Presented to The Malaysia-Canada Business Council

at The Banker’s Club, Amoda Building, Jalan Imbi, Kuala Lumpur on 9 September, 2004


by Peter K Searle and Robert Gordon




Introduction | SLIDE 1


1.                           Index | SLIDE 2


2.             Introduction

3.               Taxation of Labuan companies

3A.         Taxation of Labuan trusts

4.             Framework of International Taxation

5.                           Residence of Companies

6.                           Source of income

7.                           Permanent Establishments

8.                           High Tax countries’ use of CFC Legislation | SLIDE 3

8A.         Foreign trust provisions

9.                           Dividends from Labuan

10.                     Use of Labuan companies

10A.      Use of Labuan trusts

11.                     Comparison with Hong Kong and Singapore

12.                     General Anti-Avoidance Provisions


2.                           Introduction | SLIDE 4


This paper focuses on tax residence and compares the advantages and disadvantages of using a double tax treaty country such as Malaysia, with a non-double tax treaty country.


Malaysia has an extensive double tax treaty network with 60 countries including Canada, Australia, New Zealand, other Commonwealth countries, ASEAN countries and many EU and Arab countries (Appendix A).


Double tax treaty countries have enormous advantages including the following -

(1)                       a residence tie breaking Article which deems dual resident companies to be a resident solely of one of the Contracting States. Without treaty protection, the company is at risk of being a tax resident, and therefore taxable in both, or numerous, States, whereas dual residence companies are protected from taxation in the other Contracting State.


(2)                       Provided the non-resident does not have a “permanent establishment” in the other Contracting State:


(a)     “business profits” sourced in the other Contracting State are protected from source country tax;

(b)    Interest, unfranked dividends and royalties are subject to a reduced rate of withholding tax.

(3)                       Dividends distributed from a double tax treaty country are commonly exempt from tax in the hands of corporate shareholders in the Other Contracting State. | SLIDE 5


By way of contrast, income which is properly subject to tax in non-double tax treaty countries may also be taxable in high tax countries. The absence of a double tax treaty has the consequence that numerous tax laws are capable of applying without the benefit of any double tax treaty relief.

3.                           Taxation and regulation of Labuan incorporated and resident companies | SLIDE 6


The Offshore Financial Centre Island of Labuan, a Federal Territory of Malaysia, is strategically located in the South China Sea close to the Kingdom of Brunei.  It was proclaimed a Federal Territory of Malaysia in 1984 by the Prime Minister, who said Labuan would be developed not only as a tourist port but as an important Freeport in ASEAN.  The domestic law of Labuan remains the law of Sabah, the State of Malaysia situated in Borneo of which it formed part.


The Island of Labuan was established as an International Offshore Financial Centre (IOFC) and Freeport by six Acts passed by the Malaysian Parliament in 1990 and as such, offers unparalleled advantages as an investment, asset protection and/or e-commerce centre.


The Offshore Companies Act, 1990 provides for the incorporation of offshore companies, which are required to have a registered office in Labuan, at least one director and a resident secretary. Unless exempted, Labuan offshore companies must only trade with non-residents of Malaysia or with other Labuan companies, and in a currency other than Malaysian ringgit.


The Labuan Offshore Business Activity Tax Act, 1990 (“LOBATA”), taxes offshore trading activities (excluding shipping and petroleum activities) carried on by an offshore company at the rate of 3% on its audited offshore trading profits or, upon election, at a fixed rate of MR20,000. (The MR is fixed at the rate of 3.8 to the US$).


Offshore non-trading activity relating to investments in securities, stock, shares, deposits and immovable properties is not chargeable to tax in Labuan.

The Director General of Inland Revenue may require a person to furnish information for the purposes of LOBATA but such information shall be regarded as confidential and shall not be communicated or disclosed to any person except for the purpose of the Act only.  For further information concerning Labuan’s stringent confidentiality regime, see

The Income Tax (Amendment) Act, 1990 (Malaysia) provides that income derived by an offshore company from its offshore business activity will not be taxable in Malaysia under the Income Tax Act, 1967.


Interest, royalties and management fees paid by an offshore company to a non-resident or another offshore company are not subject to withholding tax.  An offshore company is not subject to stamp duty under the Stamp Duty Act, 1949.  There is no Malaysian tax on dividends paid by a Labuan company in respect of dividends distributed out of income derived from offshore business activities or income exempt from income tax.


Labuan has excellent internet, IT, cable and telecommunications infrastructure.  The local presence of many of the world’s leading banks’ offshore offices, as well as leading insurance and international accounting firms, means that issues pertaining to accounts, taxation and money movements can be securely arranged in cooperation with the client’s preferred international financial institutions. | SLIDES 7, 8, 9 & 10


3A.         Taxation of Labuan trusts | SLIDE 11                                                                                                                        


LOBATA provides for the taxation of offshore trusts by defining offshore companies to include “Labuan offshore trusts” (sub-section 2(1)). It should be noted that a “Labuan offshore trust” is one of which a licensed trust company in Labuan, is the trustee.

Thus, LOBATA taxes offshore trading activities (excluding shipping and petroleum activities) carried on by a Labuan offshore trust at the rate of 3% on its audited offshore trading profits or, upon election, at a fixed rate of MR20,000.

Offshore non-trading activities relating to investments in securities, stock, shares, deposits and immovable properties derived by Labuan offshore trusts are not chargeable to tax in Malaysia.

For a more comprehensive analysis of the regulation and taxation of Labuan trusts, including the taxation issues concerning trusts in Labuan of which the trustee is not a licensed trustee company, as well as the asset protection advantages of a “Labuan Offshore Trust” see the paper by Peter Searle, “Offshore Trusts in the Labuan IOFC”, at


4.                           Framework of International Taxation | SLIDE 12

Double Tax Agreements 

Whilst each country has its own rulings concerning the taxation of international business, there are a number of “norms”. These “norms” are also reflected in the various model double tax agreements. Those are the OECD model conventions (1963, 1977, 1997, and 2003), the UN model, the US model, the Andean model, and the ASEAN model.


Canada is a member of the OECD so invariably, it will look to the OECD model in its conventions with other OECD members. Malaysia is not a member of the OECD, and has its own model treaty.


Taxation treaties seek to achieve their purpose of avoiding double taxation by allocating the right to tax various types of income (and in some cases capital gain) to the country of residence only, or partly to the country of source with residual taxation to the country of residence. A country by its taxation treaties, limits its right to tax certain sources of income in the hands of the resident of the other country with which it has entered into the taxation treaty.


Most high tax countries (e.g. Canada) tax their residents on their world-wide income (with credits for foreign tax paid), but only tax non residents on income sourced within the high tax jurisdiction.


Elimination of Double Tax

Where both countries’ domestic law subjects the income to tax it is necessary to prescribe a method for relieving double taxation in the taxation treaty. Usually Canada’s taxation treaties provide a credit basis for the relief of double taxation to be applied by Canada. However, the Malaysia / Canada treaty provides for deduction for Malaysian tax in determining Canadian tax liability on Malaysian source income.

The “method for elimination of double taxation” article of Malaysia’s treaties generally provides that a Malaysian resident shall be entitled to a credit for treaty country tax paid in accordance with the treaty, whether directly or by deduction, in respect of income derived by that person from sources in the treaty country. 


Malaysia/Canada DTA


Article 4(1) of the DTA provides:


“ For the purposes of this Agreement, the term "resident of a Contracting State" means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management, place of incorporation or any other criterion of a similar nature.”


The Malaysia/Canada DTA contains “tie breaker” provisions in Article 4 where a person (including a company or a trust) is a dual resident.


Unlike many treaties, the Malaysia/Canada DTA at para 1 of the Protocol expressly recognises trusts as a “person” entitled to the benefit of the DTA.

In general, whether an individual is a resident of Canada under the domestic law, is a question of fact to be determined by reference to all the facts and circumstances of the particular case.


