Hunter Douglas Ltd. v. The Queen, 79 DTC 5340, [1979] CTC 424 (FCTD)

Grant, DJ:—The plaintiff Hunter Douglas Limited, (hereinafter referred to as “HDL”), is a company incorporated in the province of Quebec after amalgamation of two existing corporations in the year 1963. It was engaged in the manufacture and sale of home improvement articles such as aluminum storm windows, Venetian blinds and small tools. It was also the parent company of some 70 subsidiaries scattered throughout the world which were engaged in similar businesses and managed by the plaintiff, who earned considerable management fees thereby. The plaintiff’s income ws alSO augmented by dividends received from such subsidiaries.

In 1970, the officials of the plaintiff company decided to move its central management control from Canada to the Netherlands. The chief reason for such decision was the acceleration of its business in Europe and it would there be closer to the centre of its business operations. There was no tax advantage to it in making such move. Accordingly, the company’s mangagement and its officers and personnel were transferred to Rotterdam on October 3rd of that year. It sold its Canadian business at the same time to Hunter Douglas Canada Limited, one of its subsidiaries in Canada. Thereafter it conducted no more business here and owned no more assets in this country, excepting shares of and receivables from its subsidiary companies in Canada. The plaintiff’s earned surplus existing at the time of this change was not distributed but was transferred to the new company, Hunter Douglas, NV as it needed those funds in its business.

In 1957 the Kingdom of the Netherlands and the Dominion of Canada entered into a convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income. It was implemented by Statutes of Canada, c 16, Statutes of 1957 and by a similar statute of the Netherlands. It is hereinafter referred to as the Canada- Netherlands Income Tax agreement. Its scheme provided an allocation of taxing jurisdiction between the countries. Thereby, the right to tax dividends paid by a corporation is given solely to the country in which the company is resident within the meaning of the treaty. Such treaty provides a definition of the term “resident” in Article 11(1 )(f) thereof, which reads as follows:

1. In this Convention, unless the context otherwise requires:

(f) The terms “resident of the Netherlands” and “resident of Canada’’ means respectively any person who is resident in the Netherlands for the purposes of Netherlands tax and not resident in Canada for the purposes of Canadian Tax and any person who is resident in Canada for the purposes of Canadian tax and not resident in the Netherlands for the purposes of Netherlands tax; a company shall be regarded as resident in the Netherlands if its business is managed and controlled in the Netherlands and as resident of Canada if its business is managed and controlled in Canada.

Canada has similar agreements with 32 other countries. The purpose of these conventions is to regulate the taxing powers of this country and the contracting state so as to avoid double taxation of the dividends being paid.

The defendant admits that, on October 2, 1970, the management and control of the plaintiff’s business was transferred to the Netherlands and, as a result, the plaintiff thereafter came within the definition of resident of the Netherlands for the purposes of that convention. The defendant, however, submits that the terms of such convention apply only to the taxation of the shareholders of the plaintiff who are resident in Canada or the Netherlands with respect to distribution of the stock dividends in issue herein, and has no application to taxation of dividends paid to shareholders who are resident neither in Canada or the Netherlands.

As part of a reorganization involving the plaintiff in October 1971, it transferred all its business and assets to Hunter Douglas NV, a company formed in the Netherlands Antilles but resident in the Netherlands. As consideration therefore, the latter corporation issued to the plaintiff deferred and common shares of its capital stock. Such reorganization was made because carrying on business under a Quebec charter in the Netherlands created some fiscal problems.

In November 1971, pursuant to a resolution for its liquidation, the plaintiff distributed a dividend of Hunter Douglas NV common shares to the common shareholders of the plaintiff, many of whom resided outside Canada. In December of 1971, the plaintiff distributed a further dividend of Hunter Douglas NV deferred shares to the deferred shareholders of the plaintiff, none of whom were resident in Canada. It is conceded by all parties that the distribution of such shares amounted to payment of a dividend to the plaintiff’s shareholders.

As the plaintiff company was a resident of the Netherlands at the time of such liquidating distribution of the common and deferred shares of Hunter Douglas NV to its shareholders in November and December of 1971, according to both the Dutch internal tax law and the Canada-Netherlands Income Tax agreement, the same would have been subject to Dutch income and withholding tax. The plaintiff therefore approached the Dutch tax administration and on November 5, 1971 secured a ruling to the effect that such distribution thereof to its shareholders was not subject to an immediate tax but that the same should be deferred until actual distribution was made by Hunter Douglas NV.

