Potash Corporation of Saskatchewan Inc. v. The Queen

Potash Corporation of Saskatchewan Inc. v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2011-04-20
Neutral citation
2011 TCC 213
File numbers
2005-1631(IT)G
Judges and Taxing Officers
Joe E. Hershfield
Subjects
Income Tax Act
Decision Content
Docket: 2005-1631(IT)G
BETWEEN:
POTASH CORPORATION OF SASKATCHEWAN INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeal heard on common evidence with the appeal of
Potash Corporation of Saskatchewan Inc. 2005-1760(IT)G
on September 30 and October 1, 2010 at Saskatoon, Saskatchewan
Before: The Honourable Justice J.E. Hershfield
Appearances:
Counsel for the Appellant:
Stéphane Eljarrat
Olivier Fournier
Counsel for the Respondent:
Ifeanyi Nwachukwu
Ryan Hall
____________________________________________________________________
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1997 taxation year is allowed, with costs, and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the reasons set out in the attached Reasons for Judgment.
Signed at Winnipeg, Manitoba this 20th day of April 2011.
"J.E. Hershfield"
Hershfield J.
Docket: 2005-1760(IT)G
BETWEEN:
POTASH CORPORATION OF SASKATCHEWAN INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeal heard on common evidence with the appeal of
Potash Corporation of Saskatchewan Inc. 2005-1631(IT)G
on September 30 and October 1, 2010 at Saskatoon, Saskatchewan
Before: The Honourable Justice J.E. Hershfield
Appearances:
Counsel for the Appellant:
Stéphane Eljarrat
Olivier Fournier
Counsel for the Respondent:
Ifeanyi Nwachukwu
Ryan Hall
____________________________________________________________________
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1998 taxation year is allowed, with costs, and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the reasons set out in the attached Reasons for Judgment.
Signed at Winnipeg, Manitoba this 20th day of April 2011.
"J.E. Hershfield"
Hershfield J.
Citation: 2011 TCC 213
Date: 20110420
Dockets: 2005-1631(IT)G
2005-1760(IT)G
BETWEEN:
POTASH CORPORATION OF SASKATCHEWAN INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hershfield J.
Background
[1] In 1997 and 1998 the Appellant (“PCS”) incurred legal and accounting fees totalling $157,695.39 and $1,753,654.88 respectively (the “consulting fees” or “subject expenses”).
[2] The consulting fees were incurred by PCS in order to plan and implement a reorganization of a group of companies, none of which was PCS itself, the purpose of which was to reduce foreign withholding taxes on funds repatriated from a U.S. subsidiary.
[3] PCS deducted the full amount of the consulting fees in the year incurred on the basis that they were not precluded from being so treated by either paragraphs 18(1)(a) or (b) of the Income Tax Act (the “Act”). The deductions so claimed were denied on the basis that such paragraphs did preclude them and PCS was assessed accordingly in respect of each of its 1997 and 1998 years. PCS has appealed both assessments. The appeals were heard on common evidence.
[4] Essentially, all of the relevant facts relating to these appeals are set out in the Partial Agreed Statement of Facts (the “Agreed Facts”) appended to these Reasons as Schedule A. One area of controversy relating to the amount of the consulting fees was agreed to at trial. The sole issue to be decided in these appeals then is the extent to which the consulting fees are deductible, if at all. It is understood that if the subject expenses were not incurred for the purpose of gaining or producing income from a business or property no deduction will be allowed pursuant to paragraph 18(1)(a). It is also understood that although no deduction will be allowed pursuant to paragraph 18(1)(b) if the subject expenses are capital in nature, a deduction would be allowed if they are found to be eligible capital expenditures as defined in subsection 14(5) of the Act. That is how the issue in these appeals has been approached by the parties. The overall purpose of incurring the subject expenses was not disputed and neither party was open to my attempting to make an allocation of the subject expenses amongst the distinct steps of the reorganization. While the steps were entirely tax motivated, there is no suggestion of improper tax avoidance.
