TCC rules in favour of Velcro Canada: Beneficial

TCC rules in favour of Velcro Canada: Beneficial
ownership for tax treaty purposes
Discusses the
TCC’s decision in
Velcro Canada—
the second case
to consider the
meaning of
“beneficial
ownership” in the
context of
Canada’s tax
treaties.
February 27, 2012
On February 24, 2012, the Tax Court of Canada (TCC) released its decision in Velcro
Canada Inc. v. The Queen.1 Velcro Canada is only the second Canadian case to
consider the meaning of “beneficial owner” in the context of the interest, dividend and
royalty provisions of Canada’s tax treaties. The first was Prévost Car Inc. v. The Queen,2
which dealt with whether the recipient of a dividend paid by a Canadian company was the
beneficial owner of the dividend. In Velcro Canada, the payment at issue was a royalty.
The principles established in Velcro Canada (along with Prévost) are important for
taxpayers paying interest, dividends or royalties to a resident of a treaty country, in
determining whether the recipient is the “beneficial owner” of the payment.
In particular, the TCC’s decision in Velcro Canada, which is in the taxpayer’s favour, is
significant because the TCC:

applied the Federal Court of Appeals’ approach in Prévost, in which that Court found
that the separate legal existence of a holding company could be looked through only if
the holding company was a true conduit for another entity, in the sense that it was a
mere nominee or agent or had absolutely no discretion as to the use or application of
funds put through it; and

found that the contractual obligation to pay a certain amount of money to another party
did not mean that there was an automated flow of specific monies such that the recipient
of those monies was not their beneficial owner.
Background
As in Prévost, the Canada Revenue Agency (CRA) took the position that a treaty-country
resident was not the “beneficial owner” of a Canadian-source payment (in Velcro Canada
a royalty), and therefore the reduced withholding tax rate provided by the relevant treaty
was not available. In support of its position, the CRA argued that the direct recipient of the
royalties was a mere agent or conduit without the incidences of ownership, and thus was not
the beneficial owner of the payments.
1. 2012 TCC 57.
2. 2009 FCA 57 affirming [2008] 5 C.T.C. 2306.
2012-09
www.pwc.com/ca/taxmemo
2
The Facts
In 1987, Velcro Canada entered into a licence
agreement with a related Dutch resident company
(Velcro Industries), under which Velcro Canada
obtained the right to manufacture and sell Velcrobrand fastener products in Canada. Both the
technology and the trade name were owned by
Velcro Industries.
Under the licence agreement, Velcro Canada was
required to pay quarterly royalties, which were
based on a percentage of net sales (the Royalties).
The taxpayer withheld and remitted Part XIII tax of
10% on the Royalties paid to Velcro Industries, as
provided for under the Canada-Netherlands
Income Tax Convention (the Treaty).
In 1995, as part of a reorganization of the Velcro
group of companies, Velcro Industries became
resident in the Netherlands Antilles and entered
into a licence and assignment agreement with
another related Dutch-resident company (Velcro
Holdings). Pursuant to this agreement, Velcro
Industries granted to Velcro Holdings the right to
license Velcro Industries’ intellectual property and
Velcro Industries assigned to Velcro Holdings its
rights under the licence agreement with
Velcro Canada.
Under the assignment agreement, Velcro Holdings
was required to pay royalties to Velcro Industries in
an amount equal to the Royalties payable to it by
Velcro Canada, less an arm’s length percentage
satisfactory to the Dutch tax authorities. These
royalties were payable by Velcro Holdings
within 30 days of receipt of the Royalties from
Velcro Canada.
The taxpayer’s position
After the 1995 reorganization, Velcro Canada
continued to withhold 10% on the Royalties it paid
to Velcro Holdings, until 1998, when it ceased
withholding because the treaty rate on certain
royalties was reduced to 0%.
Velcro Holdings maintained that:

this was the correct amount of withholding tax
pursuant to Article 3, section 2 of the
Convention because it was the beneficial owner
of the royalties from Velcro Canada;

