The COVID-19 pandemic has revealed the fault lines of the globalized economy and triggered a rise of protectionist trade policies. The latest chapter in this trend away from a multilateralism is the U.S. withdrawal from OECD negotiations over the tax challenges of the digitalisation of the economy, which in turn has provoked European nations to retreat to unilateral solutions.
The Globalized Economy and COVID-19
In the period between the end of the Second World War and the on-set of the COVID-19 pandemic, the globalization of production created deep economic interdependencies, binding domestic economies to a global supply chain. Consequently, when the COVID-19 pandemic broke, the structure of global trade was such that a disruption in one link of the supply chain created effects all down the line.
In March 2020, the six nations hit hardest by COVID-19 were the U.S., China, Korea, Italy, Japan, and Germany. At the time, these six nations accounted for 55 percent of world supply and demand, 60 percent of world manufacturing and 50 percent of world manufacturing exports. China, where the virus first emerged, was largest contributor to global trade, the “workshop of the world,” making up 41 percent of world manufacturing exports and 20 percent of global trade in manufacturing intermediate products. Due to the globalization of production, when the pandemic decreased production in these six nations, and China in particular, the effects reverberated globally.
In January 2020, the OECD/G20 Inclusive Framework on BEPS, a group of 137 countries including Canada, endorsed a statement, which affirmed their commitment to build a global solution to the tax challenges created by the digitalisation of the economy. This work has been underway since 2015 and is slated to be finalized by the end of 2020.
The statement, itself a political expression of on-going commitment, was accompanied by additional documents which, provide an outline of the “architecture” of the currently agreed upon Unified Approach under Pillar One, a programme of work descriptions, details on the multinational enterprises (“MNEs”) that will be impacted by the initiatives under Pillar One, and a progress report on Pillar Two work (collectively the “January 2020 Statement”). The biggest development presented in this set of documents is the architecture of the Pillar One solution, including a clarified explanation of a new taxing right for market jurisdictions.
On April 22, 2020, the Canada Revenue
Agency (“CRA”) indicated that it would allow special favorable tax treatment to
employees working from home during the COVID-19 crisis.
In particular, the CRA will accept that
the reimbursement of an employee, for amounts spent on personal computer
equipment to enable the employee to work from home, mainly benefits the
employer. As a result, the reimbursed amount will not be a taxable benefit to
the employee. This relief is to apply
for amounts up to $500 and only in respect of amounts for which the employee
In the normal course, an employer can
provide an employee with an allowance for home office expenses, which is a
taxable benefit for the employee. Alternatively, the employer can decide to
reimburse an employee expense upon presentation of an invoice, in which case
the reimbursement will be a taxable benefit if it primarily benefits the
employee rather than the employer. Usually if an employee receives a
reimbursement for home office equipment, it is characterized as a personal
expense, primarily for the employee’s benefit, and therefore a taxable benefit.
The CRA’s announcement does not change
the tax consequences for employers. An
employer providing an employee with reimbursements for home office expenses,
even certain capital expenses such as the acquisition of tools, will normally
be entitled to deduct the full amount of the reimbursements as a business
expense, provided the amount is reasonable in the circumstances.
 See CRA Interpretation, 2011-0402581I7 —
Allowance for workspace in the home, July 12, 2011. See also, CRA,
Interpretation Bulletin, IT-352R2 — Employee’s Expenses, Including Work Space
in Home Expenses, August 26, 1994.
 See CRA, Tech Interp, 1999-0013955 —
Construction and expenses — workspace, February 3, 2000.
With the increase in working at home arrangements due to
current events, employers and their employees may have questions about the tax
treatment of home office expenses for these employees.
Generally, an employer can compensate an employee for home
office expenses by way of an allowance or a reimbursement. An employee can also
be given an “accountable” advance which is treated as a reimbursement assuming
that the employee can provide itemized receipts and the balance is returned to
If an employee receives an allowance or if he or she pays
for the expenses out-of-pocket, then the expenses may be deductible subject to
certain requirements discussed below. If an allowance or reimbursement is
considered a taxable benefit and not deductible to the employee, the employer
can mitigate the cost to the employee by compensating the employee for the
additional tax but will have to do so on a “gross up” basis as paying an
employee’s tax is also itself a taxable benefit.