Factual Summary
[5] In 1995 PCS had a direct (80%) equity interest in each of a U.S. holding company and a U.S. limited liability finance company (“Finance LLC”). It held the remaining (20%) equity interest in both these U.S. companies indirectly through a wholly owned Canadian subsidiary. The U.S. holding company was the top company in a chain of U.S. companies all wholly owned by the company above it and included eight operating companies at the bottom of the chain. In 1995, Finance LLC was financed by PCS to the tune of US$730,000,000 by proportionate investments from PCS and its Canadian subsidiary. Finance LLC in turn financed a wholly owned U.S. subsidiary (“Phosphate Co”) of the U.S. holding company, by way of interest bearing loans.[1] The advances were used by Phosphate Co to fund acquisitions of certain operating entities. In 1997 Finance LLC financed a wholly owned U.S. subsidiary of Phosphate Co (“Nitrogen Co”), to the tune of US$950,000,000 by way of interest bearing loans. The advances were used by Nitrogen Co to fund certain acquisitions. The total loan amounts (referred to as the “Loans”) were evidenced by Phosphate Co notes and Nitrogen Co notes (referred to together as the “Notes”) and were funded by proportionate equity investments in Finance LLC made by PCS and its Canadian subsidiary.[2]
[6] Interest payments on the Loans were distributed through Finance LLC back to Canada subject only to a 10% U.S. withholding tax. PCS’s Canadian subsidiary’s share was in turn distributed to PCS.
[7] In 1996 and 1997 Finance LLC made total distributions up the line to PCS and its Canadian subsidiary of some US$440,000,000. The distributions included both returns on investment which were subject to 10% U.S. withholding and returns of capital. The returns on investment were reported by PCS as dividend income received from Finance LLC and its Canadian subsidiary in the total amounts of Can.$182,000,000 and Can.$134,000,000 in each of 1996 and 1997, respectively. These amounts are not net of the 10% U.S. withholding tax.[3] Such dividends were exempt surplus in Canada under the Act so no further tax was incurred to repatriate this income.
[8] In August of 1997, it was announced that the Canada-U.S. tax treaty benefit on the flow through income of LLC to a non-resident was to be denied by an amendment to the Internal Revenue Code. The U.S. withholding rate on distributions from Finance LLC was increased from 10% to 30%. Since the repatriation of income to Canada was exempt surplus, the increase would substantially reduce the after tax return on PCS’s U.S. investment.
[9] The reorganization steps taken in 1997 and 1998 are detailed in paragraphs 37-39 of the Agreed Facts. The steps taken over a period of months were elaborate, involving several foreign countries whose various tax rules and treaty provisions created a network through which corporate interests and the Notes were transferred. Ultimately, the Notes were transferred to an Irish branch of a Luxemburg entity the shares of which were owned by PCS and its Canadian subsidiary in the same proportions they held their interests in Finance LLC. That is, the Luxemburg entity replaced Finance LLC as the company entitled to the Loan interest, subject to a 5% income tax in Luxemburg. The interest payments made on the Loans were not subject to U.S. withholding tax. The funds could be repatriated to Canada from Luxemburg at a withholding rate of 5% under its treaty with Canada.[4] This replaced, eliminated, the 30% U.S. withholding tax.
[10] The consulting fees were incurred by PCS to accomplish this result. That is the essence of the Agreed Facts.
[11] However, I note here that as early as April 1996 changes to the U.S.-Luxemburg tax treaty were announced that would subject the interest payments from the U.S. entities to the Luxemburg entity to a 30% U.S. withholding tax. That change although known to the Appellant when first announced, did not affect the decision to proceed as the change was not given effect or implemented until January 2001.
[12] The Luxemburg entity was wound-up in 2001. Its reported earnings from inception to its demise were as set out in paragraph 44 of the Agreed Facts.
[13] Throughout this period it paid no dividends to its two Canadian shareholders. Instead, very substantial loans were made from the Luxemburg entity to PCS as set out in paragraph 45 of the Agreed Facts. The Luxemburg entity reported no income from these loans to PCS and PCS reported no interest expense in respect of them.
[14] While this is, to say the least, a recitation of the facts in a proverbial “nutshell”, it is sufficient, at this point, to put the evidence of the Appellant’s witness in context.
