On February 26, 2009, the Federal Court of Appeal issued its decision in The Queen v. Prévost Car Inc., 2009 FCA 57 confirming the earlier decision of the Tax Court of Canada that a Dutch holding company was the "beneficial owner" of dividends for the purposes of the reduced withholding tax rate under the Canada-Netherlands Income Tax Convention.
More specifically, this case raises two issues of treaty interpretation which may be of interest to international tax practitioners. The first, as indicated above, concerns the interpretation to be given to the term "beneficial owner", found at article 10(2) of the OECD Model Tax Convention ("Model Convention"). The second raises the question of whether national courts should rely on evolving OECD commentary for guidance when interpreting bilateral treaties which are based on the Model Convention, and if so to what extent.
In essence Prévost Car is about tax authorities attacking treaty shopping. In 1995, Volvo (a resident of Sweden) and Henyls (a resident of England) jointly purchased all of the outstanding shares of Prévost Car ("Prévost"), a Canadian resident corporation incorporated in the civil law province of Quebec. The two companies incorporated a Dutch corporation, Prévost Holding B.V. ("PHB.V.") through which they held the shares of Prévost. Whereas under their respective treaties the companies would have had to pay either 10% or 15% tax in Canada on dividends from Prévost, their Dutch-based holding company was only subject to a 5% tax on dividends under that nation's treaty (were no treaty to apply the general Canadian withholding tax rate of 25% would have applied). Furthermore, any dividends paid by PHB.V. to Volvo and Henyls would not be taxed in the Netherlands.
Not liking this outcome, the Canadian tax authorities taxed both Volvo and Henyls directly on the dividends distributed to PHB.V. on the basis that they were the "beneficial owners" of those dividends. The outcome of the case thus centered on the interpretation to be given to the term "beneficial owner".
The Tax Court of Canada ("Tax Court") - the Canadian Court of first instance - found that the "beneficial owner" of dividends is the one to receive them for its own use and enjoyment, thus assuming the risk and control of the dividend received. The Court held that there was no need to pierce the corporate veil provided that the corporation was not just a conduit for another with no rights to personally use or apply the funds received. In adopting this approach, the Tax Court rejected a definition that would have looked solely at who can ultimately benefit from the dividends paid.
Despite some irregularities in Prévost's books identifying Volvo and Henlys as its shareholders (instead of PHB.V.), and PHB.V. having no physical offices or employees, and mandating another company to pay its interim dividends, PHB.V. was nevertheless held to have enough discretion over the use of its funds (the Board had to vote to issue dividends) to not be considered a conduit for its shareholders. This conclusion was sustained even though a Shareholder Agreement between Volvo and Henlys set out that Prévost dividends would be paid each quarter. The Court found that although the agreement may bind the shareholders, PHB.V. itself was not bound by these terms. As a result Volvo and Henlys were spared from paying Canadian tax on dividends paid by Prévost to PHB.V.
The Tax Court's definition of "beneficial owner" was endorsed on appeal. The Federal Court of Appeal - the Canadian appellate court in tax matters - approved of the definition primarily because it accorded with subsequent OECD Commentaries and the OECD Conduit Companies Report. The Federal Court of Appeal found that the worldwide use of the Model Convention and the general acceptance of using its Commentaries to interpret existing bilateral conventions allowed for this approach.
Indeed, the Court found that later commentaries, in other words, those released after a treaty has been signed, could be used to interpret the treaty as long as "they represent a fair interpretation of the words of the Model Convention", did not conflict with Commentaries in force at the time the treaty was signed, did not relate to a provision that had been subsequently and substantially amended, and was not one to which the treaty partners had registered an objection. The Federal Court of Appeal thus chose to apply the 2003 Commentaries to an agreement contracted to by the parties in 1987; a full 16 years earlier.
In conclusion, the Prévost Car decision seems to implicitly recognize a separate existence for holding companies as beneficial owners of dividends, even if the latter are ultimately flowed through to their shareholders, provided that, through its directors, the company exercises some discretion over the funds in the interim. Should the courts be uncertain as to what this means, they should look at current OECD Commentary for guidance.
As for the potential of applying the Tax Court's definition to the term "beneficial ownership" in other articles of the Model Convention, such as those dealing with withholding tax on interest and royalties, it is at best very limited. Regardless of how similar a structure could be to the one analysed in Prévost Car, in the end, the default position does not change. Corporations which are simply conduits for funds are not the "beneficial owners" of these funds. Thus, had there been a contractually "predetermined or automatic flow of funds" in Prevost Car, a fundamental characteristic of back-to-back financing arrangements for example, the Canadian courts may well have found that PHB.V. was a conduit for its shareholders.