There is a well-developed body of both United Kingdom and Canadian jurisprudence dealing with the issue of the residence of individual for income tax purposes. It has been held that the UK jurisprudence is influential in Canada subject to statutory differences:  Thomson v. MNR (1946), 2 DTC 812. This jurisprudence establishes that the following factors are important in determining whether an individual is a resident of Canada:

·             the maintenance of a dwelling in Canada available for occupation by the taxpayer;

·             the residence of the taxpayer's spouse and dependants in Canada

·             the taxpayer's intention to return to Canada;

·             the length of time during which the taxpayer is physically present in Canada; and

·             the taxpayer's social and economic ties with Canada.


In administering the Income Tax Act 1985, the Canada Revenue Agency (“CRA” as they changed their name to this year, formerly Canada Customs & Revenue Authority, and before that, Revenue Canada, has adopted the position that a taxpayer who leaves Canada for a period of more than two years will be presumed to have become a non resident at the time of leaving Canada. Conversely, if a taxpayer is absent from Canada for a period of less than two years, he will be presumed to have retained Canadian residence status unless he can establish that he severed all residential ties on leaving Canada: Interpretation Bulletin IT-22I R3, December 21, 2001. Further, if an individual maintains a dwelling in Canada available for his occupation during his absence from Canada or if an individual's spouse and family remain in Canada, he may be considered by the CRA to remain a resident of Canada.


In addition to the general case law dealing with individual residence, a number of statutory rules deem individuals to be resident in Canada in certain circumstances. For example, a person will be deemed to be a resident of Canada throughout a taxation year if he sojourns in Canada in the year for 183 days or more: s250(1)(a).


Similarly, members of the Canadian Forces, ambassadors, or other public officials, and the spouse and children of such persons, are deemed to be residents of Canada: s250(1)(b), (c),(d), (e), & (f).


The question of Malaysian residence for an individual is dealt with by Peter Searle in a paper entitled “Malaysian Tax Residence for Individuals” which is available at


Article 4 of the Malaysia/ Canada DTA provides the “tie breaker” for individuals as follows:


“2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined as follows:


(a) he shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him. If he has a permanent home available to him in both Contracting States, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closest (hereinafter referred to as his "centre of vital interests");


(b) if the Contracting State in which he has his centre of vital interests cannot be determined, or if he has not a permanent home available to him in either Contracting State, he shall be deemed to be a resident of the Contracting State in which he has an habitual abode;


(c) if he has an habitual abode in both Contracting States or in neither of them, he shall be deemed to be a resident of the Contracting State of which he is a national;


(d) if he is a national of both Contracting States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.”


In the case of a company (or a trust), Article 4(3) provides –

“the competent authorities of the Contracting States shall by mutual agreement

endeavour to settle the question and to determine the mode of application of the Agreement to such  person”.


In Canada, determinations so made have the force of law by virtue of s115.1.


We note that whilst this is consistent with Article 4(3) of the model Malaysian agreement, it is less advantageous than the OECD model and some Malaysian agreements, which resolve dual corporate residence on the basis of the company’s “place of effective management”.

The effect of Article 4 is that, for double tax treaty purposes, a company (or a trust) which is a dual resident should be deemed to be EITHER a tax resident of Canada OR Malaysia, but this appears to be a matter for the competent authorities to resolve without recourse to  the courts: see obiter comments in McFadyen v The Queen 2000 DTC 2473.

An interesting question may arise for the “tie breaker” where an otherwise Malaysian resident trust is deemed under the Canadian domestic provisions to be a Canadian resident: see under heading “Foreign Trust Provisions” below.


Ceasing to be a Canadian resident

“Departure  tax” is payable by an individual resident in Canada when he ceases to be resident in Canada. The taxpayer is deemed to have disposed of all its capital property other than "taxable Canadian property" and certain other property, for proceeds of disposition equal to the fair market value of such property: s128.1(4)(b). Consequently, when a taxpayer ceases to be resident in Canada, he is considered to have realised any accrued capital gains in respect of such property, and he will be required to pay Canadian tax on those gains The deemed disposition of property on a taxpayer's ceasing to be resident in Canada does not apply to any property other than capital property.


Taxable Canadian property is not deemed to be disposed of when a taxpayer ceases to be resident in Canada because capital gains in respect of such property are subject to Canadian tax even when disposed of by a non resident subject to any applicable treaty protection: s2(3)(c) & s115(1)(b).


Taxable Canadian property includes real property situated in Canada; capital property used by a taxpayer in carrying on a business in Canada; shares of a private corporation resident in Canada; shares of a public corporation if the non resident and/ or persons with whom the non resident does not deal at arm's length own 25 per cent or more of the shares of any class; certain partnership interests; capital interests in trusts resident in Canada; and units of a unit trust or a mutual fund trust: s248(1) definition of “taxable Canadian property”.


An individual ceasing to be resident in Canada may elect to exclude property from the deemed disposition rules. If this election is made, the property is deemed to become taxable Canadian property so that when it is disposed of by the non resident, any capital gain will be subject to Canadian tax: s128.1(4)(d). If the election is made, security for payment of tax may be required: s220(4.5).


Limitation of Benefits


None of Malaysia’s double tax treaties exclude residents of the Federal Territory of Labuan (corporate or otherwise) from status as Malaysian residents for the purposes of those agreements.


Generally Malaysia’s double tax treaties do not exclude Labuan offshore companies from obtaining the benefits of those agreements. At present, of 60 Malaysian double tax treaties, only six exclude Labuan companies carrying on offshore trading business subject to s2 (1) of the LOBATA. They are the 1997 United Kingdom treaty, the 1998 Netherlands treaty, the 1999 Protocol to the 1999 Japanese treaty, the 2002 Protocol to the Australian treaty, and the 2004 treaty with Luxembourg. This was achieved in all but the Japanese treaty, by an exchange of notes contemplated by the treaty, concerning tax privileged persons. The Japanese treaty refers explicitly to such Labuan companies carrying on offshore trading business subject to s2 (1) of LOBATA. Norway and Luxembourg have recently also excluded Labuan. If anything, these exclusions support the view that Labuan is part of Malaysia for the purposes of most treaties, as the Netherlands, Japan, the UK, Australia, Norway and Luxembourg have decided it was necessary to expressly exclude in their treaty or by an exchange of notes contemplated by the treaty, Labuan companies carrying on offshore business activities subject to s2(1) of LOBATA from benefit of their treaties, to achieve that result. Accordingly, Labuan companies are extremely useful for doing treaty protected business with 54 countries.


Further, as the Canada / Malaysia DTA does not exclude Labuan companies from the benefit of the DTA, Labuan companies may be used to “treaty shop” into Canada (see below under “Use of Labuan companies”), although the focus of this paper is on “outbound” investment. We note that Canada has sought to limit the benefit of some of its treaties with countries who at the time the treaty was negotiated, had “tax preferred regimes”, principally for the use of non residents e.g. Canada’s treaties with Iceland, Malta, Argentina, Chile, Croatia, Ivory Coast, Indonesia, and Kazakhstan. However, no DTAs have been terminated with countries which, subsequent to signing, have introduced “tax preferred regimes”.


CFC Legislation

A number of countries have a “territorial” system of taxation such that it is only income sourced in that country which is subject to tax there.  A good example in the Asia Pacific region is Hong Kong. Such countries are not concerned from a tax perspective about residents setting up offshore companies to derive foreign source income, as they don’t tax such income anyway.


However, most countries tax residents on domestic and foreign source income, but non residents only on domestic source income, and so several high tax countries have complex rules designed to attribute to resident taxpayers, income derived by entities resident outside that country, but controlled by a resident. The rules are designed to prevent the deferral that would otherwise apply until the controlled entity paid a dividend to the resident.  The control foreign corporation (CFC) and their related foreign investment fund (FIF) and transferor trust rules, are usually designed to attribute passive income, or income from transactions with associates (“tainted income”). Countries with CFC rules include USA, Canada, United Kingdom, Germany, France, Sweden, Norway, Japan, Australia and New Zealand. For a general overview of the operation of such regimes, see Brian J Arnold and Patrick Dibout, “Limits on the Use of Low-Tax Regimes by Multinational Businesses: Current Measures and Emerging Treads”, General Report – in 2001 IFA Cahiers vol B, pp 21-89.

