André Ouellette, Lawyer
Department of Justice Canada


The harmonization of federal legislation with the common law and the civil law requires, first, an identification of the areas of federal legislation where the private law of the provinces acts as complementary law. As regards the application of tax statutes, some interventions are more easily identifiable, particularly where Parliament resorts to a private law concept without defining it, as was explained in an earlier column.[1] Other areas of the law, however, require further study of the relationship between federal statute law and the private law of the provinces in order to determine whether other factors would modify the analysis or if the same approach still applies. This problem is raised by international law, which is governed by a set of principles that are specific to this field. The purpose of this column is to examine this problem and to this end two examples will be studied in which international factors are present. They are the characterization of foreign entities and the interpretation of international conventions.

Federal legislation has to be harmonized with the private law of the provinces in two situations: first, where a provision of a federal statute refers to a private law concept without defining it and, secondly, where a statute does not fully regulate a private law matter.[2] Tax statutes have no special status; like all federal legislation, they are subject to the principle of complementarity, a principle that has been explicitly recognized in section 8.1 of the Interpretation Act.[3]

The issue now arises as to whether the principle of complementarity should also apply when a tax provision is applied in an international context to the extent that it refers to the private law of the provinces. This column will examine two decisions to illustrate how the analysis of complementarity may be affected by the presence of international factors. It will discuss how the problem arises and examine the issues that are raised.

1. Characterizing Foreign Entities or Institutions

The first example concerns the characterization of foreign entities or institutions where a provision of the Income Tax Act is to be applied.[4] The issue was discussed by the Supreme Court in the trilogy that dealt with the essential elements for the formation of a partnership in the context of the application of the I.T.A. The cases are Continental Bank,[5] Backman[6] and Spire Freezers.[7] This column will focus on the judgment of the Supreme Court in Backman since the Court provided in that case a detailed analysis of the application of the tests it had developed in Continental Bank to a situation involving an entity constituted under a foreign law.

1.1. The Backman Case

The entity at issue in Backman was a limited partnership established in 1985 under the laws of the State of Texas. The entity acquired land and constructed an apartment building on this land, but the costs associated with this project far exceeded its fair market value. In August 1988, the taxpayer, Backman, and 38 other Canadians, purchased an interest in the Texas limited partnership. The entity then sold the apartment complex back to the original American partners, thereby realizing the accounting losses on the apartment complex. Under section 96 I.T.A., the Canadian partners deducted from their income for the 1988 taxation year the losses from this transaction.One of the issues raised on appeal was whether the taxpayers were members of a validly constituted partnership and could therefore deduct the losses under section 96 I.T.A. At the outset, the Court noted that the term “partnership” was not defined in the I.T.A. It maintained that the taxpayers then had to show that the entity in question satisfied “the definition of partnership that exists under the relevant provincial or territorial law.”[8]

The Supreme Court began its analysis by reviewing the origins of the concept of partnership.[9] It noted that the laws of the common law provinces dealing with partnerships were derived from the Partnership Act[10] of the United Kingdom. However, the concept of partnership had been recognized long before the enactment of that Act. Three essential ingredients are necessary for the formation of a partnership, that is, (1) a business (2) carried on in common (3) with a view to profit. The Supreme Court also stated at paragraph 18 of its judgment that it had reached this conclusion in Continental Bank.[11] After analysing each of the ingredients, the Court applied them to the facts before it. The Supreme Court found that the business was not carried on with a view to profit.

One of the aspects of Backman that is interesting for the purposes of this discussion is the analysis of the second thesis advanced by the taxpayers. They maintained that they became partners in a valid partnership when they acquired an interest in a partnership that already existed in Texas. According to this thesis, the applicable law to determine the existence of a partnership would be the law of Texas. The Court rejected this argument on the grounds that a person “must satisfy the essential ingredients of a partnership under Canadian law”[12] if he or she wishes to deduct partnership losses under section 96 I.T.A. In other words, “a partnership must be that entity familiar to Canadian law,” under the test stated by the Supreme Court.[13]

The Supreme Court's statement that a partnership must be “that entity familiar to Canadian law,” is a source of confusion, in the opinion of this author. It must be remembered that, at the beginning of its analysis, the Court sought to identify the essential ingredients of a partnership according to the laws of the common law provinces. It cited, inter alia, its judgment in Continental Bank where Bastarache J. had specified that it involved features common “to the majority of partnership statutes in the common law world.”[14] The author believes that the decision of the Supreme Court in Backman would have gained in clarity if it had unambiguously stated that the use of common law rules should apply in principle only to partnerships in common law provinces.