The Appellant’s Witness
[15] The current vice-president of internal audit of PCS, Ms. Arnason, testified at the hearing. At the time of the reorganization she was the director of taxation of the company and I am satisfied that she was a well-informed witness who gave her testimony in a forthright manner.
[16] She testified that by 1994 PCS had become the world’s largest potash producer by capacity with limited growth potential beyond that point. It had explored and exploited the most desirable potash opportunities on a global basis. Its focus in the years 1995 through 1997 moved to expanding beyond potash, seeking opportunities to exploit other fertilizer nutrients, namely phosphate and nitrogen. Its first purchase in 1995 was of a phosphate mining operation in North Carolina for some $800 million. Its second purchase, also in 1995, was another phosphate operation in Florida for another $280 million. These acquisitions were financed by Finance LLC and gave rise to the Phosphate Co note. The nitrogen operation was acquired by way of a merger in 1997. Finance LLC lent Nitrogen Co $950 million to allow it to make further acquisitions in 1997. This gave rise to the Nitrogen Co note and gave PCS, via subsidiaries, a significant number of nitrogen plants in both the U.S. and Trinidad. These acquisitions made it the world’s largest integrated fertilizer operation by capacity. It was a player in all three of the main fertilizer elements. The acquisitions were believed to have an added value of approximately $1.6 billion off-set by the Notes on a consolidated basis.
[17] To achieve the acquisitions a decision was made not to raise additional share capital. The strength of PCS’s balance sheet made debt financing a good option. That debt, incurred in Canada by PCS, needed to be serviced. The holding structure relating to the acquisitions needed to best accommodate a cashflow to Canada to meet that requirement.
[18] The use of Finance LLC was an ideal structural approach to maximize this cashflow. The U.S. tax rules did not tax the interest income it earned from the downstream debtor companies (Phosphate Co and Nitrogen Co) although they were allowed the interest deduction. Finance LLC was treated as a flow-through entity subject to withholding tax only on payments up-stream to PCS and the Canadian subsidiary. As noted above, the distributions were treated in Canada as tax free returns of capital and dividends. The dividends were eligible for exempt surplus treatment under the foreign affiliate provisions of the Act and not subject to tax in Canada. Under the tax rules of the two jurisdictions then, the 10% U.S. withholding was the only cost of repatriating the funds necessary to pay the debt service on the Canadian borrowings. Ms. Arnason testified that it was intended that the interest income earned by Finance LLC was to be passed up to PCS in this way, including the portion going through the Canadian subsidiary.
[19] With a 10% U.S. withholding tax, this structure met PCS’s cashflow requirements. On the other hand, a 30% U.S. withholding rate was significantly more than had been built into PCS’s analysis and its debt servicing needs. PCS also had what Ms. Arnason referred to as robust operations in Canada that were also in need of the cashflow from its new acquisitions being flowed through Finance LLC.
[20] To avoid this increased U.S. withholding rate, PCS sought a new structure with preferential treaty arrangements both between the U.S. and the new host country and that country and Canada. That involved, as well, finding a host country whose security laws, tax laws, business practises and language all gave PCS a high comfort level without imposing an onerous administrative burden on the corporate group. The host country chosen was Luxemburg. That is, the entity to hold the Notes originally held by Finance LLC was to be a Luxemburg entity. The process to get there involved certain intermediary steps being taken. For example, a direct transfer of the Notes to Luxemburg was not as efficient as routing them for a short period through an Irish company and then having the Luxemburg entity hold them in a branch in Ireland. The terms of the Notes also had to be amended to minimize a capital tax in Ireland. The shares that PCS and its Canadian subsidiary held in Finance LLC had to be transferred for a short period to a British Virgin Islands company and then, for a short time as well, to an Irish company. Still, at the end of the day, the Luxemburg entity owned the Notes and PCS and its Canadian subsidiary owned the equity interests in the Luxemburg entity in the same proportions that they had held interests in Finance LLC.
[21] In addition to ensuring that the foreign tax consequences were as planned in respect of the movement of the Notes monitored, all the steps in the series of transactions were being planned by PCS’s advisers to ensure that the transfers of the interests that PCS and its Canadian subsidiary had in Finance LLC, and the share transfers triggered by the liquidation of the short lived entities in which they would have held interests, were not subject to a tax in Canada in the course of creating the final result. Such tax, if inadvertently triggered in Canada, would be borne by PCS and its Canadian subsidiary. For example, attention had to be paid to the rollover provisions in subsection 85.1(3) of the Act applicable on the disposition of shares in a foreign affiliate.
