Treaty Shopping: A Canadian Case Study and the
With the globalization of markets and the increasing mobility of capital, tax administrations around the world are responding to a sophisticated array of tax planning structures designed to ―jump‖ international borders and ―mine‖ benefits set forth in bilateral tax treaties. Historically, national tax systems emerged to meet intrinsic social values, unique national priorities, and specific local conditions. Today, multinationals and other sophisticated taxpayers have become increasingly adept using discrepancies between different national tax systems in order to lower their tax burden where they cannot escape tax liability all together. The consequences of treaty shopping remain subtle, yet they are increasingly being felt and are potentially far reaching. In the developed world, certain countries are noticing a steady erosion of their tax base, a harrowing prospect given that many are running hefty deficits while floating welfare states are facing an imminent demographic bomb. In the developing world, on the other hand, countries have become more aggressive not only in terms of luring foreign capital but also in developing marketing niches to facilitate various kinds of investment and capital flows.
Lacking a united international effort to address fiscal erosion, many countries have embarked upon the proverbial ―race to the bottom‖ constantly nudging corporate tax rates lower with the hope of capturing more revenue. In Canada, for instance, the Mintz Report proposed reforming Canada‘s tax system by, ―lowering corporate income tax rates 2for business toward international norms and correspondingly broadening the tax base.‖
History, however, suggests that such a strategy is unlikely to succeed over the longer term. On a global scale, the market remains a closed system so that individual countries 3square off in what amounts to a zero sum game. Over the longer run, the inherent
discrepancy between the benefits reaped from predatory tax policies versus their collective cost makes taxes an ―open resource‖ subject to the classical Tragedy of the 4Commons scenario.
1 Canada Revenue Agency, Senior Advisor – Tax Treaties. The opinions expressed in this article are the
author‘s and do not represent the position of the Canada Revenue Agency. The author wishes to acknowledge the assistance of Thomas A. Boogaart II, Ph.D., in reviewing the English and the philosophical theory underpinning this article. 2 Canada, Report of the Technical Committee on Business Taxation (Ottawa: Department of Finance, April
1998), 1.7. 3 In game theory, zero sum describes a situation in which a participant's gain or loss is exactly balanced by the losses or gains of the other participants. 4 The Tragedy of the Commons scenario describes a situation where competition drives a rapid diminution of a resource, in this case the corporate tax base. The metaphor was originally coined by Garret Hardin in a seminal article, "The Tragedy of the Commons," Science, Vol. 162, No. 3859 (December 13, 1968), pp.
1243-1248. Hardin sought to explain resource degradation in a community switching over to market
In an ideal world, national governments would unite in a concerted effort to level the playing field; ironing out idiosyncratic wrinkles embedded in national tax systems and nudging them towards a common standard. In reality, the international political scene is highly fractured, rife with irresolvable divisions and polemics: a conflict of interest between the North and South, competition among super economic blocs, and various manifestations of a revanchist national sovereignty that make a solution for taxation of multinationals unlikely.
Given such barriers, even seemingly minor progress must be applauded. Currently, the European Union is moving to adopt a measure that would introduce a level playing field among member countries and this is mirrored by discussions around the OECD project on Harmful Tax Practices. The United Nations has also conducted preliminary discussions regarding the creation of an international tax body that ―could take a lead role in restraining the tax competition designed to attract multinationals—competition that […]
often results in the lion‘s share of the benefits of FDI [foreign direct investment] accruing
to the foreign investor‖ and, ―[p]erhaps most ambitious of all, it might in due course seek to develop and secure international agreement on a formula for the unitary taxation of 5 multinationals.‖
In the meantime, Canada is just one of many nations struggling with the new global reality that treaty shopping has become normal tax planning. Throughout the world, bilateral tax treaties, initially negotiated to avoid double taxation of taxpayers with cross-border dealings, are now, quite ironically, being exploited by some of them to secure unexpected double non-taxation.
