Decoding the Objective
Test under PPT - Effect of
Preamble and Case Laws
Submitted by: Tanvi Vora
(Student No.:12455083)
Supervisor:
Dr. Joanna Wheeler
Index
1
Acknowledgement ... 3
2
Abstract ... 4
3
List of Abbreviations ... 5
4
Introduction ... 6
5
History of the Principal Purpose Test ... 8
6
Deconstruction of the Principal Purpose Test ...13
6.1 The Subjective / Substantive Test ... 14
6.2 The Object and Purpose / Objective test ... 16
7
Interplay of the Object and Purpose Test and the Preamble of the Treaty19
7.1 Source of Object and Purpose of a treaty ... 197.2 Interpretative value of the Preamble ... 21
7.3 ‘Object and Purpose of the Treaty’ versus ‘Object and Purpose of the Relevant Provisions of this Convention’ ... 21
8
Case Law Analysis ...24
8.1 Factors Identified ... 25
8.2 Comparison of the Identified Factors ... 38
9
Concluding Remarks – What the future hold ...46
10
Bibliography ...48
10.1 Books and Articles ... 48
10.2 Case Laws ... 51
11
Appendix ...52
11.1 Paragraphs 8 and 9 of the Commentary of Article 1 of the OECD Model 1977 ... 52
11.2 Paragraphs 7 of the OECD, Report on Double Taxation Conventions and the Use of Conduit Companies (OECD 1987) [Conduit Companies Report] ... 52
11.3 Paragraphs 9.5 of the Commentary of Article 1 of the OECD Model 2003 – Guiding Principle 53 11.4 Paragraphs 16.1 and 16.2 to the Introduction of the 2017 OECD Model... 53
11.5 (Updated) Preamble to the OECD Model Convention 2017 ... 54
11.6 Relevant Article of the Vienna Convention on the Law of Treaties ... 54
11.7 CASE 1: Canada - Mil Investments S.A. v. Her Majesty the Queen ... 55
11.8 CASE 2: India - Union of India v. Azadi Bachao Andolan and Ors. ... 58
1 Acknowledgement
I would like to express my sincere gratitude to Dr. Joanna Wheeler, my supervisor for this thesis and the Program Director for Advanced Masters International Tax Law from International Bureau of Fiscal Documentation (IBFD) and University of Amsterdam (UvA) for allowing me to undertake this research and her continuous guidance and advice throughout the research. I faced certain personal difficulties during this time but Joanna’s constant support and nudging was instrumental to me being able to complete this thesis
My utmost gratitude goes to Mr. Carlos Gutierrez Puerto from the IBFD – LLM team for his continuous support and encouragement. I would also like to thank Miss Katharina Beberwiel and the entire IBFD Library Team for helping to carry out my research. And last but not the least, I would like to express my sincere appreciation to my family back home and the most encouraging friend Vaishali Bhutani for supporting me throughout this challenging period.
2 Abstract
The BEPS package has been designed to ensure that profits of Multinational Entities are taxed at the true location of its economic activities that lead to value creation. For its effective implementation, the Organisation for Economic Co-operation and Development promulgated the Multilateral Instrument. One minimum standard of the above BEPS package was the Principal Purpose Test brought about by Article 7 of the Multilateral Instrument.
This thesis aims to decode the Principal Purpose Test and examine the role of preamble and case law in defining the object and purpose of a treaty and/ or relevant treaty provisions for the purposes of the objective element of the Principal Purpose Test. The thesis represents an attempt to map the unexplored terrain of the interpretation of the object and purpose test as it stands to date by courts around the world. In particular, captures the possible linkage of the Principal Purpose Test with the preamble of the treaty. The thesis further examines the object and purpose test as used in the Principal Purpose Test in light of some of the existing cases wherein courts have discussed the concept of object and purpose while pronouncing said judgements. The question raised is as to how exactly the object and purpose of the treaty or relevant provisions of the treaty are determined and whether there is one multilateral common denominator – as the preamble to the 2017 OECD Model seems to suggest – or perhaps not.
In the cases analysed, the goal is to bring out factors that courts have considered to demonstrate a transaction / structure to be in accordance with object and purpose (of a treaty as a whole or specific provisions of a treaty) or not. An attempt has been made to ascertain common factors (if any) amongst such cases that can aid taxpayers and tax administration in the application of the Principal Purpose Test. It is yet to be seen if the Object and Purpose test of the Principal Purpose Test will have a game changing effect on the future application of the Principal Purpose Test as an anti-abuse provision of the tax treaty.
3 List of Abbreviations
Abbreviation Full-form
BEPS Base Erosion and Profit Shifting CBDT Central Board of Direct Taxes (India)
CIT Corporate Income Tax
CFA Committee on Fiscal Affairs
CTA Covered Tax Agreement
DTC / DTAC Double Tax Convention / Double Tax Avoidance Convention
EU European Union
FCA Federal Court of Appeal (Canada) FII Foreign Institutional Investors GAAR General Anti-avoidance Rules
G20 Group of Twenty
HC / SC High Court / Supreme Court (India)
IBFD International Bureau of Fiscal Documentation
LOB Limitation of Benefits
MLI Multilateral Instrument / Convention MNEs Multinational Entities
OECD Organisation for Economic Co-operation and Development
PPT Principal Purpose Test
SLOB Simplified Limitation of Benefits
UvA University of Amsterdam
4 Introduction
An age-old concern expressed in discussions at the Organisation for Economic Co-operation and Development (OECD) forum has been the concern of treaty shopping or improper use of treaties. The Base Erosion and Profit Shifting (BEPS) concerns are expressed in the following words:
“…the current consensus-based international framework is at risk. First, it no longer fully meets its objectives of allocating taxing rights between countries where companies operate. Instead, it facilitates the divorce between the location of the profit and the location of value creation. The consequence is that the existing international tax system in many cases allows structures and tax results that no longer pass a basic test of common sense. For example, as taxpayers increasingly rely on intangible assets as a value-driver, it has become easier for taxpayers to rely on existing principles to transfer legal ownership of those intangible assets to “cash boxes” in low-tax jurisdictions that receive a large share of profit but perform no or hardly any activity. Trillions of untaxed dollars are now located in such entities, in compliance with the existing rules. It is hard to imagine that this is what was intended when these rules were designed. Another striking example is where the features of a bilateral treaty cause investments in one country to be channelled through a particular jurisdiction by third-country investors. For example, as shown in IMF data, more than one quarter of direct investment into India was from Mauritius between 2010 and 2012.”1
The BEPS Project identifies treaty abuse and in particular treaty shopping, as one of the most important sources of BEPS concerns. BEPS Action Plan 6 on Preventing the Granting of Treaty Benefits in Inappropriate Circumstances2 recommended three-pronged approach to deal with treaty abuse, i.e., i) introduction of preamble to the treaty, ii) insertion of purpose based anti-abuse provision called “principal purpose test”; and iii) insertion of
1Testimony of Pascal Saint-Amans, Director, Centre for Tax Policy and Administration, Organisation for
Economic Co-operation and Development: Before the United States Senate Committee on Finance on July 22, 2014
2OECD (2015), Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action 6 –
2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris [hereinafter BEPS Action Plan 6]
objective anti-abuse rule called “simplified limitation on benefits”. These provisions have found their way in the text of the Multilateral Instrument (MLI).
