Source: http://taxinterpretations.com/content/355006
Timestamp: 2019-04-21 18:52:11+00:00

Document:
1995: March 2; 1995: June 22.
Income tax ‑‑ International taxation ‑‑ Withholding tax ‑‑ Residency ‑‑ Canada‑U.S. tax treaty ‑‑ Bahamian company operating in U.S. renting equipment to associated company in Canada ‑‑ Whether or not company resident in U.S. so as to benefit from lower withholding tax -- Canada‑United States Tax Convention Act, 1984, S.C. 1984, c. 20 , Schedule I (Convention between Canada and the United States of America with respect to Taxes on Income and on Capital (Canada‑United States Income Tax Convention (1980)), Preamble, Articles I, IV, XII).
In the 1987‑89 taxation years, Crown Forest rented barges from Norsk, a company incorporated in the Bahamas whose sole office and place of business was located in the United States. Norsk filed income tax returns in the U.S. only, where it was considered a foreign corporation exempt from U.S. income tax, and accordingly paid no U.S. tax on the barge rental payments. Crown Forest withheld 10 percent tax on the rental payments as permitted by Article XII of the Canada‑United States Income Tax Convention (1980), rather than the 25 percent deducted from non‑residents, on the footing that Norsk was a "resident of a Contracting State" for the purposes of the Convention. Article IV provides that a "resident of a Contracting State" is any person or entity who, under the laws of that state, is liable to tax therein by reason of domicile, residence, place of management, place of incorporation or any other criterion of a similar nature. The Minister disallowed the respondent's claim for 10 percent withholding tax and substituted 25 percent withholding tax.
The Federal Court Trial Division found Norsk to be a resident of a contracting party (the United States) and quashed the Minister's reassessment of Norsk at 25 percent. The Federal Court of Appeal upheld this decision. At issue is whether Norsk is a "resident of a Contracting State" (the U.S.) within the meaning of Article IV of the Canada-United States Income Tax Convention (1980), so that the withholding tax on its barge rentals would be 10 percent.
The basis of Norsk's liability for taxation in the United States emanates from the fact that it conducts a trade or business which is effectively connected with the United States and has income arising from that business which is also effectively connected with the United States. Although the fact that its "place of management" is located in the United States is one factor contributing to the finding that its trade or business is connected with the United States, it does not constitute the basis for Norsk's tax liability in the first place. A factual proposition which merely informs domestic tax liability cannot constitute a residency criterion under the Canada‑United States Income Tax Convention (1980). The only way for Norsk to benefit from residency status under the Convention is if source taxation on a business effectively connected with the contracting party constitutes a criterion similar to the other enumerated criteria in Article IV (residence, place of management, place of incorporation, domicile). It is not similar, since all of the other criteria constitute grounds for taxation on world‑wide income, not just source income. The parties to the Convention intended only that persons who were resident in one of the contracting states and liable to tax in one of the contracting states on their "world‑wide income" be considered "residents" for purposes of the Convention. Norsk is therefore not a "resident" of the United States for the purposes of Article IV of the Convention.
Referred to: J. N. Gladden Estate v. The Queen,  1 C.T.C. 163; Canada (Attorney General) v. Ward,  2 S.C.R. 689; Bacardi Corp. of America v. Domenech, 311 U.S. 150 (1940); United States v. Stuart, 489 U.S. 353 (1989); Utah Mines Ltd. v. The Queen, 92 D.T.C. 6194; Hunter Douglas Ltd. v. The Queen, 79 D.T.C. 5340; Thiel v. Federal Commissioner of Taxation, 90 A.T.C. 4717; Thomson v. Thomson,  3 S.C.R. 551; Sumitomo Shoji America, Inc. v. Avagliano, 457 U.S. 176 (1982).
Agreement between the Government of the United States of America and the Government of the People's Republic of China for the Avoidance of Double Taxation and the Prevention of Tax Evasion with respect to Taxes on Income (done at Beijing, April 30, 1984). Reproduced in International Legal Materials, vol. 23, No. 4, July 1984.
Canada‑United States Tax Convention Act, 1984, S.C. 1984, c. 20 , Schedule I (Convention between Canada and the United States of America with respect to Taxes on Income and on Capital (Canada‑United States Income Tax Convention (1980)), Preamble, Articles I, IV, paragraph 1, XII, paragraphs 1, 2).
Income Tax Act, S.C. 1970‑71‑72, c. 63, s. 212(1)(d) [rep. & sub. S.C. 1986, c. 2, s. 26].
Internal Revenue Code, 1986, §§ 864(c)(1), (4)(B)(i), (ii), (iii), 882(a)(1), (2), 883(a)(1).
Technical Explanation of the Convention between the United States of America and Canada with respect to Taxes on Income and on Capital Signed at Washington, D.C. on September 26, 1980, as Amended by the Protocol Signed at Ottawa on June 14, 1983 and the Protocol Signed at Washington on March 28, 1984. Reproduced in Canadian Income Tax Act with Regulations, 57th ed. Don Mills: CCH Canadian Ltd., 1987.
Vienna Convention on the Law of Treaties, Can. T.S. 1980 No. 37, Articles 31, 32.
American Law Institute. Federal Income Tax Project ‑‑ International Aspects of United States Income Taxation II ‑‑ Proposals on United States Income Tax Treaties. Philadelphia: The Institute, 1992.
