Canada v. Loblaw Financial Holdings Inc.

Canada v. Loblaw Financial Holdings Inc.
Collection
Supreme Court Judgments
Date
2021-12-03
Neutral citation
2021 SCC 51
Report
[2021] 3 SCR 687
Case number
39220
Judges
Wagner, Richard; Moldaver, Michael J.; Karakatsanis, Andromache; Côté, Suzanne; Brown, Russell; Martin, Sheilah; Kasirer, Nicholas
On appeal from
Federal Court of Appeal
Subjects
Taxation
Notes
Case in Brief SCC Case Information
Decision Content
SUPREME COURT OF CANADA
Citation: Canada v. Loblaw Financial Holdings Inc., 2021 SCC 51, [2021] 3 S.C.R. 687
Appeal Heard: May 13, 2021 Judgment Rendered: December 3, 2021 Docket: 39220
Between:
Her Majesty The Queen Appellant
and
Loblaw Financial Holdings Inc. Respondent
- and -
Attorney General of Ontario and Canadian Bankers’ Association Interveners
Coram: Wagner C.J. and Moldaver, Karakatsanis, Côté, Brown, Martin and Kasirer JJ.
Reasons for Judgment: (paras. 1 to 75)
Côté J. (Wagner C.J. and Moldaver, Karakatsanis, Brown, Martin and Kasirer JJ. concurring)
Her Majesty The Queen Appellant
v.
Loblaw Financial Holdings Inc. Respondent
and
Attorney General of Ontario and
Canadian Bankers’ Association Interveners
Indexed as: Canada v. Loblaw Financial Holdings Inc.
2021 SCC 51
File No.: 39220.
2021: May 13; 2021: December 3.
Present: Wagner C.J. and Moldaver, Karakatsanis, Côté, Brown, Martin and Kasirer JJ.
on appeal from the federal court of appeal
Taxation — Income tax — Assessment — Foreign accrual property income — Financial institution exception — Arm’s length requirement — Conducting business — Canadian corporate taxpayer not including income earned by foreign subsidiary in Canadian tax return for several taxation years — Taxpayer claiming foreign subsidiary’s activities covered by financial institution exception to rules for foreign accrual property income — Tax Court holding that exception does not apply because foreign subsidiary dealing principally with non‑arm’s length persons — Whether foreign subsidiary’s business conducted principally with persons with whom it deals at arm’s length — Whether parent corporation’s injection of capital or corporate oversight relevant to arm’s length test — Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), s. 95(1) “investment business”.
In 1992, Loblaw Financial Holdings Inc. (“Loblaw Financial”), a Canadian corporation, incorporated a subsidiary in Barbados. The Central Bank of Barbados issued a licence for the subsidiary to operate as an offshore bank named Glenhuron Bank Ltd. (“Glenhuron”). Between 1992 and 2000, important capital investments in Glenhuron were made by Loblaw Financial and affiliated companies (“Loblaw Group”). In 2013, Glenhuron was dissolved, and its assets were liquidated.
For the 2001, 2002, 2003, 2004, 2005, 2008 and 2010 taxation years, Loblaw Financial did not include income earned by Glenhuron in its Canadian tax returns as foreign accrual property income (“FAPI”). Under the FAPI regime in the Income Tax Act (“ITA”), Canadian taxpayers must include income earned by their controlled foreign affiliates (“CFAs”) in their Canadian annual tax returns on an accrual basis if this income qualifies as FAPI. However, financial institutions that meet specific requirements benefit from an exception to the FAPI rules found in the definition of “investment business” at s. 95(1) of the ITA. The financial institution exception is available where the following requirements are met: (1) the CFA must be a foreign bank or another 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 with whom it deals at arm’s length.
