The Interpretation of Tax Conventions in Canada

Stephen R. Richardson and James W. Welkoff*

PRÉCIS Les conventions fiscales bilatérales soulèvent des questions inhabituelles d’interprétation, pour trois principales raisons : 1) Les conventions fiscales bilatérales ont des objectifs très précis, soit la réduction de la distorsion de l’activité économique grâce à l’élimination ou à la réduction de la double imposition des opérations internationales et la diminution de l’évitement fiscal et de l’évasion fiscale par les contribuables par le biais d’activités à l’échelle internationale. 2) Les conventions fiscales bilatérales sont formulées par suite d’un processus de négociations entre les États contractants, négociations qui combinent certains des éléments usuels de la négociation de contrats et des éléments de la conduite diplomatique internationale. 3) Les conventions fiscales bilatérales ont en général un double statut légal, puisqu’elles sont à la fois des conventions internationales qui lient les deux États contractants en vertu du droit international et qu’elles font partie du droit national de chacun des États qui touche les droits des particuliers assujettis à la compétence de l’État. Cet article ne constitue pas un examen exhaustif des principes et de la pratique en matière d’interprétation de conventions fiscales. Il fournit plutôt un survol et un résumé de l’évolution récente dans le domaine de l’interprétation de conventions fiscales bilatérales au Canada, en particulier de la manière dont elle a été influencée par deux importants jugements rendus par la Cour suprême du Canada dans les affaires The Queen v. Melford Developments Inc. et The Queen v. Crown Forest Industries Limited et al. Dans l’affaire Melford, la Cour suprême a traité la question qui lui était soumise comme en étant une d’interaction entre deux lois nationales contradictoires, soit la Loi de l’impôt sur le revenu et la loi selon laquelle la convention fiscale entre le Canada et l’Allemagne de 1956 était intégrée dans le droit national du Canada. La Cour a ensuite réglé la cause en se fondant sur les principes d’interprétation du droit national. Cette méthode très précise d’interprétation a mené à l’élaboration de règles législatives spéciales au Canada afin de régir certains aspects de l’interprétation de conventions fiscales bilatérales.

* Of Tory Tory DesLauriers & Binnington, Toronto.

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Par contre, dans l’affaire Crown Forest, la Cour suprême a clairement confirmé le principe selon lequel une convention fiscale bilatérale doit être interprétée d’une manière libérale à la lumière de son objet, plutôt que d’une manière plus rigoureuse et littérale qui pourrait s’appliquer à la législation fiscale nationale. En réglant la question qui lui avait été soumise, la Cour, en plus d’examiner la formulation de la convention, a tenu compte de l’objet de la convention et de l’intention des États contractants et elle y a accordé une importance considérable. Par suite de la décision rendue dans l’affaire Crown Forest, il est plus vraisemblable que la méthode générale d’interprétation qu’utilise la Cour suprême sera appliquée uniformément par les tribunaux canadiens dans l’avenir dans les causes portant sur l’interprétation de conventions.

ABSTRACT Bilateral tax conventions present an unusual set of interpretive issues. There are three main reasons for this: 1) Bilateral tax conventions have very special purposes, namely, the reduction of distortion of economic activity by elimination or reduction of double taxation of international transactions and the reduction of tax avoidance and evasion by taxpayers through international activities. 2) Bilateral tax conventions are formulated through a process of negotiation between the contracting states that combines some of the usual elements of contractual negotiation with elements of international diplomatic conduct. 3) Bilateral tax conventions usually have a dual legal status, as both an international treaty binding the two contracting states under international law and a part of the domestic law of each of the states that affects the rights of private persons within the jurisdiction of the state. This article does not exhaustively examine principles and practice relating to the interpretation of tax conventions. Rather, it provides an overview and summary of the recent development of the interpretation of bilateral tax conventions in Canada, particularly as it has been influenced by two major decisions of the Supreme Court of Canada: The Queen v. Melford Developments Inc. and The Queen v. Crown Forest Industries Limited et al. In Melford, the Supreme Court treated the question before it as one of the interaction of two conflicting domestic statutes—the Income Tax Act and the statute introducing the Canada-Germany income tax agreement, 1956 into the domestic law of Canada. The court then approached the resolution of the question on the basis of principles of interpretation of domestic legislation. This very specific interpretive approach led to the development of special Canadian legislative rules to govern certain aspects of the interpretation of bilateral tax conventions. By contrast, in Crown Forest, the Supreme Court clearly confirmed the principle that a bilateral tax convention should be given a liberal interpretation in the light of its object and purpose, rather than a more

(1995), Vol. 43, No. 5 / no 5 THE INTERPRETATION OF TAX CONVENTIONS IN CANADA 1761 strict and literal interpretation that may be applicable with respect to domestic tax legislation. In resolving the issue before it, the court, in addition to looking to the language used in a tax convention, considered and placed considerable weight upon the object and purpose of the convention and the intention of the contracting states to the convention. The Crown Forest decision has made it more likely that the general interpretive approach used by the Supreme Court will be consistently applied by Canadian courts in the future in addressing issues of convention interpretation.

INTRODUCTION Bilateral tax conventions1 present more than the usual set of problems that attend the interpretation of a text with legal significance. This is because of the very special purposes, process of formulation, and legal nature of bilateral tax conventions. One of the major purposes of bilateral tax conventions is to prevent or lessen distortion of economic activity by reducing the overlapping of domestic taxation systems with respect to international exchange of goods and services and flows of capital, labour, and technology.2 It is widely recognized that it can be generally beneficial for the economies of states to increase the efficiency of the allocation among them of capital, labour, and technology and the flow of trade. Domestic taxation systems usually create distortions that inhibit such allocative efficiency. These distortions can become even worse when international economic activity results in taxation by two (or more) domestic taxation systems. While many states unilaterally or voluntarily build into their domestic taxation systems mecha- nisms for relieving international juridical double taxation,3 bilateral income tax conventions are intended to require the contracting states to eliminate or reduce double taxation by the reciprocal limitation of taxing authority and by other, more general means. In accomplishing this, bilateral tax conventions also determine to some extent the distribution of tax revenues as between states.4 The second major purpose of bilateral tax

1 Bilateral tax conventions (or tax treaties) have greatly proliferated in recent years. Canada has bilateral tax conventions currently in force with 56 countries, and several other conventions have been signed but await ratification. There are more than 200 tax conventions in force between OECD member countries alone. 2 See Donald J.S. Brean, International Issues in Taxation: The Canadian Perspective, Canadian Tax Paper no. 75 (Toronto: Canadian Tax Foundation, 1984), 11. 3 The introduction to the commentary on the OECD model convention, infra footnote 6, states, “International juridical double taxation can generally be defined as the imposition of comparable taxes in two (or more) States on the same taxpayer in respect of the same subject matter and for identical periods.” 4 See Brean, supra footnote 2, at 11-13. To illustrate how the distribution of tax revenue may differ as a result of the methods used to reduce double taxation under a bilateral tax convention, one may compare the effect of two provisions: (1) a provision that allows (The footnote is continued on the next page.)

(1995), Vol. 43, No. 5 / no 5 1762 CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE conventions is to protect or benefit the fiscs of states by reducing tax avoidance and evasion by taxpayers through international activities. Bilateral tax conventions are formulated and agreed to through a process of negotiation between the parties. This process combines some of the usual elements of contractual negotiation with the very specific and for- malistic approach of international diplomatic conduct.5 Moreover, these negotiations usually take as their starting point one of the extant “model tax treaties,” such as the OECD model convention, or some individualized variant of the model used by the particular state.6 In most contracting states, including Canada, a bilateral tax convention has a dual legal status: it is an international agreement binding the two sovereign states to its terms under international law; and it is a part of domestic law in each of the states, establishing, within the terms of that law, certain rights and obligations both of private persons within the state’s jurisdiction and of the state itself.7 As a practical matter, the formal interpretation of tax conventions has been limited almost exclusively to domestic legal forums dealing only with the relationship of taxpayer and state.8

4 Continued... a state to tax interest at source at a 15 percent rate but requires the state of the taxpayer’s residence to provide a credit for this tax against domestic tax on the interest income; and (2) a provision that prevents the source state from levying any tax at source on the interest. A taxpayer subject to tax in the state of residence at a rate greater than 15 percent will pay tax in total at that rate in both cases 1 and 2; however, in case 2 the source state receives no tax revenue and the state of residence receives tax revenue at its full domestic rate, while in case 1 the tax revenue is divided between the two states, with the first 15 percent going to the source state and the balance to the state of residence. 5 For a discussion of the process of negotiation and ratification of tax conventions, see Klaus Vogel, Klaus Vogel on Double Taxation Conventions (Deventer, the Netherlands: Kluwer, 1991), 13-18. 6 The major international model treaties are the OECD model convention, with accompanying commentary, and the UN model convention: Organisation for Economic Co- operation and Development, Model Tax Convention on Income and on Capital (Paris: OECD) (looseleaf); and the United Nations Model Double Taxation Convention Between Devel- oped and Developing Countries, United Nations publication ST/ESA/102, 1980. The OECD model convention is updated periodically; the most recent major revision was completed in 1992. A few countries have formulated and published their own model tax treaties for the purpose of creating a basis for their treaty negotiations. See, for example, United States, Treasury Department, Draft Model Income Tax Treaty, June 16, 1981 (withdrawn on July 17, 1992); and “Treasury Explains Function of Model Tax Treaties” (January 5, 1987), 34 Tax Notes 60. Canada has not published a model Canadian tax convention, though it is understood that versions of such a model have been formulated and used in negotiations by the federal government representatives responsible for Canadian tax treaty policy and im- plementation. For a history of bilateral agreements for the avoidance of double taxation, including the development of model tax treaties, see Vogel, supra footnote 5, at 8-11. 7 See Klaus Vogel and Rainer G. Prokisch, “General Report,” in International Fiscal Association, Cahiers de droit fiscal international, vol. 78a, Interpretation of Double Taxa- tion Conventions (Deventer, the Netherlands: Kluwer, 1993), 55-85, at 59-61. 8 The “mutual agreement procedures” or “competent authority” provisions normally contained in Canada’s bilateral tax conventions provide a further process for resolving (The footnote is continued on the next page.)