Arnold, Brian J., and Timothy W. Edgar, eds. Materials on Canadian Income Tax, 9th ed. Don Mills: Richard De Boo, 1990.
Boidman, Nathan, L. Frank Chopin and Alan W. Granwell. "Tax Effects for Canadians of the New U.S. Code and Treaty Residency Rules (Part Two)" (1985), Tax Mgmt. Int'l J. 183.
Dwyer, Blair P., and James Cantillon Ross. "Canada ‑‑ Recent Cases Concerning Withholding Tax" (1992), 19 Tax Plan. Int'l Rev. 29.
Edwardes‑Ker, Michael. Case Comment. International Tax Treaties Service. Dublin: In‑Depth Publishing Ltd., 1993.
Isenbergh, Joseph. International Taxation: U.S. Taxation of Foreign Taxpayers and Foreign Income, vol. I. Boston: Little, Brown & Co., 1990.
Organisation for Economic Co‑operation and Development. OECD Committee on Fiscal Affairs. Model Double Taxation Convention on Income and on Capital. Paris: Organisation for Economic Co‑operation and Development, 1977.
Peters, Victor. "Resident (Article 4)", in International Fiscal Association, Canadian Branch, Special Seminar on Analysis of Canada's Tax Conventions and Comparison to the O.E.C.D. Model Double Taxation Convention. Toronto: Richard De Boo, 1979.
Tremblay, Richard G. "Crown Forest ‑‑ Tax Treaty Interpretation Bonanza" (1994), 4 Can. Curr. Tax C41.
United States of America. Senate. Committee on Foreign Relations. Report of the Committee on Foreign Relations United States Senate on Executive T, 96th Congress, 2d Session, Tax Convention with Canada. Tax Convention and Proposed Protocols with Canada. Washington: U.S. Government Printing Office, 1984.
Vogel, Klaus. Klaus Vogel on Double Taxation Conventions. Deventer, The Netherlands: Kluwer Law and Taxation Publishers, 1991.
Ward, David A. "Principles To Be Applied in Interpreting Tax Treaties" (1977), 25 Can. Tax J. 263.
APPEAL from a judgment of the Federal Court of Appeal (1993), 94 D.T.C. 6107,  1 C.T.C. 174, 164 N.R. 222, dismissing an appeal from a judgment of Muldoon J. (1992), 92 D.T.C. 6305,  2 C.T.C. 1, 53 F.T.R. 291, allowing an appeal from the Minister of National Revenue's tax assessment. Appeal allowed.
Ian S. MacGregor, Q.C., and Al Meghji, for the appellant.
Warren J. A. Mitchell, Q.C., and Karen R. Sharlow, for the respondent.
Brian A. Crane, Q.C., for the intervener.
1 Iacobucci J. -- This appeal raises issues regarding the interpretation of international tax treaties.
2 The more specific question is whether Norsk Pacific Steamship Company Limited ("Norsk") is a "resident of a Contracting State" -- in this case the United States -- within the meaning of Article IV of the Convention between Canada and the United States of America with respect to Taxes on Income and on Capital (hereinafter the Canada-United States Income Tax Convention (1980)) (enacted in law in Canada by the Canada-United States Tax Convention Act, 1984, S.C. 1984, c. 20 ). If it is, the amount of non-resident tax imposed by Canada on Norsk and required to be withheld by Crown Forest Industries Limited ("Crown Forest") from the rent paid by it to Norsk for the lease of several maritime barges would be reduced by virtue of Article XII, paragraph 2 of the Convention from 25 percent to 10 percent. Article IV provides that a "resident of a Contracting State" is "any person [or entity] who, under the laws of that State, is liable to tax therein by reason of ... domicile, residence, place of management, place of incorporation or any other criterion of a similar nature".
3 For the reasons that follow, I would allow the appeal with the result that Crown Forest is to pay 25 percent withholding tax to Canada.
4 In the 1987, 1988 and 1989 taxation years, Crown Forest paid rent to Norsk for the use of certain barges. These barges were used to transport wood chips to pulp mills, and goods from those mills to markets in Canada and the U.S. Norsk was incorporated in the Bahamas in 1962 but its only office and place of business has been in the United States, in the San Francisco area. At this office it, at all relevant times, employed approximately 19 people with a monthly payroll of about US $75,000. Both Norsk and Crown Forest are owned by the same New Zealand corporation, Fletcher Challenge Limited.
5 For each of the years under review, the only income tax returns filed by Norsk with the United States Internal Revenue Service were entitled "Income Tax Return of a Foreign Corporation" (Form 1120F); however, Norsk has never filed income tax returns in Canada, the Bahamas, or any country other than the United States. To this end, Norsk is a foreign corporation for U.S. income tax purposes. Its primary source of income arises from the transportation of newsprint internationally.
6 In the relevant taxation years, Norsk paid no U.S. tax on the barge rental payments, claiming an exemption to which it was entitled as an international shipping company under § 883 of the U.S. Internal Revenue Code, 1986. This exemption accrued to Norsk owing to the fact that it had been incorporated in the Bahamas; given that the Bahamas has, in its income tax legislation, accorded a similar tax exemption to companies incorporated in the United States, these dual exemptions are reciprocal.
