Trinidad and Tobago: Court of Appeal quashes treaty shopping scheme

By Allan Lanthier, Montreal, retired partner of an international accounting firm and former advisor to the government of Canada

Applying a domestic anti-avoidance rule, the Court of Appeal of Trinidad and Tobago has decided that a Trinidad subsidiary’s dividend payments to a holding company in Barbados were liable to withholding tax on the basis that, in substance, the dividends were paid to the ultimate parent company in Canada (Methanex Titan (Trinidad) Unlimited v. Inland Revenue).

The decision is a reminder of the uncertain relationship that exists between domestic anti-abuse rules and tax treaty provisions.

The background

Methanex Canada, a public company, is the world’s largest producer and supplier of methanol, with production facilities in six countries, including Trinidad. Methanex Canada, through wholly-owned subsidiaries in the Cayman Islands and Barbados, had indirect ownership of all of the shares of Methanex Trinidad.

In 2007, Methanex Trinidad paid four dividends totaling US $85.4 million to Methanex Barbados: dividends in the same amounts were then paid from Barbados to Methanex Cayman, and from Cayman to the Canadian parent.

The dividend payments from Trinidad to Barbados were governed by the CARICOM tax treaty – a treaty 11 Caribbean countries entered into. Under that treaty, dividends a company resident in one member state pays to a resident of another are exempt from withholding tax.

Methanex Barbados was an international business corporation, so there was no withholding tax on dividends Barbados paid to Methanex Cayman, nor was there tax on dividends from the Cayman Islands to Canada.

The Tax Appeal Board agreed with Inland Revenue that the dividends paid to Barbados were for the benefit of the ultimate Canadian parent company and were “artificial and fictitious” under Trinidad’s Income Tax Act. The board upheld the assessment of a 5% tax, the rate under the tax treaty between Canada and Trinidad. The taxpayer appealed.

The Court of Appeal

In a unanimous decision, the court agreed that 5% withholding tax applied.

The tax act states that provisions in a tax treaty apply “notwithstanding anything in any written law.” The act also has an anti-abuse rule under which a transaction may be disregarded if it is artificial or fictitious.  The taxpayer’s position was that the “notwithstanding” language took precedence, and the anti-abuse provision could not apply to deny tax treaty relief. The court disagreed.

The court concluded that the substance of the transactions first must be examined to determine whether the CARICOM treaty applied or not. Were the transactions—as they were purported to be—dividend payments to a resident of another member state – or were they artificial and, in fact, payments to the Canadian parent company?

The court said the answer depends on the substance of the transactions and stated that OECD commentaries to the model tax convention say there is generally no conflict between domestic anti-abuse rules and the provisions of tax treaties: domestic rules are applied first to determine the facts that give rise to a tax liability.

The relevant facts

The amounts of the four dividend payments from Methanex Trinidad to Methanex Barbados were exactly the same amounts as the dividends that Barbados then paid to Methanex Cayman. The only bank accounts of Methanex Barbados and Methanex Cayman were in Canada and under the control of the Canadian parent. The funds resided in the bank account of Methanex Barbados for less than 48 hours, the court said, and were then “transmitted onwards, with extraordinary rapidity, in the exact amounts to Methanex Canada who received them.”

In emails from Methanex Canada to Methanex Trinidad, officials of the Canadian parent required that the cash dividends be paid. Referring to one such demand, the court stated that “[t]here was no subtlety in that email…it was in peremptory terms.” The court noted that, in the real world, Methanex Canada could not have required a dividend payment from a company, Methanex Trinidad, of which it was not a shareholder.

Conclusions of the court

The court concluded that the dividend payments from Methanex Trinidad to Barbados were artificial and fictitious because the dividends were intended to be, and were in fact, payments to the ultimate parent company.

Methanex Canada was the beneficial owner of the dividends, not Methanex Barbados, said the court. The directors of the Barbados company exercised no independent consideration or judgment with respect to the dividends. Methanex Barbados was no more than a conduit, and the dividends were artificially routed through it in a preconceived plan to avoid withholding tax.

That is not to say that any dividend Methanex Trinidad paid to Barbados would be artificial and fictitious, as Inland Revenue had also argued. The court stated that, while one of the stated purposes of the CARICOM tax treaty is to encourage trade and investment between CARICOM member states, this does not mean that any retransmission of dividends outside the CARICOM region would, in and of itself, be artificial. However, the payment of the four dividends in dispute was a thinly disguised attempt to use Methanex Barbados as a conduit.

Lessons learned

From the taxpayer’s perspective, the damage was self-inflicted. The court cited Aiken Industries (Aiken Industries v. Commissioner [1971] 56 TC 925) as authority for the proposition that “received by” means a taxpayer has complete dominion and control over amounts received, with no obligation to transmit the funds to another.

The result almost certainly would have been different had the Canadian parent not been seen as the directing mind behind the payments and had the directors of Methanex Barbados given more consideration to the possible payment of dividends and in what amounts.

The decision stands in stark contrast to a recent treaty shopping decision of the Supreme Court of Canada in which the taxpayer prevailed, notwithstanding facts that could hardly have been worse (Canada v. Alta Energy Luxembourg S.A.R.L., 2021 SCC 49). Two U.S. corporations had formed a Canadian company—Alta—to acquire and develop oil and gas properties in Alberta. Realizing late in the game that a gain on a sale of the Alta shares would not be treaty-protected from Canadian tax, the U.S. shareholders, through a partnership, formed a Luxembourg intermediary company and transferred the Alta shares to it.

The following year, the Alta shares were sold at a gain of C $380 million (US $300 million), and the Luxembourg intermediary claimed exemption from Canadian tax under the Canada-Luxembourg tax treaty. In a six-to-three decision, the majority decided that Canada’s general anti-avoidance rule did not apply, even though virtually the entire gain accrued to the U.S. investors under a participating note. The third-party purchaser paid all the cash proceeds to the partnership. Did the conduit entity in Luxembourg have “complete dominion and control” over the proceeds? Not even close: In fact, it never received a penny.

• Allan Lanthier is a retired partner of an international accounting firm and former advisor to the government of Canada. He lives in Montreal.