Canada: Taxpayer Prevails - Again - On Beneficial Ownership

Appeared in the April 2009 issue of The Bottom Line

The Federal Court of Appeal released its decision in The Queen v. Prevost Car Inc. on February 26, 2009. The CRA's appeal was denied. The case turned on the meaning of the term "beneficial owner."

Prevost Car Inc. ("Prevost") is a resident Canadian corporation that manufactures buses and related products in Quebec and elsewhere throughout North America. In May 1995 the shareholders of Prevost agreed to sell their shares to Volvo Bus Corporation ("Volvo"), a resident of Sweden, and Henlys Group PLC ("Henlys"), a resident of the United Kingdom. Volvo and Henlys entered into a shareholders' subscription agreement on May 3, 1995, in which Volvo undertook to incorporate a Netherlands holding company ("Holdco") and to transfer to it all of the shares that Volvo acquired in Prevost. Fifty-one percent of the shares of Holdco would be owned by Volvo and 49 percent by Henlys.

The shareholders' agreement provided that not less than 80 percent of the profits of Holdco and its subsidiaries were to be distributed to the shareholders, by way of a dividend, return of capital, or loan. The distribution for a fiscal year was to be declared and paid to the shareholders as soon as practicable up to the end of the fiscal year. The shareholders' agreement provided that the board "procure" the dividends or other payments which were declared by Prevost, or take other steps to enable Holdco to make the payments. Holdco was not a party to the shareholders' agreement.

Holdco had no employees in the Netherlands and no assets other than its investment in the shares of Prevost. There were some documents that were inconsistent with the ownership of the shares of Prevost by Holdco. For example, the minutes of the meeting of shareholders held on March 23, 1996 stated that those attending the meeting were proxies for Volvo and Henlys, not Holdco. Also, Holdco provided some information to its banker that indicated that the beneficial owners of the shares of Prevost were Volvo and Henlys, not Holdco.

Under the provisions of the Treaty, the rate of tax on dividends paid by a resident of Canada to a resident of the Netherlands was reduced to 5 percent, because the "beneficial owner" was a company holding directly or indirectly at least 25 percent of the capital or at least 10 percent of the voting power of Prevost. The CRA argued that Holdco was not the beneficial owner of the dividends within the meaning of the Treaty.

The Tax Court found in favour of Prevost and interpreted the term "beneficial owner" to mean the person who has the right to the benefits of the property (here the dividend). The Tax Court's interpretation of the term beneficial owner was consistent with the common law concept of beneficial ownership; one does not look through a corporation to its shareholders as the beneficial owners of corporate property unless the corporation has no discretion to deal with the property on its own, or is acting as a bare trustee.

The CRA appealed to the Federal Court of Appeal on the basis that the Tax Court judge gave the term beneficial owner a common law definition, not a meaning consistent with civil and international law. In interpreting these provisions the Tax Court judge had examined the ordinary meaning of the words, their technical meaning and the meaning they might have had in common law, in Quebec civil law, in Dutch law and in international law. He relied on the Vienna Convention, OECD Commentary, the Model Convention on Tax Treaties, OECD documents issued subsequent to the 1977 Commentary, and on the common law. He also had the benefit of expert evidence.

The Federal Court of Appeal held that the question as to who the beneficial owner of the dividends is a question of fact, and that the judge made no palpable or overriding error when he held as follows:

a) the relationship between Holdco and its shareholders is not one of agency, or mandate nor one where the property is in the name of a nominee;

b) the corporate veil should not be pierced because Holdco is not "a conduit for another person" and could not be said to have "absolutely no discretion as to the use or application of funds put through it as a conduit";

c) there was no predetermined or automatic flow of funds to Volvo and Henlys;

d) Holdco was a statutory entity carrying on business operations and corporate activity in accordance with the Dutch law under which it was constituted;

e) Holdco was not party to the shareholders' agreement and thus neither Henlys nor Volvo could take action against Holdco for failing to follow the dividend policy described in the shareholders' agreement;

g) Holdco's Deed of Incorporation did not obligate it to pay any dividend to its shareholders;

h) when Holdco decided to pay dividends, it paid them in accordance with Dutch law; and

i) Holdco was the registered owner of the Prevost shares, paid for the shares and owned the shares for itself. When dividends were received by Holdco they were the property of Holdco and were available to its creditors until such time as the board declared a dividend and the dividend was approved by the shareholders.

The case provides important support for the proposition that under Canada's treaties, a foreign recipient of dividends (or interest, or royalties) will be considered to be the beneficial owner of such dividends (or interest, or royalties) provided that it has the discretion to deal with such amounts. This decision, together with the decision of the Federal Court of Appeal in MIL (Investments) S.A. v. The Queen, 2006 DTC 3307 should provide substantial comfort to Canadian tax planners that foreign holding companies in treaty jurisdictions are valid.

Of particular note is the Court's finding the commentaries to the OECD Model Convention may be considered when interpreting terms in a treaty even if those commentaries came into effect after the treaty in issue. The Federal Court of Appeal concluded that for purposes of this case, the OECD Conduit Companies Report released in 1986 and the OECD 2003 amendments to the 1977 Commentary are a "helpful complement" to earlier commentaries provided they do not contradict views previously expressed.

Historically courts have been reluctant to use subsequent commentaries to interpret a treaty entered into at a particular time. One wonders how states could agree, at the time a treaty is entered into, with an interpretive comment which does not yet exist. Given that treaties are not legislation but rather contracts negotiated by sovereign states, we are surprised by this finding. Time will tell whether other countries adopt a similar view.

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