[22] The details of the reorganization are not important. However, I do note that the cross-examination of Ms. Arnason focused on the purpose of each step and the fact that each Board of each company acted independently to approve the steps taken in respect of their respective separate entities. Ms. Arnason acknowledged this but maintained that it was all about achieving the end result, namely to replace Finance LLC with the Luxemburg entity to avoid the negative impact that the increased U.S. withholding tax would have had on PCS. The end result sought was achieved without any inadvertent consequences along the way. The Notes that Finance LLC acquired in the course of financing the down-stream acquisitions ended up in the Luxemburg entity and the interest payments on those Notes left the U.S. without any withholding tax, subject to only a 5% income tax in Luxemburg and a 5% withholding tax on repatriation to Canada.
[23] As well, the cross-examination of Ms. Arnason confirmed that PCS’s business activities were the production, processing and sale of potash and that its strategy, to head a group that was to become a global leader in the integrated fertilizer arena, was growth oriented. That is, it was an investment strategy, not part of a trading activity. As well, she confirmed that a functional analysis of PCS’s custodial costs entered in evidence confirmed that in addition to the potash business, PCS performed certain services for its subsidiaries (the costs for which were allocated to its subsidiaries on a time spent basis) and had a custodial function to maintain and monitor its investments. Ms. Arnason agreed that the consulting fees did not relate to these functions.
[24] In the miscellaneous category, I add the following which was brought out on Ms. Arnason’s examination. PCS was not in jeopardy of defaulting on its bank loans during the relevant times. PCS incurred legal fees for consulting services on the 1995-97 acquisitions which were capitalized as part of the acquisition costs of those operations. Costs relating to replacing Finance LLC were not regarded as acquisition costs and were not capitalized. The acquisitions may have had a positive effect on PCS’s share values. There was no legal requirement on Finance LLC to make distributions to its two Canadian shareholders. Distribution decisions were made by the board of the entity making them. A read-in from an examination of discovery also confirmed that decisions of each of the companies involved in the reorganization that replaced Finance LLC with the Luxemburg entity, including the decisions of the Luxemburg entity, were made by the respective boards of those companies.[5]
[25] Ms. Arnason made it clear, and I accept her testimony on this as I have for all her testimony, that the actual implementation fees respecting each step in the series of transactions that constituted the overall reorganization were not part of the consulting fees. Each entity paid its own transactional costs. I have accepted her view that the purpose for incurring the subject expenses was for the benefit of PCS, not the downstream related companies. That input and advice from Canada may have assisted and influenced foreign entities that bore their own professional costs, does not mean that they did not act independently, in a legal sense. Their raison d’être did not inherently put them in a conflict of interest with PCS. Their interest, for example, in saving taxes on any assets acquired, held or disposed of, would not conflict with the interest of a shareholder no matter how far up the corporate chain.
[26] In any event, Ms. Arnason made it clear that the entire reorganization was undertaken, and the consulting fees were incurred, by PCS for one reason, namely, to replace Finance LLC with something better than what was being imposed by the new 30% U.S. withholding tax. The final structure ensured that there was no U.S withholding tax on the payments leaving the U.S.
The Appellant’s Submissions
[27] In oral argument, Appellant’s counsel likened the reorganization to a repair of a broken structure that needed fixing. The structure was the channel or pipeline through which income from property flowed and expenses incurred to repair it were incurred, in the normal course as in the case of maintaining a pipeline, with the view to maintain and enhance the receipt. In his written submission he highlighted the purpose for incurring the subject expenses as follows:
25. Put plainly, the purpose of incurring the Consulting Fees was to implement the Reorganization to address the increase in U.S. withholding tax and to maximize PCS’s income from property net of foreign withholding taxes.