Loblaw Financial claimed that Glenhuron’s activities were covered by the financial institution exception to the FAPI rules. The Minister disagreed with Loblaw Financial and reassessed it on the basis that the income earned by Glenhuron during the years in issue was FAPI. Loblaw Financial objected and appealed the reassessments. The Tax Court held that the financial institution exception did not apply, as Glenhuron’s business was conducted principally with non‑arm’s length persons. In reaching its decision, the court considered the scope of Glenhuron’s relevant business, looking at its receipt of funds and use of funds. It included in its analysis all receipts of funds indiscriminately, treating capital injections by shareholders and lenders like any other receipt of funds. The Tax Court also viewed Glenhuron’s use of funds as the management of an investment portfolio on the Loblaw Group’s behalf and regarded the influence of the Loblaw Group’s central management as pervading the conduct of business because of the Loblaw Group’s close oversight of Glenhuron’s investment activities.
The Federal Court of Appeal disagreed with the Tax Court’s interpretation of the arm’s length requirement and with its analysis based on receipt and use of funds. It held that only Glenhuron’s income‑earning activities had to be considered. It also found that direction, support, and oversight by the Loblaw Group should not have been considered, because these interactions are not income‑earning activities and thus do not amount to conducting business with the CFA. It concluded that Glenhuron was dealing principally with arm’s length persons, and that Loblaw Financial was entitled to the benefit of the financial institution exception and did not need to include Glenhuron’s income as FAPI. It referred the reassessments back to the Minister for reconsideration.
Held: The appeal should be dismissed.
Loblaw Financial was entitled to rely on the financial institution exception set out in s. 95(1) of the ITA. When the precise words of the arm’s length requirement — “the business (other than any business conducted principally with persons with whom the affiliate does not deal at arm’s length)” — are interpreted in accordance with the ordinary rules of statutory interpretation, it is clear that they do not encompass an assessment of capital contributions or corporate oversight. If capital and corporate oversight are excluded from consideration, Glenhuron’s investment business activities were conducted principally with arm’s length persons.
A parent corporation does not conduct business with its CFA when it provides capital and exercises corporate oversight. An ordinary and grammatical reading of the words “business conducted” conveys a different meaning than the word “business” alone. The addition of the verb “conducted” emphasizes Parliament’s intent to focus on the active carrying out of business rather than on the establishment of prerequisite conditions that enable a foreign affiliate to conduct business. Raising capital is a necessary part of any business, and capital enables business to be conducted; but one would not generally speak of capitalization itself as the conduct of the business. The Court has repeatedly affirmed that there is a distinction between capitalization and the conduct of a business. The banking context does not change anything. There is undoubtedly a distinction between receiving funds from depositors and receiving funds from shareholders — depositors are clients of the bank, for whom the bank provides the services associated with holding their funds; shareholders are not.
The context of the FAPI regime confirms this reading. The entire function of the regime is to classify a foreign affiliate’s income. The financial institution exception to the definition of “investment business” and its arm’s length requirement are tied to this same function: identifying income for inclusion in FAPI. It thus makes considerable sense that Parliament intended these determinations to focus on activities more directly related to income generation than to capitalization, the distinction between income and capital being well established in tax law. The FAPI regime also shows why considering capitalization as part of conducting business for the purposes of the financial institution exception would create practical problems. The FAPI regime does not provide a method for assigning capital to the different businesses within a single corporation. Interpreting “business conducted” to include the capitalization of the business would make it necessary to somehow divide the debt and equity from various sources (some arm’s length and some not) and then assign the ensuing quotient to the various businesses conducted by a foreign affiliate. Parliament’s failure to provide a method for distributing capital suggests that it did not have capital in mind. A further practical difficulty arises when considering the receipt of corporate capital in relation to newly formed CFAs. Since the Canadian parent will have provided some capital to set up the CFA, in most cases, this means that the CFA will fail the test in its early years when it is trying to build a customer base, because the ratio of corporate capital to other business receipts will likely be high. If taxpayers are to act with any degree of certainty, then full effect should be given to Parliament’s precise and unequivocal words. The grammatical and ordinary meaning of the words “business conducted”, read in the context and light of the purpose of the FAPI regime, clearly shows that Parliament did not intend capital injections to be considered.
