The Tax Court of Canada recently allowed the taxpayer’s appeal in Velcro Canada Inc. v. The Queen. The issue on appeal was whether a Dutch company was the beneficial owner of royalties paid to it by a Canadian taxpayer for purposes of the Canada-Netherlands Income Tax Convention (the Treaty), despite the Dutch company having an obligation to pay a further royalty, in an amount equal to 90% of the royalties received from Canada, within 30 days to an affiliate in the Netherlands Antilles. The court held that the Dutch company was not a mere conduit for the Netherlands Antilles company as had been alleged by the Crown. This decision is important as it provides further clarification of the circumstances under which taxpayers may arrange for payments to be made to a company in a treaty jurisdiction without loss of treaty relief for Canadian sourced payments. In particular, the decision extends the guidance regarding beneficial ownership provided by the Federal Court of Appeal in Prévost Car Inc. v. The Queen (see our Osler Update dated March 2, 2009) – a case which had considered clearly discretionary payments (dividends) – to contractually mandated payments such as interest or royalties.
In 1987, Velcro Industries BV (Velcro Industries) entered into a licence agreement with Velcro Canada Inc. (Velcro Canada), granting Velcro Canada the right to use Velcro Industries’ intellectual property to manufacture and sell fastening products in exchange for royalty payments (the Licence Agreement). At the time, Velcro Industries was a resident of the Netherlands. From 1987 to October 1995, Velcro Canada paid royalties to Velcro Industries and withheld Canadian tax at the applicable 10% rate under the Treaty, rather than the 25% rate that would apply absent any treaty relief. The Velcro group of companies underwent a reorganization on October 26, 1995, resulting in Velcro Industries becoming a resident of the Netherlands Antilles, a country with which Canada did not have an income tax treaty. The next day, Velcro Industries assigned its rights and obligations under the original Licence Agreement to Velcro Holdings BV (Holdings), a subsidiary resident in the Netherlands. Under an assignment agreement, Holdings was assigned the right to grant licenses for Velcro Industries’ intellectual property to Velcro Canada and to receive royalties from Velcro Canada. Holdings would pay Velcro Industries an arm’s length percentage of net sales of the licensed products, which represented approximately 90% of the royalty payments received from Velcro Canada, within 30 days of receiving royalty payments from Velcro Canada. The ownership of the intellectual property remained with Velcro Industries.
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