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Treaty between Canada and Luxembourg – Canadian Federal Court of Appeal upholds Tax Court decision on non-applicability of general anti-avoidance rule to sale of shares

The Federal Court of Appeal gave its decision on 23 June 2007 in the case of Mil (Investments) S.A. v. Her Majesty the Queen. Details of the decision are summarized below.

(a) Facts. An individual, Jean-Raymond Boulle, acquired shares of Diamond Field Resources Ltd. (DFR), a Canadian public company. The shares were transferred to the Appellant, a newly incorporated Cayman Islands company, wholly owned by the taxpayer. DFR discovered a major deposit of nickel, copper and cobalt in Canada, in which several mining companies were interested. As a result, the share price increased substantially.

In 1995, the Appellant exchanged shares of DFR for shares of Inco Limited (Inco), leaving the Appellant with less than 10% of DFR. The Appellant subsequently continued in Luxembourg. The Appellant sold some of the Inco shares realizing a gain of approximately CAD 65 million that was exempt from tax in Canada under Art. 13 of the Canada-Luxembourg tax treaty (the Treaty). It was also not taxed in Luxembourg as the adjusted cost base of the shares exceeded the proceeds of disposition.

In 1996, Inco offered to purchase all the shares of DFR, which was approved by the DFR shareholders. The Appellant received proceeds of disposition in the amount of CAD 427,475,645 for its DFR shares. The Appellant claimed an exemption from Canadian tax on the resulting capital gain of CAD 425,853,942 under Art. 13 of Treaty. This gain was the subject of the appeal.

(b) Issue. Whether the Tax Court was correct in finding that the taxpayer was exempt from Canadian income tax in respect of the capital gain of CAD 425,853,942 arising in its 1997 taxation year on the sale of shares of DFR by virtue of the Canadian Income Tax Act (ITA) and Art. 13 of the Canada-Luxembourg tax treaty (the Treaty).

(c) Federal Court of Appeal Decision. The Federal Court of Appeal dismissed the tax authorities' appeal as they we are unable to see in the specific provisions of the ITA and the Treaty, interpreted purposively and contextually, any support for the argument that the tax benefit obtained by the taxpayer was an abuse or misuse of the object and purpose of any of the dispositions. It is clear that the ITA intends to exempt non-residents from taxation on the gains from the disposition of treaty-exempt property. It is also clear that under the terms of the Treaty, the taxpayer's stake in DFR was treaty-exempt property.

Although the tax authorities urged the Court to look behind this textual compliance with the relevant provisions to find an object or purpose whose abuse would justify the Court's departure from the plain words of the disposition, the Court was unable to find such an object or purpose. If the object of the exempting provision was to be limited to portfolio investments, or to non-controlling interests in immoveable property (as defined in the Treaty), as the tax authorities argued, it would have been easy enough to say so. Beyond that, and more importantly, the tax authorities were unable to explain how the fact that the taxpayer or Mr Boulle had or retained influence or control over DFR, if indeed they did, was in itself a reason to subject the gain from the sale of the shares to Canadian taxation rather than taxation in Luxembourg.

To the extent that the tax authorities argue that the Treaty should not be interpreted so as to permit double non-taxation, the issue raised by GAAR is the incidence of Canadian taxation, not the foregoing of revenues by the Luxembourg fiscal authorities. As a result, the appeal was dismissed with costs.

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