Furthermore, there is no basis in the text, context or purpose of the arm’s length requirement to support the Tax Court’s consideration of corporate oversight as part of conducting business. Fundamentally, a corporation is separate from its shareholders. Its business may be conducted using money provided by shareholders or in accordance with policies adopted by the board of directors on behalf of the shareholders, but this does not change the fact that the corporation remains the party conducting business. Treating oversight by a parent corporation as shifting the responsibility for conducting business is also incompatible with the rest of the FAPI regime. The regime applies only where there is a controlled foreign affiliate. If there is a CFA, there is necessarily corporate oversight by its parent. Parliament does not speak in vain; it would not have added an arm’s length requirement if it could never be met.
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. The most lucrative of those activities undertaken by Glenhuron were conducted at arm’s length, amounting to at least 86 percent of its income during the years in issue. On the non‑arm’s length, Glenhuron’s combined activities do not reach the “principally” threshold. The arm’s length requirement was therefore met during the years in issue.
Cases Cited
Referred to: Inland Revenue Commissioners v. Westminster (Duke of), [1936] A.C. 1; Canadian Pioneer Management Ltd. v. Labour Relations Board of Saskatchewan, [1980] 1 S.C.R. 433; Smith v. Anderson (1880), 15 Ch. D. 247; Bennett & White Construction Co. v. Minister of National Revenue, [1949] S.C.R. 287; CIT Group Securities (Canada) Inc. v. The Queen, 2016 TCC 163, [2016] 6 C.T.C. 2013; Housen v. Nikolaisen, 2002 SCC 33, [2002] 2 S.C.R. 235; Michel v. Graydon, 2020 SCC 24; Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2 S.C.R. 601; Placer Dome Canada Ltd. v. Ontario (Minister of Finance), 2006 SCC 20, [2006] 1 S.C.R. 715; Tip Top Tailors Ltd. v. Minister of National Revenue, [1957] S.C.R. 703; Montreal Coke and Manufacturing Co. v. Minister of National Revenue, [1944] A.C. 126; R. v. Ulybel Enterprises Ltd., 2001 SCC 56, [2001] 2 S.C.R. 867; R. v. Cole, 2012 SCC 53, [2012] 3 S.C.R. 34; R. v. Vu, 2013 SCC 60, [2013] 3 S.C.R. 657; R. v. Friesen, 2020 SCC 9.
Statutes and Regulations Cited
Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), ss. 91(1), (4), (5), 95(1) “controlled foreign affiliate”, “foreign accrual property income”, “foreign affiliate”, “income from an active business”, “income from property”, “investment business”, (2), (2.11), (2.4)(b), (3), 248(1) “business”.
International Financial Services Act, L.R.O. 2007, c. 325, s. 4(2) “international banking business”.
Off‑shore Banking Act, L.R.O. 1985, c. 325, s. 4.
Authors Cited
Benson, E. J. Proposals for Tax Reform. Ottawa: Queen’s Printer, 1969.
Canada. Department of Finance. Special Report — Revised Draft Legislation and Technical Notes: Foreign Affiliates. North York, Ont.: CCH Canadian, 1995.
Canada. Department of Finance. Tax Measures: Supplementary Information. Ottawa, 1994.
Canada. Office of the Auditor General. Report of the Auditor General of Canada to the House of Commons, 1992. Ottawa, 1992.
Canada Revenue Agency. Foreign affiliates — Investment Business. Ruling No. 9509775, July 14, 1995.
Canada Revenue Agency. Foreign affiliates — Investment Business. Ruling No. 2000‑0006565, Ottawa, June 22, 2000.
Halsbury’s Laws of Canada: Income Tax (International), 2019 Reissue, contributed by Vern Krishna. Toronto: LexisNexis, 2019.
Holmes, Bill, and Ian Gamble. The Foreign Affiliate Rules. Toronto: Wolters Kluwer, 2020.
Krishna, Vern. Income Tax Law, 2nd ed. Toronto: Irwin Law, 2012.