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A tax convention comes into existence and is binding for purposes of international law upon the declaration by both contracting states of their consent to be bound by the convention. The method of effecting this declaration is determined by the contracting states and is included in the terms of each convention. The declaration in respect of bilateral tax conventions is usually effected through an exchange of instruments of ratification, which occurs after the convention has been signed (although a convention could provide that signature alone constituted entry into force). In Canada, the power to ratify bilateral tax conventions lies with the executive function of the federal government.9 However, the general practice is to submit tax conventions for parliamentary enactment before ratification. Although a convention is binding as a treaty between the contracting states for purposes of international law following executive ratification, it cannot affect Canadian domestic law or the rights of any person other than the government unless and until implementing legislation is enacted by Parliament.10 Because bilateral tax conventions invariably alter domestic law by limiting the application of the tax law of the contracting states, they require implementing legislation in order to be fully effective. The form of implementing legislation used in Canada is an act passed by Parliament that directly enacts the convention into law. The act implementing the convention states that, to the extent of any inconsistency between the convention and any other law, the provisions of the convention prevail.11 It is also within the power of Parliament to pass

8 Continued... questions of application of tax treaty provisions. In particular, they usually provide for interpretation by mutual agreement of the parties, as illustrated in the following extract from the Convention Between Canada and the United Kingdom of Great Britain and North- ern Ireland with Respect to Taxes on Income and Capital Gains, signed at London on September 8, 1978, as amended by the protocols signed on April 15, 1980 and October 16, 1985, article XXIII: “3. The competent authorities of the Contracting States shall endeav- our to resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the Convention.” For a discussion of this type of competent authority provision see the commentary on article 25 of the OECD model convention, supra footnote 6, at paragraphs 32-37. 9 Attorney-General for Canada v. Attorney-General for Ontario, [1937] AC 326 (PC). 10 “Within the British Empire there is a well-established rule that the making of a treaty is an executive act, while the performance of its obligations, if they entail alteration of the existing domestic law, requires legislative action.” Ibid., at 347. See also Re Arrow River & Tributaries Slide & Boom Co., [1932] 2 DLR 250 (SCC); In re Regulation and Control of Radio Communication in Canada, [1932] AC 304 (PC); Albany Packing Co. Inc. v. Registrar of Trade Marks, [1940] Ex. CR 256; and Francis v. The Queen (1956), 3 DLR (2d) 641 (SCC). 11 The following is an example of Canadian legislation implementing the provisions of a bilateral tax convention: An Act to implement a convention between Canada and the United States with respect to taxes on income and on capital Her Majesty, by and with the advice and consent of the Senate and House of Com- mons of Canada, enacts as follows: (The footnote is continued on the next page.)

(1995), Vol. 43, No. 5 / no 5 1764 CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE legislation to abrogate or override, in whole or in part, the domestic legal consequences of an income tax convention.12 However, the binding effect of the convention as a treaty between the contracting states under international law would not necessarily be affected by such legislation. In the introduction to the 1993 general report for the International Fiscal Association on the interpretation of double taxation conventions, Vogel and Prokisch state: An interpretation can only be “correct” if it has not come about by arbi- trary procedure. Therefore, criteria for interpretation are needed to guide the interpreter and let him and others control the interpreting procedure. These criteria are defined in a more or less similar way all over the world.13 The courts in Canada, while clearly maintaining domestic legal principles of statutory interpretation as the basic criteria for interpretation of income tax conventions, have often tended to apply these with some view toward more generalized internationally recognized criteria or principles of interpretation. There is obviously some considerable benefit to all states that enter into bilateral tax conventions in establishing a reasonable de- gree of certainty and mutuality (or common understanding) in the interpretation of tax conventions. Yet the national interests of states and their understandable bias in favour of their own legal systems often push interpretation in the other direction. The tension in this situation is aptly

11 Continued . . . 1. This Act may be cited as the Canada-United States Tax Convention Act, 1984. 2. In this Act, “Convention” means the Convention entered into between the Government of Canada and the Government of the United States, set out in Sched- ule I, as amended by the Protocols set out in Schedules II and III. 3.(1) The Convention is approved and declared to have the force of law in Canada during such period as, by its terms, the Convention is in force. (2) In the event of any inconsistency between the provisions of this Act, or the Convention, and the provisions of any other law, the provisions of this Act and the Convention prevail to the extent of the inconsistency. (3) The Minister of National Revenue may make such regulations as are necessary for the purpose of carrying out the Convention or for giving effect to any of the provisions thereof. 4. Notice of the day the Convention comes into force and of the day it ceases to be effective shall be given by proclamation of the Governor in Council published in the Canada Gazette. In addition, subparagraph 110(1)(f)(i) of the Income Tax Act, infra footnote 18, provides that Canadian source income of a taxpayer that is exempt from Canadian tax by virtue of an international agreement or convention but is included in the calculation of income under the Income Tax Act is deducted in computing taxable income so that no tax liability results. 12 The Queen v. Melford Developments Inc., 82 DTC 6281 (SCC), aff ’g. 81 DTC 5020 (FCA). See also Woodend Rubber Co. v. Comr. of Inland Revenue, [1971] AC 321 (PC); and Francis v. The Queen, [1954] Ex. CR 590, aff ’d. without discussion of this point in the Supreme Court of Canada, supra footnote 10. 13 Vogel and Prokisch, supra footnote 7, at 56.

(1995), Vol. 43, No. 5 / no 5 THE INTERPRETATION OF TAX CONVENTIONS IN CANADA 1765 illustrated by two important decisions of the Supreme Court of Canada involving the interpretation of tax conventions entered into by Canada. In the next section of this article, the decision of the court in The Queen v. Melford Developments Inc.14 will be reviewed, and it will be shown how the very specific interpretive approach used in that case led to the development of special Canadian legislative rules for the interpretation of income tax conventions. In a later section, the decision of the court in The Queen v. Crown Forest Industries Limited et al.15 will be examined, and the court’s application of a number of general principles of interpretation will be discussed. This article does not attempt an exhaustive examination of principles and practice relating to the interpretation of tax conventions. This is a topic well covered by the literature, both Canadian and international.16 Instead, the article provides an overview and summary of the development of the interpretation of bilateral tax conventions in Canada over the last decade and a half, particularly as it has been influenced by these two major decisions of the Supreme Court.

LEGISLATED PRINCIPLES OF TAX CONVENTION INTERPRETATION The Melford Decision The decision of the Supreme Court of Canada in the Melford case17 was responsible for a chain of events that had very substantial consequences relating to the interpretation of bilateral tax conventions within the Cana- dian tax system. The facts in Melford were quite straightforward. However, the approach adopted by the Supreme Court was so specific—in certain respects, so narrow—that it was considered necessary to reverse the decision by the creation of legislative rules to govern certain aspects of the interpretation of income tax conventions. Melford Developments Inc., a Canadian resident corporation, paid a fee to a bank that was a resident of Germany as consideration for the

14 Supra footnote 12. 15 95 DTC 5389 (SCC). 16 See the following sources: David A. Ward, “Principles To Be Applied in Interpreting Tax Treaties” (1977), vol. 25, no. 3 Canadian Tax Journal 263-70, reprinted and updated in (December 1980), 34 Bulletin for International Fiscal Documentation 545-51); Nathan Boidman, “Interpretation of Tax Treaties in Canada” (August/September 1980), 34 Bulle- tin for International Fiscal Documentation 388-401; David A. Ward, “The Income Tax Conventions Interpretation Act,” in Report of Proceedings of the Thirty-Fifth Tax Confer- ence, 1983 Conference Report (Toronto: Canadian Tax Foundation, 1984), 602-19; Marc Duval, “Interprétation des conventions fiscales” (1991), vol. 39, no. 5 Canadian Tax Jour- nal 1206-44; Jean-Marc Déry and David A. Ward, “Canada,” in Interpretation of Double Taxation Conventions, supra footnote 7, 259-89; Jacques Sasseville, “Interpretation of Double Taxation Conventions in Canada: An Update” (August/September 1994), 48 Bulle- tin for International Fiscal Documentation 374-79; Klaus Vogel, “Double Tax Treaties and Their Interpretation” (Spring 1986), 4 International Tax & Business Lawyer 4-85; Vogel, supra footnote 5; Vogel and Prokisch, supra footnote 7; and Michael Edwards-Ker, ed., Tax Treaty Interpretation (Dublin: In-Depth Publishing) (looseleaf). 17 Supra footnote 12.

(1995), Vol. 43, No. 5 / no 5 1766 CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE guarantee by that bank of a loan made to Melford by a Canadian char- tered bank. The German bank did not carry on business in Canada through a permanent establishment. Melford did not withhold any amount from the payment of the guarantee fee as tax owing by the German bank, on the basis that there was no charge to tax under part XIII of the Income Tax Act.18 This was clearly a correct conclusion unless the guarantee fee could be considered to be an amount paid as, on account or in lieu of payment of, or in satisfaction of, “interest.” The minister of national revenue assessed Melford for failing to withhold tax under part XIII, maintaining that the guarantee fee was “interest” for purposes of the withholding tax exigible under part XIII because of the application of subsection 214(15) of the Act. That subsection, which had been added to part XIII effective for amounts paid or credited after November 18, 1974,19 provides that, for the purposes of part XIII, any amount paid or credited by a resident of Canada to a non-resident as consideration for guarantee- ing the repayment of a debt obligation of a person resident in Canada shall be deemed to be a payment of interest on that obligation. Under the provisions of the Canada-Germany income tax agreement, 1956,20 Canada was not prevented from taxing payments of “interest” made by a Cana- dian resident to a German resident where such interest income was not attributable to a permanent establishment of the recipient in Canada, although the agreement limited the rate of such tax to 15 percent of the amount of the payment.21 Melford claimed that the guarantee fee was not “interest” within the meaning of the Canada-Germany income tax agreement, 1956. If the payment was not interest within the meaning of the agreement, the German resident bank recipient would not be subject to tax under the Act, because it would be entitled to the protection of article III(1) of the agreement. Article III(1) provided that the industrial and commercial profits of an enterprise of one of the states could not be taxed in the other state unless that enterprise carried on a trade or business in that other state through a permanent establishment. If, on the other hand, the payment was interest within the meaning of the agreement, article III(5) of the agreement would apply. Article III(5) created an exception from the protection of article III(1) with respect to the receipt by German residents of certain types of Canadian source income, including “interest.” Consequently, if it applied, Canada could tax the payment under part XIII of the Act. Thus, the issue

18 RSC 1985 (5th Supp.), c. 1, as amended (herein referred to as “the Act”). Unless otherwise stated, statutory references in this article are to the Act. 19 Added by SC 1974-75-76, c. 26, section 119(2). 20 The Convention Between Canada and the Federal Republic of Germany for the Avoid- ance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, signed at Ottawa on June 4, 1956 (herein referred to as “the Canada-Germany income tax agreement, 1956”). This bilateral income tax convention between Canada and the Federal Republic of Germany was given legislative force in Canada by the Canada-Germany Income Tax Agreement Act, 1956, SC 1956, c. 33. 21 Ibid., article VII.