In some countries the attribution of income from a transferor trust is of all the trust’s income. The currently legislated Canadian “Foreign Trust” rules broadly only attributed the same income as attributed from CFCs i.e. passive and tainted income. The announced changes will tax a transferor trust on its world-wide income.


5.                           Residence of Companies | SLIDE 13

The determination of residence of taxpayers is fundamental to the concept of relief of double taxation pursuant to a treaty.  The “residence” article generally defines “persons” as a resident of either treaty partner. “Person” is defined in the majority of treaties in the “general definitions” article as, “includes individual, a company and any other body of persons”. 


The “residence” article normally provides that a “person” who is a resident in one country for the purposes of the tax law of that country will be a resident of that country.   


The test of residence for companies often depends upon the place of management of the company and/or the place of incorporation of the company.

Whilst clearly the place of incorporation of a company provides certainty for corporate taxpayers it has been described as arbitrary and unrelated to economic reality.  However, the concept of placement of management or control as a test for residence of companies has been described as almost as susceptible to manipulation as the place of incorporation test.  Most countries that use the place of management as a test of residence for companies consider central management to be located at the head office or corporate seat, for example, France, Germany and Japan, or in the place where the directors meet, for example, Canada and the United Kingdom.  Only in exceptional circumstances will a foreign subsidiary corporation be considered to have its place of management or control in the country where its controlling shareholders reside.


The cases dealing with “central management and control” in the United Kingdom referred to below demonstrate the importance of the board of directors of the foreign subsidiary carrying out their duties properly in order that the foreign subsidiary be treated as a resident of the country where the board meets. Professor Arnold has said:


“If the foreign corporation is properly organised and its affairs are conducted by its own properly constituted board of directors, even though they simply act in accordance with the instructions of the controlling shareholder, corporation will be treated as a non-resident corporation.  In effect, the place of management test is largely formal; it looks to de juri control of the foreign corporation.  Consequently, the test can be easily avoided and is not effective in dealing with tax haven abuse.

“Moreover, even if the place of management test is applied to treat every tax haven corporation as resident where its controlling shareholders are resident, there are serious difficulties in enforcing any domestic tax against the tax haven corporation.  Assuming, as is quite likely, that the tax haven corporation does not have any assets within domestic jurisdiction, it will be necessary for the domestic tax authorities to collect the tax from the controlling shareholders”. 

It is an international “norm” that the fact that a company resident in a particular country has a subsidiary in another country will not of itself make the subsidiary a permanent establishment of the parent company, in the country of residence of the subsidiary. See article 5(7) of the OECD model (1997), which was adopted as article 5(7) of the Malaysia / Australia double tax agreement.

The classic general law central management and control test, which until 1988 was the sole test of company residence in the United Kingdom, was set out in the speech of Lord Loreburn in De Beers Consolidated Mines Ltd v Howe [1906] AC 455. Also see Unit Construction Co Ltd v. Bullock [1959] 3 All ER 831.    

As can be seen from Swedish Central Railway Co v. Thompson [1925] AC 495, the central management and control of a company can be shared between two countries, such that the company can under the test, be a dual resident.


More recently, both Untelrab Ltd v McGregor (Inspector of Taxes) [1996] STC(SCD) 1 and R v Dimsey; R v Allen [2000] QB 744 referred to below, highlight the need to be fastidious in ensuring that the majority of the board of a Malaysia company is resident in Malaysia, and do in fact meet for the purpose of considering resolutions, rather than that an individual, for example, in Canada, whether a director or not, conduct the Malaysian company’s board level decisions, on their own. On one occasion, the Canadian revenue successfully relied on the doctrine of sham, as the tax haven subsidiary in question was found to be a “mere puppet” of its Canadian parent: Dominion Bridge Co. Ltd. v The Queen 75 DTC 5150. Since then, the sham argument has not been accepted: Spur Oil Ltd v The Queen 81 DTC 5168; R v Redpath Industries Ltd 83 DTC 5117; Consolidated Bathurst Ltd v The Queen 85 DTC 5120.


Malaysia determines corporate residence solely on the basis of “central management and control”.


The United Kingdom and Canada are examples (there are many) of countries which now determine corporate tax residence on the alternative bases of:


(a)                       place of incorporation; or

(b)                      place of central management and control.


In contrast, the United States simply looks to the place of incorporation.


Companies incorporated in Labuan, Malaysia, will still need to have “central management and control” in Malaysia, to qualify as Malaysian resident companies for United Kingdom and Canadian purposes.


Whilst here has been no reported decision in Canada since Victoria Insurance Co. Ltd v MNR 77 DTC 320 that the CRA has sought to allege a foreign incorporated company that asserts foreign central management and control, to be a resident of Canada for tax purposes, that issue has twice been tested in the United Kingdom in the last eight years.


In Untelrab, the United Kingdom Inland Revenue asserted that the company incorporated in Jersey, with two Bermudan resident directors, and one director resident in Jersey, was nonetheless resident in the UK, where the parent company was resident. The Special Commissioners held that the company was resident in Bermuda and applied Esquire Nominees. What is interesting about the case is the depth of analysis of the evidence of the activities of the company over a six year period, including cross examination of the offshore directors.

The High Court of Australia in Esquire Nominees Ltd v FC of T (1973) 129 CLR 177 held that a company incorporated on Norfolk Island (then part of Australia but then only taxable on income sourced from the mainland), and all of whose board resided on Norfolk Island, indeed had its central management and control on Norfolk Island, notwithstanding the resolutions for board meetings were prepared in Melbourne by the ultimate shareholders’ accountants. This was on the basis that the board meet to consider such resolutions, and it would not have passed them, had they been illegal or not in the best interests of the company.


The Inland Revenue had more success in criminal proceedings in Dimsey where the defendants unsuccessfully appealed their gaol sentences for “conspiracy to cheat the public revenue” and “cheating the public revenue” respectively.

The central allegation in those cases was that companies incorporated in Jersey and other havens, and of which Mr Dimsey was a Jersey resident director, were in fact centrally managed and controlled in the UK, such that the companies were liable to UK corporations tax. The evidence accepted by the jury was that Mr Dimsey’s clients in the UK, who were not actual directors, were shadow directors, and were in fact actually managing and controlling the companies in respect of board level decisions. The result for the companies was that they were resident in the UK rather than Jersey.


The relevant principles to be gleaned from the relevant authorities are:-


(1)    Effective Management should be where the board of directors meets to conduct and manage the business including ratifying any decisions made by others and

(2)    A majority of the board should be residents of the jurisdiction the company is or purports to be resident of.

Some countries treat a trust where any of the trustees is a resident, or the central management and control of the trust in that country, to be a resident of that country. Canada treats a trust with a majority of trustees resident in Canada, as a Canadian resident trust: Thibodeau Family Trust v The Queen (sub nom. Dill v The Queen) 78 DTC 6376; Interpretative Bulletin IT-447, May 30, 1980.

6.              Source of Income | SLIDE 14

There is a “source of income” article appearing in most of Canada’s taxation treaties. More than half of those articles provide that income derived by a resident of one country which is permitted to be taxed in the other country in accordance with the taxation treaty, is deemed for all purposes of the treaty to be income arising from sources in the other country.  This empowers each country to exercise taxing rights allocated to it by the treaty. Almost all treaties specify this to be the case for the purposes of providing tax credits, which ensures double taxation relief as intended.


Under the Canadian domestic tax law, the charge to Canadian tax on a non resident is by s115, which without defining those things charged, as sourced in Canada, is to the same effect.