With the signing of the Multilateral Convention to Implement Tax Treaty Related Measures (popularly referred to as MLI) to prevent base erosion and profit shifting by a number of jurisdictions from around the world on 7th June 2017, numerous tax treaties will now include the anti-abuse rule i.e. the Principal Purpose Test (PPT).
With the introduction of such a broad and powerful general anti-avoidance rule, its implementation will be difficult and also run the risk of each country, through their revenue authorities and their courts, developing divergent and state-centric views as to the interpretation of the PPT. A standard universal interpretation may be possible if courts and revenue authorities apply a consistent approach to interpretation and would aid the uniform adoption of the PPT.
This thesis has deconstructed the PPT to bring out the different parts of the whole involved in its application to a transaction / structure. Upon such deconstruction, the thesis will mainly cover the last part of the PPT which is popularly known as the ‘object and purpose test’ or the ‘objective test’. The thesis mainly discusses the relation between the PPT and preamble of a tax treaty followed by an analysis of three well-known case laws from around the world. In the cases analysed, the goal is to bring out factors that courts have considered to demonstrate a transaction / structure to be in accordance with object and purpose (of the treaty as a whole or specific provisions of the treaty) or not. An attempt has been made to ascertain common factors (if any) amongst such cases that can aid taxpayers and tax administration in the application of the principal purpose test. The analysis wishes to comment on the possibility of an effective and harmonious of the PPT with regard to the object and purpose test based on precedent. The thesis also touches upon the concept and history behind the PPT as a whole (before concentrating on the object and purpose test) and brings out some surrounding issues.
5 History of the Principal Purpose Test
BEPS largely refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profit ‘disappear’ for tax purpose or to shift profits to locations where there is little or no real activity but taxes are low, resulting in little or no overall corporate tax being paid. The issues of treaty abuse such as treaty shopping (among other issues3) is at the heart of the OECD/G20 BEPS Project. BEPS strategies take advantage of a combination of features of home and host countries’ tax systems. It is the interaction of domestic and international tax systems which at times leave gaps, resulting many times in income not being taxed anywhere. Base erosion constitutes a serious risk to tax revenues, tax sovereignty and tax fairness for OECD member countries and non-member countries alike.
As precisely stated by authors L.G. Ogazón Juárez & R. Hamzaoui4 “… it is true that tax planning has generally been considered as a legitimate practice around the world, the manner in which tax bases have been eroded based on complex and sophisticated structures in recent years has forced governments and international organizations to revisit their position. This move was accelerated by economic recessions, budgetary cuts and the substantial growth of the tax collection gap which forced governments to change their policy and demand that (large) taxpayers settle their fair share of taxes. Aggressive tax planning has also raised issues as to the fairness of the overall tax system. Civil society organizations and non-governmental organizations have also added their voices to the general debate.” This statement in my view beautifully covers all the reasons why there was a need to counter aggressive tax planning and bring a balance around the world.
A look into the historical context of how the PPT came into being is needed in order to have a wholesome view on how it was evolved through the years and why it took so long to be included in the OECD Model. Over the years (until the 2017 update of the OECD Model
3Establishment of Special Purpose Entity in tax jurisdiction with low tax rates, inter-company debts or
financial transaction, hybrid mismatch arrangements by MNEs, aggressive tax planning, transaction of intangibles between companies and transfer pricing issues related to them etc. are some of the issues which are in limelight nowadays amongst different economies of the world.
4 L.G. Ogazón Juárez & R. Hamzaoui, Chapter 1: Common Strategies against Tax Avoidance: A Global
Overview in International Tax Structures in the BEPS Era: An Analysis of Anti-Abuse Measures (M. Cotrut et al. eds., IBFD 2015), Online Books IBFD
Convention) there was no Article that substantially dealt with the improper use of tax treaties.
The first ever inclusion in the OECD Model or its Commentaries in relation to improper use of tax treaties was in the 1977 OECD Model5 in paragraph 8 and 9 of the Commentary on Article 1 which has been annexed at para 11.1 below. The Committee on Fiscal Affairs (CFA) of the OECD, in the abovementioned 1977 Commentary voiced concerns as to the improper use of tax treaties by a person obtaining treaty benefits that may otherwise not be available to it acting through a legal entity created to obtain treaty benefits or in case of artificially created circumstances in order to obtain such benefits. This in some ways brought out the concept of treaty shopping without the actual use of the term - treaty shopping - by the OECD. The rest of the Commentary did not offer any solutions to treaty shopping but brought out some anti-abuse measures such as ‘beneficial ownership’ and ‘artise companies’ nevertheless left the use of any kind of anti-abuse to bilateral negotiations.
The OECD published the Conduit Companies Report6 wherein it addressed ‘treaty shopping’ in detail. The report candidly brings out the reasons why treaty shopping is unacceptable in Paragraph 7 which is annexed at para 11.2 below. This paragraph brings out main issues surrounding treaty shopping viz. unintended use, principle of reciprocity, double non-taxation and improper benefits. Although this Conduit Companies Report was a step towards directly dealing with treaty shopping, the report still implied (in line with what was included in the 1977 OECD Commentary to Article 1) that in the absence of specific treaty provisions dealing with anti-abuse and treaty shopping, improper use of tax treaties could not be avoided.
Many of the recommendations of the Conduit Companies Report were reproduced in the Commentaries to Article 1 of the 1992 OECD Model7. However, another issue brought to
light was the need to include such principles of countering treaty abuse in the text of the convention. The Commentary in Paragraph 24 of Article 1 of the 1992 OECD Model
5 OECD Model Tax Convention on Income and on Capital (11 April 1977), Models IBFD
6 OECD, Report on Double Taxation Conventions and the Use of Conduit Companies (OECD 1987)
[hereinafter Conduit Companies Report]
brought out that dissenting views existed as to the applicability of such anti-abuse and the legal value that such commentaries held without inclusion of text in the actual text of the treaty. The fact that this issue was eventually brought to fruition in 2017 with the signing of the MLI in my view highlights the consensus based working of the OECD.
After the recommendations of the 1998 Report on Harmful Tax Competition8 and 2002
Report Restricting the Entitlement to Treaty Benefits9, in 2003, the CFA began to actively support countering tax abuse by explicitly incorporating anti-avoidance provisions into the Commentaries on the OECD Model by establishing that the purpose of tax treaties is to prevent tax avoidance. The 2003 update to the OECD Commentary10 added that one of the purposes of tax treaties is to combat tax avoidance, and that states do not have to grant the benefits of a tax treaty where arrangements have been entered into that constitute an abuse of the provisions of that treaty11. The most notable addition to the 2003 OECD Commentary on Article 1 was the introduction of the ‘Guiding Principle’ in Paragraph 9.5. The guiding principle as it read is reproduced in the appendix at para 11.3 below.