7 Crown Forest withheld 10 percent tax on the rental payments, on the footing that Norsk was a "resident of a Contracting State" for the purposes the Canada-United States Income Tax Convention (1980). For residents, the usual 25 percent rate of withholding tax paid by non-residents (pursuant to s. 212(1) of the Income Tax Act, S.C. 1970-71-72, c. 63, as amended) is reduced to 10 percent by virtue of Article XII of the Convention. Although the Minister of National Revenue ("Minister") re-assessed Crown Forest at 25 percent, this finding was quashed by Muldoon J. of the Federal Court Trial Division who found Norsk to be a resident of a contracting party (the United States). Muldoon J.'s decision was upheld by the Federal Court of Appeal, Décary J. dissenting. The Minister appeals to this Court and is supported by the intervener, the Government of the United States of America, neither of which wishes Norsk to be considered a "resident" under the Convention.
1. For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation or any other criterion of a similar nature, but in the case of an estate or trust, only to the extent that income is derived by such estate or trust is liable to tax in that State, either in its hands or in the hands of its beneficiaries.
(iii) is derived from the sale or exchange (outside the United States) through such office or other fixed place of business of personal property described in section 1221(1), except that this clause shall not apply if the property is sold or exchanged for use, consumption, or disposition outside the United States and an office or other fixed place of business of the taxpayer in a foreign country participated materially in such sale.
(1) A foreign corporation engaged in trade or business within the United States during the taxable year shall be taxable ... on its taxable income which is effectively connected with the conduct of a trade or business within the United States.
(2) In determining taxable income for purposes of paragraph (1), gross income includes only gross income which is effectively connected with the conduct of a trade or business within the United States.
(1) Gross income derived by a corporation organized in a foreign country from the international operation of a ship or ships if such foreign country grants an equivalent exemption to corporations organized in the United States.
A. Federal Court Trial Division, 92 D.T.C. 6305, per Muldoon J.
8 Muldoon J. allowed Crown Forest's appeal from the Minister's tax assessment, holding that Norsk fit the definition of "resident of a Contracting State" in Article IV, paragraph 1 of the Convention.
9 To determine whether Norsk was a "resident" of the United States for the purposes of the Convention, Muldoon J. queried whether Norsk was liable to tax in that state by reason of the criteria listed in Article IV, or by reason of any criterion of a similar nature. He stated that the answer was a matter of United States law.
11 Muldoon J. questioned why, if the negotiators of the Convention meant to exclude foreign corporations in the U.S. (such as Norsk) from the status of "resident of a Contracting State", they simply did not write into the Convention exactly what they supposedly meant to say.
12 The Federal Court of Appeal dismissed the Crown's appeal. Heald J.A., writing for himself and McDonald J.A., rejected the argument that Muldoon J. had erred in his findings of fact. In fact, he affirmed that Norsk's liability for U.S. tax arises because the trade or business which it conducts is effectively connected with the U.S. and not because its place of management is located in the U.S. Having stated at p. 6112 that "[t]he issue is not the general application of U.S. tax law but its application to Norsk in particular" (emphasis in original) Heald J.A. said that Muldoon J.'s factual finding "was reasonably open to him on this record" and that "[i]n any event, by no stretch of the imagination, can it be said that the Trial Judge made a palpable or overriding error in the findings of fact which he made".
13 In considering whether the factual finding that Norsk's place of management is a prime factor in its liability to tax in the U.S. is sufficient to bring Norsk within Article IV, paragraph 1, Heald J.A. rejected four submissions forwarded by the Crown.
14 First, the Crown had argued that, since foreign corporations are not generally liable to tax in the U.S. on the basis of their place of management, Norsk cannot be found liable on this basis. In response, Heald J.A. ruled at p. 6112 that this contention "fails to take into account the particular circumstances which make Norsk liable.... [and] begs the very question that must be determined by this Court".
Were this the intention of the Contracting States, such a result could have been achieved simply by stipulating that only domestic corporations subject to tax on 100% of their world-wide income are residents for the purposes of the Convention.
16 The third submission advanced by the Crown was that Muldoon J.'s finding that tax liability caused by the conduct of a business effectively connected with the U.S. is similar in nature to the tax liability caused by the place of management was tantamount to an amendment to the Convention. Heald J.A. dismissed this claim; he relied at p. 6113 upon a passage from Muldoon J.'s judgment that "indicates that Norsk's liability to tax in the U.S. is by reason of its place of management, and that the Trial Judge would find Norsk to be liable by reason of a criterion of a similar nature only if it were `logically necessary'".
17 Lastly, it was argued that the interpretation given to Article IV, paragraph 1 by the trial judge would lead to anomalous results. One example given was that, upon the taxpayer's interpretation, a foreign corporation engaged in trade or business in the U.S. could earn $100 of effectively connected income (taxable in the U.S.) and $1,000,000 of foreign source income (not taxable in the U.S.) and, yet, the foreign corporation would entirely escape tax liability in respect of that foreign source income. Heald J.A.'s response was as follows: rejecting the "world-wide income" test as the only basis for tax liability does not mean that any corporation with U.S. source income is liable to tax in the U.S., and, thereby, automatically becomes a U.S. resident under the Convention.
18 Décary J.A. dissented on two grounds. First, he differed from Heald J.A. by concluding that at p. 6115 "[t]he reason for which Norsk is liable to tax in the United States is not because its place of management is located in the United States, but because the trade or business it conducts is effectively connected with the United States, that connection being established, amongst various factors, by Norsk's place of management".
The parties obviously intended to set out very specific criteria, the common element of all of them being that each was in itself and standing alone a basis for taxation, that each was easily, readily and objectively identifiable and that each could be related to a tangible location. Any criterion "of a similar nature" must ... satisfy these common elements.