it met the tests set in Prévost Car in
establishing beneficial ownership; and

the facts and evidence demonstrated that there
was no agency or nominee relationship or that it
was merely a conduit company.
The Minister’s position
The Minister assessed Velcro Canada for taxes,
interest and penalties in respect of its 1995 to 2004
taxation years for failure to withhold the
appropriate amount of tax on the Royalties under
Part XIII. The Minister’s assessment was based on
the position that Velcro Holdings (the Netherlands
company) was not the beneficial owner of the
Royalties, but that Velcro Industries (which as a
Netherlands Antilles resident company was not
entitled to the benefit of any Canadian tax treaty)
was the beneficial owner.
Alternatively, the Minister argued that Velcro
Holdings was merely an agent or a conduit
company with respect to the flow of the royalty
income.
The TCC’s decision
The TCC relied on the tests for beneficial ownership
that were established in Prévost. The Court
considered whether the Netherlands company had
received the payments for its own use and
enjoyment and had assumed the risk and control of
the payments received. Although Velcro Holdings
signed agreements under which it was obliged to
make payments to Velcro Industries equal to a
certain percentage of the royalties received by it
within 30 days of receiving payments from Velcro
Canada, there was no "automatic flow of funds."
3
Upon receipt of the funds from Velcro Canada,
Velcro Holdings deposited the funds into its own
accounts, where the funds were intermingled with
other funds and were available for use as Velcro
Holdings saw fit. Velcro Holdings had currency risk
with regard to the funds and did not have to seek
instructions from any other entity with regard to
what it did with the funds. The royalty payment
made by Velcro Canada to Velcro Holdings differed
from the amount paid by Velcro Holdings to Velcro
Industries. No priority was given to Velcro
Industries as creditor.
Although Velcro Holdings had an obligation to pay
an amount of money to Velcro Industries, which
was equivalent to 90% of the royalties received, the
funds were not necessarily the same funds as the
royalty payments received because the original
payments were co-mingled with other assets of
Velcro Holdings. The contractual obligation to pay
amounts to Velcro Industries was not the same
thing as an automated flow of specific moneys, and
Velcro Holdings therefore met the tests established
in Prévost to be considered the beneficial owner of
the royalties it received.
The TCC also considered whether Velcro Holdings
acted as an agent, nominee or conduit in respect of
the royalties from Velcro Canada. The Court found
that the relationship between Velcro Industries and
Velcro Holdings did not amount to one of agency,
because Velcro Holdings did not have the capacity
to affect the legal position of Velcro Industries.
Velcro Holdings could not be considered a
nominee, because it acted on its own account at all
times. Nor was Velcro Holdings a conduit, because
for the Court to find it to be a conduit based on the
Prévost tests, it would have to have absolutely no
discretion with respect to the funds received by it,
which was not the case.
PwC observations
Canada is not the only taxing authority to attempt
to use a beneficial ownership challenge as a way of
curtailing what it considers to be abusive “treaty
shopping.” Therefore, the case is likely to be
watched with interest outside Canada.
The Organisation for Economic Co-operation
(OECD) is currently considering further changes to
the Commentary to the Model Treaty with respect
to the term “beneficial owner.” A discussion draft of
proposed changes entitled Clarification of the
Meaning of “Beneficial Owner” in the OECD Model
Tax Convention, was issued for comment on April
29, 2011. The discussion draft was generally
considered to lack sufficient clarity to be a useful
interpretive guide. As well, many submissions
voiced concerns that the use of the concept of
beneficial owner as an anti-abuse rule is
inappropriate and would result in intolerable
uncertainty particularly because some jurisdictions
have a well-developed domestic understanding of
the meaning of beneficial ownership, whereas other
legal systems do not recognize the concept.3
TCC decisions may be appealed to the Federal Court
of Appeal.
For more help
For more information on the implications of this
decision and what it means for you or your
company, contact any of the individuals listed on
page 4 of this Tax memo.
3. These submissions are posted at:
www.oecd.org/document/39/0,3746,en_2649_33747_483915
91_1_1_1_1,00.html.
4
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