On February 12, 2020, in Canada v Alta Energy Luxembourg S.A.R.L. (2020 FCA 43), the Federal
Court of Appeal (“FCA”) unanimously
held that the general anti-avoidance rule (“GAAR”) did not deny a capital gains exemption claimed by a
Luxembourg holding company under the Convention
between the Government of Canada and the Government of the Grand Duchy of
Luxembourg for the Avoidance of Double Taxation and the Prevention of Fiscal
Evasion with respect to Taxes on Income and on Capital (the “Treaty”) following a disposition of
“taxable Canadian property” that consisted of shares of a wholly-owned Canadian
subsidiary that principally derived its value from “Canadian resource
Although the formation of the Luxembourg holding company
and its subsequent acquisition of the subsidiary’s shares were tax-motivated,
the FCA stated that treaty shopping, in itself, does not trigger the
application of the GAAR. It found that the text, context and purpose of the
relevant Treaty provisions, as
mutually chosen by Canada and Luxembourg, were not frustrated by the avoidance
transactions at issue. It concluded that the tax-free result was therefore
appropriate in the circumstances.
Alta Energy Partners, LLC (“Alta US Holdco”), a Delaware limited liability company, formed Alta
Energy Partners Ltd. (“Alta Canada”)
for the purpose of developing shale oil and natural gas properties in Alberta.
A restructuring was implemented after it was discovered
that the US holding company structure exposed foreign investors to Canadian
income tax. To fix this, ownership of Alta Canada was transferred to a
newly-formed Luxembourg holding company, Alta Luxembourg S.A.R.L. (“Alta Lux”). A year
later, Alta Lux sold the shares of Alta Canada to a third party at a
It was not disputed that the shares of Alta Canada
principally derived their value from Canadian resource property and, as a
result, were “taxable Canadian property”. However, Alta Lux took the position
that the capital gain was not taxable in Canada due to the exemption set out in
Article 13(4) of the Treaty, which provides as follows:
4. Gains derived by a resident of a
Contracting State from the alienation of:
(a) shares (other than shares listed on
an approved stock exchange in the other Contracting State) forming part of a
substantial interest in the capital stock of a company the value of which
shares is derived principally from immovable property situated in that other
taxed in that other State. For the purposes of this paragraph, the term
“immovable property” does not include property (other than rental
property) in which the business of the company […] was carried on; and a
substantial interest exists when the resident and persons related thereto own
10 per cent or more of the shares of any class or the capital stock of a
The Canada Revenue Agency reassessed Alta Lux on the
basis that the Treaty exemption did not apply and raised the GAAR in the
Tax Court of
At the Tax Court of Canada, the Crown argued that the
Treaty exemption did not apply because Alta Canada did not carry on activities
in its shale property, as it was generally set aside for future drilling and
extraction. Failing that, it argued that the exemption should be applied on a
licence-by-licence basis, with
the exemption only qualifying for those sections of the resource reserve that
had drilling and extraction activities.
The Court dismissed these arguments, largely on the
basis of a government position paper that contradicted the Crown’s restrictive
interpretation, and the commercial reality of resource exploration and
development. Accordingly, it held that Alta Lux was entitled to claim the
exemption under Article 13(4) of the Treaty.
With respect to the GAAR, the parties agreed that the
restructuring of Alta Canada under Alta Lux resulted in a tax benefit and was
an avoidance transaction in the sense that it could not be said to have been
reasonably undertaken or arranged primarily for a bona fide purpose other than to obtain a tax benefit. The only
dispute was whether the restructuring resulted in a misuse or an abuse of the Income Tax Act (Canada) (the “Act”) and/or the Treaty.
The Crown argued in the affirmative because Alta Lux (i)
was created for the sole purpose of avoiding Canadian income tax on the capital
gain; (ii) was merely a conduit used to pass on the tax exemption to its
ultimate shareholders who were not entitled to claim Treaty benefits
themselves; and (iii) paid no tax in Luxembourg.
The Court ruled that there was no misuse or abuse of the
Act because, having found that the Treaty exemption applied, the Act operated
as intended (i.e., the Alta Canada
shares were “treaty-protected property” and therefore not taxable in Canada).
The Court also held that the Treaty provisions were not
misused or abused. It stated that there could be no misuse or abuse of the
Treaty exemption in Article 13(4) if Alta Lux was a resident of Luxembourg for
the purposes of the Treaty (which the Crown did not challenge) and all of the
other requirements of the exemption were met. The Court also stated that the
absence of foreign tax paid was not relevant to the GAAR analysis, and there was
no evidence to support the Crown’s claim that Alta Lux was acting as agent (i.e., a conduit) for its ultimate
Federal Court of Appeal
The only issue before the FCA was whether the GAAR
applied to Alta Lux’s use of the Treaty exemption.
