorney General of Canada

                                                                                                Ottawa, Canada

2000-1183(IT)G

BETWEEN:

KELLY BRIAN EDWARDS,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeal heard on January 22, 23 and 24, 2002, at Ottawa, Ontario, by

the Honourable Judge Gerald J. Rip

Appearances

Counsel for the Appellant:          Roger E. Taylor

                                                Edward C. Rowe

Counsel for the Respondent:      Donald Gibson

JUDGMENT

          The appeal from the assessment made under the Income Tax Act for the 1997 taxation year is dismissed with costs.

Signed at Ottawa, Canada, this 27th day of June 2002.

"Gerald J. Rip"

J.T.C.C.