This Guiding Principle can be said12 to be the basis of the PPT as it stands now. There is no clear indication as to why the OECD did not include the changes to preamble and inclusion of the PPT (as proposed by Action Plan 6) in the 2003 OECD Model but one may perhaps imagine the reason to be unreachability of consensus among the OECD members13. Also perhaps, there was a fear that in the absence of the explicit clause in the existing treaties courts, states could take a contrary view by undermining the existing treaties based on OECD Model at the time. Therefore, the OECD merely changed the Commentary and assumed a dynamic approach to interpretation by giving the guiding principle the guise of a clarification rather than a change.
8 OECD (1998), Harmful Tax Competition: An Emerging Global Issue, OECD Publishing, Paris
9 OECD (2003), 2002 Reports Related to the OECD Model Tax Convention, Issues in International
Taxation, No. 8, OECD Publishing, Paris
10OECD Model Tax Convention on Income and on Capital (28 Jan. 2003), Models IBFD 11 Para. 9.4 OECD Model: Commentary on Article 1 (2003)
12C. Elliffe, The Meaning of the Principal Purpose Test: One Ring to Bind Them All?, 11 World Tax J.
(2019); P. Piantavigna, The Role of the Subjective Element in Tax Abuse and Aggressive Tax Planning, 10 World Tax J. (2018);
The uncoordinated approach on the part of states14 was eventually followed by the mammoth G20 / OECD’s BEPS Initiative. Action Plan 615 along with Action Plan 1516 brought forth the Principal Purpose Test. Within the context of the OECD’s BEPS Project, Action 617 is intended to counter the granting of treaty benefits in inappropriate circumstances18. Treaty shopping typically involves persons who are residents of third states
attempting to access indirectly the benefits of a tax treaty between two contracting states. Such a quasi-description of treaty shopping by the OECD is very general and equivocal19.
The quasi-definitions of treaty shopping on the part of the OECD encompass a broad spectrum of structures, ranging from the purely abusive and artificial to others with more substance20.
The OECD, as part of Action 6 of the BEPS project, recommended measures to tackle treaty abuse one of which was the incorporation of a PPT in tax treaties. The BEPS project proposes important changes such as the preamble of covered tax agreements to specifically include an express intention to exclude opportunities for treaty abuse and making the PPT a minimum standard for signatories to the MLI thereby potentially amending a number of covered tax agreements to include a general anti-abuse PPT. BEPS Action Plan 6 requires tax treaties to include as a minimum standard any one of the following tests:
(1) a simplified or detailed LOB combined and supplemented by a PPT; or
(2) the PPT only; or
14 C. Bergedahl, Anti-Abuse Measures in Tax Treaties Following the OECD Multilateral Instrument - Part
1, 72 Bull. Intl. Taxn. 1 (2018)
15 BEPS Action Plan 6, Supra n. 2
16 OECD, Developing a Multilateral Instrument to Modify Bilateral Tax Treaties, Action 15 - 2015 Final
Report (BEPS Action Plan 15 - MLI)
17BEPS Action Plan 6, Supra n.2
18Frequently employed schemes of abuse include acquiring residency of a specific country using conduit
structures or transfer of residency, attributing profits or income to a specific entity and changing the character of an income
19Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion
and Profit Shifting Project, 69 Bull. Intl. Taxn. 3 (2015), Journals IBFD
20R.S. Avi-Yonah & C. HJI Panayi, Rethinking Treaty Shopping: Lessons for the European Union, in Tax
Treaties: Building Bridges between Law and Economics sec. 2.1. (M. Lang et al. eds., IBFD 2010), Online Books IBFD
(3) a detailed LOB along with a mechanism to deal with conduit financing arrangements not already included in tax treaties.
In the transition from the Guiding Principle to the PPT, the final report of Action Plan 6 indicated that the new PPT i.e. the conditions for the application of PPT are identical to the Guiding Principle contained in the Commentaries to the 2003 OECD Model21. Contrary to
the views of the OECD reflected in the Final Report, scholars have stated that the PPT lowers the anti-abuse standard previously defined under the Guiding Principle.22
Finally, the OECD Model Convention on Income and on Capital (2017 Update)23, updated
the preamble of the treaty, incorporated the PPT in Article 29(9) along with a detailed Commentary and amended and rearranged the Commentary to Article 1.
21Para. 49 of BEPS Action Plan 6, Supra n. 2
22 L. De Broe & J. Luts, BEPS Action 6: Tax Treaty Abuse, 43 Intertax 137 (2015)
23 OECD (2017), Model Tax Convention on Income and on Capital: Condensed Version 2017, OECD
6 Deconstruction of the Principal Purpose Test
A lot has been written about the PPT ever since the OECD proposed it: both in favor and in opposition. The PPT as set out in Article 29(9) of the 2017 OECD Model is as follow24:
“Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in
accordance with the object and purpose of the relevant provisions of this
Convention.” (Emphasis supplied)
Firstly, since the text of the PPT starts with “Notwithstanding the other provisions of this Convention”, the PPT is designed to override the other provisions of a treaty. The PPT will apply not only to provisions allocating or limiting taxing rights, but also to any general or specific anti-avoidance rules in a treaty.
On a broad and simplistic basis, the applicability of PPT may be ascertained through application of the following steps:
24The differences between the PPT proposed in Action Plan 6 vis-à-vis Article 7(1) of the MLI vis-à-vis
There are two parts to the PPT, the subjective and the objective. If I were to dissect the PPT, there are two main tests to be applied. According to these tests, the first being ‘Substantive / Reasonableness Test’ which is followed by the ‘Object and Purpose Test’ which is the main focus of this thesis.
6.1 The Subjective / Substantive Test
To explain in brief, the words “reasonable to conclude, having regard to all relevant facts and circumstances” contain the so-called Reasonableness Test. The Commentaries to Article 29(9) in the 2017 OECD Model bring the importance of weighing all facts and circumstances surrounding a transaction or arrangement. It is not only necessary that the tax authority’s conclusions be reasonable, but there has to be a sound basis for the conclusions arrived at. A tax authority is required to reasonably look at all factors and circumstances which may bring rise to differing interpretations. This brings an objective element to interpretation of facts into the PPT. Different interpretation of the same facts and circumstances will create heaps of uncertainly as to the application of the PPT. The PPT rule requires an in-depth study of the facts and circumstances, and that nothing may be based
on assumptions25. A differing interpretation to the reasonableness also exists by certain authors such as Prof Lang. He writes26 that “On the other hand, the requirements are not too demanding – it must be merely “reasonable”: but not, for instance, compelling. Therefore, the tax authority does not need to produce full evidence thereof”. This view is also evident from the commentary to Article 29(9) which states that it is not necessary to find conclusive proof of the intent of a person but can rather be a reasonable conclusion27. This test should also be coupled with a ‘Results Test’ which is not a separate test all together as it is inherent in the application of the first half of the PPT. A results test would involve proving that actual benefit was received by the taxpayer ‘directly or indirectly’ through the arrangement or transaction.
The problems with the substantive test of the PPT includes who decides what are ‘relevant facts” and “relevant circumstances”. What is the standard of “reasonableness”? And “reasonableness” from whose eyes? How does the tax authority come to a conclusion that, upon perusal of the relevant facts and circumstances, it indeed appears to be a reasonable or unreasonable case? Etc. This is not the focus of my thesis and is not discussed further.