The basis of such ruling was that the reorganization which led to the distribution constituted a change in form only and not in substance and should therefore be treated as what was termed a rollover. By this was meant that shareholders subject to Dutch capital gains tax, on disposing of their new shares, should not be charged a capital gains tax in connection with their receipt of the new shares on the basis of their previous shareholding of the plaintiff company, but that their previous cost basis applied to the new basis.

It was a condition of the ruling that, for Dutch corporation income tax purposes, the new company’s capital and surplus accounts were to conform to those of the plaintiff at that time in that the plaintiffs existing earned surplus should continue to be such in the hands of the new company, thereby preserving the right of Dutch revenue authorities to levy withholding taxes at the time of actual distribution thereof.

By assessments dated November 1, 1973 and numbered 280169 and 280170, the Minister of National Revenue cancelled previous assessments made by him, and in place thereof reassessed withholding tax in the amounts of $208,603.28 against the plaintiff in respect of such dividends paid by it to holders of common shares, and $1,624,930.80 in respect of such dividend distribution made by it to persons who were holders of deferred shares in the company and not resident in Canada or the Netherlands. The plaintiff has paid such assessments under protest and without prejudice to its right to reclaim the amounts so paid by it and appeal directly to this Court. The obligation to withhold tax and remit the same to the receiver general in such circumstances is found in subsections 106(1) and 109(1) of the Income Tax Act, RSC 1952, c 148, which reads:

106.(1) Every non-resident person shall pay an income tax of 15% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account or in lieu of payment of, or in satisfaction of,

109.(1) When a person pays or credits or is deemed to have paid or credited an amount on which an income tax is payable under this Part, he shall, notwithstanding any agreement or any law to the contrary, deduct or withhold therefrom the amount of the tax and forthwith remit that amount to the Receiver General of Canada on behalf of the non-resident person on account of the tax and shall submit therewith a statement in prescribed form.

All references to numbers of sections of the Income Tax Act herein are to those of such prior Act.

In 1957, there was no statutory definition of resident in the Canada Income Tax Act. At that time, the test of corporate residency, in both Canada and the Netherlands, was found in the common law to be central management and control. See De Beers Consolidated Mines Limited v Howe, [1906] AC 445.

In 1962, a definition of residence was inserted in the Canada Income Tax Act as follows:

For the purposes of this Act, a corporation incorporated in Canada shall be deemed to have been a resident in Canada throughout a taxation year if it carried on business in Canada at any time in the year.

In 1965, this definition was amended to read:

For the purposes of this Act a corporation shall be deemed to have been resident in Canada throughout a taxation year if

(a) in the case of a corporation incorporated after April 26, 1965, it was incorporated in Canada, and

(b) in the case of a corporation incorporated before April 27, 1965, it was incorporated in Canada and at any time in the taxation year or at any time in any preceding taxation year of the corporation ending after April 26, 1965, it was resident in Canada or carried on business in Canada.

It is under this last amendment, which is inconsistent with the definition of resident contained in such convention, that the defendant attempts to justify classifying the plaintiff as resident in Canada at the time of such share dividend distribution in 1971 as it was incorporated before April 27, 1965 in Canada and in preceding taxation years of the corporation ending after April 25, 1965, it carried on business in Canada.

The defendant contends that the plaintiff herein has relied entirely on the Canada-Netherlands treaty but that if any such treaty gives relief from taxation to a non-resident recipient of dividends from the Canadian withholding tax, it must be the treaty between Canada and the country in which that foreign shareholder resides and not the convention between the Netherlands and Canada. The assessments, however, were made against the plaintiff company and not against the non-resident recipient of the distribution.

Apparently they were so made at the request of the plaintiff. See its letter of October 3, 1973 (Ex 1). This made the proceedings more convenient for all parties. There has been no objection to the assessments being made in this form.

It is the liability of the plaintiff with which we are hereby concerned and it should have every right to invoke the convention made between Canada and the country of its residence.

It was the plaintiff that paid the assessments under protest. The assessments were so made because a Canadian resident payer is obliged to withhold 15% of the non-resident’s dividend payments and remit it to the Receiver General of Canada on behalf of such recipient pursuant to the provisions of section 109 of the Income Tax Act.