[28] I acknowledge that the point of the reorganization was to relocate the Notes so as to avoid the increase in the U.S. withholding tax on repatriation of the funds to Canada. I accept, as Appellant’s counsel argued, that but for that increase, the structure utilizing Finance LLC would have been maintained. I acknowledge as well, as Appellant’s counsel argued, that there was a reasonable expectation of continued significant income from the downstream entities. He argues that the future availability of such significant amounts, as would thereby be available for distribution to PCS, is a relevant factor supporting the purpose of incurring the subject expenses.
[29] It is argued that that meets the requirement in paragraph 18(1)(a) of an expense incurred “for the purpose of gaining -- income from -- property”. It is argued that it is the intention at the time the expense is incurred that is relevant and whether or not dividends were paid from the Luxemburg entity should not, does not, impact the determination of the requisite purpose once identified. Appellant’s counsel cites authorities for this latter proposition including ones that deal more broadly with the application of the purpose test and its subjective and objective elements.
[30] That it is the intention at the time the expense is incurred that governs is supported by the decisions in 722540 Ontario Inc. v. R. (sub nom. Novopharm Limited v. R.)[6] and Ludmer et al v. R. (sub nom. Ludco Enterprises Ltd. et al v. The Queen).[7] The Appellant cites the following passage from the decision of the Supreme Court of Canada in Ludco in support of its position:
54 Having determined that an ancillary purpose to earn income can provide the requisite purpose for interest deductibility, the question still remains as to how courts should go about identifying whether the requisite purpose of earning income is present. What standard should be applied? In the interpretation of the Act, as in other areas of law, where purpose or intention behind actions is to be ascertained, courts should objectively determine the nature of the purpose, guided by both subjective and objective manifestations of purpose: see Symes, supra, at p. 736; Continental Bank of Canada, supra, at para.45; Backman, supra, at para. 25; Spire Freezers Ltd., supra, at para. 27. In the result, the requisite test to determine the purpose for interest deductibility under s. 20(1)(c)(i) is whether, considering all the circumstances, the taxpayer had a reasonable expectation of income at the time the investment is made.
55 Reasonable expectation accords with the language of purpose in the section and provides an objective standard, apart from the taxpayer's subjective intention, which by itself is relevant but not conclusive. It also avoids many of the pitfalls of the other tests advanced and furthers the policy objective of the interest deductibility provision aimed at capital accumulation and investment, as discussed in the next section of these reasons. (Emphasis added by the Appellant.)
[31] These highlighted passages make the Appellant’s point quite clearly on the basis that the same reasoning applies to paragraph 18(1)(a) and subparagraph 20(1)(c)(i). Even if the reorganization failed (which it did not) or dividends were never paid, the purpose test would still be met provided what was sought to be gained by incurring the expenditure was income at the time the expense was incurred.
[32] In what I believe was a response to a question I asked during argument dealing with whether or not PCS’s “income” was affected at all by the U.S. withholding tax, Appellant’s counsel made the following argument:
45. In addressing this point, relevant background is provided by the FCA in Novopharm, in which it applied the “income” test under 18(1)(a) of the Act based on the test applied to 20(1)(c) by the SCC in the Ludco decision. Paragraphs 19 and 20 of Novopharm read as follows:
19 However, more recent decisions of the Supreme Court of Canada indicate that, at least with respect to subparagraph 20(1)(c)(i), income is not equivalent to profit or net income. At paragraph 59 of Ludco, Iacobucci J. states:
Because it is left undefined in the Act, this Court must apply the principles of statutory interpretation to discern what is meant by "income" in the context of s. 20(1)(c)(i). The plain meaning of s. 20(1)(c)(i) does not support the interpretation of "income" as the equivalent of "profit" or "net income". Nowhere in the language of the provision is a quantitative test suggested. Nor is there any support in the text of the Act for an interpretation of "income" that involves a judicial assessment of sufficiency of income. Such an approach would be too subjective and certainty is to be preferred in the area of tax law. Therefore, absent a sham or window dressing or similar vitiating circumstances, courts should not be concerned with the sufficiency of the income expected or received.
Although his determination is with respect to the definition of income in subparagraph 20(1)(c)(i), the relevant words are so close to those in paragraph 18(1)(a) that it would be difficult to justify a different interpretation with respect to paragraph 18(1)(a).
