Cross-border tax structures periodically optimize available tax treaty benefits having regard to the differences between various bilateral tax treaties. Structures that take advantage of such differences in bilateral treaties (e.g., holding companies situated in advantageous jurisdictions) may, however, be susceptible to attack under treaty shopping principles.

This article will discuss both Canadian and international jurisprudence that has considered such principles.

There is no widely recognized definition of treaty shopping; however, the Canada Revenue Agency (CRA) has commented that it considers treaty shopping to include transactions that involve the establishment of entities or residency in a particular jurisdiction to permit a taxpayer to avail itself of the benefits of a treaty with the particular jurisdiction for tax avoidance purposes.1

Treaty shopping has developed a high profile, and the CRA has indicated that it will target treaty shopping structures.2 The CRA typically seeks to challenge treaty shopping on the basis of one or more of the following principles:

  1. specific limitation on benefit (LOB) rules;
  2. the general anti-avoidance rule (GAAR);
  3. an abuse of treaties principle;
  4. residency requirements; and/or
  5. beneficial ownership requirements.

1. Limitation on Benefit (LOB) Rules

Unlike many US treaties, Canada’s bilateral tax treaties do not generally contain detailed "limitations of benefits" or "LOB" provisions, which are expressly designed to counteract treaty shopping.

The notable exception is the current Canada-United States Income Tax Convention (Canada-US Treaty).3 On December 15, 2008, the Fifth Protocol to the Canada-US Treaty came into force. The provisions of this Protocol substantially amended the Canada-US Treaty in a number of important respects, including the amendments to Article XXIX-A of the Canada-US Treaty to create a reciprocal LOB rule that denies the benefits of the Canada-US Treaty to certain US residents where they have an insufficient nexus with the United States. While the LOB rules are highly complex, the general role of the LOB provision is that only a "qualifying person" will be entitled to all of the benefits of the Canada-US Treaty and, except as expressly provided, persons other than "qualifying persons" will not be entitled to treaty benefits.

Very generally, "qualifying persons" include natural persons, certain governmental bodies, companies (or trusts) the shares or units of which are primarily and regularly traded on a recognized stock exchange, certain other companies satisfying an indirect publicly traded test, and companies (or trusts) satisfying a combined ownership and "base erosion" test.

Persons other than qualifying persons may nevertheless access treaty benefits in relation to (i) income connected with or incidental to an active trade or business; (ii) dividends, interest and royalties received by a company where the ultimate owners of a defined percentage of the votes and value of the affected company are resident in a country that has a tax treaty with Canada, and where such treaty provides the same or lower withholding tax rate than the Canada-US Treaty on the relevant payment; and (iii) certain amounts where the competent authority permits treaty benefits to be applied. The LOB provision applies in respect of withholding taxes for amounts paid or credited after February 1, 2009, and in respect of other taxes for taxation years commencing after 2008.

Due to the short time during which such provisions have been in force, we are not aware of the CRA having challenged any structures on the basis of such rules. However, such LOB provisions will be extremely important going forward, and the introduction of LOB provisions in the Canada-US Treaty may foreshadow the introduction of similar LOB provisions in other bilateral Canadian tax treaties.

2. General Anti-Avoidance Rule (GAAR)

The retroactive change to the GAAR, which was introduced following the 2004 federal Budget, eliminated any debate over whether the GAAR applied to tax treaties as the GAAR now expressly refers to tax treaties.4

The Supreme Court of Canada has most recently provided guidance on the application of the GAAR in Lipson v. The Queen.5

The Lipson decision did not involve alleged treaty shopping, but rather involved interest deductibility on a borrowing of funds that had permitted a home to be purchased as part of the same series of transactions as the borrowing. Justice LeBel, for the majority, largely applied the framework and principles set forth in prior GAAR jurisprudence that requires the following three elements to be satisfied:

  1. a tax benefit results from a transaction or a series of transactions;
  2. the transaction is an avoidance transaction (i.e., it cannot be reasonably viewed as having been undertaken primarily for a bona fide non-tax purpose); and
  3. there was abusive tax avoidance in the sense that it cannot be reasonably concluded that a tax benefit would be consistent with the object, spirit or purpose of the provisions relied upon by the taxpayer.

