Court clarifies rules for declaring foreign accrual property income in offshore bank case
A Canadian financial company may benefit from a Canadian tax exemption involving an offshore bank it owned, the Supreme Court of Canada ruled today in a unanimous judgment that ended approximately six years of litigation.
In Canada v. Loblaw Financial Holdings Inc. – the second tax law decision the Supreme Court has issued in just a week – the court appeared consistent in its desire to bring certainty to the text and the purpose of tax legislation.
“Setting aside the specifics of the case, the single biggest thing that comes out of this decision is that it’s a strong affirmation of how you interpret the Income Tax Act,” says Al Meghji, a tax litigator and partner in Osler, Hoskin & Harcourt LLP in Toronto, who was lead counsel for the respondent Loblaw Financial Holdings.
Along with last week’s decision in Canada v. Alta Energy Luxembourg S.A.R.L., which dealt with the application of the General Anti-Avoidance Rule (GAAR) to a tax treaty, the two cases “side by side, give us a very good understanding of the Supreme Court's direction on how you deal with tax cases generally.”
That means reading tax legislation in a way that allows taxpayers to have certainty in how they conduct their business, he says.
“The taxpayers have to be able to read legislation and know what the rules of the game are,” he adds. “So the affirmation of the principle of certainty in the interpretation of tax legislation is of huge importance to Canadian taxpayers,” as well as for Canadian banks.
In 1992, Loblaw Financial Holdings, owned by Loblaw Companies Ltd., incorporated a subsidiary in Barbados. The Central Bank of Barbados issued a license for the subsidiary to operate as an offshore bank named Glenhuron Bank Limited. Between 1992 and 2000, significant investments were made in it by Loblaw Financial and affiliated companies within the Loblaw group. In 2013, Glenhuron was dissolved and its assets were liquidated.
In its Canadian tax returns for the years 2001 to 2005, 2008, and 2010, Loblaw Financial did not include income earned from Glenhuron in its Canadian tax returns as foreign accrual property income (FAPI). Under the FAPI regime in the Income Tax Act, Canadian taxpayers must include income earned by their controlled foreign affiliates (CFAs) if this income qualifies as FAPI. However, financial institutions that meet certain requirements benefit from an exception to the FAPI rules, pursuant to section 95 (1) of the Income Tax Act.
The exception is available if the following four requirements are met: 1) the controlled foreign affiliate, or CFA, must be a foreign bank or other financial institution listed in the exception provision; 2) its activities must be regulated under foreign law; 3) the CFA must employ more than five full-time employees in the active conduct of its business; and 4) its business must be conducted principally with persons it deals with at arm’s length.
Glenhuron Bank met the first three requirements, but at issue was whether its business was being conducted principally with persons with whom it had dealt with at arm's length. Loblaw Financial argued it was after the Minister of National Revenue of Canada denied the tax exception. Before the Tax court, the Crown also argued that the general anti-avoidance rule (GAAR) applied to a series of transactions by the respondent and Glenhuron to give the appearance of compliance with the ‘investment business’ exception.
“The FAPI regime is one of the most complicated statutory regimes in Canadian law,” wrote Justice Suzanne Côté in her reasons, with Chief Justice Richard Wagner and Justices Michael Moldaver, Andromache Karakatsanis, Russell Brown, Sheilah Martin and Nicholas Kasirer concurring.
However, she continued, “[a]lthough it has come before us after several years of diligent work by sophisticated auditors and legal counsel, the question in this appeal is remarkably straightforward. Does a parent corporation conduct business with its CFA when it provides capital and exercises corporate oversight? In my respectful view, the answer is an equally straightforward no.”
In dismissing the Crown’s appeal, the Supreme Court upheld the ruling of the Federal Court of Appeal, which had set aside the decision of the Tax Court and referred Loblaw Financial’s tax reassessment back to the Minister of National Revenue for reconsideration and reassessment, on the basis that Glenhuron’s FAPI consisted only of income from investment management services provided to non-arm’s length parties. In the FCA’s view, the receipts side of banking should not be considered when determining whether the investment business was conducted principally with non-arm’s length parties.
“Once corporate oversight and the capital investments received by Glenhuron are excluded, only Glenhuron’s investment activities remain part of the business that is relevant for the application of the arm’s length requirement,” Justice Côté wrote.
“The vast majority of these activities were conducted with arm’s length persons. Therefore, I conclude that this requirement was met during the years in issue and that Loblaw Financial was thus entitled to rely on the financial institution exception. The appeal should be dismissed.”
She also rejected the Crown’s position that the provision at issue should be viewed and interpreted as an anti-avoidance provision.
“I have no information showing that the arm’s length requirement has a specific purpose of anti-avoidance or promotion of international competitiveness,” Justice Côté wrote.
Further, she wrote, “I cannot find any basis in the text, context or purpose of the arm’s length requirement to support the Tax Court judge’s consideration of corporate oversight as part of conducting business.”
The case has been in the courts for years, “and after everything is done, you now have 10 judges out of 11 who have unequivocally said that Loblaw’s transaction was not only consistent with the text of the legislation, but entirely consistent with the purpose of the legislation,” says Meghji. “It gives me great pleasure and comfort to say that because this was very, very difficult litigation -- it took forever, and there were completely unwarranted allegations of tax avoidance made against Loblaw. And now you've got 10 judges [seven at the Supreme Court and three at the Federal Court of Appeal below it] who emphatically repudiated all of that.”
The Canada Revenue Agency did not provide comment in time for publication.
In a statement to Canadian Lawyer, the intervener Canadian Bankers’ Association (CBA) wrote:
“The CBA intervened in the case to preserve the careful balance that has been struck over many years through the Foreign Accrual Property Income rules. These rules were the result of carefully and deliberately developed public policies and laws passed by successive governments over more than 25 years and have guided the business decisions of Canadian banks in their activities in other countries.”