The long-awaited recent decision of the Federal Court of Appeal ("FCA") in Prévost Car, 2009 FCA 57, upholds the principle that, in determining the applicable withholding rate on dividends, interest, royalties and other payments to treaty countries such as Holland, Luxembourg and other intermediary jurisdictions with low withholding tax rates, Canada Revenue Agency ("CRA") cannot ignore the intermediary jurisdiction and apply the higher rate that may be applicable had the payment been made directly. This is a watershed decision which will have implications for existing structures and create opportunities for new planning.
Prévost Car ("Canco") was a corporation resident in Canada in the bus industry. Canco was a wholly-owned subsidiary of a holding corporation resident in Holland ("Dutchco"). Volvo Bus Corporation ("Swedeco") was a corporation resident in Sweden that owned 51% of shares of Dutchco. The other 49% of Dutchco's shares were owned by Henly's Group PLC, a corporation resident in the UK ("UKco").
Swedeco and UKco wanted to expand their business into North America and planned to do so through a holding company. They wanted a holding company in Europe for logistical reasons, and after taking into account the low withholding tax rate under the Canada-Holland Treaty, they decided to form a holding company in Holland.
Swedeco and UKco entered into a Shareholders' Agreement, to which Dutchco was not a party, in which they agreed not less than 80% of the profits of Canco, and in turn, Dutchco were to be distributed to the shareholders.
Dutchco had no employees in Holland and, other than the shares of Canco, had no other investments.
Canco paid dividends to Dutchco on which it paid 5% withholding tax to the CRA relying on the Canada-Holland Tax Treaty. CRA reassessed Canco on the basis that Dutchco did not exist - that it was an agent or conduit for its shareholders. Accordingly, the CRA applied the 15% withholding tax under the Canada-Sweden Tax Treaty to 51% of the dividends, and the 10% withholding tax rate under the Canada-UK Tax Treaty to 49% of the dividends paid to Dutchco. The taxpayer appealed to the Tax Court of Canada, where the taxpayer won and CRA appealed to the FCA.
The Court's Decision
The FCA did not agree with CRA noting the following key facts:
- The relationship between Dutchco and its shareholders is not one of agency, mandate nor one where the property is in the name of a nominee;
- The corporate veil should not be lifted because:
- Dutchco was not a conduit for any person;
- Dutchco cannot be said to have "absolutely no discretion as the use or application of funds" it receives; and
- Dutchco had not agreed to act on someone else's behalf pursuant to that person's instructions without the right to do otherwise;
- There was no predetermined or automatic flow of funds;
- Dutchco was a statutory entity carrying on business operations and corporate activity in accordance with Dutch law;
- Dutchco was not a party to the Shareholders' Agreement which mandated a flow of funds through Dutchco;
- Neither Swedeco, nor UKco, could take action against Dutchco for not following the dividend policy as set out in the Shareholders' Agreement (save and except for voting their shares to appoint its board of directors);
- Dutchco's Deed of Incorporation did not obligate it to pay any dividends to its shareholders;
- When Dutchco decided to pay dividends, it had to pay them in accordance with the Dutch law and only after its board of directors approved the payment; and
- Dutchco paid for and was the registered owner of the shares of Canco; when dividends were received from Canco, they were the property of Dutchco and were available to any of its creditors, until such time as a dividend was declared by the directors and approved by the shareholders.
Although the taxpayer won this case, the facts of the case were favourable to the taxpayer, and it is certain that CRA will not give up its efforts to attack these structures. The case may be appealed further to the Supreme Court of Canada, and even if not overturned (in our view, it is unlikely the Supreme Court will grant leave to appeal, since the case rests largely on its facts), it is certain that CRA will seek to apply Prévost Car as narrowly as possible, seek out every opportunity to make distinctions on the facts, and assess accordingly. Canada has no anti-treaty shopping provisions in its treaties with low-withholding intermediary jurisdictions (such as Holland), but CRA has sought to achieve the same result by applying domestic principles such as agency and GAAR. Prévost Car does not signal an end to this, and taxpayers need therefore to plan accordingly.
To better ensure a structure which can withstand attack, the following steps should be considered:
- A real commercial purpose for the intermediary jurisdiction holding company;
- As much substance as is feasible in the intermediary jurisdiction, including if possible, employees, and especially if possible, other investments (not just the shares of Canco) either in Canada, outside of Canada, and particularly in the intermediary jurisdiction;
- A board of directors that consists of a majority of local directors, and proper directors' meetings, preferably with local directors present; and
- Avoid back-to-back financing arrangements, and if necessary, ensure
- there is a spread in interest rates or royalty rates;
- there is minimal, if any, contractual tie-in to automatically flow through amounts - this will be a difficult fact to overcome; and
- that the holding company takes some risk.
With the decision in Prévost Car, it seems "treaty shopping" is still alive in Canada. Nonetheless, care must be exercised upfront to ensure a good fact pattern, and regular "risk management" review is warranted to ensure that those responsible for implementing the plan "respect" the proper legal steps that are required to make this planning work.