Tax Insights: Alta Energy ─ Supreme Court of Canada finds no misuse/abuse of tax treaty

Issue 2021-30

In brief

On November 26, 2021, the Supreme Court of Canada (SCC) rendered its judgment in The Queen v Alta Energy Luxembourg SARL, 2021 SCC 49. The SCC dismissed the government’s appeal from the decision of the Federal Court of Appeal (FCA), finding that the Minister of National Revenue (the Minister) did not discharge her burden of proving abusive tax avoidance. 

The SCC’s decision in Alta Energy clarifies the analysis of whether a taxpayer’s choice of a foreign jurisdiction for investment into Canada may be an abuse or misuse of a tax treaty. The SCC has confirmed that the principles of certainty, predictability and fairness require a robust analysis of the intentions of the two sovereign states who have carefully negotiated the treaty instrument. 

The SCC has confirmed that Canadian courts may not use the general anti-avoidance rule (GAAR) in section 245 of the Income Tax Act (Canada) (ITA) to rewrite tax statutes or tax treaties to prevent alleged treaty shopping where the treaty itself clearly does not do so.

In detail

Facts

In 2011, Alta Energy Partners Canada Ltd. (Alta Canada) was incorporated under the laws of Alberta as a wholly-owned subsidiary of Alta Energy Partners, LLC (Alta US LLC). Between June 2011 and April 2012, Alta Canada assembled approximately 62,000 acres in the Duvernay shale oil formation and was granted a right to explore, drill and extract hydrocarbons in this working interest. Alta Canada further expanded its interests and leases in the Duvernay Formation to 67,581 net acres and drilled six horizontal and vertical wells between 2012 and 2013.

In 2012, as a part of a restructuring, Alta Energy Luxembourg SARL (the Taxpayer) was incorporated as a Luxembourg holding company, and Alta US LLC transferred the common shares of Alta Canada to the Taxpayer. The fair market value of the Alta Canada shares was equal to their adjusted cost base, and thus there was no capital gain on the transfer.

In 2013, the Taxpayer sold its shares in Alta Canada to a third party for approximately $680 million and realized a capital gain in excess of $380 million. The Taxpayer claimed an exemption from tax in Canada under Article 13(4) of the Canada-Luxembourg Income Tax Convention (the Treaty). Additionally, this capital gain was not taxable in Luxembourg under domestic Luxembourg tax law.

The Minister reassessed the Taxpayer on the basis that the property did not satisfy the definition of “excluded property” because the Taxpayer drilled and extracted hydrocarbons from only a small portion of the Duvernay property, and therefore, the shares of Alta Canada were not treaty-protected property and the gain on the sale was taxable in Canada. In the alternative, the Minister applied the GAAR to deny benefits under the Treaty.

Tax Court of Canada (TCC) decision

The TCC addressed the two main issues: whether the property was excluded property under the Treaty, and whether the GAAR applied. The TCC found in favour of the Taxpayer on both issues.

Excluded property

Under the ITA, a gain on “taxable Canadian property” is taxable in Canada unless it is “treaty protected property.” The Alta Canada shares at issue were taxable Canadian property because they derived more than 50% of their value from immovable property situated in Canada. Therefore, the capital gain on disposition would be taxable in Canada unless a treaty exception applied. The Taxpayer relied on the exception in Article 13(4) of the Treaty, which excludes from the definition of immovable property, “property (other than rental property) in which the business of the company, partnership, trust or estate was carried on.”

The Minister argued that the exclusion applies only where the whole of the business is carried on physically on the property. Alternatively, the Minister argued the exclusion should only be applied on a license-by-license basis so that only a small fraction of the land would qualify for the exclusion. The TCC rejected both of the Minister’s arguments and found that Alta Canada’s working interest in the Duvernay property was “excluded property.” Thus, the capital gain realized by the Taxpayer was not taxable under Article 13(4) of the Treaty.

GAAR

The parties agreed that both a “tax benefit” and an “avoidance transaction” existed for the purposes of the GAAR. In respect of misuse/abuse, the Minister argued that:

• the rationale and purpose of the Treaty was to prevent or reduce double taxation on activities or transactions potentially subject to tax in both countries at the same time, and
• the avoidance transaction abused a number of sections of the ITA and Articles 1, 4 and 13 of the Treaty

Justice Hogan applied the two-step approach to this analysis, considering the object, spirit and purpose of the relevant provisions, and whether the Taxpayer’s transaction frustrated, circumvented or defeated that rationale.

Justice Hogan stated that a GAAR analysis must focus not on the general purpose of the Treaty, but rather on the rationale underlying the specific Articles of the Treaty. In considering the relevant Articles, the TCC found that the rationale underlying the carve-out rule was designed to exempt residents of Luxembourg from Canadian taxation where an investment is in immovable property used in a business.

The TCC concluded that the GAAR did not apply to preclude the Taxpayer from claiming an exemption under Article 13(5) of the Treaty.

Federal Court of Appeal (FCA) decision

The Minister appealed the TCC’s finding on GAAR to the FCA. Justice Webb, writing for a unanimous FCA, held the GAAR did not apply, upheld the TCC’s decision, and dismissed the government’s appeal.

GAAR

In the FCA, the Minister argued that:

• the TCC decision would render Canada’s treaty network ineffective
• the Treaty benefits were available only to “Luxembourg investors”
• the Taxpayer had no economic connection to or commercial purpose in Luxembourg, and
• the capital gain was not taxed in Luxembourg

Accordingly, the Taxpayer had misused or abused the Treaty.