Panteleo, Nick, and Michael Smart. “International Considerations”, in Heather Kerr, Ken McKenzie and Jack Mintz, eds., Tax Policy in Canada. Toronto: Canadian Tax Foundation, 2012, 12:1.
Yeung, Jayme. “Trading or Dealing in Indebtedness Offshore: Paragraph 95(2)(l) Revisited” (2011), 59 Can. Tax J. 85.
APPEAL from a judgment of the Federal Court of Appeal (Woods, Laskin and Mactavish JJ.A), 2020 FCA 79, [2020] 3 F.C.R. 481, [2020] 4 C.T.C. 1, 2020 D.T.C. 5040, [2020] F.C.J. No. 511 (QL), 2020 CarswellNat 1300 (WL Can.), setting aside a decision of Miller J., 2018 TCC 182, [2019] 2 C.T.C. 2001, 2018 D.T.C. 1128, [2018] T.C.J. No. 136 (QL), 2018 CarswellNat 5099 (WL Can.). Appeal dismissed.
Eric A. Noble and Elizabeth Chasson, for the appellant.
Al Meghji and Pooja Mihailovich, for the respondent.
Baaba Forson, for the intervener the Attorney General of Ontario.
Matthew G. Williams, for the intervener the Canadian Bankers’ Association.
The judgment of the Court was delivered by
Côté J. —
TABLE OF CONTENTS
Paragraph
I. Introduction
1
II. Background
5
III. Decisions Below
14
A. Tax Court of Canada, 2018 TCC 182, [2019] 2 C.T.C. 2001 (Miller J.)
14
B. Federal Court of Appeal, 2020 FCA 79, [2020] 3 F.C.R. 481 (Woods, Laskin and Mactavish JJ.A.)
21
IV. Issue
27
V. Analysis
28
A. FAPI Regime
28
B. Arm’s Length Requirement
40
(1) Introduction
40
(2) Receipt of Equity and Debt Capital
44
(3) Corporate Oversight by a Parent
63
C. Application
65
VI. Conclusion
75
Appendix
I. Introduction
[1] This case concerns the foreign accrual property income (“FAPI”) regime under the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (“ITA”).[1] In essence, this regime provides that Canadian taxpayers, like the respondent Loblaw Financial Holdings Inc. (“Loblaw Financial”), must include income earned by their controlled foreign affiliates (“CFAs”) in their Canadian annual tax returns on an accrual basis if this income qualifies as FAPI. However, financial institutions that meet specific requirements benefit from an exception found in the definition of “investment business” at s. 95(1) of the ITA. One of these requirements is that the CFA must conduct its business principally with persons with whom it deals at arm’s length, also called the “arm’s length requirement”. Only this requirement is at issue in this appeal.
[2] The FAPI regime is one of the most complicated statutory regimes in Canadian law. Although 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.
[3] I wish to emphasize from the start that while the tenor of the Crown’s submissions is that Loblaw Financial has engaged in tax avoidance, the Crown did not raise any argument based on the general anti-avoidance rule (“GAAR”) before this Court. We are tasked only with interpreting the precise words of the arm’s length requirement — “the business (other than any business conducted principally with persons with whom the affiliate does not deal at arm’s length)” — found in the financial institution exception, in accordance with the ordinary rules of statutory interpretation. When these words are read in their grammatical and ordinary sense, in harmony with their context and the ITA’s objects, it becomes clear that they do not encompass an assessment of capital contributions or corporate oversight.
[4] If capital and corporate oversight are excluded from consideration, the vast majority of business was conducted between Loblaw Financial’s foreign affiliate and persons with whom it was dealing at arm’s length. Therefore, Loblaw Financial can avail itself of the financial institution exception. Given the text, context and purpose of the provision at issue, there is no reason for a court to deny Loblaw Financial the ability to arrange its affairs so as to minimize its tax payable. As Lord Tomlin famously said:
Every man is entitled, if he can, to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax.