Justice LeBel also made certain comments relevant to tax planning and the GAAR risk:

  • The Duke of Westminster principle, which states that a taxpayer is entitled to arrange his or her affairs to minimize taxes payable, remains valid but was circumscribed by the GAAR to limit avoidance transactions while maintaining certainty for taxpayers.
  • The entire series of transactions should be considered in determining whether individual transactions within the series result in abuse of the Income Tax Act (Canada), although it is not the purpose or motivation for the transaction that determines abuse, but rather the result.
  • The GAAR is a residual provision that can apply even if the transactions fall outside the scope of more specific anti-avoidance rules.
  • The burden was on the Minister to prove, on the balance of probabilities, that the transactions had resulted in abuse — this may represent a softening of the prior GAAR jurisprudence, which held that the GAAR may only be invoked where the abuse is clear.

For the CRA to succeed on the GAAR in the treaty shopping context, it will have to demonstrate that a particular transaction defeats the object, spirit and purpose of a particular provision of a treaty. This may be difficult for CRA to establish in light of rules in most of Canada’s treaties, which already create a framework addressing who may benefit from such treaties:

  • Most of Canada’s tax treaties are drafted based upon the OECD Model Convention, and specifically address who is entitled to the benefits of the treaty. Article 1 typically provides that the treaty shall apply to persons who are residents of one or both of the contracting states, and Article 4 defines who is a resident of the contracting state for purposes of the convention.
  • A number of Canada’s treaties specifically deny the benefits of the treaty to certain types of residents.6
  • Other Canadian bilateral treaties more directly address the treaty shopping issue through express LOB provisions.
  • The residency and beneficial ownership requirements may be considered stand-alone anti-avoidance measures.

Canadian courts have addressed the GAAR in the treaty shopping context. The decision in MIL (Investments) S.A. v. The Queen7 related to a capital gains exemption claimed under the Canada-Luxembourg Tax Convention (Luxembourg Treaty) in respect of the disposition of shares of mining companies. The crown challenged the availability of such exemption based inter alia on the GAAR. MIL held over 29 per cent of the shares of a Canadian mining company, Diamond Fields Resources. Initially, MIL was a Cayman Islands company, a jurisdiction with which Canada does not have a tax treaty. Diamond Fields discovered the Voisey Bay nickel find, following which another Canadian mining company, Inco, agreed to acquire Diamond Fields. Inco effected a share exchange on a rollover basis with MIL, so that MIL held less than 10 per cent of the shares of Diamond Fields. MIL then continued into Luxembourg and subsequently sold its Inco and Diamond Fields shares, realizing a gain of almost $500 million. MIL claimed a treaty exemption under the Luxembourg Treaty on the basis that it was a resident of Luxembourg and it (and related persons) held less than 10 per cent of the shares, such that the exemption applied even though the shares derived their value from immovable property situated in Canada.

The Tax Court concluded that the GAAR did not apply on the basis that the exempt sale transaction was not part of the same series of transactions that included the reorganization transactions that permitted the taxpayer to benefit from the Luxembourg Treaty exemption, and on the basis that the sale transaction was itself undertaken for commercial and not for tax reasons.

The Federal Court of Appeal also found in favour of the taxpayer in a very brief oral decision where the Court held that, interpreting the Luxembourg Treaty purposively and contextually, it found no support for an abuse of the specific provisions of the Income Tax Act (Canada) or the Luxembourg Treaty. Further, the Court held that it could find no object or purpose whose abuse would justify a departure from the plain words of the treaty that exempted the disposition of the relevant shares. Finally, the Court stated that the issue raised by the GAAR is the incidence of Canadian taxation, so that a result of ‘double non-taxation’ was not relevant.