(1995), Vol. 43, No. 5 / no 5 THE INTERPRETATION OF TAX CONVENTIONS IN CANADA 1767 for the court to decide was whether the guarantee fee was “interest” within the meaning of article III(5). The term “interest” was not expressly defined in the agreement. How- ever, article II(2) of the agreement, read as follows: In the application of the provisions of this Convention by one of the contracting States any term not otherwise defined in this Convention shall, unless the context otherwise requires, have the meaning which it has under the laws in force in the territory of that State relating to the taxes which are the subject of this Convention.22 The Federal Court of Appeal, in its decision in favour of the taxpayer, concluded that the deeming language of subsection 214(15), while it deemed a payment of a guarantee fee to be a payment of interest, did not deem the thing paid to be interest; and further that even if the guarantee fee was interest as a result of this provision, it could not be said to be interest for purposes of article III(5) of the agreement.23 Mr. Justice Estey, expressing the unanimous judgment of the Supreme Court, did not agree with the first part of this analysis, concluding that the provisions of the Act, including subsection 214(15), would require tax under part XIII to be payable by the taxpayer. However, he went on to conclude that the further and crucial issue to be decided was the application of article III(5) of the Canada-Germany income tax agreement, 1956. He stated, at the begin- ning of his judgment, on the basis of the arguments of counsel: This appeal raises for settlement the principles applicable to the interpretation of domestic tax law and international tax conventions where their provisions are said to be competing [emphasis added].24 This focus on a supposed competition or contradiction between the provisions of the Act and the provisions of the statute introducing the Canada- Germany income tax agreement, 1956 into the domestic law of Canada led, almost inevitably, to the result in the case.25 The Supreme Court easily decided as a first step that, in the absence of subsection 214(15) of the Act, the guarantee fee would not be “interest” under the laws in force in Canada, but that if that provision were to be considered for this purpose, the guarantee fee would be considered to be interest. The court then went on to address the critical question of how to

22 This provision is very similar to article 3(2) of the OECD model convention, supra footnote 6. 23 81 DTC 5020, at 5023-24 (FCA). 24 Melford, supra footnote 12, at 6281. Also see The Queen v. Associates Corporation of North America, 80 DTC 6140 (FCA). It should, however, be noted that this case involved interpretation of the Canada-US income tax convention, 1942, which did not contain any provision like article II(2) of the Canada-Germany income tax agreement, 1956. 25 Ward observed that the “linking” of this argument involving the interaction of the 1974 amendment and the tax convention itself with the separate question whether “laws in force in [Canada]” was a reference to laws in force in 1956 or at the time of the imposition of tax “was probably unfortunate for the Crown’s case”: Ward, “The Income Tax Conven- tions Interpretation Act,” supra footnote 16, at 606.

(1995), Vol. 43, No. 5 / no 5 1768 CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE construe the effect of article II(2). While this article clearly required the term “interest” to be defined by reference to “the laws in force in [Canada],” these words could be construed either as a reference to the laws in force in Canada from time to time (the so-called ambulatory or dynamic approach to interpretation) or as a reference to the laws in force at the time of the coming into force of the Canada-Germany income tax agreement, 1956 (the so-called static approach to interpretation). Mr. Justice Estey, having decided to treat the question as one of the interaction of two conflicting domestic statutes, approached the resolution of the question on the basis of principles of interpretation of domestic legislation. In this regard, he enunciated the following legal conclusions: first, that it is within the power of Parliament to alter or amend a prior statute that brings an income tax convention into force for domestic legal purposes, by passing a subsequent statute that evidences a clear intention to do so; and, second, that the introduction into the Act of the “deemed interest” provisions of 1974 “evidence[d] no intention of Parliament to amend the 1956 statute.”26 It is worth noting that Mr. Justice Estey ap- peared to have disposed of the question whether the implementing statute of 1956 was intended by Parliament to be overridden by subsequent legislation, not whether the agreement itself was amended.27 It is perhaps questionable whether the issue should have been dealt with as a conflict of domestic legislative provisions at all. A direct interpretation of the text of the original enacting statute might have involved instead a determination of the meaning of the words in article II(2), based upon the intention of the parties to the agreement in formulating the article. This line of analysis would not involve a view of whether the enacting legislation was or was not “amended” by the introduction of subsection 214(15), because it would begin with the conclusion that no amendment to such legislation was necessary in order to determine that the guarantee fee was considered to be interest by virtue of the domestic law of Canada. The question, following this line, is whether the parties to the convention, in agreeing to article II(2), could reasonably be considered to have contemplated, and therefore originally intended, that as the domestic laws of Canada and Germany evolved, article II(2) would have the effect of causing the agreement to evolve with them, by defining terms in the agreement with reference to their meaning in domestic law as

26 Melford, supra footnote 12, at 6286. 27 This conclusion is to be distinguished from the more questionable suggestion that Canada can unilaterally amend an international convention binding the states that are parties to it. However, there is still some confusion in the Melford judgment surrounding the amendment question, and an indication that it affected the court’s conclusion. In this regard, see Mr. Justice Estey’s comments, ibid., at 6286-87, including his remarks when dealing with two UK cases, which were the only foreign sources referred to in the judgment: “These cases add little to the analysis of the present appeal as the terms of the 1974 amendments to the Canadian Income Tax Act evidence no comparable intention by the Canadian Parliament to override the 1956 Agreement.”

(1995), Vol. 43, No. 5 / no 5 THE INTERPRETATION OF TAX CONVENTIONS IN CANADA 1769 that meaning changed from time to time. Nevertheless, it was not at all clear, even on the basis of this more general interpretive approach and on international experience, whether it would have been correct to have found an “ambulatory” rather than a “static” effect for article II(2).28

The Income Tax Conventions Interpretation Act The decision in Melford, with its potentially broad implications for the interpretation of Canada’s bilateral tax conventions, appears to have en- gendered a reaction of shock and dismay on the part of the Canadian taxation authorities, because less than nine months later the government introduced a proposed new statute entitled the Income Tax Conventions Interpretation Act.29 One of its main provisions was designed to reverse the specific effect of the decision in Melford, but on a prospective basis only.30 The statute was originally drafted to operate retroactively in all other respects. The question therefore arises whether it was the Melford type of situation that motivated the government to move quickly to legis- late rules for the interpretation of tax conventions, or whether the Melford decision had brought other issues into play. To assist in obtaining an understanding of the reasons behind the formulation of the ITCI Act, it is useful to review its three main substantive provisions. It should be noted that once the ITCI Act was passed by Parliament, none of these provisions were drafted so as to have a direct retroactive effect, although they can apply to activities subsequent to the coming into force of the statute that result from arrangements existing at that time. The only complete “grandfathering” provision in the ITCI Act is section 6, which preserves the results of the Melford case for guarantee fees paid pursuant to an agreement in writing entered into before June 23, 1983 and protected from

28 Vogel, in “Double Tax Treaties and Their Interpretation,” supra footnote 16, at 71-72, states that the reference to domestic law in provisions based on article 3(2) of the OECD model convention “ordinarily has been understood to be a reference to that law as amended from time to time,” and, after some discussion of the merits of the “static” interpretation, concludes that “the ambulatory interpretation of Article 3(2) should be preferred.” See also John F. Avery Jones et al., “The Interpretation of Tax Treaties with Particular Refer- ence to Article 3(2) of the OECD Model—I” [1984], no. 1 British Tax Review 14-54 and “. . . II” [1984], no. 2 British Tax Review 90-108. See also the discussion in Edwards-Ker, supra footnote 16, at chapter 9 and paragraph 10.13, where some generally concurring statements with regard to the Melford decision are made. Ward, in his 1983 article, “The Income Tax Conventions Interpretation Act,” supra footnote 16, at 606-8, discusses at some length the view that there was no clear conclusion under international law, on the basis of the authority that then existed from other sources, that would require the imposition of an ambulatory meaning on terms used in a bilateral income tax convention. See also paragraph 11 of the commentary on article 3 of the OECD model convention, supra footnote 6, which states, after describing both the static and the ambulatory approach to interpretation, that “the Committee on Fiscal Affairs concluded that the latter [that is, the ambulatory interpretive approach] should prevail.” 29 Now RSC 1985, c. I-4, as amended (herein referred to as “the ITCI Act”). 30 See sections 3 and 6 of the ITCI Act and the discussion in Ward, “The Income Tax Conventions Interpretation Act,” supra footnote 16, at 610 and 616.

(1995), Vol. 43, No. 5 / no 5 1770 CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE taxation in Canada by a tax convention given the force of law in Canada before November 19, 1974.31 The first substantive provision of the ITCI Act is section 3, which (subject to the “grandfathering” rule in section 6) reverses the “static” approach to the interpretation of terms in income tax conventions defined by reference to domestic law, as established by the Melford decision. This provision states: Notwithstanding the provisions of a convention or the Act giving the convention the force of law in Canada, it is hereby declared that the law of Canada is that, to the extent that a term in the convention is (a) not defined in the convention, (b) not fully defined in the convention, or (c) to be defined by reference to the laws of Canada, that term has, except to the extent that the context otherwise requires, the meaning it has for the purposes of the Income Tax Act, as amended from time to time, and not the meaning it had for the purposes of the Income Tax Act on the date the convention was entered into or given the force of law in Canada if, after that date, its meaning for the purposes of the Income Tax Act has changed. This provision, like sections 4 and 5, is stated to operate “[n]otwithstanding the provisions of a convention or the Act giving the convention the force of law in Canada.” The reference to the “provisions of a convention” raises the question whether the ITCI Act attempts to unilaterally “amend” or “override” existing income tax conventions as international treaties and thereby is an abrogation of existing conventions.32 This is probably a moot point so far as domestic Canadian tax consequences are concerned, since by expressly overriding the statutes that implement these conventions as part of Canadian law, the provisions of the ITCI Act are legally effective in determining tax consequences to taxpayers who are subject to that law. The provisions of section 5 of the ITCI Act might be suspected to have been considered, from the point of view of the government, to be at least as important as section 3. Section 5 declares an overriding meaning for several terms commonly used in Canadian tax conventions, including the term “Canada.” The section defines Canada to include every offshore area surrounding Canada that “in accordance with international law and the laws of Canada” is an area in respect of which Canada may exercise rights to natural resources. Canada’s income tax treaties normally contain the relatively common provisions that allow each state to tax the business activities of a resident of the other state to the extent allocable to a

31 Section 7 of the ITCI Act makes it generally applicable for part XIII purposes to amounts paid or credited after June 23, 1983, and otherwise to taxation years ending after June 23, 1983. Section 6.1 was added to ensure that additional tax (other than part XIII tax) for a taxation year ending after June 23, 1983 that results from application of the ITCI Act is prorated for the period after that date. 32 See Ward, “The Income Tax Conventions Interpretation Act,” supra footnote 16, at 615, for a discussion of this point.