The next few words of the PPT i.e. “that obtaining that benefit was one of the principal purposes of any arrangement or transaction” form substantive part of the test. A contrasting change from the Guiding Principle explained above, the principal purpose test makes its application conditional upon the fact that the obtaining of a treaty benefit was one of the principal purposes of the transaction that resulted directly or indirectly in that benefit. In my view and as opined by several authors28 the OECD has lowered the threshold of the applicability of the PPT by requiring the one of the principal purposes to be a treaty benefit
25Dennis Weber, "The Reasonableness Test of the Principal Purpose Test Rule in OECD BEPS Action 6
(Tax Treaty Abuse) versus the EU Principle of Legal Certainty and the EU Abuse of Law Case Law", Erasmus Law Review, 1, (2017):48-59
26M. Lang, BEPS Action 6: Introducing an anti-abuse rule in tax treaties, Tax Notes International, 655 27Para 178 of OECD Model: Commentary on Article 29(9) (2017 Update)
28L. De Broe & J. Luts, BEPS Action 6: Tax Treaty Abuse, 43 Intertax 137 (2015); A.B. Moreno, GAARs
and Treaties: From the Guiding Principle to the Principal Purpose Test. What Have We Gained from BEPS Action 6?, 45 Intertax 6/7, pp. 440-441 (2017); B. Kuźniacki, The Principal Purpose Test (PPT) in BEPS Action 6 and the MLI: Exploring Challenges Arising from Its Legal Implementation and Practical Application, 10 World Tax J. (2018); Tax treaty abuse and the Principal Purpose Test - Part 2, Duff, D.G., Canadian Tax Journal Revue Fiscale Canadienne. - Toronto. - Vol. 66 (2018), No. 4, p. 947-1011; Cf. L. De Broe, Fighting Treaty Shopping after the Multilateral Instrument, in Tax Treaties after the BEPS Project, A Tribute to Jacques Sasseville p. 99 (B. Arnold ed., Canadian Tax Foundation 2018)
which earlier (and in many domestic GAARs) was restricted to cases only where the main purpose was a treaty benefit.
For the purpose of brevity, I have not further analysed this test.
6.2 The Object and Purpose / Objective test
Without the object and purpose test as it has been framed in the PPT, after the satisfaction of the abovementioned test, the PPT would apply to deny treaty benefits. However, the object and purpose test aims to provide relief to the taxpayers in cases where “granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention”. This test operates as an exception to the general rule meaning that PPT will not apply if is ‘established’ that granting the benefit would be in accordance of the object and purpose of the relevant provisions of the convention. Accordingly, the PPT provides that transactions that might otherwise constitute treaty abuse may be acceptable if undertaken in accordance with the "object and purpose" of the provisions of the treaty.
It appears that unlike the first test that leads to a question of fact, this test leads to a question of law and would require the judiciary to evaluate whether the taxpayer’s claim merits acceptance within the framework of object and purpose of relevant provisions of the Covered Tax Agreements (CTAs) under the MLI. While facts and circumstances can change from case to case, the object and purpose of a provision or even a treaty would as such remain on the same line. The analysis leading to ascertaining the object and purpose would lie with interpretation and not be based on arbitrary facts. The objective nature of this second part of the PPT is not always certain because it can be very difficult on occasion to determine what the purpose of treaty provisions and/or of a tax treaty is29.
Philip Baker sees the potential for the unpredictable interpretation of tax treaties in the application of the PPT to “undermine the whole system of tax treaty benefits” 30. The
possibility of countries not adopting an international autonomous meaning and substituting
29B. Kuźniacki, Supra n. 28
30J. Avery Jones & P. Baker, The Multiple Amendment of Bilateral Double Taxation Conventions, 60 Bull.
their own domestic views is very real, and the consequences are very problematic.31 Of course, how this will play out is uncertain. And therefore, by way of case law analysis I have attempted to find common factors that courts have considered in relation to object and purpose. Before I dwell into the analysis of the case laws it is imperative to understand how the object and purpose test relates with the preamble of a treaty. It is imperative because, tax treaties being a part of international law, its interpretation must be based on certain set of principles and rules of interpretation. In order to interpret the object and purpose of a treaty or of a provision of a treaty we need to understand the sources that lead the way to understanding the intent of a tax treaty and the reasons and context under which states enter into such treaties.
The statement - object and purpose of the relevant provision of the convention - has not been explained in detail in the OECD commentaries. In some examples32 provided by the OECD in the commentaries it looked at the object and purpose of relevant Article of the CTA while in some examples it looked at the object and purpose of the CTA as a whole. OECD acknowledges that the PPT must be read in the context of paragraphs 1 to 7 of Article 29 i.e. the Limitation of Benefits clauses (LOB) and of the rest of the Convention, including its preamble. This is particularly important for the purposes of determining the object and purpose of the relevant provisions of the Convention33.
The burden of proof lies neither with the tax authorities nor with the taxpayer, but is split between them whereby the tax authorities would make the first move by gathering and demonstrating evidence that one of the principal purposes of the taxpayer’s arrangement or transaction was to obtain a treaty benefit; the taxpayer must then counter this by gathering and demonstrating evidence to show the opposite state of affairs and to explain how in their view the object and purpose of the treaty provisions was followed.
The Commentary on Article 29(9) of the 2017 OECD Model and, in particular, the examples therein do not always make clear which prong of the test is addressed, i.e. the “principal
31C. Elliffe, Supra n.12
32Para 182 of OECD Model: Commentary on Article 29(9) (2017) – Example E and J have looked at the
object and purpose of relevant provision whereas certain others such as Example A, B, C, D and I have looked at the object and purpose of the treaty (While other examples have no mention of object and purpose)
purposes” part or the “object and purpose” part. A clear distinction would be useful but because the subjective and objective tests are so intertwined, a clear distinction may also be difficult34.
The legal consequence(s) of the PPT is that treaty benefits ‘shall not be granted’. The exact scope of ‘not granting treaty benefits’ is unclear, and is not explained in any way in the proposed Commentary. Will a taxpayer be denied only some or all treaty benefits? Would a recharaterisation be applied? Although the answer to these is important for the application of PPT by states, they have not been further analysed in this thesis.
7 Interplay of the Object and Purpose Test and the Preamble of the
Treaty
Since the purpose and the context of tax treaties are first and foremost reflected in the wording of the treaty provisions, the mere addition of the new preamble would not be enough to refuse granting treaty benefits in tax avoidance cases35. For this, a provision (a rule/legal norm) is needed that designates the purpose and the context of the treaty in line with the new preamble viz. the PPT.
It is important to note the two paragraphs 16.1 and 16.2 added to the Introduction of the 2017 OECD Model which have been reproduced in appendix below at para 11.4. These paragraphs give reference to the changes incorporated into the OECD Model and Commentaries post the BEPS project. It is the first point of reference to the interpretative value of the title and the preamble and provides that they form part of the convention and therefore constitute a general statement of the object and purpose of the treaty.
We need to ascertain when would not levying a tax in the presence of a principal purpose to obtain a benefit – or, more in general, avoiding tax – not be in accordance with the object and purpose of any rule of taxation?36
7.1 Source of Object and Purpose of a treaty
The primary source for the ‘object and purpose’ of a treaty is found in the text of the treaty itself. The text of the treaty comprises all the treaty provisions, the title of the treaty and also the preamble to the treaty. After Action Plan 637 of the BEPS project, Article 6 of the MLI38 introduced the new preamble. The updated preamble has been annexed in para 11.5 below.
