Canada’s tax court provides insight on tax treaties, foreign holdcos and treaty-shopping


Financier Worldwide Magazine

November 2018 Issue

In a recent case, Alta Energy Luxembourg S.A.R.L v. The Queen, Canada’s tax court ruled favourably on a tax planning structure used by foreign investors pursuing a development in Canadian shale oil. In its decision, the court provided clarity on how investors in Canadian early stage oil & gas developments can qualify for treaty benefits under the Canada-Luxembourg Income Tax Convention 1999 (Treaty). Additionally, the court provided helpful commentary on the application of Canada’s general anti-avoidance rule (GAAR) in the context of foreign holding companies, and useful insights on treaty-shopping in general.


In the spring of 2011, Blackstone Group LP, a major private equity fund, partnered with Alta Resources LLC, an industry leader in US shale oil & gas, to form a US LLC with the goal of investing in oil & gas reserves in North America. The investment team ultimately decided to develop a shale property in the Duvernay Formation, situated in north-western Canada. Consequently, Alta Energy Partners Ltd (Alta Canada) was incorporated as a wholly-owned Canadian subsidiary of the US LLC, and served as the operating company for the development.

As a result of investing in assets situated outside of the US, the existing corporate structure became suboptimal from a US tax perspective. Therefore, the investment team pursued a reorganisation in which the shares of Alta Canada were transferred to a Luxembourg holding company (Luxembourg Holdco). This transaction would have triggered capital gains tax but for the fact that the US LLC’s cost in the shares was equal to their fair market value. In the end, the restructuring put the investors in a better tax position.

After approximately 18 months of operations involving early-stage drilling and exploration activities, Alta Canada was sold to a third-party for a significant gain. This gain became the subject of litigation as the Canada Revenue Agency (CRA) claimed jurisdiction to tax the gain, while Luxembourg Holdco relied on Article 13(5) of the Treaty to exempt the gain from Canadian tax.

Canada’s domestic tax law

Under Canada’s domestic tax law, a non-resident is subject to Canadian income tax on taxable capital gains realised from the disposition of ‘taxable Canadian property’ that is not ‘treaty-protected property’. Taxable Canadian property includes Canadian resource properties or shares of private companies that derive the majority of their value from Canadian resource properties. In the Tax Court’s view, there was no question that the shares of Alta Canada were ‘taxable Canadian property’ since their value was derived entirely from the development at the Duvernay Formation. Therefore, the main issue before the court was whether the Alta Canada shares were ‘treaty-protected property’ – property that, when disposed of, results in a gain that is exempt from Canadian tax because of a tax treaty signed by Canada and another country.

The Canada-Luxembourg Tax Treaty

Canada signed the Canada-Luxembourg Income Tax Convention 1999 with the Grand Duchy of Luxembourg on 10 September 1999. The Treaty has been in force since 17 October 2000.

Under Article 13 of the Treaty, Canada and Luxembourg specifically address the tax treatment of capital gains. The Treaty states that gains derived from the sale of shares owned by a Luxembourg company are taxable in Canada when the value of those shares was derived principally from ‘immovable property’ situated in Canada. Otherwise the gain is only taxable in Luxembourg, where capital gains are generally not taxed.

The court found that the shares of Alta Canada derived their value from immovable property situated in Canada. However, Article 13(4) of the Treaty provides a carve-out exception, which states that property “in which the business of the company…was carried on” (excluded property) is not to be included as ‘immovable property’ for the purposes of determining whether the value of a company’s shares is derived principally from immovable property situated in Canada. Therefore, the critical issue in this case was determining whether the Duvernay Formation development fell under this exception, whether it was ‘excluded property’.

The court’s decision

Ultimately, the court interpreted the Treaty in a manner such that Alta Canada’s development at the Duvernay Formation was considered ‘excluded property’. This meant that the gains derived by Luxembourg Holdco were not taxable in Canada.

In reaching its decision, the court interpreted the Treaty liberally, with a view to implementing the true intention of the parties. The court found that the Treaty’s negotiators intended for a resource property to qualify as excluded property when such property is developed in accordance with the industry’s best practices.

The court recognised that oil & gas projects are not typically fully developed and exploited at once. In order to attract sufficient capital for a full-scale development and extraction project, a resource owner must first prove the economic value of the reserve. This normally involves several stages of preliminary drilling and testing in different locations throughout the resource area. The court found that Alta Canada used these industry best practices in the development of the Duvernay Formation, which ultimately supported its finding that the development was ‘excluded property’, notwithstanding the relatively limited scale of operations conducted on the project.