(Inland Revenue Commissioners v. Westminster (Duke of), [1936] A.C. 1 (H.L.), at pp. 19‑20).
II. Background
[5] Loblaw Financial is a Canadian corporation and an indirect wholly‑owned subsidiary of Loblaw Companies Ltd., a Canadian public corporation controlled by George Weston Ltd. Loblaw Companies Ltd., George Weston Ltd., and their subsidiaries (“Loblaw Group”) deal with one another on a non‑arm’s length basis.
[6] In 1992, Loblaw Financial incorporated a subsidiary in Barbados, Loblaw Inc. The Central Bank of Barbados issued a licence to Loblaw Inc. to operate as an offshore bank under Barbados’ Off‑shore Banking Act, L.R.O. 1985, c. 325 (“Barbados OSBA”), later replaced by the International Financial Services Act, L.R.O. 2007, c. 325 (“Barbados IFSA”). Loblaw Inc. was then renamed Glenhuron Bank Limited (“Glenhuron”) and was regulated by the Central Bank of Barbados. Glenhuron’s activities were required to be limited to those falling within the definition of “international banking business” in s. 4(2) of the Barbados IFSA.
[7] Between 1992 and 2000, the Loblaw Group made important capital investments in Glenhuron. Loblaw Financial injected nearly $500 million by subscribing to shares, and a Dutch subsidiary invested $142 million by subscribing to shares and $133 million by providing interest-free loans.
[8] Glenhuron’s activities can be broken down into the following lines of business: (1) short-term debt securities; (2) asset management for a fee; (3) intercorporate loans; (4) independent operator loans; (5) interest rate and cross‑currency swaps; and (6) equity forwards. Every party with assets under management by Glenhuron was related to it, except Waterman Insurance Inc. Nonetheless, many of Glenhuron’s lines of business involved investments with third parties. For example, Glenhuron bought most of its short-term debt securities from Salomon Brothers, Merrill Lynch, and Citibank. It entered into swaps agreements with other financial institutions as well (e.g., UBS, JP Morgan, Gen Re, and ABN AMRO). Moreover, these investments in short-term debt securities and these swaps agreements involving third parties were the most lucrative of its activities by far — representing at least 86 percent of its total income during the years in issue — and mobilized the largest proportion of its assets.
[9] Due to the success of its financial activities, Glenhuron was able to grow its asset base, primarily through an increase in its retained earnings from approximately $100 million at the end of the 2000 taxation year to approximately $700 million at the end of the 2010 taxation year. Its share capital remained stable during that period, decreasing from $476 million to $443 million following capital distributions and further injections.
[10] In 2013, Glenhuron was dissolved, and its assets were liquidated to provide Loblaw Companies Ltd. with funds for a major acquisition.
[11] The dispute between Loblaw Financial and the Crown concerns the application of the FAPI regime to the income earned by Loblaw Financial’s foreign subsidiary Glenhuron. During the years in issue, Loblaw Financial did not include income earned by Glenhuron in its Canadian tax returns as FAPI. It claimed that Glenhuron’s activities were covered by the financial institution exception to the FAPI rules, found in the definition of “investment business” at s. 95(1) of the ITA, so that Glenhuron’s income could not be characterized as FAPI. As I will explain in further detail below, four requirements must be met for this exception to apply: (1) the CFA must be a foreign bank or another 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 with whom it deals at arm’s length.
[12] The Minister of National Revenue disagreed with Loblaw Financial. In 2015, the Minister thus reassessed Loblaw Financial for the 2001, 2002, 2003, 2004, 2005, 2008, and 2010 taxation years on the basis that the income earned by Glenhuron was FAPI. The following amounts were added as income realized by Loblaw Financial from its shares in Glenhuron:
Loblaw Financial Taxation Year
FAPI Reassessed (CAN Dollars)
2001
$84,145,457
2002
$95,522,133
2003
$63,898,088
2004
$43,602,018
2005
$43,468,016
2008
$128,948,511
2010
$13,838,390
(2018 TCC 182, [2019] 2 C.T.C. 2001, at para. 145)
[13] Shortly thereafter, Loblaw Financial filed a notice of objection and then appealed the reassessments to the Tax Court of Canada.