20 The Minister submits that paragraph 18(1)(a) is generally aimed at deductions of outlays which are not profit motivated. However, I think the rationale outlined by Iacobucci J. in Ludco, as to why income in subparagraph 20(1)(c)(i) is not equivalent to profit or net income, is equally applicable to paragraph 18(1)(a). Nowhere in the language of paragraph 18(1)(a) is a quantitative test suggested. Nor is there any support in the words of paragraph 18(1)(a) that suggests a judicial assessment of the sufficiency of income. And, as with subparagraph 20(1)(c)(i), such an assessment would be too subjective where certainty is to be preferred. For these reasons, I am of the opinion that the view of Pigeon J. in Lipson, supra, to the extent that it may have been applied to paragraph 18(1)(a), must now be considered to have been superseded by the rationale in Ludco. (Emphasis added by the Appellant.)
[33] The argument then is that incurring expenses to increase income net of foreign withholding taxes meets the income test under paragraphs 18(1)(a) and 21(1)(c) of the Act. The Appellant equates additional cashflow with additional income. To further support the Appellant’s position the following paragraph in Ludco is also cited:
61 I agree. Indeed, when one looks at the immediate context in which the term "income" appears in s. 20(1)(c)(i), it is significant that within the provision itself the concept of "income" is used in contradistinction from the concept of tax-exempt income. Viewed in this context, the term "income" in s. 20(1)(c)(i) does not refer to net income, but to income subject to tax. In this light, it is clear that "income" in s. 20(1)(c)(i) refers to income generally, that is an amount that would come into income for taxation purposes, not just net income. (Emphasis added by the Appellant.)
[34] The Appellant’s argument goes on to assert that the consulting fees were also incurred for the purpose of earning income from the business of PCS. The reorganization was designed to increase cash available for distribution to PCS for use in its business.
[35] The Appellant submits that the decision in BJ Services Co. Canada v. R.[8] stands for the proposition that expenses that are not directly related to income earning activities can nevertheless be deductible if they meet a business need of the corporation. Paragraph 18(1)(a) cannot apply to limit their deduction in such circumstances. In that case, professional fees were incurred to make changes to the corporation’s capital structure to fend off an unsolicited takeover bid.
[36] In BJ Services, this Court, referring to the Symes decision of the Supreme Court of Canada (cited thereunder) held as follows:
29 (…) [T]he Supreme Court, in Symes v. R. (1993), [1994] 1 C.T.C. 40 (S.C.C.), is clear that if the expenses are business in nature, instead of personal, the test for deductibility may be met by showing the expense satisfied a need of the company. Expenses incurred by a business, which are ancillary to its primary functions and activities, are not immediately excluded from being deductible. As a result this renders the paragraph 18(1)(a) restriction porous and allows the Nowsco expenses to pass through the excluding provisions, as long as they are business in nature and not personal. There need not be a direct link between expenses and revenue. Expenses may be deductible, provided they are not personal and meet some business need of the taxpayer.
30 The expenses here were certainly ancillary expenses. However the hello and break fees, as well as the other expenses, must be viewed in the larger context of the commercial operations of Nowsco. (…) (Emphasis added by the Appellant.)
[37] While the consulting fees may not have been directly related to PCS’s business of mining, processing and selling potash, in the larger context of its commercial operations, it was argued that PCS needed the subject cashflow in both its operations and to service its external debt. I acknowledge that there was a business need for the cashflows expected from Finance LLC. The activities of PCS in Canada were, as Ms. Arnason testified, robust and like any thriving enterprise, PCS might well rely on strong cashflows from downstream sources.
[38] Appellant’s counsel also referred me to International Colin Energy Corp. v. R.[9] and Boulangerie St-Augustine Inc. v. Canada.[10] In International Colin, consulting fees paid by a failing corporation to find a suitable merger candidate was held to have been incurred for the purpose of improving its ability to earn income and deductible on that basis. The Appellant argues that this test of satisfying some business need is not restricted to dire circumstances such as needing cash to the point where one would otherwise be in a default position.