Taxation treaties which do not contain a “source of income” article, other than one which is only for the purposes of the “relief from double taxation” article, often have limited source rules for particular types of income. For example, Article 23(5) of the Malaysia / Canada agreement in relation to “profits, income or gains”, Article 11(6) in relation to interest, and Article 12(7) in relation to royalties.


Where there is no “source” rule in a Canadian treaty, the effect of s3 of the Income Tax Conventions Interpretation Act 1985 is to preserve the domestic “source” rule in s115.


In contrast to the international norms concerning residence, there is more variation concerning what is regarded as domestic source income by various countries.  Generally, for businesses carried on within a country, the income from the business will be considered to be domestic source income.  Similarly, income from sources located within a country, such as real estate, is usually taxed as domestic source income.  Whilst few countries have sophisticated source rules, the United States is a major exception. Often, questions concerning the source of income are resolved by tax treaties.  For example, under most tax treaties, income is allocated to a taxpayer’s foreign permanent establishment on the principle that it is treated as a separate entity dealing at arm’s length with the taxpayer.

It is an international norm that the gross proceeds of a non-resident manufacturer or merchant from the sale of goods in the ordinary course of business are income according to ordinary concepts. In Anglo-Canadian jurisprudence the source of income from the sale of trading stock by a simple merchant is the place where the contract of sale was entered into. The source of income where the taxpayer’s business involves a range of activities, such as extraction, manufacture/processing and sale, is apportioned between the places at which the various activities are carried out.


An intending purchaser may inspect sample goods in, for example, the Canadian warehouse of an agent for an overseas manufacturer. However, if the purchaser then orders goods from the overseas manufacturer the place of the contract of sale is where the manufacturer posts a letter of acceptance: for an exposition of the rules which determine where a contract is made see the judgment of Denning LJ in Entores Ltd v Miles Far Eastern Corporation [1955] 2 QB 327 at 332-4.


The precise mechanism which brings a contract into existence may be significant. Sending a catalogue from overseas to potential buyers, for example, in Canada is not a legal offer, it is an invitation to treat: Granger & Son v. Gough [1896] AC 325. As a result, an order from a purchaser is an offer and the contract will be made where the acceptance is received.  In Entores Ltd v. Miles Far Eastern Corporation Denning LJ stated that where the offeror and the offeree are located in different countries and communication is not by post, but telephone, telegram, telex or some instantaneous means of communication, acceptance will only be effective when it is received – not at the moment of transmission – “and the contract is made at the place where the acceptance is received”.

The decision in Entores v Miles Far East Corporation was applied by the Nova Scotia Supreme Court in The Queen in Right of Nova Scotia v Weymouth Sea Products Ltd; Commercial Credit Corp. Ltd, Third Party (1983) 149 DLR 3rd 637 at 651. 

As the place the contract is made is where the offeror receives notice of the acceptance of the offer, a Canadian purchaser from a Labuan resident communicating electronically, is entering into the contract in Labuan if the Labuan resident’s e-commerce server is in Labuan. That is, Labuan is the place of receipt of acceptance. For a general overview of income source considerations in electronic commerce, see Gary D. Sprague and Michael P. Boyle, “Taxation of income derived from electronic commerce”, General Report – in 2001 IFA Cahiers Vol A, pp 21-63. For a more Canadian specific analysis, see Robin J MacKnight and Charles Ormrod’s Canadian National Report, in that same volume.


Where the law of the contract is specified to be that of Malaysia, and any dispute concerning the contract is to be litigated in Malaysian, it is likely that the contract will be made in Malaysia.  It follows that the source of the income arising from the contract will often be Malaysia.


The observation has been made that the significance of the Entores v Miles Far East Corporation case is limited to determining the source of income where the place of the contract is the most important factor in determining the source.  However, the place of entry into of the contract is always a factor in determining source, even though its significance may depend upon other factors. 


The “common law” source rules in any particular country may be modified by statute. For instance, in Australia, under the domestic law the source of income from the sale of goods is dependent upon goods being sold in Australia, or where any person in Australia is instrumental in bringing about the sale of goods to an Australian resident party.

Notwithstanding the domestic source rules, a relevant double taxation agreement precludes the source country from subjecting the vendor of the goods to source country taxation unless the vendor has a “permanent establishment” in the source country with which the income is “effectively connected”.

7.              Permanent Establishments | SLIDE 15


The “business profits” article of most Double Tax Treaties provide that the business profits of a resident of one treaty country are taxable only in that country unless it carries on business in the other country through a permanent establishment.  Under these circumstances, the profits of the enterprise which are “attributable” or “effectively connected” to the permanent establishment may be subject to tax in the treaty country in which the permanent establishment is located.


Where a treaty country in which the permanent establishment exists subjects the permanent establishment’s profits to tax, the country of residence of the enterprise is required to avoid double taxation by providing a credit against its tax payable or an exemption from tax on the permanent establishment’s profits.


The term “permanent establishment” is defined in the “permanent establishment” article as a fixed place of business through which the business of an enterprise is wholly or partly carried on. The concept of “permanent establishment” in taxation treaties requires that there be a “fixed” place of business, although the OECD commentary suggests that the concept requires a specific geographical place with some degree of permanence (even though it may have existed only for a short time e.g. because of investment failure). The concept of “permanent establishment” is of crucial importance for determining the taxation liability of an enterprise of one contracting state in the other contracting state. Recently, the concept was considered in Australia in Unysis Ltd v FC of T (2002) 51 ATR 386.


The Canadian domestic tax law does not levy tax on a non resident having a “permanent establishment” in Canada as such, but rather whether the non resident is “carrying on business in Canada”: s115(1)(a)(ii), s248(1) & s253.


As the format of the “permanent establishment” article of Canada’s taxation treaties is subject to significant variations, it is necessary to examine each particular taxation treaty carefully in this regard.


The “permanent establishment” article in Canada’s taxation treaties often includes in the term; a place of management; a branch; an office; a factory; a workshop; a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; a building site, a construction, assembly or installation project, or supervisory activities in connection therewith (but usually only where that site or project or those activities continue for a period or periods aggregating more than 183 days within any 12 month period); a warehouse in relation to a person providing storage facilities for others; and an agricultural, pastoral or forestry property.


If a person other than an independent agent acts in one country on behalf of an enterprise of the other country, that person is likely to be a permanent establishment if he or she has and habitually exercises an authority to conclude contracts on behalf of his or her principal. Independent agents, being brokers, general commission agents or any other type of agent acting in the ordinary course of the business which the agent carries on, do not constitute a permanent establishment of the principal.


Sometimes the provisions of the “permanent establishment” article are applied for the purposes of determining the existence of a permanent establishment outside both countries, and whether an enterprise, not being an enterprise of one of the countries, has a permanent establishment in the other country. 

It should be noted, s4 of the Income Tax Conventions Interpretation Act 1985 (Canada) has the effect preserving the Canadian domestic calculation of the profit of a permanent establishment the subject of a treaty.


8.         High tax countries’ use of  “controlled foreign corporation” anti-avoidance Legislation | SLIDE 16



Whether the Canadian CFC regime applies to attribute income to a Canadian resident or not depends on –

(1)        whether a Canadian resident directly or indirectly controls a 50% or more interest in the company; or 5 or fewer Canadian residents directly or indirectly control a 50% or more interest in the company (in which case the company is a “Controlled Foreign Affiliate” (“CFA”),

(2)    the type of income derived by the CFA;


But does not depend on -


(3)    whether the CFA is resident in a country with which Canada has a DTA; or

                     (4) whether any tax is paid in the country of residence of the CFA.



CFC Attribution


Attribution to Canadian resident controllers of a CFA is on a transactional basis, rather than an entity basis (i.e. where all the income of the entity is attributed if the entity fails whatever is the entity test). Under the Canadian transactional tests, broadly the only items attributed, are of income and gains which are either passive, or from sales or services to parties who will claim a tax deduction in Canada for the payment made to the CFA.


