By Etienne Bruson and Yves-Andre Grondin

The Tax Court of Canada on 22 April 2008 finally released its long-awaited decision in the Prevost Car case, which is the first case to address the meaning of “beneficial ownership” for purposes of Canada’s tax treaties. The court decided that a Dutch holding company that received dividends from a Canadian subsidiary was the beneficial owner of the dividends and thus entitled to the lower rate of withholding tax provided by the Canada-Netherlands tax treaty.

All shares of Prevost Car, a Canadian company, were held by a Dutch company (DutchCo). The shares of DutchCo were held by a Swedish company (51%) and an unrelated U.K. company (49%). DutchCo did not have an office, employees, activities or any significant assets other than the shares of Prevost Car. Prevost Car withheld 5% of dividends paid to DutchCo in accordance with the Canada-Netherlands tax treaty, which provides that this reduced rate applies in certain cases where the beneficial owner of the dividends is a company resident in the Netherlands.

The Canada Revenue Agency (CRA) assessed Prevost Car for the difference between the amount withheld and the withholding tax that would have been payable if the dividends had been paid directly to the ultimate shareholders, contending that they were the beneficial owners of the dividends paid to DutchCo. The taxpayer appealed the assessment to the Tax Court.

In his decision, the judge reviewed extensive material on the meaning of beneficial ownership, including domestic and international case law, dictionary meanings of the relevant words in French, English and Dutch, and the OECD Commentary to the Model Treaty. However, it is difficult to determine which authorities the judge considered to be most relevant and persuasive. The judge simply concluded that, in his view, “the ‘beneficial owner’ of dividends is the person who receives the dividends for his or her own use and enjoyment and assumes the risk and control of the dividend he or she received. In short, the dividend is for the owner’s own benefit and this person is not accountable to anyone for how he or she deals with the dividend income.”

The judge indicated that when corporate entities are concerned, “one does not pierce the corporate veil unless the corporation is a conduit for another person and has absolutely no discretion as to the use or application of funds put through it as conduit, or has agreed to act on someone else's behalf pursuant to that person's instructions without any right to do other than what that person instructs it (such as, for example, a stockbroker who is the registered owner of the shares it holds for clients).”

Although there was a shareholder agreement between the ultimate shareholders, which contained a dividend payment policy, the judge indicated that this agreement was not enforceable against DutchCo given that it was not a party to the agreement. DutchCo had discretion with respect to the payment of dividends to its shareholders and until it chose to exercise that discretion, any dividends received were its property and available to its creditors, if any. There was no predetermined or automatic flow of funds to the shareholders. For these reasons, the judge found that DutchCo was the beneficial owner of the dividends. The judge did not appear to find the fact that DutchCo had no physical office or employees in the Netherlands or elsewhere to be relevant to the determination of beneficial ownership. In addition, minor administrative errors such as a reference in Prevost’s minute book to the ultimate shareholders as being the shareholders of Prevost were not fatal.

Prevost Car follows another loss by the Crown in MIL Investments, in which the Crown unsuccessfully sought to apply the general antiavoidance rule to “treaty shopping.” It is expected that the Minister will appeal the Tax Court decision in Prevost Car. However, given their experience in these two cases, the government may begin to look for alternate solutions to combat treaty shopping, such as anti-conduit rules or the inclusion of limitation on benefits articles in Canadian tax treaties. A limitation on benefits rule for investment into Canada has been proposed for the first time in the recently signed protocol to the Canada-U.S. tax treaty.

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