This decision is welcome, clarifying news to non-resident investors that have adopted similar holding structures for their investments in Canada. Note, however, that the Crown has appealed this decision to the Federal Court of Appeal.

As a general rule but subject to any treaty exemptions, Canada’s domestic laws subject non-residents to tax on capital gains where the gains result from the disposition of 'taxable Canadian property', a term that generally includes corporate shares that derive their value principally from real property situated in Canada. Although most of Canada’s bilateral tax treaties do not exempt capital gains from the disposition of such shares, Article XIII(4) of the Lux Treaty provides that:

the term "immovable property" does not include property (other than rental property) in which the business of the company, partnership, trust or estate was carried on; and a substantial interest exists when the resident and persons related thereto own 10% or more of the shares of any class or the capital stock of a company. 

This carve-out has historically been interpreted, including by Canadian tax authorities, to apply to oil and gas properties that form part of a company’s oil and gas business. The issue in Alta Energy Luxembourg was whether a minimum activity level for the otherwise immovable property was required in order to establish it as property “in which the business of the company…was carried on”. Given the limited drilling activities, the Crown argued that the exemption should be applied on a lease-by-lease basis, which would have resulted in the majority of the oil and gas leases being considered inactive and, consequently, the shares held by the appellant failing to apply for the exemption. The Tax Court concluded that the purpose of the exemption was to encourage foreign direct investment. Concluding that the exemption should be applied in accordance with industry practices, the Tax Court reaffirmed the liberal interpretation given to tax treaties and found in favour of the taxpayer, taking a common sense, purposive approach to the analysis:

The law is well settled:  a “tax treaty or convention must be given a liberal interpretation with a view to implementing the true intention of the parties”.With this principle in mind, I am of the view that the Treaty negotiators intended for a resource property to qualify as Excluded Property when such property is developed in accordance with the industry’s best practices.

The Crown then argued that the use of the Lux Treaty constituted abusive treaty-shopping under Canada’s general anti-avoidance rule (GAAR). The Tax Court was decisive in its rejection of the Crown’s alternative argument. In particular, the court noted that the law presumes that the government knew Luxembourg’s laws when it was negotiating the Lux Treaty, so the Tax Court could find no other rationale for Article XIII(4) than the apparent one to exempt residents of Luxembourg from Canadian taxation where there is an investment in immovable property used in a business. The Court was not at all moved by the fact that the Lux Treaty had as one of its general purposes the 'prevention of fiscal evasion'. Although raised briefly in its Notice of Reply, the Crown appears not to have seriously challenged the taxpayer’s residence in Luxembourg for purposes of the Lux Treaty.  

It will be interesting to see how the Federal Court of Appeal addresses both the technical issue under Article XIII(4) and the treaty-shopping arguments.

Nancy Diep

Nancy Diep  
Partner, Calgary

Tel:  403-260-9779
Email: nancy.diep@blakes.com

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