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Federal appeal court creates certainty around 'beneficial owner'

|Written By Kelly Harris

The Federal Court of Appeal has maintained the need for “certainty and stability” in tax treaties in R. v. Prévost Car, Inc. ruling.

At issue in the case was whether or not Netherlands-based holding company Prévost Holding B.V., the sole owner of Canadian bus manufacturer Prévost Car, Inc. was the beneficial owner for tax purposes. If the holding company was the beneficial owner — as ruled by the Tax Court of Canada in 2008’s R. v. Prévost Car, Inc. — it would be subject to a five-per-cent-withholding tax as outlined in the 1986 Convention Between Canada and the Kingdom of the Netherlands for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income.

“Counsel for the Crown has invited the court to determine that ‘beneficial owner,’ . . . ‘mean the person who can, in fact, ultimately benefit from the dividend,’” wrote Federal appeal court Justice Robert Décary in the decision.

“That proposed definition does not appear anywhere in the [Organization for Economic Co-operation and Development] documents and the very use of the word ‘can’ opens up a myriad of possibilities which would jeopardize the relative degree of certainty and stability that a tax treaty seeks to achieve.”

The Crown had argued the holding company was not the beneficial owner of Prévost Car, Inc. and was simply a holding company. Dividends from Prévost were actually paid through the holding company and ended up going to the Sweden-based Volvo and United Kingdom-based Henlys, which is now defunct. Volvo and Henlys had owned the holding company, and now only the Swedish automotive giant owes the company.

“The Crown, it seems to me, is asking the court to adopt a pejorative view of holding companies which neither Canadian domestic law, the international community nor the Canadian government through the process of objection, have adopted,” says the ruling.

Under the Income Tax Act, Canadian companies that are not the beneficial owner would be required to withhold 25 per cent of dividends paid to non-resident shareholders and remit this amount to the Canada Revenue Agency on behalf of the non-resident.

“I think what [the judge] is doing is he is referring indirectly to the Supreme Court of Canada [R. v. Canada Trustco Mortgage Co. ruling], where they talked about the need for certainty of people’s tax affairs,” says William Innes, of Fraser Milner Casgrain LLP who argued on behalf of Prévost Inc.

“When you have international structures there is a need for people to be able to rely upon the certainty and stability of the rules before they invest a gazillion dollars in Canada or we invest a gazillion dollars in Brazil, for example.”

Innes says part of his argument to the appeal court was a law, but not a Canadian statute, rather Sir Isaac Newton’s Third Law of Motion, that every action has an equal and opposite reaction. Basically, if Canada is viewed as unfairly treating foreign companies investing here, how will Canadian companies be treated abroad? Will that hamper investment in Canada in the future?

Ironically, the federal government has been renegotiating tax treaties since the 1993 budget so all countries would be subject to between five- and 15-per-cent-withholding tax based on the share of the company. At the time the case began, Sweden’s treaty was a flat 15 per cent which changed in 1996, and England a 10-per-cent rate ending in 2003. Both rates were reduced to five per cent for a company holding 25 per cent of the shares or 10-per-cent voting power of the Canadian subsidiary.

“Part of the case we were making was everybody knew these rates were going down, there was no magic to setting up this structure,” Innes says. “It was two large companies, one from England and one from Sweden and they wanted a neutral base for this joint venture company.

“Essentially what happened is when CRA reassessed, they reassessed on the basis that ‘OK, the half of the dividends that goes to England we’ll charge you the 10 per cent then in place under the treaty with England, and the half that go to Sweden, in the early years, we will charge 15 per cent’.’”

Innes says it didn’t end there either, even after the 1996 Convention Between Canada and Sweden for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income was signed harmonizing the tax rates, the CRA still didn’t want to pass on the five per cent rate.

Innes says the argument was the treaty with Sweden requires shares are held directly and the CRA argued, “you don’t hold them directly, so we are going to charge you the 15-per-cent rate.”

Canadian Revenue Agency spokesperson Philippe Brideau told Canadian Lawyer InHouse the CRA is reviewing the decision and has until Apr. 27, 2009, to seek leave to appeal to the Supreme Court of Canada.