The preamble is essentially an amendable, descriptive component of the statute. It is the useful guide with the intention of the signatories explaining the reason, purpose, objects or scope of the treaty and details facts or values which are relevant to the treaty. Although not an enacting part, the preamble is expected to express the scope, object and purpose of an act
35B. Kuźniacki, Supra n. 28 36S. van Weeghel, Supra n. 13 37BEPS Action Plan 6, Supra n. 2
or convention more comprehensively than the long title. Preambles can be seen to have both a contextual and a constructive role in statutory interpretation. The contextual role is where the preamble assists with confirming the ordinary meaning of the enactments, and assists with determining if there is any ambiguity. The constructive role is where the preamble is effectual in clarifying or modifying the meaning of ambiguous enactments.
Bifurcating the text of the preamble as it exists in the 2017 OECD Model, it has three stated purposes: (i) the elimination of double taxation; (ii) the prevention of tax evasion; and (iii) the prevention of tax avoidance. The preamble language also mentions the ‘desire’ of states to develop economic relations and enhance tax cooperation which is an optional text in the MLI that may be opted by member states. Additionally, it can be observed in the Commentaries to the 2017 OECD Model certain additional purposes of the convention which do not find its way into the text of the updated preamble viz. the purpose of the treaty also includes bona fide exchange of goods and services and the movement of capital and persons39.
According to the OECD40, treaty abuse, particularly treaty shopping, is one of major ways in which companies indulge in BEPS activities. Hence, the amendment of the preamble ensures to include specific reference to tax avoidance through treaty shopping. Accordingly, the main reason for including the amended language in preambles to tax treaties appears to be explicitly to elevate the prevention of non-taxation and reduced taxation via tax avoidance (and tax evasion) to the level of the context − and as one of the purposes − of tax treaties41 and therefore consider not only the primary aim of the treaty to encourage cross-border economic activity by allocating taxing rights in a fair and reasonable manner in order to reduce or eliminate double taxation, but also the intention of the contracting jurisdictions that the treaty not create opportunities for non-taxation or reduced taxation through tax treaty shopping and other forms of tax avoidance42. This may therefore possibly change
39Para 54 of OECD Model: Commentary on Article 29(9) (2017 Update) 40BEPS Action Plan 6, Supra n. 2
41B. Kuźniacki, Supra n. 28
precedence value of the Supreme Court of India case43 which held in the context of the India-Mauritius tax treaty, that treaty shopping is consistent with the object and purpose of tax treaties because it encourages capital and technology inflows.
By the signing of the MLI, the new preamble will replace any existing preamble or the absence of any existing preamble thereby amending a large number of tax treaties to include the updated preamble.
7.2 Interpretative value of the Preamble
Paragraph 16.2 of the Introduction to the 2017 OECD Model annexed in para 11.4 below clarifies the applicability of the rules of interpretation under the Vienna Convention on the Law of Treaties (VCLT)44. The preamble’s interpretative value is highlighted by the rule of interpretation under Article 31(1) (annexed at para 11.6 below) of the VCLT. According to the basic rule of interpretation of treaties in Article 31(1) of the VCLT it is elucidated that a treaty shall be interpreted in ‘good faith’ and in accordance with the ordinary meaning to be given to the terms of the treaty interpreted “in their context” and in light of their “object and purpose”. Further, Article 31(2) (annexed at para 11.6 below), confirms that, for the purpose of this basic rule, the context of the treaty includes its preamble.
By including in the title of the 2017 OECD Model that the purpose of the convention is the prevention of tax avoidance and evasion and by elucidating in the preamble to the convention that it is not a purpose of the convention to allow double non taxation or reduced taxation through avoidance strategies, the OECD obviously hopes that henceforth Courts will interpret the provisions of tax treaties that follow the amended 2017 OECD Model in light of those objectives.
7.3 ‘Object and Purpose of the Treaty’ versus ‘Object and Purpose of the Relevant Provisions of this Convention’
Article 31 of the VCLT is in marked contrast from both the commentary in Article 1 of the OECD Model as well as the express mandate of Article 29(9) of the OECD Model. While
43IN: Supreme Court, 7 Oct. 2003, Union of India v. Azadi Bachao Andolan. Although it should be noted
that Mauritius has not included the treaty with India in its Covered Tax Agreements and therefore the MLI will not amend the India-Mauritius tax treaty to include the updated preamble and the PPT.
the former emphasizes on an understanding of the object and purpose of the treaty, the latter two emphasize on the object and purpose of the relevant provisions.
Such difference in text has many authors45 discussing differing interpretations and applications. They believe that the wordings of Article 29(9) is rather restrictive as compared to Article 31 of the VCLT inasmuch as it makes a direct reference to the object and purpose of the relevant treaty provisions and not to the object and purpose of the treaty itself.46 The subtle difference could have significant implications. If the PPT is interpreted
on a strict wording it would take into account just the object and purpose of the specific provision. However, it is not always easy to ascertain the object and purpose of a relevant provision. There is some guidance in the OECD commentaries with regard to a few of the articles of the convention for e.g. i) the commentary explains that the object and purpose of Article 15(2) of the convention is to avoid the source taxation of short-term employments to the extent that the employment income is not allowed as a deductible expense in the State of source because the employer is not taxable in that State as it neither is a resident nor has a permanent establishment therein; or ii) although article 5(3) of the OECD model convention states that “[a] building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months,” it is reasonable to conclude that the object and purpose of this provision is to exclude short-term building or construction or installation projects from source taxation of business profits that would otherwise be permitted under article 7(1) of the convention if the project were characterized as a permanent establishment; or iii) although the substituted property rule in article 13(4) of the OECD model convention does not explicitly say so, it is reasonable to infer from its text and its relationship to articles 13(1) and (5) that its object and purpose is “to prevent the non-taxation by the source state of capital gains derived principally from immovable property situated in the source state.”. This may not be possible for all provisions of the OECD Model. Although the specific object and purpose of each distributive rule in a tax treaty may not be immediately obvious, the overall object and purpose of such provisions is generally understood to be to allocate taxing rights among contracting states in a fair and
45S. van Weeghel, Supra n. 13; A.B. Moreno, Supra n. 28; L. De Broe & J. Luts, Supra n. 22 46A.B. Moreno, Supra n. 28
reasonable manner, in order to encourage cross-border economic activity by reducing or eliminating economic double taxation.
Treaties are negotiated and finalised for multiple purposes and a specific provision is agreed to within the framework of overall treaty object such that each provision helps towards achieving larger treaty objects. Most treaty provisions limit themselves to establish limits or thresholds, therefore one is not able to interpret them in isolation, as the individual purpose of each treaty provision cannot exist in a vacuum but rather feeds into the operative purposes of the tax treaty and eventually into its ultimate purpose47.