(1995), Vol. 43, No. 5 / no 5 THE INTERPRETATION OF TAX CONVENTIONS IN CANADA 1771 permanent establishment of the non-resident in the former state. Accord- ingly, section 5 confirmed an expanded jurisdiction of Canada to tax offshore resource exploration and related activities of non-residents as businesses carried on “in Canada” through a permanent establishment “in Canada” in situations (such as those governed by the Canada-US tax convention, 1942) where the particular convention contained a narrower definition. The original retroactive version of this provision was highly controversial, and the objections raised against it may well have been the main reason for the elimination of the retroactive application of the ITCI Act when it was legislated in 1984.33 Section 5 also defines, on the same basis, the terms “annuity,” “periodic pension payment,” “immovable property,” and “real property.” The third operative provision of the ITCI Act is perhaps the most in- triguing. Section 4 provides an overriding rule for the determination of the profits of a business activity attributable or allocable to a permanent establishment in Canada. It states that in determining the profits from a business activity attributable or allocable to a permanent establishment in Canada for any period, (a) there shall, except where the convention expressly otherwise provides, be included in the determination of those profits all amounts with respect to that activity that are attributable or allocable to the permanent establishment and that would be required to be included under the Income Tax Act, as amended from time to time, by a person resident in Canada carrying on the activity in Canada in the computation of his income from a business for that period; and (b) there shall, except to the extent that an agreement between the competent authorities of the parties to the convention expressly otherwise provides, not be deducted in the determination of those profits any amount with respect to that activity that is attributable or allocable to the permanent establishment and that would not be deductible under the Income Tax Act, as amended from time to time, by a person resident in Canada carrying on the activity in Canada in the computation of his income from a business for that period. The genesis of this provision is probably traceable to claims that were made by certain non-resident corporations carrying on resource-related businesses in Canada, particularly by those resident in the United States, following the Melford decision. In 1974, the Act had been amended to prevent the deduction for income tax purposes of royalties paid to provincial governments by taxpayers in the resource exploration and production business, and instead to allow as a deduction from income a limited “resource allowance” determined under specific provisions of the Act and the Income Tax Regulations.34 It is understood that some US resident

33 SC 1984, c. 48. 34 Paragraph 18(1)(m) of the Act generally disallows deduction of royalties paid to the federal or a provincial government relating to the acquisition, development, or ownership of a resource property or the production of oil, gas, and other related hydrocarbons or (The footnote is continued on the next page.)

(1995), Vol. 43, No. 5 / no 5 1772 CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE corporations that carried on resource businesses in Canada extrapolated the following argument from the Melford decision to justify continued entitlement to the deduction of provincial royalties following the introduction of these changes. The argument was based on the provisions of the Canada-US tax convention, 1942.35 Article I of that convention allowed Canada to tax profits of a US resident carrying on business in Canada only to the extent that such profits were “allocable in accordance with the Articles of this Convention” to its permanent establishment in Canada; and article III(1) provided that, in determining the amount of profits so allocable, “there should be allowed as deductions all expenses . . . reasonably allocable to the permanent establishment.” Therefore, it was argued, there was an inconsistency or conflict between the provisions of Canada’s domestic tax law and the convention of 1942. Following Melford, the resolution of this conflict was to be found in the conclusion that the priority of the convention prevented this legislative limitation on deduction of royalties from applying to a US resident, since it was not applicable at the time the convention was entered into in 1942. This argument then went on to the effect that a non-resident in such circumstances would be entitled, in computing the profits of its permanent establishment in Canada, to deduct not only provincial royalty payments because of the application of these provisions to the convention, but also the “resource allowance” introduced by domestic legislation to replace that deduction. The prospect that this position could be taken by numerous US multi- national resource corporations carrying on business in Canada must have caught the attention of the government. By 1983, provincial royalty deductions for these taxpayers for taxation years from 1975 to 1982 would have been an issue, representing a very large amount of government tax revenue already collected. Section 4 of the ITCI Act, fully retroactive as originally drafted, was presumably designed to eliminate any such argument. As noted above, the section provided that, in the computation of profits for a period of a permanent establishment of a non-resident carrying on business in Canada, there shall... not be deducted . . . any amount... that would not be deductible under the Income Tax Act, as amended from time to time, by a person resident in Canada... in the computation of his income from a business for that period. Given the extravagant nature of the argument for full deductibility of resource royalties and allowances, and its somewhat tenuous connection

34 Continued... metal or minerals. The paragraph was added by SC 1974-75-76, c. 26, section 7(1), generally applicable after May 6, 1974. The “resource allowance,” formulated as a limited deduction in lieu of such payments, is provided for in paragraph 20(1)(v.1), added to the Act at the same time, and in part XII of the Income Tax Regulations. 35 The Convention and Protocol for the Avoidance of Double Taxation and the Estab- lishment of Rules of Reciprocal Administrative Assistance in the Case of Income Taxes, signed at Washington, DC on March 4, 1942 (herein referred to as “the Canada-US tax convention, 1942”). The convention was given the force of law in Canada by SC 1943-44, c. 21, as amended by SC 1950, c. 27.

(1995), Vol. 43, No. 5 / no 5 THE INTERPRETATION OF TAX CONVENTIONS IN CANADA 1773 to the decision in the Melford case, section 4 of the ITCI Act might be viewed as an overreaction. At some point, this may have been recognized; otherwise, it is difficult to understand why, in April 1984, the revised version of the ITCI Act abandoned retroactivity for section 4. While it will be seen from the discussion of the Utah Mines Ltd. case, below, that the government eventually succeeded in persuading the courts to come to an appropriate conclusion on this point, there appears also to have been some additional government activity on another front in this regard. This may be seen in Order-in-Council PC 1984-1758, dated May 24, 1984. It is an order made pursuant to section 17 of the Financial Administration Act36 for the remission of certain taxes payable under part I of the Act by Chevron Standard Limited for taxation years from 1975 to 1982 in the aggregate amount of $90 million. This remission was granted on condition that Chevron would, with respect to the calculation of its taxes payable under the Act for those years, discontinue all outstanding actions commenced by it in the Federal Court of Canada, withdraw all issues in outstanding Notices of Objection and not commence any action in any court by which any claim is made for a reduction in the income taxes payable by it by reason of... the non-inclusion or deduction for the purposes of computing its income of provincial royalties.

Utah Mines Ltd. v. The Queen37 When the question of deduction of provincial royalties by residents of the United States did finally come to be decided by the courts, the theory of continued deductibility of such royalties under articles I and III of the Canada-US tax convention, 1942 was easily rejected. Utah Mines Ltd. was a US resident corporation carrying on a mining business in Canada through a permanent establishment. In computing its income for tax purposes in its 1974 taxation year, it deducted certain mineral royalties paid to a Canadian province. This type of royalty, though previously allowed as a deduction for income tax purposes, was by that time not allowed as a deduction by virtue of the addition of paragraph 18(1)(m) to the Act, effective May 6, 1974. Revenue Canada reassessed the taxpayer and dis- allowed the royalty deductions. The taxpayer argued that the provisions of the Canada-US tax convention, 1942 in effect prevented Canada from unilaterally changing the basis of the computation of income allocable to a permanent establishment of a US resident, and in particular that article III(1) allowed “as deductions all expenses... reasonably allocable to the permanent establishment.” The Melford case was cited in argument as authority for the proposition that Canada cannot “unilaterally attempt to amend the Convention by means of

36 Now RSC 1985, c. F-11, as amended, section 23. 37 92 DTC 6194 (FCA). The subject matter of this case was the Canada-US tax convention, 1942; and, as stated in footnote 24 supra, that convention did not contain any general interpretive provision similar to article II(2) of the Canada-Germany tax agreement, 1956, which was considered in the Melford case.

(1995), Vol. 43, No. 5 / no 5 1774 CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE a change in the domestic law.”38 Both the Federal Court—Trial Division and the Federal Court of Appeal rejected this argument. They concluded that the purpose of the provisions of the convention relating to calculation of profits of a permanent establishment was not to create for non-resident enterprises carrying on business in Canada (or the United States) a “separate and different system of taxation” from that prevailing for resident taxpayers. As Mr. Justice Hugessen stated for the Court of Appeal: The interpretation adopted by the Learned Trial Judge gives effect to the purpose of the parties to the Convention and does no violence to the language used by them. The interpretation proposed by the appellant [Utah Mines], on the other hand, would have the effect of giving a US taxpayer with a permanent establishment in Canada a more favourable tax treatment than its Canadian competitor engaged in the same business in this country. Such a result would not be in accordance with the policy expressed in the preamble to the Convention and indeed would be contrary to it. It would take much clearer language than a simple reference to “all expenses” to bring it about.39 To the extent that the court commented on distinguishing the Melford decision, there is a reference in the judgment of Mr. Justice Walsh at the Trial Division to the Crown’s arguments, including the point that, in contrast to questions relating to imposition of withholding tax, the determination of the components of business income allocable to a permanent establishment in Canada involves expenses completely within the domestic taxation jurisdiction. Mr. Justice Walsh went on to state that the domestic law provision under review in Melford was directed only at non-residents, whereas paragraph 18(1)(m) affected the way both residents and non-residents compute their income under the Act.40 It is difficult to disagree with the conclusion of the courts in Utah Mines Ltd. It is also difficult to see what effect is now left for section 4 of the ITCI Act, other than its being an accurate declaration of the law of Canada.