This paper addresses the problem of treaty shopping on the Canadian scene in the wake 6of the recent The Queen v Mil (Investments) S.A decision (the ―MIL decision‖). It is the
author‘s position that the significance of this decision can be brought into sharper relief by putting it inside a broader global context. In particular, the author will compare it with 7the French decision Bank of Scotland. The parallels and divergence between these two
cases provides a fertile ground for considering how treaty shopping is evolving on the international scene, while also pointing towards remedies for dealing with this problem.
production. The metaphor has since enjoyed wide diffusion inside both the social sciences and the policy fields, proving particularly useful in explaining market failures on the international scene where nations have competing economic interests or where there is a poor correlation between the benefit and costs incurred by a policy such as with carbon emissions. Applied to this example, any revenue reaped by a country over the short term by decreasing the effective corporate tax rate would be quickly off set as competitors lowered their tax rate in response, ensuring an overall erosion of the global tax base. Hardin‘s model points to the necessity of reaching a collective solution that recalibrates costs and benefits among community members. 5 United Nations: Report of the High Level Panel on Financing for Development, p. 28. Available at http://www.un.org/reports/financing/full_report.pdf. 6 The Queen v Mil (Investments) S.A., 2007 FCA 23. 7 Bank of Scotland (CE Dec. 20, 2006, No. 283314).
Interpreting a Tax Convention
It seems obvious that any treaty must be interpreted in terms of both its object and
purpose. The text of any treaty is never the exclusive source for its interpretation, and therefore jurists must be prepared to make exceptions to the ordinary meaning of terms, especially in cases where they produce unintended outcomes. Having said that, this article sadly concludes that Canadian Courts have so far proven reluctant to assess whether a specific outcome was intended by a particular piece of tax legislation. The complexity of tax rules for international transactions further deters our Courts from entering what they apparently view as treacherous waters, seeking safe haven instead in a strict literal approach that often put the original intent of a tax treaty on its head.
As the philosopher Ludwig Wittgenstein pointed out in Philosophical Investigations
(1959), there is no such thing as a literal meaning apart from the context that makes it meaningful. Wittgenstein gives the following example: ―Someone says to me: ‗Shew the children a game.‘ I teach them gaming with dice [gambling], and the other says ‗I didn't mean that sort of game.‘ Must the exclusion of the game with dice have come before his 8mind when he gave me the order?‖ Gambling is one of a variety of things properly
considered a game using its ordinary meaning. However, it was clearly not the intent to be introduced to children. What Wittgenstein‘s example succinctly points out is that the type of game the speaker had in mind was determined by the context.
Wittgenstein‘s example has important implications for treaty interpretation. It shows that
sometimes the literal meaning of a text may include something that the treaty negotiator may not have had in mind during the actual negotiation, and would even be shocked to discover in a later application. Obviously far more than just the act of reading is involved when interpreting any treaty and it is essential to return any text to its ―context‖ so as to read it in terms of the intent of its negotiators.
Some of Wittgenstein‘s principles are reflected in the Vienna Convention on the Law of
Treaties, which states that ―context‖ for the purpose of treaty interpretation shall comprise, in addition to the text, any agreement between the parties, any subsequent agreement between the parties, or any subsequent practice in their application. Also, when an interpretation leaves the treaty‘s meaning ambiguous or obscure, or when it produces a result that is manifestly absurd or unreasonable, Article 32 of the Vienna
Convention states that we must examine ―supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion‖.
The OECD commentary is widely accepted as an external resource for interpreting tax treaties. It is reasonable and prudent therefore, to consult the OECD Commentary even 9when the literal meaning of a text appears unambiguous. For example, the Supreme
8 Ludwig Wittgenstein, Philosophical Investigations, 2nd ed. (Oxford: Basil Blackwell, 1958) at 33,
footnote. 9 See National Corn Growers Assn. v. Canada (Import Tribunal)  2 S.C.R. 1324.
Court of Canada in the Crown Forest case referred to the OECD Model Convention and
the Commentary as being ―of high persuasive value‖.
Currently within the international tax community there is a debate as to whether or not amendments to the OECD Commentary that extend beyond a mere clarification of existing Commentary are relevant when interpreting existing treaties. This is especially true for treaties signed with countries that are not members of the OECD. Most experts, however, agree that the current version of the OECD Commentary is relevant to the 10interpretation of all tax treaties. It simply becomes a matter of how much weight a
particular commentary has on a given issue.