[39] In Boulangerie St-Augustine it was held that professional fees incurred in relation to preparing a circular for shareholders concerning a takeover bid were deductible. Justice Archambault found that adopting a more generous interpretation of the requirement in paragraph 18(1)(a) that the expense be incurred for the purpose of earning income from a business was required. It was not necessary that the expense relate directly to the business operation.
[40] The Appellant’s counsel’s submissions also deal with paragraph 18(1)(b) of the Act. He maintains that the deduction of the consulting fees is not precluded by that paragraph.
[41] It is noted, as a starting point, that the consulting fees are said not to represent the cost of acquiring a specific asset but rather represent the cost to plan and watch over the implementation of the reorganization. It is submitted that the acquisition cost of the shares in the Luxemburg entity must be limited to the direct cost of their acquisition. There was a subscription price in relation to that acquisition and it was paid separate and apart from the consulting fees. Further, the consulting fees continued to be incurred after the subscription for the shares in the Luxemburg entity.
[42] It is further submitted that the consulting fees were not incurred with a view to bringing into existence an advantage for the enduring benefit of PCS.
[43] Appellant’s counsel argued that a tax benefit (which is the advantage sought by the reorganization) is not by its very nature an enduring benefit. Both the change in the U.S. withholding rate imposed by the U.S. on payments from Finance LLC and the later changes in the withholding rates on payments from the U.S. to Luxemburg, evidence the stroke of a pen absence of any enduring benefit that might be attributed to a tax benefit.
[44] Further, Appellant’s counsel cites the minority opinion of Locke J. in British Columbia Electric Railway Company Limited v. The Minister of National Revenue:[11]
72. Furthermore, in the minority opinion of Locke, J. in BC Electric Railway (concurring however in the result with the majority opinion written by Abbott, J.) the SCC referred to another decision in Anglo- Persian Oil, which suggests that an “enduring benefit” is not one that, for some time, relieves you of an income payment:
20 In Anglo-Persian Oil Company v. Dale (1931), 16 T.C. 253, Rowlatt J., referring to the word "enduring" in the passage from Lord Cave's judgment, said (p. 262) that quite clearly he was speaking of a benefit which endures in the way that fixed capital endures, not a benefit that endures in the sense that for a good number of years it relieves you of a revenue payment. (…) (Emphasis added by the Appellant.)
[45] Another reason that it cannot be found, as a matter of fact, that there was an enduring benefit to the reorganization is that it was known that any tax benefit from the Luxemburg structure would be temporary at best. In such circumstances, it is argued that it cannot be found that the subject expenses were incurred with a view of bringing into existence an advantage for the enduring benefit of PCS.
[46] In the alternative, the Appellant argues that if I find that the consulting fees were incurred on account of capital, then they are eligible capital expenditures of PCS.
[47] The definition of “eligible capital expenditures” at subsection 14(5) of the Act requires:
a) an amount incurred, in respect of a business, for the purpose of gaining or producing income from the business;
b) that the amount be incurred on account of capital; and
c) that none of the exclusions in that definition apply to the amount.
[48] The Appellant submits that the first requirement is met based on this Court’s decision in BJ Services. The second requirement would be met on the basis of my making that finding. Lastly, it is submitted that none of the exclusions to the definition of eligible capital expenditures apply to the consulting fees.
The Respondent’s Submissions
[49] Counsel for the Respondent asserted, in effect, that I should look at the planning steps separately and the multi-faceted objectives they each sought to implement. The subject expenses should be seen as having been incurred to facilitate these distinct objectives. On that basis, none of the individual transactions in the series can be found to be for the purpose of gaining or producing income for PCS.
[50] It is submitted that only the acquisition of shares of the Luxemburg entity was a transaction entered into for the purpose of producing dividend income for PCS. However, it is argued that it should be clear that most of the steps and transactions undertaken by PCS’s foreign subsidiaries, if viewed independently, were not undertaken to acquire shares of the Luxemburg entity. Accordingly, the consulting fees cannot be found to have been incurred to earn income from these shares. They were incurred for other purposes inherent in each of those separate transactions.
