Sub-paragraph (a) of paragraph 2 of Article 10 of the Tax Treaty was replaced effective January 15, 1999 as follows:
(a) 5% of the gross amount of the dividends if the beneficial owner is a company (other than a partnership) that owns at least 25% of the capital of, or that controls directly or indirectly at least 10% of the voting power in, the company paying the dividends;
(ii) The Tax Treaty is based on the Organisation for Economic Cooperation and Development (‘OECD’) Model Tax Convention on Income and on Capital 1977 (‘Model Convention’).
(iii) Paragraphs 2 of Article 10 of the Model Convention and the Tax Treaty require that the recipient of dividends be the ‘beneficial owner’ or, in French, ‘le beneficiaire effectif’ of the dividends. The words used for ‘beneficial owner’ and ‘Ie beneficiaire effectif’ in the Dutch version of the Treaty is uiteindelijk gerechtigde. These words are defined neither in the Model Convention, nor in the Tax Treaty. The French version of the Act generally uses the words ‘proprietaire effectif or ‘personne ayant la proprieie effective’ for ‘beneficial owner ‘.
(iv) The Commentary on Article 10 of the 1977 _ OECD Model Convention states that:
12. Under paragraph 2, the limitation of tax in the State of Source is not available when an intermediary, such as an agent or nominee, is interposed between the beneficiary and the payer, unless the beneficial owner is a resident of the other Contracting State. States which wish to make this more explicit are free to do so during bilateral negotiations.
Canada has not undertaken any negotiations with the Netherlands to make paragraph 2 of Article 10 of the Tax Treaty any more explicit.
(v) In 2003 the OECD Commentaries to Article 10 of the OECD Model Convention were modified. Paragraphs 12, 12.1 and 12.2 of the Commentaries explain that the term ‘beneficial owner in Article 10(2) of the Model Convention’ is not used in a narrow technical sense, rather, it would be understood in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance. With respect to conduit companies, a report from the Committee on Fiscal Affairs concluded “that a conduit company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties”.
(vi) In 1995, Article 10, paragraph 2 of the Model Convention, 1977 was amended by replacing the words ‘if the recipient is the beneficial owner of the dividends’ with ‘if the beneficial owner of the dividends is a resident ofthe other Contracting State’. (There was no change to this wording in the Tax Treaty.) The Commentary was also amended to explain that the Model Convention was amended to clarify the first sentence of the original commentary above, ‘which 7 See paras. 62-64 infra. has been the consistent position of all member countries’. The second sentence of the Commentary was not altered. The key words, as far as these appeals are concerned, in both the 1977 and 1995 versions of the GECD Model Convention and the Tax Treaty, are ‘beneficial owner’ and the equivalent words in the French and Dutch languages.
(vii) Article 3(2) of the Tax Treaty provides an ap-proach to understanding undefined terms :
2. As regards the application of the Convention by a State, any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the law of that State concerning the taxes to which the Convention applies.
In other words, when Canada wishes to impose our income tax, a term not defined in the Tax Treaty will have the meaning it has under the Act, assuming it has a meaning under the Act.
(viii) The Income Tax Conventions Interpretation Act, at S. 3, directs how the meaning of undefined terms in a tax treaty are to be understood:
3. Notwithstanding the provisions of a convention or the Act giving the convention the force of law in Canada, it is hereby declared that the law of Canada is that, to the extent that a term in the convention is
(a) not defined in the convention,
(b) not fully defined in the convention, or
(c) to be defined by reference to the laws of Canada, that term has, except to the extent that the context otherwise requires, the meaning for the purposes of the Income Tax Act has changed.
(ix) The Vienna Convention on The Law of Treaties (‘VCLT’), at Article 31(1), states that:
A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and are the light of its object and purpose.
(x) Tax treaties are to be given a liberal interpretation with a view of complementing the true intentions of the contracting states. The paramount goal is to find the meaning of the words in question.
(xi) Article 3(2) of the GECD Model Convention 1977 is similar to Article 3(2) of the Tax Treaty:
… [A]s regards the application of the Convention by a Contracting State any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the law of that State concerning the taxes to which the Convention applies.
(xii) In 1999 Article 3(2) of the Model Convention, was amended as follows :
2. As regards the application of the Convention at any time by a Contracting State, any term not defined therein shall, unless the context other-wise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which the Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State.
(xiii) The concept of ‘beneficial ownership’ or ‘beneficial owner’ is not recognised in the civil law of Quebec or other civil law countries who are members of GECD.
3. Expert evidence:
The assessee-company produced several expert witnesses to explain Dutch law and the development of the GECD Model Conventions and the Commentaries on the Model Conventions.