To say that the fact that the place of management is a factor in determining the very reason of Norsk's liability to tax (i.e. conducting a business ...), renders Norsk liable to tax by reason of its place of management, is to transform a factor used in assessing a tax liability that does not fall under article IV, into one of the four criteria recognized by the article.
1. For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation or any other criterion of a similar nature...?
22 In interpreting a treaty, the paramount goal is to find the meaning of the words in question. This process involves looking to the language used and the intentions of the parties. Both upon the plain language reading of Article IV and through an interpretation of the goals and purposes of the Canada-United States Income Tax Convention (1980), I reach the same destination: to allow the appeal.
23 At this stage of the analysis, the primary question to ask is why Norsk is liable to pay tax in the United States. If its liability is rooted in the fact that "it is engaged in a trade or business effectively connected with the U.S.", then it would seem that Norsk is not a "resident" of the United States under Article IV since "engaged in a trade or business" is not listed as a factor to trigger residency under that article. The only way residency could be found in such a situation would be to determine "engaged in a trade or business" to be a "similar criterion" under Article IV. On the other hand, if Norsk's tax liability in the U.S. emanates from the fact that its "place of management" is in the U.S., then it would appear, prima facie, that Norsk could satisfy the residency requirements under Article IV, since "place of management" is a sufficient condition of residence.
24 Article IV states that the term "resident" means "any person who, under the laws of [the contracting party in question], is liable to tax therein by reason of... domicile, residence, place of management, place of incorporation or any other criterion of a similar nature". The courts below found Norsk's place of residence to be in the United States. At first blush, this seemingly disposes of the matter since such a finding appears to be sufficient to warrant a determination that Norsk is in fact a resident under the Convention.
25 Nevertheless, there is one important caveat. Under Article IV it must be shown that the liability to taxation operates by reason of one of the listed grounds. This connotes the existence of some sort of causal connection or, in the least, some relationship of proximity. In my opinion, the fact that Norsk's place of management is in the U.S. is not causally or even proximately connected to the basis of Norsk's tax liability in the U.S. Quite the contrary: in my mind, the reason why Norsk was liable to taxation in the U.S. was because of the income flowing from the business or trade it conducted that was connected to the United States.
Norsk is liable to tax in the U.S.A. because it conducts a "trade or business which is effectively connected with the United States".... This latter expression is not identified in the Internal Revenue Code... but is determined by subjective factors according to common law.... The United States taxes foreign corporations on the basis of the continuous and continuing conduct of an active trade or business within the territorial jurisdiction of the U.S. and taxes the trade's or business' worldwide income "sourced" either within or outside of the U.S. . . . The fact that the foreign corporation's head office and place of management are in the U.S. are one factor -- a principal factor -- in determining whether it carries on a trade or business in the U.S. . . .
28 Norsk's tax liability thus derived from s. 882 of the Internal Revenue Code which provides that a foreign corporation (such as Norsk) engaged in a trade or business within the United States shall be taxed in the same manner as a U.S. corporation only on that portion of its taxable income which is effectively connected with the conduct of its U.S. trade or business. In this respect, for a foreign corporation to be liable, under American law, to taxation in the U.S. it must meet two conditions: (1) it must be "engaged in trade or business in the United States", and (2) it must have income which is "effectively connected" to that trade or business. Clearly, a foreign corporation may have source income which is not effectively connected to its American operations; in that case, the U.S. would not have the jurisdiction to tax such income.
29 The place of management is only one factor in the determination of whether the first condition mentioned above is met. To this end, ascertaining that Norsk is a resident under the Convention because its place of management is in the United States erroneously amounts to elevating a factor used in determining its tax liability into the actual grounds for that tax liability. Place of management is one step removed from the true and immediate basis for tax liability.
30 I further note that, in the determination of whether a company is "engaged in a trade or a business within the United States", other factors may also be considered along with "place of management". These are all analogous to "place of management" and include, but are not limited to: the extent of the activity within the country whose residence is claimed, the location of books and records, the location of the head office, the nationalities of the persons employed, the use of resources, the continuing conduct of the business over a period of time, and the location of the principal place of business. I find it somewhat perverse to have all of these criteria individually elevated to actual grounds for tax liability; nevertheless, such a result logically flows from ascribing such a status to "place of management".
31 With respect, both Muldoon J. and Heald J.A. unfortunately conflated "place of management" and "engaged in business" and consequently introduced a degree of circularity into their reasons. For example, Muldoon J. explicitly found, at p. 6309, that Norsk is liable to tax in the United States on income connected with a trade or business which it carries on in the United States and that both of the experts agreed, in principle, with this conclusion. The fact that Norsk's place of management was in the U.S. was determined to be a "prime criterion" for determining whether Norsk was carrying on a trade or business in the United States. Nevertheless, after arriving at these conclusions, Muldoon J. then went on to find that "place of management", even standing alone, could ground Norsk's U.S. tax liability and hence deem it a U.S. resident under the Convention.
32 In my view, the majority of the Federal Court of Appeal took an even more troublesome approach. It noted, at p. 6111, that Norsk is liable to tax on that portion of its income which is effectively connected with the conduct of its U.S. trade or business but that, in making this finding, various factors are to be considered including: the head office location, the place of management, the extent of the activity within the U.S., the employment of individuals, the use of resources, and the continuity of the conduct of the business over a period of time.