GENERAL PRINCIPLES AND METHODS OF TAX CONVENTION INTERPRETATION: THE CROWN FOREST DECISION In 1994, the Supreme Court of Canada gave leave to hear an appeal from the decision of the Federal Court of Appeal in the Crown Forest case,41 which involved the interpretation of the Canada-US tax convention, 1980.42 This was to result in the first discussion by the Supreme Court of the approach to the interpretation of tax conventions since the Melford case. The decision of the Supreme Court in this case is significant, not only

38 91 DTC 5245, at 5248 (FCTD). 39 Supra footnote 37, at 6197. 40 Supra footnote 38, at 5248-49. 41 Supra footnote 15. 42 The Convention Between Canada and the United States of America with Respect to Taxes on Income and on Capital, signed at Washington, DC on September 26, 1980, as amended by the protocols signed on June 14, 1983 and March 28, 1984 (herein referred to as “the Canada-US tax convention, 1980”).

(1995), Vol. 43, No. 5 / no 5 THE INTERPRETATION OF TAX CONVENTIONS IN CANADA 1775 because, in reversing the decision of the Federal Court of Appeal, it came to a well-reasoned and correct conclusion on an important interpretive issue, but also because, in doing so, the court discussed and sanctioned the use of a number of important principles and methods for interpretation of Canadian bilateral income tax conventions. It will be seen in the following discussion of the case how far the approach used by the court in this regard developed beyond the approach of the same court in the Melford case.

Facts Crown Forest Industries Limited, a Canadian resident corporation, paid rent to Norsk Pacific Steamship Company Limited, a non-resident of Canada, for the use of certain barges to transport wood and paper prod- ucts. Norsk was incorporated in the Bahamas and maintained its only place of business (consisting of an office with some 19 employees) in the United States. Norsk filed income tax returns with the United States as a foreign corporation under US domestic income tax law43 and did not file any income tax returns in the Bahamas or with any other jurisdiction. As the result of an exemption under US domestic tax law for certain international shipping income,44 Norsk was exempt from US income tax on the barge rental payments. This exemption applied because Norsk had been incorporated in the Bahamas and because the Bahamas had provided a reciprocal exemption for companies incorporated in the United States. Under part XIII of the Act,45 Crown Forest was required to withhold tax at the rate of 25 percent from the rental payments it made to Norsk. This rate of withholding is reduced to 10 percent under the terms of the

43 A foreign corporation under US tax law is any corporation not incorporated in the United States. The US taxation of foreign corporations is provided for in section 882(a)(1) of the Internal Revenue Code of 1986, as amended, as follows: SEC. 882. TAX ON INCOME OF FOREIGN CORPORATIONS CONNECTED WITH UNITED STATES BUSINESS. (a) IMPOSITION OF TAX— (1) IN GENERAL.—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. 44 The exemption was contained in section 883(a)(1) of the Internal Revenue Code as follows: SEC. 883. EXCLUSIONS FROM GROSS INCOME. (a) INCOME OF FOREIGN CORPORATIONS FROM SHIPS AND AIRCRAFT.— The following items shall not be included in gross income of a foreign corporation, and shall be exempt from taxation under this subtitle: (1) SHIPS UNDER FOREIGN FLAG.—Earnings derived from the operation of a ship or ships documented under the laws of a foreign country which grants an equivalent exemption to citizens of the United States and to corporations organized in the United States. 45 Paragraph 212(1)(d).

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Canada-US tax convention, 1980, in respect of royalties arising in one contracting state and paid to a resident of the other contracting state.46 Article IV of the convention defines the term “resident of a Contracting State” as “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.”47 Crown For- est withheld 10 percent tax from the rental payments it made to Norsk on the basis that Norsk was a resident of the United States within the meaning of article IV. The minister of national revenue disagreed that Norsk satisfied the condition of the definition and reassessed Crown Forest for failing to withhold tax at the rate of 25 percent as required by the Act. The issue for the courts was thus whether Norsk was a “resident of a Contracting State,” in this case the United States, within the meaning of article IV.

Lower Court Decisions The Federal Court—Trial Division upheld Crown Forest’s appeal from the minister’s reassessment.48 The court noted that, as a foreign corporation for US tax purposes, Norsk was liable to tax in the United States because it conducted a trade or business that was effectively connected with the United States and found 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.49 The court then held that Norsk was a resident of the United States within the meaning of article IV because it was liable to tax under US law by reason of its place of management or by reason of its place of conducting its trade or business, the court having characterized “place of trade or business” as a “criterion of a similar nature” for the purposes of article IV. The minister appealed the decision of the Trial Division to the Federal Court of Appeal, which dismissed the appeal.50 The court held that the factual finding made by the Trial Division that the reason Norsk’s income was effectively connected with a trade or business within the United States was that Norsk’s place of management was located in the United

46 Article XII(2) of the Canada-US tax convention, 1980. 47 Article IV(1) of the Canada-US tax convention, 1980 reads in its entirety as follows: “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 derived by such estate or trust is liable to tax in that State, either in its hands or in the hands of its beneficiaries.” 48 92 DTC 6305 (FCTD). 49 Ibid., at 6310. 50 94 DTC 6107 (FCA).

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States was “reasonably open... on this record” and could not be said to be “a palpable or overriding error in the findings of fact.”51 The court further held that the Trial Division did not err in its interpretation of article IV as applied to the facts of the case. In coming to this conclusion, the Court of Appeal rejected four arguments made by the Crown. First, the evidence established that under US domestic tax law, a foreign corporation was not generally liable for tax in the United States by reason of its place of management, but rather would be taxable in the United States if it conducted a trade or business that was effectively connected with the United States. The Crown therefore argued that because this basis of taxation is not one of the four enumerated in article IV, nor is it one of a similar nature, Norsk was not a resident of the United States for purposes of the convention. The court rejected this argument, stating: The wording of the Convention suggests that any inquiry into resident status must have regard for the basis of liability of a particular taxpayer rather than for the application of domestic tax law generally. The submis- sion that foreign corporations cannot be liable to tax in the U.S. by reason of their place of management begs the very question that must be determined by this Court. Accordingly, the question is not whether, as a general rule, the U.S. imposes tax by reason of the foreign corporation’s place of management, but whether, on these facts, Norsk is liable to pay tax by reason of its place of management.52 Second, the Crown argued that a common element of the criteria listed in article IV is that they are the basis for the imposition of taxation on the worldwide income of a person. Thus, because Norsk was not liable to US tax on its worldwide income, but only on its US source income, Norsk was not a resident of the United States under article IV. The court noted that, under US law, only domestic corporations (that is, corporations incorporated in the United States) were liable to US worldwide taxation and rejected this argument on the following basis: 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.53 In coming to this conclusion, the court referred to the definition of “resident of a Contracting State” contained in article 4(1) of the 1977 OECD model convention, which reads as follows: 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 or any other criterion of a similar nature. But this term does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein [emphasis added by the court].

51 Ibid., at 6112. 52 Ibid. 53 Ibid., at 6113.

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The court noted that the last sentence of this definition was not included in article IV of the Canada-US tax convention, 1980 and concluded that this omission “indicates that it was not the intention of the drafters to make liability to tax on a worldwide basis a necessary condition for resident status under the Convention.”54 Third, the Crown argued that the trial judge’s finding that US tax liability caused by the conduct of a business effectively connected with the United States could bring a taxpayer within the ambit of article IV was tantamount to an amendment to the convention. The court disagreed with this, stating that the basis for the trial judge’s finding was that Norsk was liable to tax in the United States by reason of its place of management. The Crown’s fourth argument was that the trial judge’s holding would lead to anomalous results in that it would permit a foreign corporation with only a minimal amount of income effectively connected with the United States to benefit from the convention. The court dismissed this argument on the basis that its refusal to accept that worldwide taxation was needed for residence status under article IV did not mean that any corporation with US source income would be a US resident under the convention. It was still necessary that that income be subject to US tax by reason of the criteria listed in article IV.

Supreme Court of Canada Decision The minister appealed the Federal Court of Appeal decision to the Su- preme Court of Canada and was supported in the appeal by the government of the United States, as intervener. The Supreme Court allowed the appeal, holding that Norsk was not a resident of the United States within the meaning of article IV.

General Methodology of Tax Convention Interpretation In analyzing the issue before the Supreme Court, Mr. Justice Iacobucci, writing the unanimous decision of the court, set out the method to be followed in addressing questions of tax convention interpretation: 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.55 The court also accepted with approval the following statement from Glad- den Estate v. The Queen: Contrary to an ordinary taxing statute a tax treaty or convention must be given a liberal interpretation with a view to implementing the true intentions of the parties. A literal or legalistic interpretation must be avoided when the basic object of the treaty might be defeated or frustrated in so far as the particular item under consideration is concerned.56

54 Ibid. 55 Supra footnote 15, at 5393. 56 85 DTC 5188, at 5191 (FCTD).

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The principle that bilateral tax conventions should be given a liberal interpretation in the light of their object and purpose, rather than a more strict and literal interpretation that may be applicable with respect to domestic tax legislation, has been generally accepted in Canadian and UK jurisprudence.57 Canadian courts have considered both the object and purpose of a tax convention as a whole and that of a particular provision in a convention in resolving tax convention interpretation issues.58 The basis of this principle appears to be twofold. First, it recognizes that a tax convention is an international agreement between two states rather than purely domestic legislation.59 Second, it recognizes that tax conventions are not drafted in the precise and detailed form in which domestic legislation is drafted, but in more general language.60