3.1 Professor Dr. S. van Weeghel:
He is a Professor of Law and practises taxation law in the Netherlands. He is an expert in Dutch tax treaties, Dutch tax law and abuse of tax treaties.
3.1.1 Professor van Weeghel concluded that under the Dutch law, PHB.V. is the beneficial owner of Prevost’s shares. He relied, in particular, on an interpretation by the Hoge Raad (Dutch Supreme Court) 6 April 1994, BNB 1994/217, sometimes called the ‘Royal Dutch’ Case. Based on the Hoge Raad’s interpretation, Professor van Weeghel concluded that:
. . . a clear and simple rule emerges. A person is the beneficial owner of a dividend if (i) he is the owner of the dividend coupon, (ii) he can freely avail of the coupon, and (iii) he can freely avail of the monies distributed. One could read the formulation of this rule by the Court so as to leave open the question whether the freedom to avail of the coupon or of the distribution must exist in law or in fact, or both. The reference to the wording pertaining to the ‘zaakwaarnemer’ and the ‘lasthebber’, however, seems to require a narrow reading of the ruling, i.e., one in which the freedom must exist in law. The addition of these terms cannot be read as a further condition, because a zaarkwaarnemer and a lasthebber by definition cannot freely avail of the dividend. Thus the addition must be seen as a clarification of the conditions of free avail and the zaakwaarnemer and the lasthebber both lack that freedom in law.
3.1.2 The assessee’s counselled evidence that the Canada Revenue Agency, or its predecessor, and the Dutch tax authorities disagreed who was the ‘beneficial owner’ of the dividends received from Prevost. The Dutch are of the view PHB.V. was the ‘beneficial owner’. The appellant requested competent authority assistance relating to the term ‘beneficial owner’ in Article 10(2) of the Tax Treaty. There was some communication between the tax authorities of Canada and the Netherlands, but when the Dutch and Canadian views differed as to whether the beneficial ownership requirement in Article 2 of the 1986 Convention affected situations similar to those in the appeals at bar, the Canadian authorities terminated the competent authority review.
3.1.3 Professor van Weeghel stated that under Dutch law, PHB.V. would be considered as the beneficial owner of the dividends. However, if PHB.V. were legally obligated to pass on the dividends to its shareholders, Dutch law would consider PHB.V. not to be the beneficial owner of the dividends.
3.2 Professor Rogier Raas
Professor Rogier Raas is a professor in European banking and securities law at the University of Luden in the Netherlands. Since 2000 he has practised law; he also acts as counsel to corporations and financial institutions on finance-related and regulating matters .
3.2.1 Professor Raas opined that the dividends received by PHB.V. were within the taxing authority of the Dutch government and that, but for the participation exemption granted by the Dutch government to PHB.V., PHB.V. would have been subject to Dutch tax in respect of the dividends. Despite the existence of a Shareholders’ Agreement between Volvo and Henlys and the Powers of Attorney granted to TIM, PHB.V. itself was not contractually or otherwise required to pass on the dividends it received from the appellant. In all cases, dividend payments had to be authorised by PHB.V.’s directors in accordance with Dutch law and practice. The Shareholders’ Agreement and Powers of Attorney did not have any effect on the ownership of the dividends by PHB.V., he stated.
3.2.2 In respect of the impact of the dividend policy in the Shareholders’ Agreement on the powers of PHB.V., Professor Raas concluded that:
(a) the dividend policy in the Shareholders’ Agreement does not provide for a limitation of the powers of the Board of Directors of PHB.V. that is uncommon in a Netherlands law context. A considerable influence of share-holders on the dividend policy of a Dutch B.V. is very common; and
(b) unlike the default scenario or where annual profits are at the disposal of the general meeting of PHB.V.’s shareholders, the Board of Directors had the discretion under PHB.V.’s Articles of Association and the dividend policy to decide the adequacy of the working capital requirements, before dividends were paid.
3.2.3 The revenue responded that Professor Raas assumed incorrectly that PHB.V. had a dividend policy independent of that of the Corporate Group set out in the Shareholders’ Agreement and referred to in PHB.V.’s Articles of Association. Instead, the respondent’s counsel argued, the discretion of the directors of PHB.V. to determine the adequacy of working capital of PHB.V.was inextricably tied to the same determination being made by the directors of Prevost. The proviso in the Shareholders’ Agreement on the payment of not less than 80%of the after-tax profits of the Corporate Group was limited only by a determination of the Board of Directors of both PHB.V. and Prevost ‘as to the adequacy of normal and foreseeable working capi-tal requirement of the Corporate Group at the time of each dividend payment. The dividend policy of PHB.V.,as described in the Raas report, was in fact a resolution of purported shareholders of Prevost, represented as Volvo and Henlys, and adopted by the Board of Directors of Prevost, both occurring on March 23, 1996.