33 In fact, the place of management criterion was found not to be a factor which in itself would determine the corporation's income to be effectively connected with the conduct of its U.S. trade or business. Yet, despite arriving at these conclusions, the Court of Appeal at p. 6112 still found it not unreasonable to conclude, as did the trial judge, that "[t]he reason for which Norsk's income is effectively connected with a trade or business which it actively conducts in the U.S.A., is because Norsk's place of management is located in the U.S.A. where it conducts its trade or business". The majority of the Court of Appeal then further found that Norsk benefitted from residency status under Article IV because its place of management was in the United States. However, the point of the matter is that the finding that Norsk's place of management is a prime factor in its liability to tax in the U.S. does not mean that its U.S. tax liability operates by reason of its place of management in the U.S.
The reason for which Norsk is liable to tax in the United States is not because its place of management is located in the United States, but because the trade or business it conducts is effectively connected with the United States, that connection being established, amongst various factors, by Norsk's place of management. The nuance is of major significance: liability to tax derives from Norsk's trade or business, not from Norsk's place of management which, in itself, does not make Norsk liable to tax in the United States.
To say that the fact that the place of management is a factor in determining the very reason of Norsk's liability of tax (i.e. conducting a business...), renders Norsk liable to tax by reason of its place of management, is to transform a factor used in assessing a tax liability that does not fall under article IV, into one of the four criteria recognized by the article. Had the contracting states intended to qualify as residents foreign corporations liable to tax by reason of the conduct of their business, it would have been very easy to add another criterion such as conduct of business or place of business.
36 Out of this web of nuance flow, in my opinion, two conclusions: Norsk conducted a trade or business connected to the United States and Norsk's place of management was in the United States. Both of these findings of fact appear fully reasonable; however, the veritable lynch-pin of Norsk's U.S. tax liability is the "engaged in a trade or business" criterion, not the "place of management". While the courts below were correct that Norsk's place of management was a factor relevant to its American tax liability, they erred when they concluded that the legal basis of Norsk's tax liability was the fact that its place of management was in the U.S. In other words, the courts below erred in interpreting the expression "by reason of" as found in the Convention.
37 The respondent argues that this Court should not interfere with the findings, allegedly of fact, of the trial judge. It is further submitted that an appellate court should normally only overturn a trial judge's finding of fact if there is evidence of palpable or overriding error.
38 I agree with this latter submission. However, at issue in this appeal are not factual findings, but the trial judge's interpretation of the Convention, this being a conclusion as to law or, in the least, mixed law and fact, and, hence, properly reviewable by an appellate court. I further note that the expert testimony was clear that the legal basis for Norsk's tax liability was the "engaged in a business in the United States" criterion. Therefore, it is proper to revisit the legal conclusions of the trial and Federal Court of Appeal judges and clearly find, as did Décary J.A. in dissent, that Norsk's U.S. tax liability as a foreign corporation arose by reason of the fact it derived some income which was effectively connected to the United States from a business in which it was engaged in the United States. Although the barge income itself may not have been "effectively connected" to the United States, Norsk did have other sources of income that appear to be so connected.
39 Nevertheless, the analysis does not end here. Should the respondent successfully demonstrate that "engaged in a business in the U.S." is a criterion of a nature similar to the enumerated grounds, then Norsk will be deemed to be a resident under the Convention.
40 I agree with the appellant that the most similar element among the enumerated criteria is that, standing alone, they would each constitute a basis on which states generally impose full tax liability on world-wide income: Klaus Vogel on Double Taxation Conventions (1991), at pp. 154-59; Joseph Isenbergh, International Taxation: U.S. Taxation of Foreign Taxpayers and Foreign Income, vol. I (1990), at pp. 326-27. In this respect, the criteria for determining residence in Article IV, paragraph 1 involve more than simply being liable to taxation on some portion of income (source liability); they entail being subject to as comprehensive a tax liability as is imposed by a state. In the United States and Canada, such comprehensive taxation is taxation on world-wide income. However, tax liability for the income effectively connected to a business engaged in the U.S., pursuant to s. 882 of the Internal Revenue Code, amounts simply to source liability. Consequently, the "engaged in a business in the U.S." criterion is not of a similar nature to the enumerated grounds since it is but a basis for source taxation.
To say that Norsk, which is not liable to tax by reason of its place of management, is liable to tax by reason of a criterion of a similar nature because its place of management is one of the factors to be considered in determining the very reason of its liability to tax, i.e. the conduct of a business..., is to beg the question and try to enter through a door that has already been closed.
B. What was the Intention of the Drafters of the Convention?
42 On a direct application of Article IV, I hold that Norsk is not a "resident". This conclusion is confirmed when undertaken with an eye to the intentions of the drafters of the Convention and to the goals of international taxation treaties. In other words, I do not believe that Norsk should be considered a resident under Article IV of the Convention nor that the designers of the Convention would have envisioned that it ought to benefit from the preferential tax treatment accorded to residents.
See David A. Ward, "Principles To Be Applied in Interpreting Tax Treaties" (1977), 25 Can. Tax J. 263; see also the methodology used by this Court in Canada (Attorney General) v. Ward,  2 S.C.R. 689, at pp. 713-16 (albeit not within the context of taxation, but refugee determination). A similar position underpins American jurisprudence. In Bacardi Corp. of America v. Domenech, 311 U.S. 150 (1940), the Supreme Court of the United States held at p. 163 that a treaty should generally be "construe[d] ... liberally to give effect to the purpose which animates it". See also United States v. Stuart, 489 U.S. 353 (1989), at p. 368, per Brennan J. (delivering the opinion of the Court).