57 See, for example, Stag Line, Ld. v. Foscolo, Mango & Co., [1932] AC 328, at 350 (HL), where Lord Macmillan stated, “It is important to remember that the Act of 1924 was the outcome of an International Conference and that the rules in the Schedule have an international currency. As these rules must come under the consideration of foreign Courts it is desirable in the interests of uniformity that their interpretation should not be rigidly controlled by domestic precedents of antecedent date, but rather that the language of the rules should be construed on broad principles of general acceptation.” This passage was cited with approval in Furness, Withy & Co. Ltd. v. MNR, 66 DTC 5358 (Ex. Ct.); Hunter Douglas Ltd. v. The Queen, 79 DTC 5340 (FCTD); Re Regina and Palacios (1984), 45 OR (2d) 269 (CA); and Fothergill v. Monarch Airlines, [1981] AC 251 (HL). See also Saunders v. MNR, 54 DTC 524 (TAB); Canadian Pacific Ltd. v. The Queen, 76 DTC 6120 (FCTD); Shahmoon v. MNR, 75 DTC 275 (TRB); Scott Estate v. The Queen, 88 DTC 6012 (FCTD); National Corn Growers Assn. v. Can. (CIT) (1990), 74 DLR (4th) 449 (SCC); Canada (Attorney General) v. Ward, [1993] 2 SCR 689; Thomson v. Thomson, [1994] 3 SCR 551; In re Arton (No. 2), [1896] 1 QB 509 (QB); Bulmer v. Bollinger, [1974] 2 All ER 1226 (CA); Buchanan & Co. v. Babco Ltd., [1978] AC 141 (HL); Government of Belgium v. Postlethwaite, [1987] 2 All ER 985 (HL); and IRC v. Commerzbank, [1990] STC 285 (Ch. D.). Some courts have expressed the view that a liberal interpretation cannot ignore or wholly depart from the express language of the convention. See Interprovincial Pipe Line Co. v. MNR, 59 DTC 1018, at 1023 (Ex. Ct.), where Mr. Justice Thurlow stated, “[D]espite the purpose of the Convention, as declared in it, of avoiding double taxation, the Conven- tion goes no further in avoiding double taxation than what is set out in its several Articles”; and Avery Jones v. IRC, [1976] 2 All ER 898, at 906 (Ch. D.), where Mr. Justice Walton accepted submissions of the Crown that the words sought to be read into a tax convention by the taxpayer “were plainly not in the article” and that “one had to take the convention as one found it.” In Commerzbank, supra, the clear words of a provision of a tax convention gave a result that was very unlikely to have been the intention of the contracting states. However, Mr. Justice Mummery held that the clear words must be followed because there was nothing in the context of the convention to qualify the clear words and no supplementary means of interpretation were available to the court to displace the clear words. See also Vogel and Prokisch, supra footnote 7, at 73. 58 Gladden Estate, supra footnote 56; Hunter Douglas Ltd., supra footnote 57; and Utah Mines Ltd., supra footnote 37. 59 In Saunders, supra footnote 57, at 526, it was stated, “Where a tax convention is involved . . . a liberal interpretation is usual, in the interests of the comity of nations.” 60 See Fothergill v. Monarch Airlines, supra footnote 57, at 281-82, where the House of Lords stated, “The language of an international convention has not been chosen by an English parliamentary draftsman. It is neither couched in the conventional English legislative idiom nor designed to be construed exclusively by English judges. It is addressed to a much wider and more varied judicial audience than is an Act of Parliament that deals with (The footnote is continued on the next page.)

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In seeking to find the meaning of the words in question, the Supreme Court began its analysis by undertaking a plain language reading of article IV.61 It noted that the question to be answered was why Norsk was liable to pay tax in the United States. Was it because Norsk was engaged in a trade or business effectively connected with the United States? If so, Norsk would not be a resident of the United States because being engaged in a trade or business was not a criterion listed in article IV (unless it were found to be a “similar criterion”). Or, rather, was Norsk liable to pay US tax because its place of management was in the United States? If so, Norsk would be a resident of the United States under the requirements of article IV. The court stated that under article IV, it must be shown that the liability to taxation operates by reason of one of the listed grounds, which connotes the existence of some sort of causal connection. The court noted that the legal basis for Norsk’s tax liability in the United States was derived from section 882 of the Internal Revenue Code,62 which provides that, for a foreign corporation to be liable to US tax, it must be engaged in a trade or business in the United States and have income effectively connected to that trade or business. Expert evidence given at the Federal Court—Trial Division indicated that place of management was one of the main factors considered in determining whether a foreign corporation conducted a trade or business in the United States.63 However, the Su- preme Court concluded that a finding that Norsk’s place of management is a prime factor in its liability to tax in the United States does not mean

60 Continued... purely domestic law. It should be interpreted . . . unconstrained by technical rules of Eng- lish law, or by English legal precedent, but on broad principles of general acceptation.” See also Bulmer v. Bollinger, supra footnote 57, at 1237, where Lord Denning stated: The treaty is quite unlike any of the enactments to which we have become accus- tomed. The draftsmen of our statutes have striven to express themselves with the utmost exactness. They have tried to foresee all possible circumstances that may arise and to provide for them. They have sacrificed style and simplicity. They have foregone brevity. They have become long and involved. In consequence, the judges have followed suit. They interpret a statute as applying only to the circumstances covered by the very words. They give them a literal interpretation.... How different is this treaty. It lays down general principles. It expresses its aims and purposes. All in sentences of moderate length and commendable style. But it lacks precision.... Seeing these differences, what are the English courts to do when they are faced with a problem of interpretation? They must follow the European pattern. No longer must they examine the words in meticulous detail. No longer must they argue about the precise grammatical sense. They must look to the purpose or intent.... They must divine the spirit of the treaty and gain inspiration from it. 61 This approach is consistent with the view that the starting point of interpretation of tax conventions is the ordinary meaning of the text itself. See Déry and Ward, supra footnote 16, at 268. See also the Federal Court—Trial Division decision in Crown Forest, supra footnote 48; and Commerzbank, supra footnote 57. 62 See supra footnote 43. 63 Supra footnote 48, at 6308.

(1995), Vol. 43, No. 5 / no 5 THE INTERPRETATION OF TAX CONVENTIONS IN CANADA 1781 that its US tax liability operates by reason of its place of management in the United States. In this respect, the court stated: [A]scertaining that Norsk is a resident under the Convention because its place of management is in the United States erroneously amounts to elevat- ing 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.64 Accordingly, the court held that the lower courts erred when they concluded that the legal basis of Norsk’s tax liability in the United States was the fact that its place of management was in the United States and thereby erred in their interpretation of the expression “by reason of” in article IV. The court then reviewed the question whether being “engaged in a business” was a criterion that was similar to the criteria listed in article IV. On this question, the court agreed with the position put forward by the Crown that the common element of the listed criteria is that they would each constitute a basis on which states generally impose full tax liability on worldwide income and thus that the criteria “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.”65 Because the tax liability pursuant to section 882 of the Internal Revenue Code amounts to source liability, the “engaged in a business” criterion was held not to be similar in nature to the enumerated criteria. In addition to analyzing the plain language of the Canada-US tax convention, 1980, the court considered the intention of the drafters of the convention and the goals of international taxation conventions.66 In this regard, the court concluded that both the intentions of the drafters of a tax convention and the purpose of the convention are important elements in interpreting the provisions of the convention.67 The court described its view of the general intentions of the convention as follows: 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 Cana- dian companies operating in the United States (again, or vice versa). It was

64 Supra footnote 15, at 5394. 65 Ibid., at 5395. 66 In doing so, the Supreme Court referred to a number of extrinsic materials. The use of extrinsic materials is discussed in detail in the text below. 67 “Reviewing the intentions of the drafters of a taxation convention is a very important element in delineating the scope of the application of that treaty.... Clearly, the purpose of the Convention has significant relevance to how its provisions are to be interpreted.” Supra footnote 15, at 5396. In Thomson v. Thomson, supra footnote 57, at 578, Mr. Justice La Forest stated, “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.”

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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).... An ancillary goal would also be to mitigate the administrative complexities occasioned by having to file si- multaneously income tax returns in two unco-ordinated taxation systems.68 The court further stated: 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.... 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.... 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.... 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.69 For these reasons, the court concluded that the intention of the drafters of the convention was that Norsk not be considered a US resident under the convention.

Extrinsic Materials In reviewing the purpose and intentions of the Canada-US tax convention, 1980, the Supreme Court made extensive use of extrinsic materials, stating that in ascertaining these goals and intentions, a court may refer to extrinsic materials which form part of the legal context (these include accepted model conventions and official commentaries thereon) without the need first to find an ambiguity before turning to such materials.70 The court further stated that reference could be made to “other international taxation conventions and general models thereof, in order to help illustrate and illuminate the intentions of the parties”71 to the convention.

68 Supra footnote 15, at 5396. 69 Ibid., at 5397. 70 Ibid., at 5396. 71 Ibid., at 5398.

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The use of supplementary means of interpretation to assist in the interpretation of international conventions has been generally accepted in many jurisdictions.72 Although there is UK authority for the view that extrinsic materials should be referred to only in cases of ambiguity or obscurity,73 the Supreme Court did not accept this limitation, at least in respect of extrinsic materials that form part of the “legal context” of a tax convention. This position is consistent with the principle set forth in the Vienna Convention on the Law of Treaties, which provides that recourse may be had to supplementary means of interpretation “in order to confirm” a meaning otherwise determined.74 The Supreme Court made reference to a number of different types of extrinsic materials,75 including the following: • the OECD model convention and commentaries, • the UN model convention and commentaries, • the US technical explanation of the convention, • US jurisprudence, • US Senate hearings,76 • submissions made by the US government in its status as intervener in the appeal, and • the US-China income tax treaty.77

72 See, for example, Fothergill v. Monarch Airlines, supra footnote 57, at 283, where the House of Lords stated, “Accordingly, in exercising its interpretative function of ascertaining what it was that the delegates to an international conference agreed upon by their majority vote in favour of the text of an international convention where that text itself is ambiguous or obscure, an English court should have regard to any material which those delegates themselves had thought would be available to clear up any possible ambiguities or obscurities.” See generally Vogel, supra footnote 5, at 26-38. 73 Fothergill v. Monarch Airlines, supra footnote 57, and Commerzbank, supra footnote 57. 74 UN Doc. A/Conf. 39/27, opened for signature at Vienna on May 23, 1969 (herein referred to as “the Vienna convention”), article 32. The Vienna convention is discussed in detail in the text below. 75 The Supreme Court also referred to the preamble to the Canada-US tax convention, 1980 in order to determine the object and purpose of the convention. The preamble provides as follows: “Canada and the United States of America, desiring to conclude a Convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital, have agreed as follows.” The Federal Court of Appeal also has referred to the preamble to the Canada-US tax convention, 1942: see Utah Mines Ltd. v. The Queen, supra footnote 37. 76 United States, Senate, Report of the Committee on Foreign Relations, 96th Cong., 2d sess., Tax Convention and Proposed Protocols with Canada (Washington, DC: US Govern- ment Printing Office, 1984). 77 Vogel has expressed the view that references to parallel conventions should be made only with caution: supra footnote 5, at 36-38. See also Padmore v. IRC, [1989] STC 493, at 499 (CA): “Reference to the provisions of other taxation arrangements are not, in my view, of assistance. We are construing this particular Arrangement. Other countries may have negotiated different bargains.”

