Alta Energy – Supreme Court of Canada finds that Treaty shopping to avoid capital gains tax on Canadian resource assets was contemplated, and not a Treaty abuse

Two US firms transferred their investment in a Canadian subsidiary (Alta Canada), that was to develop a shale formation in northern B.C., to a Luxembourg s.à r.l. (Alta Luxembourg). Alta Luxembourg was resident in Luxembourg for Treaty purposes as it had its legal seat there, albeit no substantial economic presence there. About two years after the acquisition by Alta Canada of the exploration licences, it was sold to Chevron Canada at a significant gain. The Crown no longer disputed that such gain was exempted from Canadian capital gains tax under the exclusion in Art. 13(4) of the Canada-Luxembourg Treaty (the “business property exemption”), which provided that the Alta Canada shares were not deemed immovable property (and thus not subject to Canadian capital gains tax) on the basis that the exploration licences were property of Alta Canada “in which the business of the company … was carried on” - but maintained its position that such exemption of the gain constituted an abuse of the Treaty, contrary to s. 245(4).

Rowe and Martin, JJ, jointly speaking for the minority of three, accepted that, under the Treaty, the “allocation of taxing powers follows the theory of ‘economic allegiance’," under which “taxes should be paid on income where it has the strongest ‘economic interests’ or ties, either in the state of residence or the source state,” – whereas here there was an abuse of that Treaty object since the “evidence demonstrate[d] that Alta Luxembourg had no genuine economic connections with Luxembourg as it was a mere conduit interposed in Luxembourg for residents of third-party states to avail themselves of a tax exemption under the Treaty.”

Côté J, for the majority, considered this to be contrary to a proper appreciation of the nature of the bargain that Canada had struck under the Treaty. The object of the business property exemption was to provide a “tax break [that] encourages foreigners to invest in immovable property situated in Canada in which businesses are carried on (e.g. mines, hotels, or oil shales).”

Moreover, the use of conduit corporations, ‘legal entit[ies] created in a State essentially to obtain treaty benefits that would not be available directly’, was not an unforeseen tax strategy at the time of the Treaty” and, instead, Luxembourg was well known as “an attractive jurisdiction to set up a conduit corporation and take advantage of treaty benefits.” Indeed, Canada’s acceptance of the use of conduit corporations was implicit in Art. 28(3), which provided a very narrow exception to Treaty residence status for only certain, rather than all, types of “holding companies with minimal economic connections to Luxembourg.” Canada “could also have insisted on a subject-to-tax provision” under which it would forego its right to tax capital gains only if the other state actually taxed those gains – but did not.

Côté J stated:

The absence of a subject-to-tax provision, combined with Canada’s knowledge of Luxembourg’s tax system, confirms my view that Canada’s primary objective in including art. 13(4) was to cede its right to tax capital gains of a certain nature realized in Canada in order to attract foreign investment. It was not part of the bargain that Luxembourg actually tax the gains to the same extent that Canada would have taxed them.

Thus, Canada had bargained for treaty shopping in order to increase investment in assets of this type, so that such treaty shopping was not abusive.

Neal Armstrong. Summaries of Canada v. Alta Energy Luxembourg S.A.R.L., 2021 SCC 49 under s. 245(4), Treaties – Income Tax Conventions, Art. 4, Statutory Interpretation - Treaties.