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. (1995), Vol. 43, No. 5 / no 5 1759 1760 CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE 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 in- come 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, bilat- eral 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 rev- enue 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 proc- ess 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