However, the Supreme Court did not consider the issue of which provincial law applied in that case; instead it looked at the essential ingredients found in the partnership legislation of common law jurisdictions. The Court referred to the Ontario statute, at paragraph 37 of its judgment, and to the Alberta statute, at paragraph 39, without deciding whether it should give preference to one of these statutes even though the taxpayers were residents of Alberta. The question arises as to why the Supreme Court did not push its analysis further with respect to the applicability of the Alberta legislation, especially if it believed that the taxpayers had to satisfy the definition in the provincial legislation applicable to the case.[15]

1.2. The Backman Case and the Civil Law

The Supreme Court's analysis left unresolved the question of which tests would have to be used to characterize the Texas partnership for the purposes of the I.T.A. if the taxpayers had been Quebec residents. Indeed, the definition in the Civil Code of Québec[16] shows a difference between the civil law and the common law. Section 2186, paragraph 1 C.C.Q. provides:

A contract of partnership is a contract by which the parties, in a spirit of cooperation, agree to carry on an activity, including the operation of an enterprise, to contribute thereto by combining property, knowledge or activities and to share any resulting pecuniary profits.

Upon reading this provision, it can be noted that a partnership in civil law is not limited to the operation of a business.[17] Furthermore, the common law requires that the partners intend to make a profit while the Civil Code deals with the sharing of profits.[18] Would a court be justified in using the three essential ingredients described in Continental Bank to characterize a foreign partnership if the partners of the partnership at issue were Quebec taxpayers? Would a court instead apply the civil law of Quebec to determine whether the entity at issue satisfied “the definition of partnership that exists under the relevant provincial law” as stated by the Supreme Court in Backman?[19] The author believes that, pursuant to section 8.1 of the Interpretation Act , Quebec provincial law should be applied as the suppletive law in such a situation since the determination of the validity of a partnership requires a reference to the provincial private law. At the beginning of its analysis, the Supreme Court explained that the taxpayer had “to satisfy the definition of partnership that exists under the relevant provincial or territorial law.”[20] In the author's opinion, this statement supports the view that the civil law of the province of Quebec is the applicable suppletive law for the purposes of characterizing partnerships created outside Canada or any other foreign entity carrying on business in Quebec or whose members are Quebec residents.

The characterization of an entity or an institution for purposes of the I.T.A. raises questions that, in the author's opinion, fall within the area of private international law to the extent that it is necessary to identify the connecting factors to the laws of a particular province. It will be interesting to see how, in the years to come, the courts will clarify the reasoning of the Supreme Court by developing rules for choosing the applicable provincial law.

2. Interpretation of Treaties

Another area where bijuralism must be taken into account is the interpretation of international conventions. The question of interpreting a concept that is not defined in an international tax convention arose in Wolf v. Canada.[21] The case involved a determination of whether the taxpayer, an American citizen, was an employee or an independent contractor. The person provided his services as a consultant through a Calgary company (Kirk-Mayer) for a company situated in Quebec (Canadair).

The Minister of National Revenue assessed the taxpayer for the 1990 to 1995 taxation years on the basis that he had earned employment income and not business income. The taxpayer contested the assessments, arguing that he was a citizen of and resident in the United States and that, according to Article XIV of the Canada−United States Income Tax Convention,[22] his income was supposed to be taxed in the United States since it was income in respect of independent personal services.

The Tax Court of Canada rejected the taxpayer's arguments. According to the Court, the taxpayer was not an independent contractor but an employee of Kirk-Mayer when he worked at Canadair.[23] The Federal Court of Appeal overturned that finding on the basis that the taxpayer had, on the contrary, worked as an independent contractor. For the purposes of this column, the legal reasoning followed by Justices Desjardins and Décary in reaching this conclusion will be examined.

The discussion in the Federal Court of Appeal dealt with Articles XIV and XV of the Canada-United States Income Tax Convention, which read as follows:

Article XIV - Professions indépendantes

Article XIV - Independent Personal Service

Les revenus qu'une personne physique qui est un résident d'un État contractant tire d'une profession indépendante sont imposables dans cet État. Ces revenus sont aussi imposables dans l'autre État contractant si la personne physique dispose, ou a disposé, de façon habituelle d'une base fixe dans cet autre État mais uniquement dans la mesure où les revenus sont imputables à la base fixe.

Income derived by an individual who is a resident of a Contracting State in respect of independent personal services may be taxed in that State. Such income may also be taxed in the other Contracting State if the individual has or had a fixed base regularly available to him in that other State but only to the extent that the income is attributable to the fixed base.

Article XV - Professions dépendantes

Article XV - Dependent Personal Services

1. Sous réserve des dispositions des articles XVIII (Pensions et rentes) et XIX (Fonctions publiques), les salaires, traitements et autres rémunérations similaires qu'un résident d'un État contractant reçoit au titre d'un emploi salarié ne sont imposables que dans cet État, à moins que l'emploi ne soit exercé dans l'autre État contractant. Si l'emploi y est exercé, les rémunérations reçues à ce titre sont imposables dans cet autre État.