Non-Canadian sourced business profits derived by a CFA (say, in Labuan, Malaysia) will generally not be attributable. A CFAs business profits will only be potentially attributable to its Canadian controlling shareholders if the income derived by it is from trading with Canadian affiliates i.e. it is “tainted”.


Foreign Accrual Property Income (“FAPI”)


Section 91(1) of the Income Tax Act 1985 attributes to share holders in a CFA, their participating percentage in the CFA’s “foreign accrual property income”.


Section 95(1) defines FAPI so as to exclude income from the carrying out of an “active business”. The section defines “active business” to mean any business other than (a) an investment business, or (b) a business deemed by s95(2) to be other than an active business.


“Investment business” is defined in s95(1) to be that, the principle purpose of which, is to derive income from property (including interest, dividends, rents, royalties or any similar returns or substitutes therefor), income from the insurance or reinsurance of risk, income from the factoring of trade accounts receivable, or profits from the disposition of investment property, (except for certain companies dealing at arm’s length who employ more than five employees in the full time active conduct of the business).


“Investment property” is defined in s95(1) to include shares, interests in a partnership or trust (other than an in a partnership or trust that is “excluded property” of the affiliate), indebtedness or annuities, commodities or commodities futures, currency, and real estate.

“Excluded property” includes (a) any property that is used or held by the foreign affiliate principally for the purpose of gain or producing income from an active business, or (b) shares where all or substantially all of the property of the other foreign affiliate is excluded property.


Accordingly, gains from disposal of Excluded Property are generally not FAPI.


Most relevantly for present purposes, it can be seen that generally sales and services income would be outside the definition of “investment business”.


However, to protect the domestic revenue base, s95(2)(a1) specifies that sales income from sale to parties who will claim a tax deduction in Canada for the payment made to the CFA (unless at least 90% of such transactions are with arm’s length parties dealing at arm’s length), will be FAPI.


Also, s95(2)(b) specifies that service income of a CFA from providing services to affiliated parties who will claim a tax deduction in Canada for the payment made to the CFA, will be FAPI.


Royalty income will only potentially not be “investment business” if the CFA “leasing or licensing of property” conducts that business with parties at arm’s length and employs more than five employees full time in the active conduct of that business outside Canada. If the employees are provided by an affiliate, then the affiliate must be reimbursed the cost of providing those employees.


For a more comprehensive analysis of the Canadian CFC regime, see Nick Pantaleo and Frank Zylberberg, Canadian National Reporters, in 2001 IFA Cahiers, at pp 435-455.


8A.  Foreign Trust Provisions | SLIDE 17                                                                                                                                                             

In the absence of specific provisions dealing with foreign trusts, the operation of the CFC provisions would be simply defeated.


Most countries with CFC provisions have “grantor” or “transferor” trust provisions, which as their names imply, are relevant to a foreign trust which a resident of a high tax country has created, or caused the creation of, or transferred property or services to such a trust.


As previously noted, some countries discriminate against transferor trusts, compared to CFCs. The discrimination usually takes the form of attributing all of the transferor trust’s income to the transferor in the high tax country, whereas usually, only passive or tainted income is attributed in the case of a CFC. The currently legislated Canadian Foreign Trust rules generally attribute only income of foreign trust, in similar circumstances to that of a CFA. However, the new provisions, where they apply, will tax the non resident trust as though it was a resident, on its world-wide income.


The rules usually depend on whether the foreign trust is a discretionary trust, or fixed trust (such as a unit trust).


The related anti avoidance tool to the CFC and transferor trust provisions are the FIF  provisions, known in Canada as the “offshore investment fund” (“OIF”) provisions, which generally involves the Canadian resident who makes an “investment” in such a fund, which would often be a unit trust, if the offshore structure is a trust structure.


The 1999 budget announced measures to tighten the OIF rules and foreign trust rules, and  rename them: the foreign investment entity (FIE) and the non-resident trust (NRT) regimes. The government stated, that in general terms, these regimes are designed to ensure that Canada taxes investment income earned by Canadians through foreign intermediaries in the same manner that that income would have been taxed if the Canadian taxpayer had made the underlying investment directly. It was stated that the 1999 budget proposals responded to concerns about the growing use of non-resident intermediaries by Canadians to avoid Canadian income tax.


Initial draft legislation in respect of the proposals was issued for public comment on June 22, 2000. A revised draft, which took into account the comments received on the initial draft, was released for public comment on August 2, 2001, and a third draft of the legislation was released as a Notice of Ways and Means Motion on October 11, 2002. The October 2002 release made it clear that the rules would have effect for the 2003 and subsequent taxation years.


On 30 October, 2003 a fourth draft was released which contained revisions made to the October 2002 release. The fourth draft was published by CCH as a “Special Report – Notice of Ways and Means Motion and Explanatory Notes re Taxation of Non-resident Trusts and Foreign Investment Entities” (hereafter referred to as the “Special Report”). As at the date of writing, these measures have not been legislated for.



The 1999 budget’s proposed approach for NRTs generally provided for NRTs to be treated as resident in Canada, while a contributor to the NRT was resident in Canada. The contributor would, in these circumstances, be jointly liable with the NRT for the NRT’s Canadian tax.


The previous provisions had the effect of deeming non resident persons who contributed to an offshore trust within 18 months of ceasing residence, to be resident contributors. The new provisions extent this period to 5 years (other than for testamentary trusts).


A transfer of property to a trust will be considered a "contribution" to the trust unless the transfer is an "arm’s length transfer". An arm’s length transfer cannot involve a transfer of restricted property. Restricted property includes growth shares or debt acquired as part of an estate freeze (i.e., a reorganisation of ownership interests in a corporation to transfer future growth in value of the corporation to selected persons). Taxpayers will be apply to the CRA to determine whether property otherwise treated as restricted property can avoid such a characterisation.


Interests in commercial foreign investment trusts are exempted from the deemed residency provision of the NRT rules because of the "exempt foreign trust" rule, will generally be subject to the rules for FIEs.


In the 1999 budget the proposed approach for FIEs would annually allocate a FIE’s undistributed income to a Canadian investor in the FIE. If insufficient information were available for an investor to adopt this approach, the investor would be taxed each year on any increase in the fair market value of their interest in the FIE.


There are now three alternatives for calculating a taxpayer’s income from an interest in a FIE. First, the mark-to-market regime, if the taxpayer so elects and the taxpayer’s interest has a readily obtainable fair market value. Second, also by election and where the taxpayer has the required information, the accrual method, which permits a taxpayer to report its share of entity level income computed using Canadian income tax rules. Third, the imputed income regime, under which a prescribed rate of return would be applied to the designated cost of the interest.


If the FIE is a corporation that is a foreign affiliate of the taxpayer, the taxpayer may be able to elect to treat the FIE as the taxpayer’s controlled foreign affiliate, in which case the FIE regime generally will not apply to the taxpayer’s interest in the FIE.


A number of rules apply to permit a taxpayer relief, where appropriate, from FIE characterisation of the entity in which they have invested. These rules require access to reliable information including acceptable financial statements. Taxpayers will be able to use Generally Accepted Accounting Principles (GAAP) statements (prepared using accounting consolidation rules) and, if available, unconsolidated entity statements (prepared in accordance with GAAP but for the lack of consolidation). Taxpayers with sufficient information may elect to apply a special consolidation rule with respect to entities that have a significant interest (more than 25%) in underlying entities.


A set of reconciliation rules is introduced to reduce the amount of income imputed under the FIE rules to the extent that, upon the disposition of the interest in the FIE, the imputed amounts exceed the taxpayer’s economic gain from the interest.


Non resident discretionary trusts


For present purposes, we will only deal with discretionary trusts, as they are more likely to be presently relevant.