Luxembourg Holdco argued at trial that much of its resource properties were being held for future use. Importantly, the court placed a large emphasis on the fact that the CRA had publicised a document confirming its view that resource property would qualify as ‘excluded property’ if the property was actively exploited or held for future exploitation. Since the court had already found that the Duvernay Formation was actively exploited in accordance with industry best practices, the CRA was hard-pressed to argue that the property was not ‘excluded property’. The court held the CRA to its interpretation as outlined in the publicised document, and rejected the alternatives they submitted at trial. In this respect, the court explicitly reassured taxpayers that they should be able to rely on the stated positions of the CRA.

GAAR and treaty-shopping

Perhaps the most interesting and valuable commentary coming from the tax court in this decision is the discussion of the application of Canada’s GAAR and treaty-shopping. Canada’s domestic tax law includes a GAAR, which is used to override tax avoidance transactions that are considered abusive. In this case, the CRA failed to make a case that the restructuring was abusive to either the Income Tax Act (Canada) or the Treaty.

First, the CRA argued that the restructuring amounted to an abuse of subsection 115(1)(b) of the Act. Subsection 115(1)(b) imposes tax on capital gains realised by non-residents on the disposition of taxable Canadian property that is not ‘treaty-protected property’. The court found that the Alta Canada shares were ‘treaty-protected property’ and that Luxembourg Holdco was therefore properly exempted from Canadian capital gains tax. Since the exception for ‘treaty protected property’ found in subsection 115(1)(b) operated as intended, the court concluded that there was no abuse of the Act.

Second, the CRA argued that the restructuring was abusive to the Treaty, but ultimately the court found that the underlying rationale of Article 13(4) of the Treaty was to limit Canada’s power to tax capital gains in circumstances where there is a sufficient level of economic activity exercised in owning the Canadian immovable property. In reaching this conclusion the court made a number of observations. First, the carve-out for immovable property contained in the Treaty was a departure from the Organisation for Economic Co-operation and Development (OECD) Model Treaty. The court held that this departure was intentional and a result of a bargain struck between Canada and Luxembourg. The court was therefore inclined to give effect to the carve-out, and was reluctant to apply the GAAR to disturb the bargain struck between the two countries. Second, parties to a tax treaty are presumed to know the other country’s tax system. Luxembourg typically does not tax capital gains, and Canada is presumed to have known this when it was negotiating a tax treaty with Luxembourg. Therefore, if Canada wanted to avoid the potential for a situation giving rise to double non-taxation (which was the result of the restructuring in this case), it could have insisted on limiting the benefits of Article 13 to situations where the capital gain was otherwise taxable in Luxembourg. Finally, the CRA argued that the restructuring was abusive of the Treaty because the overall result amounted to treaty-shopping. Treaty shopping is a term of art and is not defined or referred to in the Income Tax Act nor the tax treaties.

The court determined that applying the GAAR to combat treaty-shopping in this case was not appropriate as the Treaty has relatively narrow anti-treaty-shopping provisions compared to other treaties, such as the Canada-United States Tax Convention, which contains a comprehensive limitation of benefits provision. The court noted that the Treaty has no similar limitation of benefits provision. Therefore, absent a limitation of benefits provision in the Treaty, residence is the determining factor for whether a taxpayer is entitled to treaty benefits. Since Luxembourg Holdco was a resident of Luxembourg, and there was no comprehensive limitation of benefits provision in the Treaty, it would be inappropriate to deny it the benefits of the Treaty.

Also, in 2014, Canada proposed broad domestic anti-treaty-shopping legislation that was to apply to all of Canada’s tax treaties, but the legislation was never enacted. The court was of the opinion that the CRA was seeking to use the GAAR to effectively achieve the same result that was proposed in the legislation. The court felt that this was an inappropriate use of the general anti-avoidance rule and that amending tax treaties should be left to parliament.


This case is helpful to taxpayers that are using, or considering the use of, foreign holding companies for investments in Canadian businesses which derive their value primarily from Canadian real estate or Canadian resource properties. For now, it appears that the Tax Court of Canada is reluctant to take an active role in denying treaty benefits through the application of the general anti-avoidance rule to a taxpayer where they are resident for the purposes of the treaty. Taxpayers can be confident that residence remains the determining factor for entitlement to treaty benefits in the absence of a limitation of benefits provision. Additionally, the court clearly placed the onus on governments to address any shortfalls in anti-treaty-shopping provisions, rather than using the general anti-avoidance rule to achieve the same result. Going forward, taxpayers should be aware of Canada’s participation in the OECD’s Multilateral Instrument, which will modify many of Canada’s existing bilateral tax treaties by introducing a principle purpose test and perhaps a comprehensive limitation of benefits provision in the future. Although the taxpayer in this case was successful, the future treaty regime may result in different outcomes.


Jack Bernstein is a partner and Tyler Brent is an associate at Aird & Berlis LLP. Mr Bernstein can be contacted on +1 (416) 865 7766 or by email: Mr Brent can be contacted on + (416) 865 7729 or by email:

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