45 I accept the appellant and intervener's submission that, since the application of the Convention is to be limited to taxpayers bearing full tax liability in one of the contracting parties, then Norsk cannot benefit from the Convention and is consequently not to be characterized as a resident under Article IV, paragraph 1. As shall become apparent in the discussion infra, the courts below departed from the historical raison d'être of international tax treaties when proposing that the Canada-United States Income Tax Convention (1980), covers taxpayers liable only to source taxation in one of the contracting parties.
46 At this point in the analysis, it is important to take a step backwards and isolate exactly whom the Convention was intended to benefit. The target group are Canadians working in the United States (or vice versa) and Canadian companies operating in the United States (again, or vice versa). It was deemed important, in order to promote international trade between Canada and the U.S., to spare such individuals and corporations double taxation (consequently promoting the equitable allocation of profits of enterprises doing business in both countries): see Preamble to the Convention; see also Utah Mines Ltd. v. The Queen, 92 D.T.C. 6194 (F.C.A.), and U.S. Senate (Foreign Relations Committee), Tax Convention and Proposed Protocols with Canada, at p. 2: "The principal purposes of the proposed income tax treaty between the United States and Canada are to reduce or eliminate double taxation of income earned by citizens and residents of either country from sources within the other country, and to prevent avoidance or evasion of income taxes of the two countries." An ancillary goal would also be to mitigate the administrative complexities occasioned by having to file simultaneously income tax returns in two unco-ordinated taxation systems.
47 I note that states have the jurisdiction to tax income arising from all commercial transactions, whether these be domestic or international in nature. Where money flows from a domestic to a foreign party, and the income received by the foreign party is outside the jurisdiction of the state, the state exercises its jurisdiction over the transaction by requiring the domestic party to withhold a certain amount from the foreign party. This amount is what is termed a "withholding tax"; it is this type of tax that constitutes the subject matter of the appeal at bar. Withholding taxes creates immediate problems, since it gives rise to the possibility that the taxpayer shall be vulnerable to double taxation on all foreign transactions. The root of this double liability emanates from the fact that, upon one transaction, a withholding tax may be imposed by the payor's government and, at the same time, an income tax may be imposed by the recipient's government. So, theoretically, international transactions could be subject to twice the tax exposure of domestic transactions. This, in turn, creates a potential deterrent to foreign trade and transboundary transactions.
48 In the case at bar, I underscore that there is no need to prevent double taxation because the U.S. has declined to tax Norsk's revenue. Although this does not affect Norsk's tax liability, the effect is still that Norsk is not required to pay any tax in the United States by virtue of the s. 883(a) exemption, this exemption arising by virtue of a reciprocal arrangement between the U.S. and the Bahamas, where Norsk is incorporated. Further, it is unclear whether the specific rental income at issue is even, independent of the exemption, subject to taxation in the U.S. because, pursuant to s. 864(c)(4) of the Internal Revenue Code, it might not be considered to be effectively connected with the conduct of Norsk's American trade or business. Allowing Norsk to benefit from the Convention in this case would actually lead to the avoidance of tax on the rental income because the liability for tax asserted by the Canadian authorities would be reduced notwithstanding that the United States chooses not to impose any tax thereon or does not even have the jurisdiction therefor.
49 The goal of the Convention is not to permit companies incorporated in a third party country (the Bahamas) to benefit from a reduced tax liability on source income merely by virtue of dealing with a Canadian company through an office situated in the United States. As far as I can see it, if there were any tax convention that Norsk would be able to benefit from, it is that concluded between the U.S. and the Bahamas. There is no reason to assume that, in the context of this case, Canada entered into a treaty with the United States with a view to ceding its taxing authority to a jurisdiction that is a stranger to the Convention, namely the Bahamas. As mentioned earlier, the reason Norsk benefitted from the s. 883 U.S. Internal Revenue Code tax exemption was because it was incorporated in the Bahamas which grants an equivalent exemption to U.S. corporations. It seems to me that both Norsk and the respondent are seeking to minimize their tax liability by picking and choosing the international tax regimes most immediately beneficial to them. Although there is nothing improper with such behaviour, I certainly believe that it is not to be encouraged or promoted by judicial interpretation of existing agreements.
50 Nor do I believe it to have been within the intentions of the drafters of the Convention to permit a corporation (such as Norsk) who is liable for tax on a limited amount that is "sourced" to one of the contracting states -- in this case only on income that is effectively connected to the United States -- to avail itself of the benefits of the Convention even in respect of income which is not so connected and in respect of which the U.S. has no interest. Naturally, were Norsk to be a domestic corporation, it could properly benefit from the Convention since it would be subject to double taxation on the rental income in the U.S. (by virtue of its residency) as well as in Canada (by virtue of the "source" principle).
Assume that ... a foreign corporation is engaged in a trade or business in the United States and earns $100 of "effectively connected income" (which is taxable in the U.S.) and $1,000,000 of foreign source "non-connected income" (assume income from Canada) which is not taxable in the United States.