1. Subject to the provisions of Articles XVIII (Pensions and Annuities) and XIX (Government Service), salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State.

The Federal Court of Appeal ruled that three elements are required for Article XIV to apply:

  1. the residence qualification of the individual,
  2. whether the services he offers are independent personal services, and
  3. whether the individual has a fixed base regularly available to him in the contracting State other than the one of his residence.[24]

The parties acknowledged that the taxpayer, Wolf, was an American resident (item no. 1) and that he did not have a fixed base regularly available to him in Canada (item no. 3). The Federal Court of Appeal judges therefore had to determine whether the taxpayer was an independent contractor or an employee.

2.1. Madam Justice Desjardins

In analysing the applicable law, Madam Justice Desjardins developed an approach that integrates both the Civil Code rules as well as the main tests developed by the tax case law.[25] Madam Justice Desjardins cited Hôpital Notre-Dame de l'Espérance et Théoret v. Laurent[26] in concluding that the distinction between a contract of employment and a contract for services “can be examined in light of the tests developed through the years both in the civil and in the common law.”[27] It was on the basis of her analysis of a series of criteria developed by various courts and recognized in the tax case law that Madam Justice Desjardins found that the taxpayer was providing independent personal services for the purposes of Article XIV of the Canada-United States Income Tax Convention.

2.2. Mr. Justice Décary

Mr. Justice Décary reached the same result as Madam Justice Desjardins but his reasoning was somewhat different. First, Mr. Justice Décary began his analysis with a more detailed examination of the Canada-United States Income Tax Convention. Like Madam Justice Desjardins, Mr. Justice Décary was of the opinion that the issue to be decided was whether the taxpayer's income derived from “independent personal services”within the meaning of Article XIV or from “dependent personal services” within the meaning of Article XV. But, unlike Madam Justice Desjardins, Mr. Justice Décary noted that this convention explicitly permitted reference to domestic law in order to define the meaning of these terms. To that effect, he cited Article III, paragraph 2 of this Convention, which reads as follows:

Article III - Définitions générales

Article III - General Definitions

2. Pour l'application de la Convention par un État contractant, toute expression qui n'y est pas définie a le sens que lui attribue le droit de cet État concernant les impôts auxquels s'applique la Convention, à moins que le contexte n'exige une interprétation différente et sous réserve des dispositions de l'article XXVI (Procédure amiable).

2. As regards the application of the Convention by a Contracting State any term not defined therein shall, unless the context otherwise requires and subject to the provisions of Article XXVI (Mutual Agreement Procedure), have the meaning which it has under the law of that State concerning the taxes to which the Convention applies.

Since the words “independent personal services” and “dependent personal services” are not defined in the Canada-United States Income Tax Convention, Mr. Justice Décary was of the opinion that the meaning of these terms is the one they have “under Canadian law.”[28]

The reasons of Mr. Justice Décary may also be distinguished from those of Madam Justice Desjardins with respect to the applicable suppletive law. In Mr. Justice Décary's opinion, the concepts of independent contractor and employee had to be interpreted in the case at bar according to the private law of the relevant province, consistent with the decision in St-Hilaire v. Canada[29] and sections 8.1 and 8.2 of the Interpretation Act. Mr. Justice Décary looked at what could be called the connecting factors and noted that the “contractual reality of the parties”[30] was situated in Quebec. He was of the opinion that the taxpayer's situation had to be examined in the light of the Civil Code. Accordingly, Mr. Justice Décary concluded that the circumstances in which the contract was formed, the interpretation already given to it by the parties and usage in the aeronautic industry meant that the taxpayer was not in a position of subordination and that Canadair was not in a position of control.[31] In sum, the taxpayer worked for himself and the income that he received was as an independent contractor.

Mr. Justice Décary's approach in Wolf raises the more general question of the method used by domestic courts to interpret international conventions. In the case of international tax conventions, difficulties of interpretation can normally be resolved through a provision such as Article III, paragraph 2 of the Canada-United States Income Tax Convention. A reference to the domestic law of the State applying the convention is explicitly required. In the Canadian context, the author believes that the application of the private law of the provinces is fully justified where a provision refers to domestic law. A court must apply the civil law of Quebec to define any undefined term in an international tax convention where the enactment is applied in Quebec. This is what Mr. Justice Décary did in Wolf when he examined the nature of the contractual relationship between the taxpayer and Canadair.

The Income Tax Conventions Interpretation Act[32] contains a clause similar to Article III of the Canada-United States Income Tax Convention that provides for reference to domestic law in the case of undefined concepts. Such clauses that refer to the private law are seldom found in other kinds of international conventions. In such cases, it would then be necessary to refer to the principles and general rules of interpretation for international treaties.