The FCA considered whether the transaction resulted in an abuse of the provisions of the ITA or the Treaty, and noted that the capital gain exemption under the Treaty was not present in all of the treaties negotiated by Canada with other countries. In considering the Treaty specifically, the FCA concluded that the object, spirit and purpose of the relevant provisions of the Treaty were reflected in the words chosen by Canada and Luxembourg. The FCA noted that the GAAR cannot be used to add a requirement that would have to be satisfied if the GAAR applied, but which would not have to be satisfied if the GAAR did not apply. The FCA concluded that the rationale behind Articles 1, 4 and 13(4) of the Treaty is that a person will qualify for the exemption, which applies to gains arising on the disposition of certain shares if:

• that person is a resident of Luxembourg for the purposes of the 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

As the provisions of the Treaty operated as intended, there was no abuse and the GAAR did not apply.

Supreme Court of Canada (SCC) decision

In the SCC, the Minister argued that the FCA had failed to conduct the proper GAAR analysis, and improperly focused on the text of the Treaty when determining object, spirit and purpose. Further, in the Minister’s view, the FCA had failed to examine the overall result of the Taxpayer’s transactions. The Minister argued that the result of the FCA’s decision was to render the GAAR inapplicable to Canada’s tax treaties, and provided a “roadmap” to the avoidance of Canadian tax. The Minister believed the FCA decision eroded the integrity of Canada’s bilateral tax treaties.

At the hearing of the appeal on March 19, 2021, the SCC questioned the Minister’s assertion that an “economic connection” was required to obtain treaty benefits, and the SCC expressed skepticism about the Minister’s alleged policy considerations. Several of the SCC’s judges expressed support for both sides of the relevant policy considerations – namely, raising revenue and encouraging economic development and investment into Canada.

In its decision, Justice Côté writing for a majority of the SCC (Abella, Moldaver, Karakatsanis, Brown and Kasirer JJ. concurring) dismissed the Minister’s appeal, finding that, while the GAAR acts to bar abusive tax avoidance transactions, including those in which taxpayers seek to obtain treaty benefits that were never intended by the contracting states, the GAAR cannot be used to fundamentally alter the criteria under which a person is entitled to treaty benefits.

Accepting that both a tax benefit and avoidance transaction arose in this case, the SCC then applied the same two-step analysis as the courts below to determine whether the Taxpayer’s transaction was abusive. The SCC considered first, the object, spirit and purpose of the treaty provisions (namely, Articles 1, 4 and 13(4) and (5) of the Treaty), and second, determined whether the transaction at issue frustrated or defeated the rationale of the provisions.

The SCC concluded that the object, spirit, and purpose of Articles 1 and 4, which make residence central to the application of the Treaty, are to allow all persons resident under the laws of Canada or Luxembourg to claim a benefit under the Treaty, so long as their resident status could expose them to full tax liability. There is no requirement in the Treaty that a person otherwise resident in a treaty country must also have sufficient substantive economic connections to the jurisdiction. The SCC then determined that the object, spirit and purpose of Articles 13(4) and (5) of the Treaty are to foster international investment by exempting residents of a contracting state from taxes in the source state on capital gains realized on the disposition of immovable property in which a business was carried on, or shares whose value is derived principally from such immovable property.

In respect of the Taxpayer’s residence in Luxembourg and the disposition of the shares of Alta Canada, the SCC held that the provisions of the Treaty operated as intended, there was no misuse or abuse of the Treaty, and the GAAR did not apply to deny the tax benefit claimed by the Taxpayer.

In dissent, Justices Rowe and Martin (Wagner J concurring) stated that, in their view, the Taxpayer lacked an economic connection to Luxembourg. Further, the purpose of the Treaty provisions was to allocate taxation rights to the jurisdiction with the strongest economic claim to the relevant income. The Taxpayer's transactions at issue were a “contrivance” that was not contemplated by the object, spirit and purpose of Article 13(4).

The takeaway

The SCC decision in Alta Energy provides a useful reminder of the scope and operation of the GAAR:

[96] … It bears repeating that the application of the GAAR must not be premised on “a value judgment of what is right or wrong [or] theories about what tax law ought to be or ought to do” (Copthorne, at para. 70). Taxpayers are “entitled to select courses of action or enter into transactions that will minimize their tax liability” (Copthorne, at para. 65). The courts’ role is limited to determining whether a transaction abuses the object, spirit, and purpose of the specific provisions relied on by the taxpayer. It is not to rewrite tax statutes and tax treaties to prevent treaty shopping when these instruments do not clearly do so.

In Alta Energy, the SCC has provided greater certainty, predictability and fairness regarding international investment into Canada via a treaty jurisdiction. Canada’s policy choices regarding its bilateral treaty network cannot be ignored by the Minister in favour of broad allegations of treaty shopping. Canada acted in its national interest in balancing business competitiveness and revenue generation in our network of tax treaties, and the GAAR cannot be used to unilaterally usurp these deliberate policy choices.

Taxpayers should consider their international structures in light of the SCC’s decision in Alta Energy, and also in light of the “principal purpose test” (PPT) that was recently added to many of Canada’s tax treaties (including the Treaty with Luxembourg) by the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the application of the PPT was not considered in the SCC’s Alta Energy decision, as the facts of the Taxpayer’s transactions predated the PPT’s introduction).