In defence to such contention, the plaintiff must be entitled to advance the fact that by the terms of the Canada-Netherlands convention, Canada has agreed that it would not impose such a tax and has thereby become deprived from enforcing such section against the plaintiff. The evidence indicates that all such treaties made by Canada with other countries are designed to avoid double taxation and contain provisions similar to paragraphs 1 and 5 of such Article IV. To plead the terms of the agreements with every country in which the recipient of such distribution resided would be repetitious and unnecessary, even though their terms were also relevant to such fact.

It may be that if the non-resident shareholder recipient was assessed for such tax and was the plaintiff appealing against the same that he wouldrely on the agreement existing between the state in which he resided and Canada, but that is not the situation in this appeal.

In MNR v Paris Canada Films Limited, [1962] CTC 538; 62 DTC 1339, cited by the defendant, the company charged with the obligation to withhold the tax had its head office in Canada and conducted all its business in this country so that the situation was not present, as here, where the payer company was domiciled outside Canada in a country which had such an agreement with Canada. It is therefore not an authority for the proposition that the plaintiff herein must rely on the taxing agreement between Canada and the country in which the recipient of the distribution resided.

Paragraphs 1 and 5 of Article IV of the said convention read:

1. The profits of an enterprise of one of the States shall not be subject to tax in the other State unless the enterprise is engaged in trade or business in that other State through a permanent establishment situation therein. If it is so engaged, tax may be imposed on those profits by the last-mentioned State, but only on so much of them as is attributable to that permanent establishment.

5. Where a company which is resident in one of the States derives profits or income from sources within the other State, that other State shall not impose any form of taxation on dividends paid by the company to persons not resident in that other State, or any tax in the nature of an undistributed profits tax on undistributed profits of the company, by reason of fact that those dividends or undistributed profits represent, in whole or in part, profits or income so derived.

In applying the wording of such paragraph 5 of the facts of this case, the plaintiff is the company, as it was resident at the time of the distribution in the Netherlands according to the definition of resident contained in such convention. The other state referred to must be Canada because (a) it is the other party to the agreement, and (b) it derived the undistributed profits or income which it possessed at the time of its move to the Netherlands while resident in Canada and carrying on its business here. It is also the “other state” which is enjoined from imposing the tax on the dividends or undistributed profits paid by such company to persons not resident therein.

To determine the true meaning of the sections, they must be read together. Paragraph 1 protects the profits of the enterprise from taxation by the other state, except to the limited extent thereby permitted. It refers to a corporation tax as opposed to a tax on non-resident shareholders. Paragraph 5 restrains taxation by such state on the dividends or undistributed profits of the company. It is significant that it does not differentiate between payments to resident of third countries not parties to the convention and those made to residents of Canada or the Netherlands. Canada’s right to have such dividends included in the taxable income of its own residents is not interfered with.

The defendant further claims that the terms of the Canada-Netherlands tax convention do not apply to the taxation of the shareholders of the plaintiff company who are resident neither in Canada nor in the Netherlands with respect to the distribution of the stock dividends in issue, and that the terms of such convention do not apply to relieve the plaintiff from its obligation to withhold such tax and remit it to the Reveiver General of Canada pursuant to subsection 109(1) of the Act nor does the imposition of such tax by the Minister contravene the provisions of such convention.

The defendant’s contention would lead to double taxation of those dividends received by shareholders not resident in either of such countries in respect of the dividend to which they are entitled on such distribution as the arrangements made with the Dutch tax authorities in 1971 amounted only to a postponement of taxation thereon by that state. Such a result would be contrary to the purpose of all of Canada’s 32 international treaties in respect of such form of taxation. The convention should be construed in such a manner that it is consistent with the understanding that the Crown does not intend to act in contravention of its international obligations. See Black-Clawson I nt Ltd v Papierwerke, [1975] AC 591 at 640-1.

Mr A Cooiman of Rotterdam, Holland, who is a Dutch tax adviser and practitioner in the Netherlands, where he has handled that country’s domestic and international tax matters since 1964, was called as a witness by the plaintiff, and stated:

It is a principle of Dutch law that in the event of any inconsistency between the domestic law and a treaty which has been entered into and ratified by the Kingdom of the Netherlands and another country that the provisions of the Treaty must prevail. Such provisions have the force of law in the Netherlands.

Thus, although Article I paragraph 3 of the Dutch dividend withholding tax law of December 23, 1965, provides that a company incorporated under Dutch law is deemed resident in the Netherlands for dividend withholding tax purposes, this is overridden where the company in question is resident in another country within the meaning of a double taxation agreement between the Netherlands and such other country having provisions similar to article IV(5) of the Canadian Netherlands Tax Treaty.