3. Abuse of Treaties Principle

Canada’s tax treaties contain no express abuse of treaties principles. Any abuse of treaties principle would need to be implied, perhaps on the basis of one or more of the following arguments:8

  • the preamble of the relevant treaty, which often provides that its purpose includes the prevention of fiscal evasion;
  • Article 26 of the Vienna Convention on the Law of Treaties, which provides that parties to a treaty must perform the treaty in good faith, coupled with the revised 2003 OECD Commentary;
  • an abuse of treaties principle may be an accepted principle of international law; and/or
  • an abuse of treaties principle may be an accepted principle of Canadian law based upon the principle against treaty shopping adopted in Crown Forest Industries Ltd. v. Canada.9

It is not at all clear that the combined effect of these arguments establishes a recognized abuse of treaties principle.

The pre-2003 OECD Commentary strongly suggests an abuse of treaties principle should not be implied. Where both Canada and the foreign treaty state are OECD members, a court would likely consider the OECD Commentary in construing the Luxembourg Treaty.10

7. … taxpayers have the possibility, irrespective of double taxation conventions, to exploit differences in tax levels between States and the tax advantages provided by various countries’ taxation laws, but it is for the States concerned to adopt provisions in their domestic laws to counter such manoeuvres. Such States will then wish, in their bilateral double taxation conventions, to preserve the application of provisions of this kind contained in their domestic laws.

10. … It may be appropriate for Contracting States to agree in bilateral negotiations that any relief from tax should not apply in certain cases, or to agree that the application of the provisions of domestic laws against tax avoidance should not be affected by the Convention.11

43. Existing conventions may have clauses with safeguards against the improper use of their provisions. Where no such provisions exist, treaty benefits will have to be granted under the principle of "pacta sunt servanda" even if considered to be improper.12

The OECD Commentary was, however, substantially revised in January 2003. The revised 2003 OECD Commentary represents a significant departure from the essence of the older commentary and is more consistent with an implied abuse of treaties principle.

9.4 … it is agreed that States do not have to grant the benefits of a double taxation convention where arrangements that constitute an abuse of the provisions of the convention have been entered into.

9.5 It is important to note, however, that it should not be lightly assumed that a taxpayer is entering into the type of abusive transactions referred to above. A guiding principle is that the benefits of a double taxation convention should not be available where a main purpose for entering into certain transactions or arrangements was to secure a more favourable tax position and obtaining that more favourable treatment in these circumstances would be contrary to the object and purpose of the relevant provisions.

8.1 … It would be equally inconsistent with the object and purpose of the Convention for the State of source to grant relief or exemption where a resident of a Contracting State, otherwise than through an agency or nominee relationship, simply acts as a conduit for another person who in fact receives the benefit of the income concerned. For these reasons, the report from the Committee on Fiscal Affairs entitled "Double Taxation Conventions and the Use of Conduit Companies" concludes that a conduit company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties.13

International jurisprudence that has considered the existence of the abuse of treaties principle has been mixed. The Supreme Court of India in Union of India v. Azadi Bacho Andolan14 rejected the argument that an abuse of treaties doctrine was implied in India’s tax treaties. The Court noted that international law has historically permitted treaty shopping and that at least one of India’s treaties contained an express limitation on benefits provision. In contrast, the Swiss Federal Court in A Holding ApS v. Federal Tax Administration,15 held that an abuse of treaties doctrine could be implied into the Danish treaty and denied treaty benefits in respect of a dividend paid to a Danish intermediate holding company.16

In Canada, the Tax Court in MIL (Investments), supra stated that only the OECD commentary in existence at the time the relevant treaty was negotiated and entered into may be considered in assessing the intentions of the contracting states and in construing the treaty provisions.17 The Tax Court concluded that there was no ambiguity in the Luxembourg Treaty such that an "abuse of treaties rule" could be implied. Most Canadian bilateral tax treaties were entered into prior to 200318 so that, on this reasoning, the revised 2003 OECD commentary would not typically be relevant.