[51] The Respondent asserts then that the purpose test must be applied in respect of each of the transactions even though the overall purpose of the series of transactions was to maximize the cashflow, through the group, back to PCS. For example, some expenses were incurred to ensure that the entity that received the interest payments on the Notes would only be subject to a minimal local income tax. Other expenses were incurred to minimize capital taxes in both Ireland and Luxemburg. It would not be helpful, in my view, to go through each step of the reorganization, as did Respondent’s counsel, and reiterate counsel’s position that the particular purpose of that particular step was this or that, as opposed to being for the purpose of producing income for PCS. His point is made without going through that exercise.
[52] Reliance is placed on Singleton v. M.N.R.[12] where Major J. of the Supreme Court of Canada noted at paragraph 34 as follows:
… it is an error to treat this as one simultaneous transaction. In order to give effect to the legal relationships, the transactions must be viewed independently. When viewed that way, on either version of the facts (i.e. regardless of the sequence), what the respondent did in this case was use the borrowed funds for the purpose of refinancing his partnership capital account with debt. This is the legal transaction to which the Court must give effect. (Emphasis added by the Respondent.)
[53] Relying, as did the Appellant, on the almost identical language in paragraph 20(1)(c) to that in paragraph 18(1)(a), Respondent’s counsel also referred to an observation of Rothstein J.A. writing for the Federal Court of Appeal in Singleton as follows:[13]
In the context of the Income Tax Act in which the phrase “series of transactions” appears 41 times, its absence from paragraph 20(1)(c) implies that there is no legislative intent to import the series test into that paragraph or, in other words, to link a series of individual transactions as if they were one transaction …
[54] Similarly, reliance is placed on Rothstein J.A.’s finding in Novopharm where he again confirmed at paragraph 12 that these provisions do not contemplate treating individual transactions as part of a series but rather each must be viewed independently.
[55] Since the consulting fees were incurred for different immediate purposes in respect of each of the steps taken, their deductibility must be governed accordingly.
[56] Considering the paragraph 18(1)(a) requirement in the context of the subject expenses being incurred to earn income from a business, the Respondent relies more on the construction of the provision that would match the expenditure to income from a particular business. Benefits, even cashflow benefits, that arise from expenditures unrelated to the particular business of PCS cannot be said to have been incurred for the purpose of earning income from that particular business. Respondent’s counsel cites Royal Trust Co. v. Minister of National Revenue[14] at paragraph 33 as follows:
The essential limitation in the exception expressed in [Section 18(1)(a)] is that the outlay or expense should have been made by the taxpayer "for the purpose" of gaining or producing income "from the business". It is the purpose of the outlay or expense that is emphasized but the purpose must be that of gaining or producing income "from the business" in which the taxpayer is engaged. … (Emphasis added by the Respondent.)
[57] Based on admitted facts and the evidence presented at the hearing, it is asserted that the business of PCS during its 1997 and 1998 taxation years was solely the mining, processing and sale of potash. The consulting fees did not relate in any way to these businesses and, accordingly, do not meet the “from the business” test in paragraph 18(1)(a).
[58] It is further argued that seeking to deduct on income account expenses associated with all the various steps involved in the reorganization ignores the separate legal existence of the various foreign subsidiaries. It is submitted that if the separate corporate existence of PCS and its foreign subsidiaries are respected, then the consulting fees incurred by PCS to enable its foreign subsidiaries to move the Notes from the U.S. to Luxemburg are expenses of the respective foreign subsidiaries because it was each foreign subsidiary that actually implemented each successive step for its own account. On this basis, it is submitted that the consulting fees that affected the relocation of the Notes, even though incurred by PCS are, nonetheless, expenses of the foreign subsidiaries whose existence PCS chose to have the benefit of in the course of the Notes being relocated. As to the principal benefactor of that relocation, it is asserted that it could be the Luxemburg entity. The subject transactions did, after all, create an income earning capacity for the Luxemburg entity. From that perspective the consulting fees can be said to have been incurred for the purpose of enabling the Luxemburg entity to earn income, not PCS. In R. v. MerBan Capital Corp.[15] the Court noted that “A payment made to allow a subsidiary to earn income is a payment made in respect of another taxpayer’s business”[16] and as such does not meet the requirements of paragraph 18(1)(a), at least with respect to the gaining or producing income from the business requirement.
[59] Having created the Luxemburg entity to