Under Income Tax Act as it currently stands, in the basic scenario, a discretionary trust with a trustee outside Canada, which is therefore not actually a tax resident of Canada, will be treated as though it was a resident of Canada under s94(1), and  taxed in Canada on its FAPI, and Canadian source income, in a particular tax year, where:

·             any beneficiary is a resident of Canada; AND

·             the trust acquired property directly or indirectly in any manner whatever, from THAT Canadian resident beneficiary, or from a person “related” to that beneficiary, or an uncle, aunt, nephew or nice of that beneficiary (who might be termed “the transferor”); AND

·             the transferor had before the end of that year, been resident in Canada for a period of, or periods the total of which is more than 5 years; AND

·             the transferor was resident in Canada at any time in the 18 month period before the end of the tax year.

The current legislative provisions have been interpreted so that, if an expatriate who has not resided in Canada before, was going to take up residence in Canada, and a non resident of Canada who isn’t going to become a Canadian resident, settles a foreign trust (in which the expatriate is a named beneficiary) into which the expatriate makes transfers, the effect of s94(1) is that the foreign trust with respect to which he is a transferor, will not be subject to Canadian taxation on its FAPI, until 5 years after the expatriate has commenced to reside in Canada.


If the expatriate has resided previously in Canada for more than 5 years, and a non resident of Canada who isn’t going to become a Canadian resident, settles a foreign trust (in which the expatriate is a named beneficiary) into which the expatriate makes transfers more than 18 months after he has ceased Canadian residence, then the effect of the current s94(1) is that the foreign trust will be deemed to be a Canadian resident on the expatriate’s resumption of residence in Canada. If the facts were the same, but the transfers took place within 18 months of ceasing residence, it would be deemed to be a Canadian resident from the time of the first transfer.


It should be observed that provided the expatriate has been a non resident of Canada for more than 18 months, under the current legislation, the foreign trust will be in a similar position to the expatriate himself, in that no Canadian tax is payable on foreign source income until the expatriate resumes Canadian tax residence. The difference in those circumstances to holding the assets in the expatriates own name, is that the asset protection features of the offshore trust (say compared to a Canadian resident trust - obviously subject to the Canadian jurisdiction) will be available thereafter, which would not be available had the assets been in his own name (or in a Canadian trust).


The current s75(2) is designed to prevent the benefit of offshore “blind” trusts, at least from the date the former Canadian resident resumes residence in Canada. It provides:


“ Where, by a trust created in any manner whatever since 1934, property is held on condition


(a) that it or property substituted therefor may

(i) revert to the person from whom the property or property for which it was substituted was directly or indirectly received (in this subsection referred to as "the person"), or

(ii) pass to persons to be determined by the person at a time subsequent to the creation of the trust, or

(b) that, during the existence of the person, the property shall not be disposed of except with the person's consent or in accordance with the person's direction,


any income or loss from the property or from property substituted for the property, and any taxable capital gain or allowable capital loss from the disposition of the property or of property substituted for the property, shall, during the existence of the person while the person is resident in Canada, be deemed to be income or a loss, as the case may be, or a taxable capital gain or allowable capital loss, as the case may be, of the person.” (emphasis added)


Section 75(2) is to be amended by the NRT measures, but only to give precedence to the new s94(3) if it applies.


New s94(3) deems an otherwise non resident trust (other than an “exempt foreign trust”) to be a Canadian resident trust at a particular time if EITHER:


(a)                       the trust has a Canadian resident beneficiary at that time; OR

(b)                      a resident contributor to the trust at that time.


A named beneficiary will be a “beneficiary” even though their right is only contingent, or subject to the exercise of a discretion: s248(25).


New s94(1) defines:


·             An “exempt foreign trust” to include those for:


·                             disabled persons;

·                             children of marriage breakdowns;

·                             charitable purposes;

·                             employee benefits;

·                             salary deferral;

·                             superannuation, pension, or retirement;

·                  foreign university study by non resident children


·             A “resident contributor” to be a resident of Canada OTHER than someone who has been resident for less than 5 years in total.


·             A “resident beneficiary” in relation to a trust is:


(a)                       a beneficiary who is resident; WHERE

(b)                      there is a “connected contributor” to that trust.


·             A “connected contributor” to a trust is a contributor OTHER THAN:


(a)                       one who at the time had not been resident in Canada in total for more than 5 years; OR

(b)                      whose only contribution to the trust was made at a “non resident time”.


·             “Non resident time” to be a time at which the contributor has not been a resident for 5 years before the contribution (or 18 months in relation to a trust which arose as a consequence of the death of an individual).


New s94(10) deems a contribution of a non resident within 5 years of resuming residence to have been made at a “non resident time”: see Special Report pp 176, 190, 224-226.


Thus under the new provisions:


1.                           the Canadian resident beneficiary does not have to be related to the contributor (as was previously the case);

2.                           generally, the offshore trust (other than an “exempt foreign trust”) will be treated as a Canadian resident if:


(a)                          the contributor is a resident; OR

(b)                         the contribution is made within 5 years of ceasing residence (previously 18 months), unless the contributor had not previously resided in Canada for a total of more than 5 years; OR

(c)                          the contributor referred to in (b) resumes Canadian residence within 5 years of making the contribution (which is a new provision).


Accordingly, former long term residents of Canadian need to become non residents for at least 10 years, and to time their contribution more than 5 years after they cease residence, and 5 years before they resume residence, to not be caught by the new provisions.


Even under the new provisions, tax can only be collected from Canadian resident beneficiaries to the extent they have received distributions from the deemed Canadian resident trust: s94(8), and see Special Report pp 220-223.


Where the deemed Canadian resident trust is an actual resident of Malaysia, the “tie breaker” in Article 4(3) of the DTA can be called into play, but only with success if the competent authorities can reach agreement: however, see Special Report p213.


9.         Dividends from Labuan | SLIDE 18


Malaysia is a country with which Canada has a DTA. Labuan is a Federal Territory of Malaysia, not excluded from the benefit of that DTA.


A dividend paid by a Labuan, Malaysia company to a Canadian company (in its own right and not as a trustee of a trust), that holds a “non portfolio” shareholding in the Labuan company (10% or more of the voting shares), will be effective an exempt dividend under s.113(1).


If the Canadian holding company distributes dividends to its shareholders, those dividends will be assessable to the shareholders. That is, the use of a Labuan subsidiary in those circumstances, would only achieve tax deferral for as long as dividends are not paid by the Canadian holding company to its shareholders.


10. Use of Labuan companies | SLIDE 19

From the analysis above, it will become apparent that for Canadian owned Labuan companies, to avoid attribution under the Canadian CFC the income should not be passive income, tainted sales, or tainted services income. 


To illustrate the diversity of uses of Labuan companies, we set out some examples, in each referring to the Canaidan client as “Canco” and its offshore subsidiary company as “Offshoreco”. In each case, Canco:

·             wants to keep the cost of doing offshore business down; preferably in English; in a country with a recognisable legal system; that is reasonably politically stable

·             realises that a website will allow clients to find it, rather than the other way around

·             wants to choose an international base that will allow it maximum flexibility for potential customers in many jurisdictions | SLIDE 20


10.1 Trading in Goods | SLIDE 21


·             Canco is in the business of buying goods in or outside Canada, and selling them in and outside Canada

·             Canco is looking for more vendors and purchasers

·             Canco accepts that sales in Canada are probably best effected through Canco, but wants to make sales outside Canada though Offshoreco, to enhance its international credentials

·             If Offshoreco is formed under the Labuan regime, if the source of its income will be from Offshoreco purchasing goods either in or outside Canada from unrelated suppliers, and selling the goods to unrelated customers outside Canada, none of that income will be attributed back to Canco as the holding company under the CFC regime i.e. the income will not be “tainted sales income”


10.2 Manufacturer “Offshoring” | SLIDE 22


·             Canco is in the business of manufacturing goods in Canada with raw material sourced in or outside Canada, and selling the finished product in or outside Canada