More recently, the Federal Court of Appeal, in Prévost Car Inc. v. The Queen,19 adopted a more liberal view that has essentially permitted subsequent OECD commentary to be considered where it meets certain criteria, including that it does not conflict with the commentary in force at the time the treaty was entered into:

[c]ounsel for both sides agree that the Judge was entitled to rely on subsequent documents issued by the OECD in order to interpret the Model Convention. I share their view. It is true that this Court, in Cudd Pressure Control Inc. v. R. (1998), 98 D.T.C. 6630 (Fed. C.A.), at 6635, qualified the relevance of the 1977 Commentary as being "somewhat suspect" in the search of the intention of the drafters of a Convention signed thirty-five years earlier, in 1942, but there was no Model Convention in 1942 and in any event Robertson J.A., for the Court, went on to recognize that OECD Commentaries "can provide some assistance" as the 1942 Convention follows the same general principles as the 1972 OECD Model. To the extent that it might be said that a contrary view was expressed by the Tax Court in MIL (Investments) S.A. v. R., 2006 D.T.C. 3307 (Eng.) (T.C.C. [General Procedure]) at 3320, it does not appear that such a view was in the mind of this Court when it dismissed the appeal from the Bench 2007 FCA 236 (F.C.A.). The worldwide recognition of the provisions of the Model Convention and their incorporation into a majority of bilateral conventions have made the Commentaries on the provisions of the OECD Model a widely accepted guide to the interpretation and application of the provisions of existing bilateral conventions … The same may be said with respect to later commentaries, when they represent a fair interpretation of the words of the Model Convention and do not conflict with Commentaries in existence at the time a specific treaty was entered and when, of course, neither treaty partner has registered an objection to the new Commentaries.

I therefore reach the conclusion that, for the purposes of interpreting the Tax Treaty, the OECD Conduit Companies Report (in 1986) as well as the OECD 2003 Amendments to the 1977 Commentary are a helpful complement to the earlier Commentaries, insofar as they are eliciting, rather than contradicting, views previously expressed.

The comments of the Federal Court of Appeal, however, were made in the context of assessing beneficial ownership and not in the context of implying an abuse of treaties principle in Canada’s tax treaties. While a more flexible approach to interpreting tax treaties has been endorsed in the Canadian jurisprudence, an abuse of treaties principle has still not been recognized by the Canadian courts. Furthermore, given the rather contradictory statements in the revised 2003 OECD Commentary (as compared to the pre-2003 OECD Commentary) relating to the availability of treaty benefits in apparent treaty shopping circumstances, it is not at all clear that the principles set forth in Prévost Car, supra would permit the later OECD Commentary to be considered in the context of assessing whether an abuse of treaties principle should be recognized.

4. Treaty Residence

A treaty shopping challenge may also be advanced on the basis that the treaty resident intermediary is not resident in the particular state for treaty purposes and, therefore, not entitled to treaty benefits.

Residence for this purpose must be determined in accordance with the relevant tax convention. Most Canadian bilateral tax treaties define a resident as any person that is liable to tax under the laws of the relevant state by reason of that person’s domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature. The Supreme Court in Crown Forest, supra clarified that:

… the criteria for determining residence in Article IV.1 involve more than simply being liable to taxation on some portion of income (source liability); they entail being subject to as comprehensive a tax liability as is imposed by a state.

In certain instances, persons seeking to claim treaty benefits may only be subject to a comprehensive base of taxation in the foreign country (as required per Crown Forest) where they are considered to be a resident of such a country. In such circumstances, transaction planning must ensure that the holding company will be recognized as a resident company such that it becomes subject to a comprehensive base of taxation. Certain non-Canadian jurisprudence has considered the concept of residence in relation to treaty resident intermediary companies with limited connections to the treaty country.