52 But the shortcomings to the respondent's interpretation go beyond the scenarios envisioned by the appellant. In fact, under the respondent's interpretation, a foreign corporation whose place of management is in the U.S. would be a resident of the U.S. for purposes of the Convention notwithstanding that such a corporation may not have any effectively connected income to the U.S. and hence no U.S. tax liability at all. I find this possibility to be highly undesirable. "Treaty shopping" might be encouraged in which enterprises could route their income through particular states in order to avail themselves of benefits that were designed to be given only to residents of the contracting states. This result would be patently contrary to the basis on which Canada ceded its jurisdiction to tax as the source country, namely that the U.S. as the resident country would tax the income. On this point, see also Richard G. Tremblay, "Crown Forest -- Tax Treaty Interpretation Bonanza" (1994), 4 Can. Curr. Tax C41.
... if a United Kingdom corporation, the sole business of which for 50 years has been operating a Wyoming ranch, receives some passive income from Canada, it would not be considered a resident of the United States under the Appellant's interpretation simply because of its historic place of incorporation, even though all of its economic connections are with the United States.
I find this scenario far less troubling than the one proposed by the appellants. In the above situation, the mere incorporation of a company in the United States to which the passive income from Canada would flow would permit the taxpayer to benefit from the Convention.
54 I now turn to another set of extrinsic materials, other international taxation conventions and general models thereof, in order to help illustrate and illuminate the intentions of the parties to the Canada-United States Income Tax Convention (1980). Articles 31 and 32 of the Vienna Convention on the Law of Treaties (Can. T.S. 1980 No. 37) indicate that reference may be made to these types of extrinsic materials when interpreting international documents such as taxation conventions; see also Hunter Douglas Ltd. v. The Queen, 79 D.T.C. 5340, (F.C.T.D.), at pp. 5344-45, and Thiel v. Federal Commissioner of Taxation, 90 A.T.C. 4717 (H.C. Aust.), at p. 4722.
56 The underscored sentence does not form part of Article IV of the Canada-United States Income Tax Convention (1980). Nevertheless, as I will discuss below, I reject the respondent's argument (accepted by Heald J.A.) that the failure to reproduce the second line of the OECD Model Convention residency definition in Article IV of the Canada-United States Income Tax Convention (1980) indicates a desire to permit even those only liable for source income to qualify as residents under the Canada-United States Income Tax Convention (1980). Consequently, I do not find that this omission indicates that the intention of the drafters of the Convention was to permit entities such as Norsk to benefit from "residency" status.
Under the prevailing practice, a country entering into an income tax treaty extends the benefits of the treaty to a person or entity that is a "resident of (the other) Contracting State". "Residence", in turn, is defined in terms of taxing jurisdiction. A person or entity is considered resident in a country if that country asserts an unlimited right to tax his or its income -- that is, a right based upon the taxpayer's personal connection with the country (as opposed to the source of the income or other income- or asset-related factors). The test of residence requires that the person or entity claiming treaty benefits be "fully taxable" in the residence country, in the sense of being fully subject to its plenary taxing jurisdiction.
Full tax liability is not satisfied in a case where an entity is liable to tax in a jurisdiction only on a part of its income.
In accordance with the provisions of the second sentence of paragraph 1, however, a person is not to be considered a "resident of a Contracting State" in the sense of the Convention if, although not domiciled in that State, he is considered to be a resident according to the domestic laws but is subject only to a taxation limited to the income from sources in that State or to capital situated in that State. That situation exists in some States in relation to individuals, e.g. in the case of a foreign diplomatic and consular staff serving in their territory.
The court's approach implies that a person taxed by a particular country solely on a source basis can be considered to be a resident of that country for treaty purposes. This was apparently not Canada's view when it subscribed without reservation to the portion of the Commentary to the OECD Model Treaty that equates the "state of residence" with the state that imposes comprehensive tax liability.
It may be questioned whether the omission of the second sentence of the residence definition in the Canada-U.S. treaty makes this agreement substantively different from the OECD Model, on the facts of Crown Forest. . . . There is no indication in the Commentary to the 1977 OECD Model Treaty that the addition of the second sentence, which was not found in the 1963 OECD Model, was intended to affect the position of a person not viewed as a resident by the domestic law of the taxing state. . . . The 1977 Commentary and later OECD Reports make it clear that the change was intended to address the position of a person viewed as a resident by the domestic law of the taxing state (e.g., by reason of an attachment such as residence or place of management), but who, by reason of special privileges (diplomatic personnel, base companies, etc.) was not subject to worldwide taxation by the state. . . . Canada did not need a provision like the second sentence, because its legislation generally does not include such source-taxation privileges.
60 I would also refer to Victor Peters, "Resident (Article 4)", Special Seminar on Analysis of Canada's Tax Conventions and Comparison to the O.E.C.D. Model Double Taxation Convention (1979). Mr. Peters concludes at p. 49 that "in virtually any case in which [one] might wish to qualify for some sort of tax relief pursuant to a provision of the Model Treaty, [one] will first have to be able to qualify thereunder as a resident of at least one of the Contracting States".
61 Had this second sentence been included in the Canada-United States Income Tax Convention (1980) it would only have applied to exclude from the definition of a "resident" a domestic corporation if it were only subject to source-based taxation in the United States. Since (as shall be further discussed infra) under U.S. law all domestic corporations are taxed on world-wide income, the second sentence was simply not required in the Convention.
