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28 February 2020

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Canadian Appeals Court Holds Restructuring to Benefit from Tax Treaty with Luxembourg Not Subject to GAAR

A 12 February 2020 judgment of the Canadian Federal Court of Appeal has been published in the case of the Crown v. Alta Energy Luxembourg S.A.R.L. (Alta Luxembourg). The case concerns the application of Canada's general anti-avoidance rule (GAAR) to deny Alta Luxembourg from benefiting from the capital gains provisions of the 1999 Canada-Luxembourg tax treaty in relation to gains from the alienation of shares in a Canadian corporation, Alta Canada.

Alta Canada was formed in 2011 and acquired various petroleum and natural gas licenses. In 2012, a restructuring was undertaken. As part of the restructuring, Alta Luxembourg was formed under the laws of Luxembourg and the shares of Alta Canada were transferred to it. Following the restructuring, all of the shares of Alta Luxembourg were held by Alta Energy Canada Partnership.

At the time, the parties recognized that this transfer of shares was a taxable transaction. However, the Canada Revenue Agency agreed that the fair market value of the shares of Alta Canada at that time was equal to the adjusted cost base of these shares. Therefore, no capital gain was realized on the transfer of the shares of Alta Canada to Alta Luxembourg.

In 2013, the shares of Alta Canada were sold for approximately CAD 680 million, resulting in a capital gain in excess of CAD 380 million. Alta has conceded that this was an avoidance transaction because the purpose of the restructuring was only to obtain the tax benefit of the Canada-Luxembourg treaty but argued that the gain was covered by the treaty and that the GAAR did not apply because there was not an abuse of the provisions of the treaty.

A decision on the case was first made by the Canadian Tax Court in 2018, which answered two main questions:

  • whether the shares of Alta Canada qualified as treaty-protected property as a result of the application of Articles 13(4) and (5) of the Canada-Luxembourg treaty; and
  • if the shares did qualify as treaty-protected property, whether the GAAR would apply to deny the tax benefit of only taxing the gain realized on the disposition of these shares in Luxembourg (and not in Canada).

The Tax Court found that the shares did qualify as treaty-protected property and that the GAAR did not apply because there was no abuse of the Income Tax Act (the Act) or the Canada-Luxembourg treaty. The decision regarding the application of the GAAR was appealed.

In its decision, the focus of the Federal Court of Appeal for the GAAR analysis was on the provisions of the Canada-Luxembourg tax treaty, noting that if there is no abuse of the treaty, there would be no abuse of the Act. This included a two-step process. The first step of the process was to identify the object, spirit, and purpose of the relevant provisions the treaty and the second step was to determine whether the transactions resulted in an abuse of these provisions.

In this respect, the Court found that the object, spirit and purpose of the treaty is that a person will qualify for the exemption at issue in the appeal, which is applicable to gains arising on the disposition of certain shares, if:

  • that person is a resident of Luxembourg for the purposes of the Luxembourg treaty, and
  • the value of the shares is principally derived from immovable property (other than rental property) situated in Canada in which the business of that corporation is carried on.

Based on this, Alta Luxembourg qualifies for the treaty benefits and since the provisions operated as they were intended to operate, the Court found that there was no abuse and the GAAR does not apply. The Court also addressed steps taken by the Department of Finance to curb treaty shopping, noting that no steps were taken prior to the transaction in this case and that any steps taken after the transaction are not applicable.

Note - The Canada-Luxembourg tax treaty has been impacted by the BEPS MLI with effect from 1 January 2020 for withholding taxes and 1 June 2020 for other taxes, including the addition of a principal purpose test (PPT). The MLI is not relevant for the Alta case, although if a similar restructuring and sale were to take place on or after the effective date of the MLI, the PPT would likely impact the application of treaty benefits.

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