The CRA has commented on so-called "residence of convenience" in Income Tax Technical News no. 35 (February 26, 2007). The CRA primarily confirmed the principles outlined in Crown Forest, supra and noted that residence may be established even where no tax is imposed:

… unless the arrangement is abusive (e.g., treaty shopping where the person is in fact only a "resident of convenience"). Such could be the case, for example, where a person is placed within the taxing jurisdiction of a Contracting State in order to gain treaty benefits in a manner that does not create any material economic nexus to that State … The determination of residency for the purposes of a tax treaty remains a question of fact, and each case will be decided on its own facts with an eye to the intention of the parties of the particular convention and the purpose of international tax treaties.

The issue of residence has yet to receive any recent Canadian judicial consideration in the treaty shopping context.20

5. Beneficial Ownership

A treaty shopping attack may also be brought on the basis that the person claiming treaty benefits in respect of a particular payment (e.g., dividends) is not the beneficial owner of such payment so that it does not qualify for treaty benefits based upon the beneficial ownership requirement in various provisions of Canadian tax treaties.

The beneficial ownership requirement was not considered to be satisfied in the Indofood, supra decision where the UK Court of Appeal found that treaty benefits would be denied on the basis that an interposed Netherlands company would not be the beneficial owner of any interest income received by it, despite being the formal owner of such funds, as it would not have "full privilege to directly benefit from the income" since it would be bound to pay out this income under the proposed structure.

The recent Canadian decision in Prévost Car, supra was a landmark decision on beneficial ownership and tax treaty benefits in circumstances involving a foreign holding company resident in an intermediate treaty jurisdiction. The taxpayer was successful at both the Tax Court and the Federal Court of Appeal. Volvo Bussar AB (Sweden) acquired the shares of a Canadian company, Prevost Canada. Volvo transferred the Prevost Canada shares to a Dutch holding company (Dutchco) and subsequently Volvo transferred 49 per cent of the Dutch holding company shares to a UK company, Henlys Group PLC. The treaty withholding tax rate on dividends was lower under the Dutch treaty than under the Swedish or UK treaties. Dutchco had no office or employees in the Netherlands. Volvo and Henlys agreed in their shareholders’ agreement that not less than 80 per cent of the profits of Prevost Canada and Dutchco would be distributed to the shareholders.

The Tax Court rejected the Crown’s argument that Dutchco was a "conduit" for Volvo and Henlys and found that it was the beneficial owner of the dividends paid by Prevost Canada. Further, the Tax Court stated that the term "beneficial owner" of dividends means the person who receives the dividends for its own use and enjoyment and assumes the risk and control of such dividends. The Tax Court also noted that the corporate veil should not be pierced in this way, except where the corporation has no discretion to use or apply the dividends it receives or where it is an agent for another.

The Federal Court of Appeal endorsed the Tax Court’s definition of "beneficial ownership," stating:

It is common ground that there is no settled definition of "beneficial ownership" (or in French, "bénéficiaire effectif") in the Model Convention, in the Tax Treaty or in the Canadian Income Tax Act… In the end the Judge determined, at par. 100 of his reasons, that "the "beneficial owner" of dividends is the person who receives the dividends for his or her own use and enjoyment and assumes the risk and control of the dividend he or she received…" The Judge's formulation captures the essence of the concept of "beneficial owner" (or "bénéficiaire effectif") as it emerges from the review of the general, technical and legal meanings of the terms. Most importantly, perhaps, the formulation accords with what is stated in the OECD Commentaries and in the Conduit Companies Report.

This reasoning highlights the need for proper directors’ meetings, minutes and other corporate formalities so that it is clear the holding company assumes the risk and control of the relevant property and exercises its discretion to distribute or otherwise deal with dividend (or similar) proceeds.


In light of the current state of Canada’s LOB provisions, the GAAR jurisprudence, and the Canadian and international jurisprudence that has considered alleged treaty shopping transactions, the current state of the law in Canada remains quite favourable for transactions structured to efficiently utilize Canada’s array of bilateral tax treaties. In the context of Canada-US transactions, proper consideration of the LOB provisions will be essential, and in cross-border transactions involving the US and other countries, proper administration of such structures will be vital to ensure residency and beneficial ownership conditions are satisfied and to defend against possible attacks on the basis of the GAAR.