62 The OECD Model Convention is not the only international agreement worthy of consideration as an extrinsic material. I also draw from the U.N. Model Convention. Article IV of this convention does not contain the "second sentence" but, in the Commentary thereto, recognizes that, in order for a person to be a "resident of a Contracting State", that person must be liable to tax in that state on world-wide income. See also the Agreement between the Government of the United States of America and the Government of the People's Republic of China for the Avoidance of Double Taxation and the Prevention of Tax Evasion with respect to Taxes on Income (done at Beijing, April 30, 1984). In this connection, I find persuasive the submission that only those corporations that are liable to taxation for the full amount of their world-wide income meet the definition of "resident" in the Canada-United States Income Tax Convention (1980). This appears to me to be the intention of the contracting parties.
It would be odd if in construing an international treaty to which the legislature has attempted to give effect, the treaty were not interpreted in the manner in which the state parties to the treaty must have intended.
This is also the view in American jurisprudence. The Supreme Court of the United States, in Sumitomo Shoji America, Inc. v. Avagliano, 457 U.S. 176 (1982), at pp. 184-85, held that "[a]lthough not conclusive, the meaning attributed to treaty provisions by the Government agencies charged with their negotiation and enforcement is entitled to great weight".
64 I am sensitive to the fact that limiting residence to those taxed only on world-wide income effectively narrows the benefits of the Convention (in so far as American companies are concerned) only to entities actually incorporated in the United States. After all, "foreign corporations" (i.e., those not incorporated in the United States) remain liable only for their U.S. source income. This was a concern of Heald J.A., at p. 6113. For my part, I see nothing fundamentally unjust with the situation where, owing to the nature of U.S. tax legislation, the Convention would be limited to those who actually incorporated in the U.S. (i.e., those who are actually American residents). After all, why should entities not regarded as "residents" by a contracting state be regarded as residents of that state for the purposes of the Convention? Article I of the Convention specifically states that it is generally applicable to persons who are "residents of one or both of the Contracting States"; see also the Technical Explanation of United States-Canada Income Tax Convention, 1980 which, with respect to Article IV, notes at p. 1349: "Article IV provides a detailed definition of the term `resident of a Contracting State'. The definition begins with a person's liability to tax as a resident under the respective taxation laws of the Contracting States." I do not really see anything "tautological" (as alleged by the respondent) about grounding residency under the Convention in actual residency in one of the contracting parties according to that party's domestic legislation. As noted by the appellant, the Convention was not intended to allow entities to achieve a higher status of residence under its terms than would be available at domestic law.
65 The intervener makes several informative submissions that support the conclusion that it was expressly intended by the United States to have residence under the Convention determined (for its part) only by place of incorporation. It is noted that Article 4, paragraph 1 of the OECD Model Convention does not contain "place of incorporation" as grounds for residence. However, recognizing that "place of incorporation" is the only criterion that has any relevance to the determination of world-wide tax liability under U.S. law, the U.S. entered a reservation to Article 4, paragraph 1 for the right to use "place of incorporation" as an indicator of residence. However, in order to preserve overall conformity with the OECD Model Convention, the decision was taken not to remove the other OECD criteria from Article IV, paragraph 1. Nevertheless, the term "place of incorporation" is the only term in Article IV, paragraph 1 that governs the determination of the residence of a corporation in the United States for purposes of its tax conventions.
66 It is for this reason that the trial judge's rhetorical conclusion, at p. 6310, ("if the negotiators of the Convention meant to exclude foreign corporations in the U.S., like Norsk, from the status of "resident of a Contracting State" (i.e., the U.S.A.) one wonders why they simply did not write into the Convention exactly what they allegedly meant to say") must be rejected. The extrinsic materials reveal that such explicit "writing-in" was simply not necessary. This analysis helps further rebut the respondent's other submission that, since in its tax treaties with other nations the U.S has chosen to utilize more restrictive language in terms of the definition of "resident", the intention of the U.S. in its agreement with Canada was not to limit the benefit of the Convention solely to those liable to taxation on world-wide income.
67 In sum, the intentions of the drafters of the Convention and the other extrinsic materials demonstrate that Norsk is not a resident under the Convention.
1.The basis of Norsk's liability for taxation in the United States emanates from the fact that it conducts a trade or business which is effectively connected with the United States and has income arising from that business which is also effectively connected with the United States. Although the fact that its "place of management" is located in the United States is one factor contributing to the finding that its trade or business is connected with the United States, it does not constitute the basis for Norsk's tax liability in the first place. A factual proposition which merely informs domestic tax liability cannot constitute a residency criterion under the Convention.
2.As such, the only way for Norsk to benefit from residency status under the Convention is if source taxation on a business effectively connected with the contracting party constitutes a criterion similar to the other enumerated criteria in Article IV (residence, place of management, place of incorporation, domicile). It is not similar, since all of the other criteria constitute grounds for taxation on world-wide income, not just source income.
3.The parties to the Convention intended only that persons who were resident in one of the contracting states and liable to tax in one of the contracting states on their "world-wide income" be considered "residents" for purposes of the Convention.
4.Norsk is thus not a "resident" of the United States for the purposes of Article IV of the Canada-United States Income Tax Convention (1980).
69 As a result, the courts below erred in limiting Crown Forest's non-resident withholding tax to 10 percent instead of 25 percent. Consequently, I would allow the appeal with costs throughout, set aside the judgment of the Federal Court of Appeal, and in substitution therefor restore the Minister's assessment of 25 percent withholding tax required of Crown Forest on rental payments to Norsk for the taxation years in question.
Solicitor for the appellant: John C. Tait, Ottawa.
Solicitors for the respondent: Thorsteinssons, Vancouver.
Solicitors for the intervener: Gowling, Strathy & Henderson, Ottawa.

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