US Trust Investors Challenge Canadian Tax

by Mike Godfrey, Tax-News.com, Washington

02 November 2007

The Canadian government is facing a NAFTA (North American Free Trade Agreement) challenge by two American trust investors over its controversial decision last year to slap a tax on distributions made by income trusts.

Their Notice of Intent to Submit a Claim to Arbitration under NAFTA is based on Finance Minister Jim Flaherty’s announcement on October 31, 2006 of plans to eliminate the tax advantages then enjoyed by income trusts compared with companies, as part of the Conservative government's 'Tax Fairness Plan'.

The action has been brought by Chicago couple, Marvin and Elaine Gottlieb. They allege that the Canadian government discriminated against Americans when they imposed the new measures, in breach of the terms of NAFTA. They are seeking at least $6.5 million in damages they claim to have suffered as a result of the tax.

"We are the first Americans to launch a NAFTA action related to the taxation of energy trusts," Marvin Gottlieb said in a statement announcing his intent to submit an arbitration claim, according to Reuters.

The income trust distribution tax, which was devised largely without consultation and announced without warning, caused consternation in Canada's business and investment sector. While companies that had converted to trusts before the announcement have until 2011 before the new tax regime comes into force, new conversions immediately fall under the new regime, and several corporations with well-advanced plans towards converting to trust status have been forced to rethink their strategies.

The tax is, according to Mr Flaherty, designed to tackle a "growing trend toward corporate tax avoidance" caused by the vehicle's more favourable tax treatment - income trusts do not pay corporate tax - compared with the more conventional company structures.

However, one Toronto-based trade specialist informed Canada's National Post that the claim has little chance of succeeding, because the NAFTA excludes investment disputes over taxation except where there is clear discrimination against investors in a certain member country.

"None of that exists here. The government's income trust measures apply across the board," Lawrence Herman, a lawyer at Cassels Brock law firm, told the Financial Post on Wednesday in an email.

He went on to add that "when you have to go through complex legal gymnastics to make out a case, as here, I think you're in for a rough ride before any arbitration panel".

"The NAFTA landscape is littered with the wrecks of these kinds of Chapter 11 investment claims that didn't go anywhere," Herman told the Post.

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