Specifically, it would be contrary to the law of the Netherlands as superseded by the Canada/Netherlands tax authorities to impose withholding tax on dividends paid by a company formed under the laws of the Netherlands whose management and control is situated in Canada.

Such opinion had been confirmed by the Dutch Secretary of State for finances.

Canadian Pacific Ltd v The Queen, [1976] CTC 221; 76 DTC 6120 concerned interpretation of the Canada-United States convention and protocol. Consideration was given to the effect that should be given to the rulings of the United States taxing authorities. At 246 [6135] Mr Justice Walsh stated:

While it is true that this Court has the right to interpret the Canadian US Tax convention and Protocol itself and it is in no way bound by the interpretation given to it by the United States Treasury, the result would be unfortunate if it were interpreted differently in the two countries when this would lead to double taxation. Unless therefore it can be concluded that the interpretation given in the United States was manifestly erroneous it is not desirable to reach a different conclusion, and I find no compelling reason for so doing.

In Staglines Ltd v Foscalo, Mango & Co, [1932] AC 328, Lord Macmillan in speaking of the rules to be followed in interpreting such conventions, stated at 350:

It is important to remember that the Act of 1924 was the outcome of an international conference and that the rules in the schedule have an international currency. As these rules must come under the consideration of foreign courts it is desirable in the interests of uniformity that their interpretation should not be rigidly controlled by domestic precedents of antecedent date, but rather that the language of the rules should be construed on broad principles of general acceptation.

The words “that other state shall not impose any form of taxation on dividends paid by the company to persons not resident in that other state”, contained in such paragraph 5, in my opinion, make it clear that shareholders of the company not resident in either Canada or the Netherlands are entitled to the benefit of such provision and that the purpose thereof is to insure that the dividends of a corporation resident in one State shall not be taxed by the other state except as provided by Article VII where they are received by a resident of the state seeking to impose such tax. If it had been meant otherwise, appropriate language would have been used.

The words “‘by reason of the fact that those dividends or undistributed profits represent in whole or in part, profits or income derived’’ in the last four lines of such paragraph 5 create some uncertainty as to the meaning of the whole phrase. It can be argued that the prohibition against imposition of the tax is confined to those cases where the reason for attempting to levy the same is that dividends or undistributed profits of the payer company were derived by it in the country so prohibited. That, however, does not appear to constitute a reasonable interpretation. A majority of the Canadian treaties with other countries dealing with the same subject matter have the same wording except that the words “by reason of the fact” are replaced by the words “even if”. This makes the meaning of this subsection clearer and closer to what is the purpose of all such conventions. James L Martin, who is an officer of the Department of National Revenue and tax policy officer with Provincial and International Relations Division thereof, was examined for discovery. He has taken part in the negotiations leading to a number of such later treaties and advised in relation to their application. He stated that the change to the word “even if” from “by reason thereof” did not represent a change in policy by the Government of Canada and that both expressions had the same meaning in all such treaties.

The Vienna Convention on the Law of Treaties, to which both Canada and the Netherlands are parties, contains the general rules of interpretation of international conventions. Paragraph 1 of article 31 thereof reads:

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.

The Canada-Netherlands Income Tax Agreement Act, 1957, c 16, whereby the agreement entered into between the two countries for the avoidance of double taxation was approved and declared to have the force of law in Canada, contains the following section:

3. In the event of any inconsistency between the provisions of this act or agreement, and the operation of any other law, the provisions of this act and the agreement prevail to the extent of this inconsistency.

The amendments made in 1962 and 1965 to the Canada Income Tax Act (supra) contravene the provisions of the Canada-Netherlands Income Tax convention and are therefore ineffective to abrogate the provisions of Article IV(5) of such convention. The Minister of National Revenue for Canada therefore had no authority to impose liability against the plaintiff company for not withholding the 15% tax on dividends paid by it to shareholders not resident in Canada.

The appeal should therefore be allowed and judgment should go vacating the assessments of withholding tax made by the Minister of National Revenue against the plaintiff and directing that all amounts paid by the plaintiff in respect of such assessments be repaid by the defendant to the plaintiff with interest thereon at the rate established by the Income Tax Act and the Income Tax Regulations. The plaintiff should have its costs of these proceedings against the defendant.