As explained earlier, the examples in the 2017 OECD Model and Commentaries also use both object and purpose of the convention and object and purpose of the relevant provision is different examples. It is therefore understood that the text of a treaty provision remains the starting point, in particular the ordinary meaning of the terms in their context and in light of the object and purpose of the treaty. Since the title and preamble form part of the context of the Convention and constitute a general statement of the object and purpose of the Convention, they should play a role in the interpretation of the provisions of the Convention.
However, divergence in interpretation should be resisted because it is clear that an international autonomous meaning is intended to be introduced through the uniform adoption of the PPT. Common language may be possible only if courts and revenue authorities apply a consistent approach to interpretation. With this background we not move to the case law analysis to see the factors considered by courts.
8 Case Law Analysis
Based on the above deconstruction of the principal purpose test, the analysis of case laws below will mainly involve the ‘object and purpose test’. As explained, the PPT is relatively new with respect to its inclusion in the OECD Model Convention. However, it has developed over the years through similar concepts which have been included in domestic laws of various countries or in some select tax treaties. The different parameters of the PPT as explained above will depend on the way it is interpreted and applied by the state judiciaries around the world. The OECD Model and its Commentary are drafted as if the object and purpose would be identical for each country that would use it as a model for its tax treaties, while in reality that is not the case48.
For that reason, below are analysed three well-known cases tried in the courts of their respective jurisdictions that involved a discussion on the object and purpose of a treaty. The goal is to bring out factors that courts have considered to demonstrate a transaction / structure to be in accordance with object and purpose or not. An attempt has been made to ascertain common factors (if any) amongst such cases that can aid taxpayers and tax administration in the application of the principal purpose test.
The selection is based on the cases that have been decided specifically on Article 13 of OECD Model (i.e. Capital Gains). The cases involving a discussion on object and purpose have then been analysed and researched in detail. The scope has been limited only to Article 13 keeping in mind that this is a Master thesis with a restricted word count.
Accordingly, the cases selected and discussed below are:
Mil Investments S.A. v. Her Majesty the Queen, Citation: [2006 TCC 460, 18 August 2006] & [2007 FCA 236, 13June 2007] – Jurisdiction: Canada – Facts of the Case and Decision Held is annexed at para 11.7 below.
Union of India v. Azadi Bachao Andolan, Citation: [2002 256 ITR 563 (HC), 31 May 2002] & [2003 263 ITR 0706 (SC), 7 October 2003] – Jurisdiction: India – Facts of the Case and Decision Held is annexed at para 11.8 below.
Alta Energy Luxembourg S.A.R.L. v. The Queen, Citation: [2018 TCC 152, 22 August 2018]49 – Jurisdiction: Canada – Facts of the Case and Decision Held is annexed at para 11.9 below.
8.1
Factors Identified
Factors considered to arrive at the decisions have been listed and described below. Later, in para 8.2 such factors have been analysed to ascertain its effect (or not) on the object and purpose test keeping in mind the subject of this thesis.
8.1.1 CASE 1: Canada - Mil Investments S.A. v. Her Majesty the Queen
8.1.1.1 Reasons for sale – Bonafide Purpose?
As part of the steps to invoke and apply the Canadian GAAR, although both parties had accepted that the transactions involved did result in a tax benefit, the Court found that the sale of DFR shares to Inco was undertaken for a bona ride purpose other than to obtain the tax benefit. It is explained that Mr. Boulle was a "paper millionaire" with financial burden, his entire wealth being held in non-liquid shares of DFR. The sale ensured him of financial security, regardless of the success or failure of DFR50. Boulle also testified that he wanted to “pay off debts” and wanted to “get back to exploring and building mines in Africa”. These have been accepted by the Court as “bona fide purpose”.
8.1.1.2 Influence on transactions / decisions
It has also been taken into consideration by the Court that MIL (through Boulle) along with his associates held a minority holding in DFR and in fact declared their interest at the board meeting and refrained from voting thereat. The Court held that Boulle did not have the ability to organize and effect a favorable vote for the sale to Inco, not being entitled to vote on the directors' recommendation, and being a minority shareholder. Under the circumstances, it was unimaginable that Boulle could have persuaded other sophisticated shareholders, to vote in favor of the Sale simply because he alone might
49A decision by the higher court was pronounced by the Federal Court of Appeals on 12February 2020
having citation [2020 FCA 43, 12 February 2020]. This decision has not been covered in this thesis since it was made available in public domain towards the end of my research period.
50CA: TCC, 18 Aug. 2006, Mil Investments S.A. v. Her Majesty the Queen, 9 ITLR 2006, 25, Tax Treaty
enjoy a tax benefit’51 (emphasis supplied). The non-influence of MIL on the sale was considered to be non-existent and was accordingly said to be for a bona fide purpose other than to obtain a tax benefit.
8.1.1.3 Preordained transactions – Part of “series”
The minister alleged that MIL undertook a “series of transactions” that resulted in an avoidance transaction. The alleged series involved the exchange of DFR shares for Inco shares followed by the declaration of dividend to the shareholders of MIL and concluded with the move of MIL’s residency to Luxembourg. These transactions were specifically undertaken to reduce the shareholding of MIL below 10% in order to enjoy the benefit under Article 13(4) of the Canada-Luxembourg treaty. The Court ruled against the Tax Department to find that none of the transactions were an avoidance transaction based on the reasoning provided by MIL’s counsel. Further, a discussion has been undertaken to understand whether the final transaction of sale of DFR shares which resulted in the capital gains of CAD 426 million formed part of the alleged series or was a “tax consequence” of the series. The court held that the “tax benefit” as defined under GAAR ended with the series and therefore cannot be extended to the final sale unless the said sale was proved to be part of the series.
In order to assert whether the transactions were ‘preordained’ or ‘contemplated’ at the time of the “series”, the Court relied on the Supreme Court case of Canada Trustco Mortgage Co.52. Evidence was placed to show that DFR took active steps to prevent any purchase53 e.g. entering into standstill agreements prohibiting further purchase of DFR shares, etc. It could not be shown that the sale was intended when the first transaction was entered into. The Court concluded that the sale could not be included in that series because of the mere possibility of a future potential sale of any shares.
51Ibid, at Para 40
52CA: 2005 SCC 54, 2005 D.T.C. 5523 (Eng.)
53CA: TCC, 18 Aug. 2006, Mil Investments S.A. v. Her Majesty the Queen, 9 ITLR 2006, 25, Tax Treaty
8.1.1.4 Reasons for change in Residence – Avoidance Transaction?
The move of MIL from Cayman Islands to Luxembourg was a point of contention. MIL’s counsel submitted that the choice of Luxembourg was due to the fact that it was a better jurisdiction than the Cayman Islands in which to carry on a mining business in Africa54. To solidify this argument, MIL also submitted that shortly after the move, Boulle continued another Cayman Islands company, Gondwana, with mining activities in Africa, to Luxembourg for the same reasons55. This reasoning of MIL was accepted by the court
to establish that although the move effected a tax benefit, it was not the main motive for the move. Accordingly, the Court held that the Canadian GAAR did not apply because none of the transactions, including the move into Luxembourg, were avoidance transactions that were undertaken primarily to obtain a tax benefit.
At the time of appeal to the FCA, MIL conceded that the continuation into Luxembourg was an avoidance transaction, nonetheless the FCA upheld the decision on the ground that the Tax Department had failed to establish that the transactions were abusive.