The Vienna Convention says that treaties are to be interpreted in accordance with subsequent agreements and subsequent practices among the signatory parties. In the author‘s opinion, the application of a treaty provision based on the OECD Model Convention may evolve over time, and if there is sufficient consensus for the OECD member countries to agree to an amendment, the new Commentary would serve as both a ―subsequent agreement‖ and evidence of a "subsequent practice". The fact that the OECD members are going through the very laborious OECD process of agreement indicates that this is now an internationally accepted practice and that it should be given weight in subsequent treaty interpretation.
Also paragraph 3 of the Introduction to the OECD Model Convention states that ―Member countries […] should conform to this Model Convention as interpreted by the Commentaries thereon and having regard to the reservations contained therein and their tax authorities should follow these Commentaries, as modified from time to time and
subject to their observations thereon, when applying and interpreting the provisions of their bilateral tax conventions that are based on the Model Convention.‖ [Emphasis added]
Canada then, has a commitment to interpret its tax treaties in light of these commentaries and our commitment is part of the context of each of our treaties. Obviously it would cause great inconsistency if taxpayers used different commentaries.
10 Cudd Pressure Control Inc v The Queen (FCA 98 DTC 6630) where the Federal Court of Appeal used
and relied on the 1994 OECD Commentary to interpret the provisions of the 1942 Canada - US tax treaty. The Federal Court of Appeal ruled that subsequent OECD Commentaries can provide assistance in discerning the "legal context" surrounding previous conventions. See also paragraph 3 of the Introduction to the OECD Model Convention, which represents the view of OECD Countries members. See also the Introduction in Brian Arnold and Jacques Sasseville eds., Special Seminar on Canadian Tax Treaties:
Policy and Practice (Kingston, ON: International Fiscal Association (Canadian branch), 2001), 1:6-12. A different approach is preferred in Klaus Vogel on Double Taxation Conventions: A Commentary to the
OECD-, UN- and US Model Conventions for the Avoidance of Double Taxation of Income and Capital, 3d
ed. (London: Kluwer Law International, 1997), p.46, where it is viewed that OECD Commentaries are binding only to subsequent treaties, unless they are truly clarifying.
11The Science and Art of Treaty Shopping
Treaty shopping refers to any intentional effort to structure a transaction so that it can 12harvest the benefits of a particular tax treaty that would otherwise not be applicable.
Such a transaction usually results in a person becoming a resident in one of the contracting states in order to achieve that purpose. Requirement to qualify as a resident under a treaty typically revolves around the concept of ―liable to tax‖ and an additional
condition to be the ―beneficial owner‖ is required under Article 10, 11 and 12 of the OECD Model in order to access certain treaty benefits. Treaty shopping structures are usually designed to meet the legal requirement of residence. Therefore, when combating treaty shopping, a country must rely on a broad interpretation of the treaty, based on its purpose and object. Some countries, like Canada, may also rely on a domestic provision aimed at combating tax avoidance in general, while countries such as Germany or Korea use domestic legislation specifically designed for this purpose. Other measures, such as general or specific limitation of benefit clauses embedded inside a particular treaty represent a third avenue for deterring treaty shopping.
To put Wittgenstein‘s example into the context of treaty shopping, if a person enters into a transaction in order to benefit from a particular provision of a treaty, it must be ascertained whether or not the negotiator‘s intent was to award treaty benefits under such
circumstances, even if nothing in the text, except for its context, suggests that such person should be excluded from them. For example, in the author‘s view, the negotiators of the Canada-Luxembourg treaty certainly did not anticipate, and would probably be shocked to discover now, that the treaty benefit exempting gain on Canadian resource property could be siphoned off by a company resident in a tax haven country that continued into a Luxembourg company solely to access the treaty exemption.
More Recent Canadian Experience
13The MIL Decision
Briefly, the MIL decision involved the disposition of shares of a Canadian public company, Diamond Fields Resources Ltd. ("DFR") by MIL Investments S.A. ("MIL"), a