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The use of some of these types of extrinsic materials has been generally accepted. In the case of others, however, the interpretive value is less clear. The Supreme Court referred to the OECD model convention and the commentary on the model convention as being “[of] high persuasive value” in providing interpretive aid, because the OECD model served as the basis for the Canada-US tax convention, 1980 and “has world-wide recognition as a basic document of reference in the negotiation, application and interpretation of multi-lateral or bi-lateral tax conventions.”78 This view has been accepted by a court in the United Kingdom79 and also has been espoused by a number of commentators.80 As well, it is supported by statements made by the OECD Committee on Fiscal Affairs in the introduction to the OECD model convention and commentary.81 In this regard, the interpretive value of the OECD model convention and commentary

78 Supra footnote 15, at 5398. The commentary on the OECD model convention has been referred to in one prior reported Canadian case: see Hinkley v. MNR, 91 DTC 1336 (TCC). 79 Sun Life Assurance Company of Canada v. Pearson (HMIT), [1986] BTC 282 (CA). In Commerzbank, supra footnote 57, the court compared the provisions of the tax convention at issue with the provisions of the OECD model convention. 80 Vogel, supra footnote 5, at 33-36; and Déry and Ward, supra footnote 16, at 278. 81 Paragraphs 2, 3, 15, and 29 of the introduction to the commentary, supra footnote 6, provide as follows: 2. It has long been recognized among the Member countries of the Organisation for Economic Co-operation and Development that it is desirable to clarify, stand- ardize and guarantee the fiscal situation of taxpayers in each Member country who are engaged in commercial, industrial, financial or any other activities in other Member countries through the application by all Member countries of common solutions to identical cases of double taxation. 3. This is the main purpose of the OECD Model Tax Convention on Income and on Capital, which provides a means of settling on a uniform basis the most common problems which arise in the field of international juridical double taxation. As recommended by the Council of the OECD, Member countries, when concluding new bilateral conventions or revising existing bilateral conventions between them, should conform to this Model Convention, as interpreted by the commentaries thereto and having regard to the reservations and derogations contained therein.... 15. Third, the worldwide recognition of the provisions of the Model Convention and their incorporation into a majority of bilateral conventions have helped make the commentaries on the provisions of the Model Convention a widely-accepted guide to the interpretation and application of the provisions of existing bilateral conventions. This has facilitated the interpretation and the enforcement of these bilateral conventions along common lines. As the network of tax conventions continues to expand, the importance of such a generally accepted guide becomes all the greater.... 29. As the Commentaries have been drafted and agreed upon by the experts appointed to the Committee on Fiscal Affairs by the Governments of Member countries, they are of special importance in the development of international fiscal law. Although the Commentaries are not designed to be annexed in any manner to the conventions to be signed by Member countries, which alone constitute legally binding international instruments, they can nevertheless be of great assistance in the application and interpretation of the conventions and, in particular, in the settlement of any disputes.

(1995), Vol. 43, No. 5 / no 5 THE INTERPRETATION OF TAX CONVENTIONS IN CANADA 1785 should be greatest where the text of a convention or a particular provision of a convention has been adopted from the OECD model, because it should be reasonable to conclude that, in adopting the OECD text, the contracting parties intended also to adopt the interpretation of that text as contemplated by the OECD model convention and commentary. In other circumstances, the weight that will be given to the OECD model convention and commentary will likely depend on the extent to which a court can determine, on the basis of the particular facts, that they reflect the common intention of the contracting states. Interestingly, the Supreme Court also referred to the UN model convention.82 Although the OECD model convention was used as the basis of the Canada-US tax convention, 1980, and the general purpose of the UN model convention is to provide a model for treaties between developed and developing countries, the UN model itself draws substantially from the OECD model. In particular, the UN definition of “resident of a Con- tracting State” is identical to the OECD definition except that it omits the second sentence of paragraph 1.83 However, the commentary on the UN definition indicates that it is intended that worldwide taxation be required for residency status. Presumably, this was the basis on which the Su- preme Court concluded that it would be appropriate to refer to the UN model convention and commentary as evidence of the intention of the Canadian and US governments in adopting the OECD definition but without the second sentence. The United States has adopted the general practice of publishing a legislative history and technical explanation of the tax conventions it enters into. The US technical explanation of the Canada-US tax convention, 1980 was formally endorsed by Canada’s minister of finance, who stated for the record that it “accurately reflects understandings reached in the course of negotiations with respect to the interpretation and application of” the convention.84 Given this endorsement, it seems appropriate for a court to refer to the US technical interpretation in determining the intention of the contracting parties, even though it was prepared by only one of the parties.85 However, the Supreme Court also considered unilateral statements of intention, in particular referring to the report of the US Senate Foreign Relations Committee and to submissions made by the intervener as to the United States’ intentions regarding the application of the convention. Other Canadian courts also have referred to unilateral statements as evidence of the intention of the contracting parties to a

82 Supra footnote 15, at 5399. The Supreme Court cited articles 31 and 32 of the Vienna convention, supra footnote 74, in support of the use of models of taxation conventions. 83 The OECD definition is set out in the text above, under the heading “Lower Court Decisions.” 84 Canada, Department of Finance, Release, no. 84-128, August 16, 1984. 85 The Tax Court of Canada had previously referred to the US technical interpretation in Coblentz v. The Queen, 94 DTC 1364 (TCC).

(1995), Vol. 43, No. 5 / no 5 1786 CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE convention.86 However, the value of such unilateral material in ascertaining the common intention of both of the parties to a convention is questionable.87 The Supreme Court referred to US jurisprudence in support of its view that a tax treaty should be construed liberally to give effect to its pur- pose88 and for the proposition that, although not conclusive, the meaning attributed to treaty provisions by the government agency responsible for the negotiation of the treaty is entitled to great weight.89 Canadian courts have previously referred to decisions of foreign courts in addressing issues of tax convention interpretation. In two Canadian cases, the court referred to a decision of a court of the other contracting state interpreting the particular provision of the convention that was at issue before it.90 There is also one Canadian case in which the court went further and referred to decisions of courts of jurisdictions other than the other contracting state that interpreted similar provisions of tax conventions to which Canada was not a party.91 UK courts have expressed some caution regarding the persuasive value of decisions of foreign courts.92

86 The Federal Court of Appeal in Utah Mines Ltd., supra footnote 37, referred to the presidential message to the US Senate seeking ratification of a supplementary amendment to the Canada-US tax convention, 1942; and in Hunter Douglas Ltd., supra footnote 57, the Federal Court—Trial Division considered testimony of an officer of the Department of National Revenue regarding the interpretation of the Canada-Netherlands tax convention. 87 See Vogel and Prokisch, supra footnote 7, at 69 and 74; and Avery Jones et al., “. . . II,” supra footnote 28, at 97. 88 Supra footnote 15, at 5396. The Federal Court—Trial Division made a similar reference in Gladden Estate, supra footnote 56, at 5191. 89 Supra footnote 15, at 5399. This is in contrast to statements made by the court in Commerzbank, supra footnote 57. In referring to a joint statement issued by the US Inter- nal Revenue Service and the UK Board of Inland Revenue expressing their views regarding the interpretation of the tax convention at issue, Mr. Justice Mummery stated, at 302, that “this joint statement has no authority in the English courts. It expresses the official view of the Revenue authorities of the two countries. That view may be right or wrong.” He also stated, ibid., that “no such principle [that the meaning given a treaty by an appropriate government agency is of great weight] is applied by the English courts to the provisions of a convention which had been incorporated into municipal law by primary or secondary legislation.” 90 No. 630 v. MNR, 59 DTC 300 (TAB); and Canadian Pacific Ltd., supra footnote 57, at 6135, where Mr. Justice Walsh stated, “While it is true that this Court has the right to interpret the Canada-U.S. Tax Convention and Protocol itself and is in no way bound by the interpretation given to it by the United States Treasury, the result would be unfortunate if it were interpreted differently in the two countries when this would lead to double taxation. Unless therefore it can be concluded that the interpretation given in the United States was manifestly erroneous it is not desirable to reach a different conclusion, and I find no compelling reason for doing so.” Commentators have expressed support for the practice of the courts of one contracting state referring to the case law of the courts of the other contracting state in order that, to the extent possible, a common interpretation of a tax convention or of one of its particular provisions can be reached. See generally Vogel, supra footnote 5, at 31-33; Vogel and Prokisch, supra footnote 7, at 62-64; and Edwards-Ker, supra footnote 16, at chapter 29. 91 See Qing Gang K. Li v. The Queen, 94 DTC 6059, at 6061 (FCA), where the justifi- cation for such reference was described as follows: “The Agreement is one of many that (91, 92 Continued on the next page.)

