CRA Asserts Window Dressing, Denies TCP Treaty Exemption

Non-residents are taxed on gains realized on the disposition of taxable Canadian property (TCP)—for example, Canadian real estate, Canadian resource properties, and timber resource properties, as well as corporate shares that derive their value from these properties. However, the immovable-property exemption in certain Canadian treaties (those with Germany, the Netherlands, and Luxembourg) carves out from the TCP regime gains on shares if the underlying immovable property was used to carry on the company's business in Canada. Taxpayers should pay attention to the level of business activities when an exception requires business to be carried on. To help prevent an assertion by the CRA that the activities are mere window dressing, there should be evidence of genuine investment and consistent business activities, such as qualified employees, an appropriate place of business, and executed contracts and agreements. Alta Energy Luxembourg SARL's appeal (2014-4359(IT)G), scheduled to be heard by the TCC in June 2018, highlights the importance of this point.

According to the filed pleadings, a US LLC acquired Canadian oil and gas assets indirectly through a Canadian corporation (Canco) in 2011. In 2012, the US LLC incorporated the taxpayer, a Luxembourg SARL (Luxco), and transferred the shares of Canco to Luxco. In 2013, the shares of Canco were sold, triggering a $380 million capital gain. When filing its tax return for 2013, Luxco claimed the immovable-property exemption, such that the gain would not be taxed in Canada.

The minister assessed Luxco on the basis that the exemption did not apply because Canco's oil and gas properties were not properties in which business was carried on; Canco did not exploit its assets on a regular, continuous, and substantial basis. The activities carried on between March 1, 2012 and the closing of the sale to the third party were mere window dressing "designed to give the appearance that [Canco] was carrying on a business." In particular,
  1. there was no production or significant development in the assets of Canco by April 2012;

  2. Canco had no employees, and its management, exploration, and development activities were contracted out between April 2012 and the closing; and

  3. during that latter period, drilling activity was minimal: only one well went into production, two wells were operated by a third party, five wells had no activity, and six wells were drilled, cased, and cemented.

The minister's position in the case appears consistent with its past pronouncements. For example, in a TI (9703965, June 12, 1997), the CRA stated that the exemption should apply when mineral and timber rights are "actively exploited."

Other cases that have considered whether a business is carried on illustrate that the determination is highly fact-specific. For example, in Standard Life Assurance Company of Canada v. The Queen (2015 TCC 97), the taxpayer attempted to rely on an exemption to bump up the cost base of certain assets by purporting to carry on an insurance business in Bermuda. Factors such as failing to hire qualified employees, not having proper office space, providing no evidence of trying to make insurance sales, and failing to enter into contracts consistent with furthering the goals and objectives of the taxpayer's business contributed to the TCC's finding that the actions of the taxpayer were nothing more than mere window dressing.

Nevertheless, minimal business activities may not necessarily be fatal. Caballero v. The Queen (2009 TCC 390) recognized that there can be different levels of activities and even periods of dormancy, depending on the life cycle of the business. More specifically, what a business does during its startup or winding-down phase can differ significantly from what it does during its operational phase.

Monica Cheng
Blake Cassels & Graydon LLP, Calgary

Canadian Tax Focus
Volume 7, Number 4, November 2017
©2017, Canadian Tax Foundation