8.1.1.5 Process of Negotiation - Article 13(4) of the Canada-Luxembourg Treaty vs OECD Model Convention
The court looked at Article 13 of the treaty. Under paragraph 4 of Article 13 Canada is allowed to tax the capital gain on the shares of a company that is a resident of Canada, the value of which shares is derived principally from immovable property situated in Canada provided that the taxpayer has a substantial interest in the capital stock of the company. A substantial interest exists when the taxpayer and persons related thereto own 10% or more of the shares of any class of the capital stock of a company. Therefore, a capital gain on the sale of an interest of less than 10% in such a company is exempt from Canadian tax.
This exemption is not found in the OECD Model Convention upon which the treaty is based. This led the Court to view that the negotiators were aware of the tax treatment of capital gains is Luxembourg and knew that capital gains may not be taxed in Luxembourg
54Ibid, at Para 49 55Ibid
and nevertheless ceded an exemption of source taxation on capital gains to residents of Luxembourg. It further stated that “In drafting those exemptions it must be presumed that Canada had a valid reason to allow Luxembourg to retain the right to tax capital gains in those specific circumstances, for example, the desire to encourage foreign investment in Canadian property. The MIL's reliance upon a Treaty provision as agreed upon by both Canada and Luxembourg cannot be viewed as being a misuse or abuse.”56. MIL is also
one of several cases in which the Canadian courts have compared the wording of a treaty with that of other Canadian treaties in order to determine what sorts of provisions the negotiators have chosen not to include and then have drawn negative inferences from the absence of those provisions57.
In the appeal to the FCA, the issue of whom such concession was designed to be given was raised. The FCA held that if the object of the exempting provision was to be limited to portfolio investments, or to non-controlling interests in immoveable property, it could have been specified in the Treaty58. However, the FCA did not address the more fundamental question of whether, when a person undertakes a transaction solely, or mainly, for the purpose of meeting a threshold necessary to access a tax benefit, it respects the object of the exempting provision or contravenes the intent of the negotiators.
8.1.1.6 Inherent anti-abuse rule
The Tax Department presented an alternative written argument that even if the GAAR does not apply to deny the treaty benefit in this case, it is still possible to deny the treaty based on the anti-abuse rule inherent within the Treaty itself resulting in the of application of a substance over form approach59. In order to establish an "inherent rule" the Minister presented an expert from Luxembourg, Professor Alain Steichen.
56Ibid, at Para 74
57IFA Cahiers 2010 - Volume 95A. Tax treaties and tax avoidance: application of anti-avoidance provisions
- Canada - Branch Reporters: Nathalie Goyette, Phil D. Halvorson
58CA: FCA, 13 June 2007, Mil Investments S.A. v. Her Majesty the Queen, 9 ITLR 2007, 1111, Tax Treaty
Case L. IBFD, at Para 7
59It should be noted that Vogel (2015) favours a textual approach, in maintaining that “the limits of the
application of tax treaties can only be ascertained by interpreting the treaty” and accordingly does not side with the contention of the Court
The expert’s first argument was that a specific treaty benefit may be denied in situations where both Canadian and Luxembourg domestic anti-avoidance rules would deny that benefit. To determine presence of anti-abuse rule, reliance was placed on Articles 26, 31 and 32 of VCLT. In accordance with Article 31 of the VCLT for the application of “ordinary meaning”, the Court found that neither Article 13 nor any other article of the Treaty provided for a specific anti-treaty shopping provision explicitly authorized to deny the Treaty Benefits under Article 13(5). Only the preamble to the Treaty referring to the prevention of tax avoidance might be relied upon60. In the opinion of the Judge, the
preamble, does not constitute an anti-treaty shopping provision on which Luxembourg could rely upon in order to deny treaty benefits. The Court further opined that the preamble would need to be backed up by provisions in the tax treaty itself defining the various elements of avoidance transactions to deny treaty benefits.
The Court further backed its decision by stating that at the time of concluding the treaty, both Canada and Luxembourg had domestic anti-avoidance rules and yet the Treaty made no reference to them61.
Accordingly, the Court held that without any explicit wording to the contrary, an anti-avoidance rule could not be deemed inherent to the tax treaty in question62.
8.1.1.7 Misuse or Abuse – Legitimacy of Tax Planning
As the Tax Court found that the sale was not an avoidance transaction, it was not necessary to analyse whether the sale was abusive under the GAAR. The court stated, however, that if it were to do such an analysis, it would focus on whether the exemptions relied upon by MIL in Article 13(4) of the treaty were misused or abused. The Tax Court did not agree that the prima facie finding of abuse could arise from the choice of the most beneficial treaty: “There is nothing inherently proper or improper with selecting one foreign regime over another. Tax Department’s counsel was correct in arguing that the selection of a low tax jurisdiction may speak persuasively as evidence of a tax purpose for an alleged avoidance transaction, but the shopping or selection of a treaty to minimize
60CA: TCC, 18 Aug. 2006, Mil Investments S.A. v. Her Majesty the Queen, 9 ITLR 2006, 25, Tax Treaty
Case L. IBFD, at Para 81
61Ibid, at Para 83
tax on its own cannot be viewed as being abusive. It is the use of the selected treaty that must be examined63”.64The Court relied on the landmark case of IRC v. Duke of Westminster65, wherein every man’s entitlement to arranging one’s affairs in a tax efficient manner was legitimate and acceptable. Accordingly, it was held that, commercial transactions without any particular tax motive and carried out in such a manner to achieve least unfavourable tax consequence is not avoidance.
The court therefore concluded that “the shopping or selection of a treaty to minimize tax on its own cannot be viewed as being abusive” and the taxpayer’s “reliance upon a Treaty provision as agreed upon by both Canada and Luxembourg cannot be viewed as being a misuse or abuse66.
8.1.2 CASE 2: India - Union of India v. Azadi Bachao Andolan and Ors.
8.1.2.1 Sanctity of tax treaty
Power to enter into a treaty is an inherent part of the sovereign power of the State. Accordingly, the SC held that the courts are not concerned as regards the manner in which tax treaties are negotiated or enunciated; nor is it concerned with the wisdom of a particular treaty. Regarding the merits of the challenge to the constitutionality of the treaty itself, the SC held that such validity has to be tested on the anvil of the law-making power. The contention that the tax treaty between India and Mauritius was ultra vires was rejected, firstly because the tax treaty was entered into by the central government within the parameters of the legislative provision giving it this power and secondly, because the purpose of the tax treaty is to effectuate the prescribed objectives namely to grant relief in respect of which income tax has been paid in India and a foreign country and avoidance of double taxation of income under the Income Tax Act and under the foreign country’s tax laws.