·             Canco is looking for more purchasers

·             Canco wants to commence manufacturing in China, due to its significantly lower costs

·             Canco accepts that sales in Canada are probably best effected through Canco, but wants to make sales outside Canada though Offshoreco, to enhance its international credentials

·             If a subsidiary of Offshoreco can be formed in China (Chinaco), that will manufacture the goods to Offshoreco’s specifications, using raw materials purchased either in or outside Canada from unrelated suppliers, and selling the finished product to Offshoreco on a cost plus basis, none of Chinaco’s income will be attributed back to Canco as the holding company under the CFC regime i.e. the income will not be “tainted sales income”

·             If Offshoreco is formed under the Labuan regime, then as the source of its income will be from Offshoreco buying finished product from Chinaco, and selling the goods to unrelated customers outside Canada, none of that income will be attributed back to Canco as the holding company under the CFC regime i.e. the income will not be “tainted sales income”


10.3 Provider of Services

10.3.1 Computer Services | SLIDE 23

·             Canco is in the computer services business

·             So far, it has only done work for Canadian resident clients

·             Canco is looking to do work for clients overseas

·             If Offshoreco is formed under the Labuan regime, then as the source of its income will be from providing services to clients outside Canada, none of that income will be attributed back to Canco as the holding company under the CFC regime i.e. the income will not be “tainted services income”


10.3.2 Architectural Drafting | SLIDE 24


·             Canco is in the architectural drafting profession

·             So far, it has only done work for Canadian resident clients

·             Canco is looking to do work from clients overseas

·             If Offshoreco is formed under the Labuan regime, then as the source of its income will be from providing services to clients outside Canada, none of that income will be attributed back to Canco as the holding company under the CFC regime i.e. the income will not be “tainted services income”


10.4 Royalties

10.4.1 Software Licensing | SLIDE 25

·             Canco is in the computer software writing business

·             Canco is looking to licence clients overseas

·             Canco wants to license its programs to overseas clients though an offshore company (Offshoreco), to enhance its international credentials

·             If Offshoreco is formed under the Labuan regime, and writes new programs from there using more than five full time employees, then as the source of its income will be royalties from unrelated clients outside Canada, none of that income will be attributed back to Canco as the holding company under the CFC regime i.e. the income will not be “investment income”


10.5 Exempt Dividends | SLIDE 26


In each of the cases referred to above, Offshoreco can pay a dividend back to Canco exempt from Canadian tax under s113(1).


It should be noted that under s113(1), the exempt amount includes that amount prescribed to have been paid out of the “exempt surplus” of the foreign affiliate. Regulation 5907(1) defines “exempt surplus” with reference to “exempt earnings” which in turn is defined at subpara (d) to be the affiliates net earning from an active business carried on by a resident of a “designated treaty country”.  Regulation 5907(11) defines “designated treaty country “ to be one that has an operative DTA with Canada, and regulation 5907(11.2) requires the affiliate to be a resident of that DTA country “for the purpose of” that DTA.


Article 4(1) of the Canada / Malaysia DTA specifies that the term  “resident of a Contracting State” means “any person who under the law of that State is, is liable to taxation therein by reason of his domicile, residence, place of management, place of incorporation or any other criterion of a similar nature”


Is it that the business income was “subject to tax” in Malaysia. This test was satisfied provided the 3% tax rate was paid, and the better view is that it was also “subject to tax” if the election is made to pay RM20,000 flat tax


10.6 Treaty Shopping into Canada | SLIDE 27


Whilst the main focus of this paper is “outbound” investment, it should be noted that by virtue of Labuan companies not being excluded from the operation of the Canada / Malaysia DTA, the opportunity for “treaty shopping” into Canada arises.

It is submitted that the problem that confronted the Bahamian company arguing that it was a tax resident of the US for the purpose of the Canada / US treaty in The Queen v Crown Forest Limited et al 95 DTC 5389, would not apply to a Labuan company, which after all is naturally a resident of Malaysia, being incorporated there and with its central management and control there. For discussion of that case, see Pantaleo and Zylberberg, ibid, at pp 446-7.


In relation to the potential for treaty shopping -

·             For example, companies or individuals resident in the Middle East (except Israel) have no protection from Canadian taxation, as Canada has no double tax agreements with any of those countries

·             Residents of countries without a treaty with Canada (NonTreatyResidents) may want to choose an international base to set up a company (Offshoreco) that will allow it maximum flexibility for potential customers in many jurisdictions

·             NonTreatyResidents can “treaty shop” into Canada as Labuan is not excluded from Malaysia for the purpose of the Malaysia/Canada DTA

·             Malaysia has double tax agreements with the following countries that do not have agreements with Canada:

·             Albania, Bahrain, Mauritius, Mongolia, Myanmar, Namibia, Pakistan, Turkey, United Arab Emirates

·             It has also signed the agreements with the following countries, but to date they have not been gazetted:

·             Iran, Kuwait, Brunei, Oman, Lebanon

·             As Malaysia is a majority Muslim country and as a leader of the non aligned movement, it has good credentials in the Middle East | SLIDE 28


10A.      Use of Labuan Trusts | SLIDE 29


As Canada didn’t previously discriminate against foreign trusts compared to CFAs, in relation to attribution of only the affected foreign trust’s FAPI, and as Malaysian trusts are recognised as Malaysian residents for the purpose of the Canada/Malaysia DTA by virtue of para 1 of the Protocol to the DTA, Labuan offshore trusts were able to be used in similar ways to Labuan companies. That is, if the income wasn’t Canadian source and wasn’t FAPI, then Canadian tax deferral was available though a Labuan offshore trust.


However, as it is not common in Malaysia’s DTAs to treat trusts as persons the subject of the DTA, active offshore business sourced in third countries is usually best carried out by a Labuan company, which is more likely to get third country DTA treatment.


Labuan offshore trusts are therefore more useful as shareholders in Labuan companies, or as accumulation vehicles for long term expatriates, or those who can use “exempt foreign trusts”, which may defer Canadian taxation on foreign income, and will potentially provide significant asset protection.


11.           Comparison with Hong Kong and Singapore | SLIDE 30


Dividends paid back to a Canadian holding company from Hong Kong are not exempt income as Canada has no DTA with Hong Kong. Also, the use of profits of a Hong Kong CFC other than for reinvestment into the active business in Hong Hong may have  lead to deemed dividends.


Hong Kong IRD Practice Note (reviewed 15 May, 2002) concerning the “Territorial Source Principle of Taxation” interprets “Hong Kong sourced profits” very broadly, so Hong Kong tax rates of currently 16% are increasingly likely to apply. In order to prove that the profits from trading in goods bought and sold outside Hong Kong does not have a source in Hong Kong, the Hong Kong company must prove that substantial activity of the company was effected outside Hong Kong, thereby putting the Hong Kong company at greater risk of being taxable on its profits in the high tax jurisdictions in which it makes sales: see CIR v Euro Tech Far East Ltd (1995) 1 HKRC para 90-076 and Board of Review cases D28/86 and D47/93 (Case D24 (1994) 1 HKRC para 80-274); and compare CIR v Magna Industrial Co Ltd [1996] HKCA 542.


Singapore’s ordinary company tax rate is currently 22%, and the ability to get a special 10% tax rate requires Ministerial approval, which usually requires an expensive office set up with employment of high wage staff. As Singapore companies are taxable on income accruing in or derived from Singapore (and foreign source income remitted into Singapore), the difficulties described above for companies trading in goods through Hong Kong, also arise in Singapore. In any event, profits can generally only be paid out of Singapore companies as a dividend, if Singapore company tax is paid on those profits.


The Hong Kong tax problems which arose in cases such as Euro Tech and D28/86 and D47/93 do not arise in Labuan, where the 3% tax rate (or flat tax of RM20,000 (US$5,260)) encourages Labuan offshore companies to be taxable on their trading activities “carried on in or from Labuan … with non-residents”. Thus, there is greater flexibility in relation to trading in goods, thereby reducing the risk of assessment to Offshoreco in the high tax jurisdictions with which Offshoreco trades.