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The extrinsic materials referred to by the Supreme Court in the Crown Forest case confirmed, in its view, the position put forward by the Crown that the intention of the parties to the Canada-US tax convention, 1980 was that only persons who are liable to tax on their worldwide income should be considered residents for the purposes of the convention. The Supreme Court stated that the authority for this position could be found in the first sentence of the definition of resident in the OECD model convention93 and that the absence of the second sentence of the definition from the Canada-US convention, 1980 does not detract from this position, because the second sentence is relevant to a situation in which a person is considered a resident under domestic law but where that person, by reason of a special privilege, nevertheless is not subject to tax on the basis of world-wide income. Paragraph 8 of the Commentary to Art. 4 of the O.E.C.D. Model Convention addresses this point: 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.94

91, 92 Continued . . . Canada has entered into with foreign States and is patterned on the Model Convention for the Avoidance of Double Taxation with respect to Taxes on Income and on Capital which was adopted by the Organization for Economic Co-operation and Development (OECD) on April 11, 1977. As a result, the decision of Courts in OECD States as to the meaning of the various articles in similar provisions in their governing conventions could be of assistance in deciding the meaning of the words in the Agreement.” 92 In Fothergill v. Monarch Airlines, supra footnote 57, at 284, Lord Diplock stated, “As respects decisions of foreign courts, the persuasive value of a particular court’s decision must depend upon its reputation and its status, the extent to which its decisions are binding upon courts of co-ordinate and inferior jurisdiction in its own country and the coverage of the national law reporting system. For instance your Lordships would not be fostering uniformity of interpretation of the Convention if you were to depart from the prima facie view which you had yourselves formed as to its meaning in order to avoid conflict with a decision of a French court of appeal that would not be binding upon other courts in France, that might be inconsistent with an unreported decision of some other French court of appeal and would be liable to be superseded by a subsequent decision of the Court of Cassation that would have binding effect upon lower courts in France.” To the same effect is the following comment of Mr. Justice Mummery in Commerzbank, supra footnote 57, at 298: “decisions of foreign courts on the interpretation of a convention or treaty depend for their authority on the reputation and status of the court in question.” Mr. Justice Mummery found that a decision of a US court was of no real assistance in the case before him because it applied different principles of interpretation from those that an English court would apply. See also Buchanan & Co. v. Babco Ltd., supra footnote 57, and Ulster-Swift Ltd. v. Taunton Meat Haulage Ltd., [1977] 3 All ER 641 (CA), where decisions of foreign courts were not found to be of persuasive value because of their conflicting nature. 93 Supra footnote 15, at 5398. 94 Ibid., at 5398-99.

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The court concluded that, because the Canadian and US taxation systems do not include such source-income restrictions, the second sentence was simply not required in the convention, and thereby disagreed with the view of the Federal Court of Appeal that the omission of the second sentence indicates that worldwide taxation is not intended to be a condition for resident status under the convention.95 The court also stated that the extrinsic materials indicated that it was the intention of the parties to the convention that only US domestic corporations be regarded as residents of the United States for the purposes of the convention, and that explicit drafting to provide for this was simply not necessary.96 In particular, the court referred to submissions made by the intervener 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 Art. 4(1) of the O.E.C.D. 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 Art. 4(1) for the right to use “place of incorporation” as an indicator of residence. However, in order to preserve overall conformity with the O.E.C.D. Model Conven- tion, the decision was taken not to remove the other O.E.C.D. criteria from Art. IV(1). Nevertheless, the term “place of incorporation” is the only term in Art. IV(1) that governs the determination of the residence of a corporation in the United States for purposes of its tax conventions.97

Vienna Convention As noted above, the Supreme Court cited articles 31 and 32 of the Vienna convention as support for its reference to other international taxation conventions and general models of taxation conventions. The Vienna convention is an international convention that codifies various aspects of international

95 The Supreme Court also referred to the UN model convention and the US-China income tax treaty in this respect. As described above, the definition of resident in the UN model convention is identical to the OECD definition except that it does not contain the second sentence, but the UN commentary indicates that it is intended that worldwide taxation be required for residency status. The US-China income tax treaty also does not contain the second sentence. The US technical explanation of the US-China income tax treaty states that the definition of resident “would not include a person liable to tax only in respect of income from sources in the taxing country, such as a resident of a third country subject to tax in the United States or China only on a source basis”: United States, Treas- ury Department, Technical Explanation of the Agreement Between the Government of the United States and the Government of the People’s Republic of China for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, July 30, 1985, article 4. 96 This responds to the statement by the Federal Court of Appeal that, if this were the intention of the parties, the convention could have been drafted to stipulate that only domestic corporations are residents. See supra footnote 53 and the accompanying text. 97 Supra footnote 15, at 5400.

(1995), Vol. 43, No. 5 / no 5 THE INTERPRETATION OF TAX CONVENTIONS IN CANADA 1789 law relating to the law of treaties.98 It came into force on January 27, 198099 and applies to treaties concluded after that date.100 The principles for the interpretation of treaties are contained in articles 31 to 33: ARTICLE 31 General rule of interpretation 1. A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose. 2. The context for the purpose of the interpretation of a treaty shall comprise, in addition to the text, including its preamble and annexes: (a) any agreement relating to the treaty which was made between all the parties in connection with the conclusion of the treaty; (b) any instrument which was made by one or more parties in connexion with the conclusion of the treaty and accepted by the other parties as an instrument related to the treaty. 3. There shall be taken into account, together with the context: (a) any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions; (b) any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation; (c) any relevant rules of international law applicable in the relations between the parties. 4. A special meaning shall be given to a term if it is established that the parties so intended. ARTICLE 32 Supplementary means of interpretation Recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the application of Article 31, or to determine the meaning when the interpretation according to Arti- cle 31: (a) leaves the meaning ambiguous or obscure; or (b) leads to a result which is manifestly absurd or unreasonable. ARTICLE 33 Interpretation of treaties authenticated in two or more languages 1. When a treaty has been authenticated in two or more languages, the text is equally authoritative in each language, unless the treaty provides or the parties agree that, in case of divergence, a particular text shall prevail.

98 See generally Ward’s Tax Law and Planning (Scarborough, Ont.: Carswell) (looseleaf), chapter 21, at section 214. 99 Article 84 of the Vienna convention provides that it enters into force on the 30th day after the deposit of the instrument of ratification or accession of the 35th state, which was January 27, 1980. 100 Article 4 of the Vienna convention.

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2. A version of the treaty in a language other than one of those in which the text was authenticated shall be considered an authentic text only if the treaty so provides or the parties so agree. 3. The terms of the treaty are presumed to have the same meaning in each authentic text. 4. Except where a particular text prevails in accordance with paragraph 1, when a comparison of the authentic texts discloses a difference of meaning which the application of Articles 31 and 32 does not remove, the meaning which best reconciles the text, having regard to the object and purpose of the treaty, shall be adopted. Canada deposited instruments of accession with respect to the Vienna convention on October 14, 1970, but it has not enacted the Vienna convention into domestic legislation. As described above, enabling legislation must be passed by Parliament in order to enact a treaty that is inconsistent with domestic law.101 However, existing principles of customary international law form part of the domestic law without the requirement for implementing legislation provided that such principles do not conflict with statutory or common law rules.102 Accordingly, to the extent that the Vienna convention represents a codification of existing customary international law, it appears to be effective under Canadian law without the need for adoption by Parliament through specific implementing legislation.103 In this regard, the House of Lords has stated that what the Vienna convention “says in articles 31 and 32 about interpretation of treaties... does no more than codify already-existing public international law.”104 The interpretation rules set out in the Vienna convention have been referred to in a number of Canadian cases involving the interpretation of income tax (and other) conventions.105 It is interesting to note that this

101 See the discussion in the text accompanying footnotes 10 and 11. 102 See Chung Chi Cheung v. The King, [1939] AC 160, at 168 (PC), where Lord Atkin stated, “The Courts acknowledge the existence of a body of rules which nations accept amongst themselves. On any judicial issue they seek to ascertain what the relevant rule is, and, having found it, they will treat it as incorporated into the domestic law, so far as it is not inconsistent with rules enacted by statutes or finally declared by their tribunals.” See also Reference as to Whether Members of the Military or Naval Forces of the United States of America Are Exempt from Criminal Proceedings in Canadian Criminal Courts, [1943] SCR 483, at 502, where the court stated that “rules of international law . . . will be followed in the absence of any domestic law to the contrary”; and Reference as to Powers To Levy Rates on Foreign Legations and High Commissioners’ Residences, [1943] SCR 208. 103 See Ward’s Tax Law and Planning, supra footnote 98, at section 214.3[b], for a general discussion on the legal applicability in Canada of the Vienna convention. 104 Fothergill v. Monarch Airlines, supra footnote 57, at 282. See also Vogel and Prokisch, supra footnote 7, at 66. 105 R v. Parisien, [1988] 1 SCR 950; Thomson v. Thomson, supra footnote 57; Hunter Douglas Ltd., supra footnote 57; Gladden Estate, supra footnote 56; Coblentz, supra footnote 85; the Federal Court—Trial Division in Melford, 80 DTC 6074; and Canada-Israel Development Ltd. v. MNR, 85 DTC 718 (TCC). The House of Lords also made reference to the Vienna convention in Fothergill v. Monarch Airlines, supra footnote 57, as did Mr. Justice Mummery in Commerzbank, supra footnote 57 (the Vienna convention is not incorporated into UK municipal law by any enactment).

(1995), Vol. 43, No. 5 / no 5 THE INTERPRETATION OF TAX CONVENTIONS IN CANADA 1791 reference has been made without an inquiry into whether or not the principle sought to be applied from the Vienna convention is one of customary international law. Although in Crown Forest the Supreme Court cited articles 31 and 32 of the Vienna convention as support for reference to other international taxation conventions and general models of taxation conventions, there is no discussion of the basis for this conclusion. In this regard, although some commentators have concluded that the OECD model convention and commentary can, in the appropriate circumstances, be properly considered as supplementary means of interpretation within the meaning of article 32, and possibly part of the “context” of a convention within the meaning of article 31,106 there may be some question whether a reference to other taxation conventions is supported by either article.

CONCLUSION It is difficult to generalize about the overall historical development of the interpretation of tax conventions in Canada. The contrast between the judgments in the two important cases of Melford and Crown Forest illus- trates this. It is not difficult to conclude, however, that with the Crown Forest decision, the Supreme Court of Canada has clearly confirmed the principle that a bilateral tax convention should be given a liberal interpretation in the light of its object and purpose, rather than a more strict and literal interpretation that may be applicable in interpreting a domestic statute. In addition to looking to the language used in a convention, the Supreme Court, in resolving the interpretive issue before it, considered and placed considerable weight upon the intention of the contracting states to the convention, and not only the object and purpose of the particular convention but also that of international tax conventions in general. In doing so, the court referred to a wide array of extrinsic materials. While this general interpretive approach had previously played a part in a number of important lower court decisions (such as Hunter Douglas,107 Gladden Estate,108 and Utah Mines109), the Crown Forest decision has made it much more likely that such an approach will be consistently applied by Canadian courts in the future and will continue to develop further, as they address issues of tax convention interpretation.

106 See Vogel and Prokisch, supra footnote 7, at 64; and Déry and Ward, supra footnote 16, at 274. 107 Supra footnote 57. 108 Supra footnote 56. 109 Supra footnote 37.

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