63CA: TCC, 18 Aug. 2006, Mil Investments S.A. v. Her Majesty the Queen, 9 ITLR 2006, 25, Tax Treaty
Case L. IBFD, at Para 72
64R. Danon, Double Taxation Conventions: Latest Developments, 3rd Symposium of International Tax
Law. Schulthess, Zurich 2010
6519 T.C. 490 (1935)
66Duff, David G., Tax Treaty Abuse and the Principal Purpose Test - Part I (September 21, 2018). Canadian
8.1.2.2 Residence Criteria under the Tax Treaty and Principle of “liable to taxation”
For the purpose of definition of the term “resident” under a tax treaty, what is relevant is the legal liability to tax in a particular country, and not the fiscal fact of actual payment of tax in that country. Merely because the Mauritius government had granted exemption from Mauritius tax to a particular source of income (e.g. capital gains), it cannot be said that the taxpayer is not “liable to tax” in Mauritius. The premise that “liability to taxation” is the same as “payment of tax” is fallacious. “Liability to taxation” is a legal situation; “payment of tax” is fiscal fact. For the purpose of application of the India-Mauritius tax treaty, what is relevant is the legal situation, namely, “liable to taxation”, and not the fiscal fact of actual “payment of tax”. Merely because an exemption has been granted in respect of taxability of a particular source of income in Mauritius, it cannot be postulated that an entity is not “liable to tax” in Mauritius. Hence the argument of the public interest litigators that the investors are not ‘resident’ under the Treaty is not applicable.
Accordingly, the SC held that the test of liability for taxation is not to be determined on the basis of an exemption granted in respect of any particular source of income but by taking into consideration the totality of the provisions of the income tax law that prevails in either of the contracting states entering into a tax treaty. “Liability to taxation” does not mean “payment of tax”.
8.1.2.3 Process of Negotiation
Tax treaties should not be interpreted in the same manner as domestic tax legislation. This is because they are negotiated and entered into at a political level and have several considerations as their bases. The main function of a tax treaty should be seen in the context of aiding commercial relations between the countries entering into it and as being essentially, a bargain between two treaty countries as to the division of tax revenues between them in respect of income taxed in both their jurisdictions.
8.1.2.4 Absence of LOB Clause – No inherent anti-abuse rule
Tax treaties of countries not favoring “treaty shopping” incorporate a “limitation of benefits” clause therein (for example the tax treaty between India and the United States). Such a “limitation of benefits” clause is not provided in the India-Mauritius tax treaty and
so there are no disabling or disentitling conditions prohibiting the resident of a third nation from deriving benefits thereunder (i.e. treaty shopping).
Further, the Supreme Court upheld the contention of the Indian government that there are many principles in a fiscal economy which, though at first blush might appear to be evil, are tolerated while entering into tax treaties between countries since they are in the interest of long-term development of the countries entering into these tax treaties. If the Indian government intended to bar a national of a third country to take the benefits of the tax treaty between India and Mauritius, it would have provided for a suitable “limitation of benefits” clause therein. By implication, where such a clause does not exist in the tax treaty, the same cannot be read into it.
8.1.2.5 Legality of Treaty Shopping
“Treaty shopping” should ideally be looked at by the government and not by the courts as it involves various political considerations. Many developed countries tolerate “treaty shopping” for other non-tax reasons unless this leads to significant loss of tax revenues. Many developing countries also allow “treaty shopping” to attract scarce foreign capital and technology, which they need. “Treaty shopping” is therefore to be viewed holistically and perhaps regarded in contemporary thinking as a necessary evil in a developing economy
The SC held that if the residents of a third contracting state qualify for a benefit under the India-Mauritius tax treaty they cannot be denied the benefit on a ground that “treaty shopping” is unethical and illegal. If it was intended that a national of a third country should be precluded from the benefits of the treaty, then a suitable term of limitation to that effect should have been incorporated therein.
A number of cases have been cited through-out the order. Relevant to this analysis it is imperative to note that relying on the observations in certain international and Indian decisions, the SC concluded that the principle laid down in the Duke of Westminster67
case could still hold good, notwithstanding the temporary turbulence created in the wake of the McDowell case68.
8.1.2.6 Relevance of Preamble
The Preamble of the Treaty, which recites that it is for ‘encouragement of mutual trade and investment’ cannot be lost sight of, while interpreting the treaty. SC notes that drafting of treaties is notoriously sloppy because to get agreement, uncertainty is required, and that one cannot interpret a treaty based on the technical principles of interpretation of law alone.
8.1.3 CASE 3: Canada - Alta Energy Luxembourg S.A.R.L. v. The Queen
8.1.3.1 Purpose of Articles of the treaty
On deciding the issue, the Court has analyzed the purpose of Article 13. It states that all provisions are distributive rules that define circumstances under which each contracting state can tax gains. Article 13(1) and 13(5) sheds light on the purpose of Article 13(4)69.
Article 13(1) is a provision commonly found in most tax treaties. It provides that gains derived from the disposition of immovable property are subject to tax in the source state. Article 13(5) is a distributive rule of last application. It applies only in cases where capital gains are not otherwise taxable under paragraphs (1) to (4) of Article 13 of the Treaty. Article 13(5) embodies the principle that the source state gives up its right to tax the capital gain as an incentive to promote capital inflows to fund business operations in that jurisdiction.
The purpose of Article 13(4) is to prevent the non-taxation by the source state of capital gains which is derived principally from immovable property. Absent this rule, it would be possible for a company to conduct a share sale instead of an asset sale to avoid taxation in the source state. The court held that the carve-out which excludes properties in which the business is carried on is a ‘exception to the principle’. It thus reflects a compromise between two contracting states.
68IN: McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148/22 Taxman 11 (SC)
69CA: 22 August 2018, Alta Energy Luxembourg S.A.R.L. v. The Queen, 2018 TCC 152, Tax Treaty Case
Thereby, the Court has placed enormous reliance on the purpose of a specific articles and has taken into consideration principles behind entering into each article and concluded that Excluded Property exception has been intended to encourage investments by Luxembourg residents in Immovable Property acquired to be used in a company’s business.
8.1.3.2 Reliance of External Sources
The court in the Alta Luxembourg case has placed reliance on Positon Paper, Joint Book, Vol IX, Tab 117, at p 3016 dated 31st January 1991 wherein a government official has traced the dividing line between “Immovable Property” and “Excluded Property”70.
Various references have been made to this Position Paper specifically with regard to ascertaining excluded property in the resource sector. It states that two conditions must be satisfied for oil and gas reserves to qualify as Excluded Property. First, the corporation must be actively engaged in the exploration of the reserve. Secondly, the reserve must be actively exploited or kept for future exploitation by the owner. Although the Tax Department argued in the negative, the Court held that the CRA cannot repudiate its position as taxpayers should be able to rely on stated positions71.
8.1.3.3 Considering Industrial Practices
Alta Canada drilled in and extracted hydrocarbons only from a very small portion of the property it controlled in the Duvernay Formation. This was due to a number of reasons including (a) the nature of conventional oil extraction is such that since oil is often present in a large pool, a vertical well on a particular section of a formation often allows the operator to extract oil from many of the sections where no drilling takes place; and (b) initial drilling is done on a trial and error basis, and only once the best drilling methods are identified and documented, the same methods are used to drill wells elsewhere in the formation. Before the final product is brought to market, the stakeholders would need to build a processing facility and pipeline for transportation. Such infrastructure involves large amounts of capital which should be justifiable in comparison to the steady supply of the hydrocarbons. Shale oil deposits present greater development challenges than
70Ibid, at Para 42 71Ibid, at Para 56