12. General Anti-Avoidance Provision (“GAAR”) | SLIDE 31


In order to examine the question of the potential application of the Canadian GAAR (section 245) rewritten in 1988 it is necessary to have some factual background. Assume the following:

·             Canco prefers to set up the offshore company in the south east Asian region. Accordingly, the area under consideration spans, China, South Korea, Japan, Hong Kong, Thailand, Vietnam, Malaysia, The Phillipines, Singapore, & Indonesia

·             Canco wants to keep the costs of its offshore company down

·             Canco prefers to set up in a country with a British Common Law background as this is the legal system it understands

·             Canco prefers to deal with staff and customers, to the extent possible, in English

·             Canco prefers as stable as possible political climate

·             Canco wishes to incur the least possible overseas taxes on its world-wide income. This requires as low a possible offshore tax rate and an extensive network of double tax agreements to minimise source country tax


Discussion | SLIDE 32


·             Based on these considerations, it narrows its choice down to three jurisdictions, Hong Kong, Singapore & Malaysia

·             The cost of doing business in Hong Kong is “sky high”

·             Whilst Hong Kong has no tax on foreign source income, as its only double tax treaty is with China, third country source income tax may be payable in those countries for sales made by Offshoreco if it was resident in Hong Kong. The risk that China will fully take back Hong Kong soon is also a concern

·             The cost of doing business in Singapore is nearly as high as Hong Kong, but Singapore has an extensive list of double tax treaties. However, its ordinary company tax rate is currently 22%, and the ability to get a special 10% tax rate requires Ministerial approval, which usually requires an expensive office set up with employment of high wage staff.

·             Labuan, Malaysia has excellent telecommunications including Broadband internet, a modern airport serviced by several 737 jet flights per day, extensive port facilities, and cheap but reliable mail and courier services. | SLIDES 33 & 34


The most relevant parts of section 245 provide: | SLIDE 35

                                                                                                                                                                                                                                          “(1) In this section,


"tax benefit" means a reduction, avoidance or deferral of tax or other amount payable under this Act or an increase in a refund of tax or other amount under this Act;


"tax consequences" to a person means the amount of income, taxable income, or taxable income earned in Canada of, tax or other amount payable by or refundable to the person under this Act, or any other amount that is relevant for the purposes of computing that amount;


General anti-avoidance provision


(2) Where a transaction is an avoidance transaction, the tax consequences to a person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that, but for this section, would result, directly or indirectly, from that transaction or from a series of transactions that includes that transaction.


Avoidance transaction


(3) An avoidance transaction means any transaction


(a)    that, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit; or


(b)    that is part of a series of transactions, which series, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.


Where s. (2) does not apply


(4)    For greater certainty, subsection 245(2) does not apply to a transaction where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of this Act or an abuse having regard to the provisions of this Act, other than this section, read as a whole.” (emphasis added)


For the history and policy considerations behind the rewritten s245, see Brian J Arnold “The Canadian General Anti-Avoidance Rule”, Tax Avoidance and the Rule of Law, Graeme S Cooper (ed), IBFD 1997 pp 221-245.


Arnold observes at p 232 that s245 requires an essentially factual determination where a transaction is carried out for a combination of tax and non-tax purposes, but observes that the Canadian courts are accustomed to making similar determinations under other statutory provisions that require determination of the purpose of the transactions, and footnotes that at the time of writing, there had been at least 36 cases involving a determination of “business purpose” since 1967. Two of the three tentative propositions he then puts forward are:


·             In certain circumstances, the use of a company to earn or receive income that would otherwise have been earned or received by an individual shareholder may be considered to lack a business purpose

·             …a captive foreign insurance company …[has] been found to be a bona fide purpose


Of course, there have now been a number of Supreme Court cases dealing with the current  GAAR: Shell Canada Limited v The Queen [1999] 3 S.C.R 622, and The Queen v John R Singleton  [2001] 2 S.C.R 1046. There have also been some significant Federal Court of Appeal cases: OSFC Holdings v The Queen [2002] 2 F.C. 288, and The Queen v Canadian Pacific Ltd [2002] 3 F.C. 170. However, none of them deal with the application of the GAAR to treaty benefits. We observe that Dave Beauine and Angelo Nikolakakis, Canadian National Reporters for “Double non-taxation”, 2004 IFA Cahiers, Vol A pp 235-255, at 252-3 note, even non taxation in the treaty partner with Canada should not trigger the GAAR, as long as the existence of the related treaty party resident has a principally bona fide purpose. Pantaleo and Zylberberg, ibid, at p 451 also note the difficulties that would face that application of the GAAR to treaty benefits. However, the 2004 budget announced a proposal to expressly allow the GAAR to override treaty benefits, and to do so going back to 1988! Canada’s treaty partners may not be impressed.


If a purpose involves avoiding foreign tax, this is not a proscribed purpose under the GAAR.


Accordingly, where  Canadian parties wish to do business overseas, the GAAR shouldn’t apply to the decision to use an Offshoreco rather than through Canco as the purpose of the use of Offshoreco is likely to be primarily for a bona fide purpose other than to obtain a Canadian tax benefit.


Disclaimer | SLIDE 36

This paper does not constitute advice. It should not be relied on as such. Persons wishing to explore these opportunities further should seek professional advice.



ROBERT GORDON                                             


5 September, 2004


Peter Searle BEc LLB (Hons), LLM is a Trust Officer and Barrister who has been a tax and trust law specialist for over 27 years. He commenced his tax career in 1977 in the Compliance and Appeals Division of the Australian Taxation Office in Canberra.


He completed an Honours degree in Law, including International Law, at the Australian National University in 1979 and was admitted as a Solicitor and Barrister in the Supreme Court of Victoria in 1982. From 1982 until 1985 he worked as a Senior Taxation Manager at Coopers and Lybrand where his clients included large multinational corporate groups. He completed a Masters of Law in Taxation at Monash University in 1985. In 1986 Peter was called to the Victorian Bar and for the next sixteen years was an Australian barrister appearing in taxation, commercial, equity, bankruptcy, insurance and criminal law cases in the High Court of Australia, the Federal Court of Australia and the State Supreme Courts. 


Peter moved to the Federal Territory of Labuan, Malaysia in 2001/ 2002, where he is a Director and Trust Officer of EC Trust (Labuan) Bhd ( Peter is a prolific writer and speaker at numerous international conferences including the International Bar Association, the Australian Taxation Institute and the Asia Pacific Bar Association and has been Assistant Editor of the “Australian Tax Review”, President of the Victorian Society for Computers and the Law and  Vice President of the International Commission of Jurists (Victorian Division).


A number of his articles concerning international taxation, company  and trust law may be viewed online at



Robert Gordon BA LLB LLM FCPA commenced his tax career in 1979 with Greenwood Challoner & Co., Chartered Accountants, in Sydney and worked with Ernst & Whinney (Sydney), Coopers and Lybrand (Melbourne) and Minter Ellison (Melbourne) before becoming a tax partner at Corrs Chambers Westgarth, Solicitors, in Sydney. He is admitted to practice in England and Wales as well as in four Australian States. Since 1992 he has been a member of the New South Wales Bar specializing in international tax and other revenue law.                               
Appendix A







Albania #








Saudi Arabia*





South Korea



Sri Lanka

Sudan #











Czech Republic




Myanmar #

United Arab Emirates

Egypt #

Namibia #

United Kingdom+



United States of America*


New Zealand








Zimbabwe #












Treaties have also been signed with the Iran, Kuwait, Brunei, Morocco, Luxembourg+, Kazakstan, Oman, South Africa, Lebanon, and Croatia, although not gazetted to date.

 *Restricted double tax treaty.

 +excludes Labuan Offshore companies.  

 # net yet effective