The FCA rejected the Crown’s suggestion that there had
been an abuse of the Treaty, on the basis that the purpose of the Treaty
exemption was to encourage entities who have the potential to realize income
and have commercial and economic ties in Luxembourg to invest in Canada.
First, it did not accept that a Luxembourg taxpayer must
make an investment in a Canadian company in order to claim the exemption.
Second, the FCA did not accept that a taxpayer may only access the exemption if
it actually pays tax on the relevant capital gain in its country of residence.
And third, the FCA did not accept that the exemption should only benefit
Luxembourg residents who have commercial or economic ties to Luxembourg.
The FCA held that the object, spirit and purpose of the
Treaty exemption are no broader than its text, such that a Luxembourg entity
will qualify for the exemption if: (a) it is a resident of Luxembourg for
the purposes of the Treaty, (b) it holds a “substantial interest” in the
corporation the shares of which are disposed of, and (c) the value of the
corporation’s shares is principally derived from immovable property (other than
rental property) situated in Canada in which the corporation’s business is
carried on. Alta Lux having met all of these conditions, the FCA dismissed the
Of equal importance, the FCA also commented on the
Crown’s perceived abuse of Alta Lux’s treaty shopping. Although it acknowledged
that the Department of Finance has signalled that it would take steps to curb
this practice, it found that no such steps had been formally taken during the
period in dispute. The FCA further stated that treaty shopping is not, in
itself, abusive. In this regard, it cited with approval the TCC’s decision in MIL (Investments) S.A. (2006 TCC 460,
aff’d by 2007 FCA 236), which said in part that “[t]here is nothing inherently
proper or improper with selecting one foreign regime over another” and “the
shopping or selection of a treaty to minimize tax on its own cannot be viewed
as being abusive”. Instead, “[i]t is the use of the selected treaty that must
be examined.” Having found that Alta Lux used the Treaty (and, in particular,
the exemption under Article 13(4)) as the contracting states had intended, the
FCA Court concluded that the application of the GAAR could not be justified in
Although this decision is nothing short of a resounding
victory for the taxpayer, its long-term practical impact is questionable.
Importantly, this decision was made without reference to
the Multilateral Convention to Implement
Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting
(the “MLI”) and its principal
purpose test (“PPT”), neither of
which were in effect at the time of the transactions in question.
The PPT is a broad anti-avoidance rule which provides
that a benefit under a tax treaty shall not be granted if it is reasonable to
conclude that obtaining the benefit was one of the principal purposes of the
relevant arrangement or transaction, unless it is established that granting the
benefit would be in accordance with the object and purpose of the relevant
provisions of the treaty.
Furthermore, the MLI provides that all “Covered Tax
Agreements” will be amended to include the following text (which expressly
prohibits treaty shopping) in their preamble:
to eliminate double taxation with respect to the taxes covered by this
agreement without creating opportunities for non-taxation or reduced taxation through
tax evasion or avoidance (including through treaty-shopping arrangements
aimed at obtaining reliefs provided in this agreement for the indirect benefit
of residents of third jurisdictions),”. [Emphasis added.]
The MLI became effective for Canada’s tax treaties with
many countries, including Luxembourg, (a) for withholding taxes on January 1,
2020, and (b) for other taxes (including capital gains taxes), for taxation
years beginning on or after June 1, 2020 (which, for calendar year taxpayers,
would be January 1, 2021).
The MLI raises questions about its impact on the outcome of the
FCA’s decision and beyond, including the following:
If the MLI had been in effect
at the time of the Alta Canada sale, would the result have been the same?
If not, what if the Luxembourg
holding company structure had been implemented from the outset?
Will foreign courts and tax
authorities apply the PPT in a consistent manner across a common set of facts?
Although the FCA’s decision may significantly curtail the Minister’s ability to challenge treaty shopping under the GAAR moving forward, the same cannot be said with respect to the PPT. The impact of the MLI, however, may not be known until many years from now, once tax assessments make their way through court systems in Canada and abroad. In the meantime, taxpayers may need to rely on rulings and other administrative positions for guidance.