3.2.4In short, the Revenue submitted that the dividend policy in the Shareholders’ Agreement, the shareholder and director resolutions of March 23, 1996, coupled with the authorisation in PHB.V.’s Articles of Association to pay interim dividends defined the scope of the discretion of the directors of the PHB.V.to determine its working capital requirement. This discretion was purely academic.
3.3 Mr. Daniel Luthi:
3.3.1 Mr. Daniel Luthi, a graduate in law, worked in the Swiss Ministry of Finance and negotiated about 30 tax treaties on behalf of Switzerland. He was also a member of the Swiss delegation to the – – “DECO Fiscal Committee, member of OECD Committee on Fiscal Affairs (‘CFA’), a member and chairman of the Swiss delegation to the OECD Working Party 1 on ‘Double Taxation, as well as a member of the OECD Informal Advisory Group in international tax matters.
3.3.2 Mr. Luthi’s report was essentially a fact-driven recollection of events that transpired during OECD Model Convention discussions and negotiations. Mr. Luthi testified on matters relating to the term ‘beneficial owner’ and to the issues facing drafts-men of the OECD Convention more for background than for anything else.
3.3.3 The term ‘beneficial owner’ was introduced into Article 10(1)of the 1977OECD Convention, Mr. Luthi stated, so as to explicitly exclude intermediaries in third States, such as agents and nominees, from treaty benefits. Article 10(1)still caused concern as to whether the shareholder was entitled to treaty benefits in a case where the dividend was received by an agent or nominee, but not the shareholder directly. Hence Article 10(1) was further amended in 1995.
3.3.4 Mr. Luthi could find ‘no traces’ why the term ‘beneficial owner’ had been chosen in the 1977 OECD Convention. Other terms were considered, for example, ‘final recipient’. The intention was that the ‘beneficialowner’ of the incomebeing a resident of the other Contracting State was to benefit from a treaty, not an agent or nominee who is not considered to be the beneficial owner of the income.
3.3.5 There was no expectation that a holding company was a mere agent or nominee for its share-holders, that is, that its shareholders were the beneficial owners of the holding company’s income. Indeed, a holding company is the beneficial owner of dividend paid to it, unless there is strong evidence of tax avoidance or treaty abuse.
3.3.6 Conduit Companies:
Mr. Luthi referred to the CFA Report of 1987, Double Taxation Conventions and the Use of Conduit Companies. An OECD working party’s report on conduit companies adopted by the OECD Council on 27 November 1986 distinguishes between two types of conduit companies, direct conduit companies and ‘stepping-stone’ conduits; the former is the conduit discussed here and is described as follows:
Direct conduits :
A company resident of State A receives dividends, interest or royalties from State B. Under the tax treaty between States A and B,the company claims that it is fully or partially exempted from the with-holding taxes of State B. The company is wholly owned by a resident of a third State not entitled to the benefit of the treaty between States A and B. It has been created with a view to taking advantage of this treaty’s benefits and for this purpose the assets and rights giving rise to the dividends, interest or royalties were transferred to it. The income is tax exempt in State A, e.g., in the case of dividends, by virtue of a parent-subsidiary regime provided for under the domestic laws of State A, or in the convention between States A and B.
He summarised the CFA’s report as follows:
… According to this Report, OECD does not deny every conduit company the ability to be the beneficial owner by stating “The fact that the conduit company’s main function is to hold assets or rights is not itself sufficient to categorise it as a mere agent or nominee, although this may indicate that further examination is necessary”. On the other hand, a conduit company cannot normally be considered to be the beneficial owner of the income received if it has very narrow powers, performs mere fiduciary or administrative functions and acts on account of the beneficiary (most likely the shareholder). In the view of OECD, such a company has only title to property, but no other economic, legal or practical attributes of ownership. In such a case, the company, based on a contract by way of obligations taken over, will have similar functions to those of an agent or a nominee.
According to Article 4 of the OECD Model Convention, a conduit company, in order to be entitled to claim treaty benefits, must be liable to tax in its residence country on the basis of its domicile, place of management, etc. In addition, the assets and rights giving rise to the income must have effectively been transferred to the conduit company. If this is the case, the conduit company cannot be considered to act as a mere agent or nominee with respect to the income received.
The analysis, observations and conclusions by the Tax Court will be discussed in Part II of the Article which will appear in the next issue of the Journal.