III. Decisions Below
A. Tax Court of Canada, 2018 TCC 182, [2019] 2 C.T.C. 2001 (Miller J.)
[14] The first issue before the Tax Court was whether the financial institution exception applied during the years in issue. If so, Glenhuron’s income would not need to be included as FAPI in Loblaw Financial’s taxable income. The second issue was whether the GAAR precluded Loblaw Financial from availing itself of the exception.
[15] On the first issue, the Tax Court judge held that the financial institution exception did not apply. Although Glenhuron was a regulated foreign bank with more than five full‑time employees, its business was conducted principally with non‑arm’s length persons. Therefore, only three of the four requirements were satisfied.
[16] In order to apply the arm’s length requirement, the Tax Court judge first had to determine the scope of Glenhuron’s relevant business. To do so, he relied on the definition of “international banking business” under Barbadian law. Pursuant to that definition, he saw Glenhuron’s business as a Barbados international bank as being comprised of two basic elements: (1) the receipt of funds; and (2) the use of funds. In order to determine how these two elements fit within the arm’s length test, the Tax Court judge turned to the purpose underlying the arm’s length requirement. He found that the requirement is aimed primarily at promoting competition between foreign affiliates and other businesses in their respective foreign markets. Given this purpose, the judge opined that the receipt side should be given greater weight in the analysis, because this is the side of a banking business that involves the highest measure of competitiveness.
[17] On the receipt side, the Tax Court judge found that Glenhuron was overwhelmingly dealing with non‑arm’s length persons. In his analysis, he included all receipts of funds indiscriminately, thereby treating capital injections by shareholders and lenders like any other receipt of funds. As such, the judge compared the funds received from Waterman Insurance Inc. (the only arm’s length person on the receipt side) to the totality of assets under Glenhuron’s management, including funds received from shareholders and lenders, and retained earnings reinvested by Glenhuron. He found that the funds received from arm’s length persons were a mere drop in the ocean: never more than $18 million a year in comparison to assets under management ranging from $175 million to $1.2 billion.
[18] On the use side, the Tax Court judge also found that Glenhuron was principally dealing with non‑arm’s length persons. First, he viewed Glenhuron’s use of funds as, in essence, the management of an investment portfolio on the Loblaw Group’s behalf, with the objective of making “as much money as possible for Mr. Weston” and for Loblaw (paras. 242 and 246). Second, he regarded the influence of the Loblaw Group’s central management as “pervad[ing] the conduct of business” because of the Group’s close oversight of Glenhuron’s investment activities via derivative policies, regular reporting requirements, and regular attendance at board meetings (para. 247).
[19] Because Glenhuron was dealing principally with non‑arm’s length persons on both sides, the Tax Court judge held that the financial institution exception was not available. Therefore, Glenhuron’s income derived from its investment business had to be included in Loblaw Financial’s taxable income as FAPI for the years in issue, and the judge upheld the Minister’s determination on that basis.
[20] The Tax Court judge also analyzed in obiter the second issue and held that the GAAR did not apply because Glenhuron’s incorporation, name change, and licence renewals were not a series of avoidance transactions.
B. Federal Court of Appeal, 2020 FCA 79, [2020] 3 F.C.R. 481 (Woods, Laskin and Mactavish JJ.A.)
[21] Loblaw Financial appealed the Tax Court judge’s decision pertaining to the arm’s length requirement. For its part, the Crown did not cross-appeal the judge’s findings on the other three requirements of the financial institution exception. Nor did the Crown challenge his decision about the GAAR. Therefore, the sole issue before the Federal Court of Appeal concerned the arm’s length requirement.
[22] The Federal Court of Appeal disagreed with the Tax Court judge’s interpretation of the arm’s length requirement. According to the unanimous panel, the Tax Court judge’s starting point was incorrect. The Federal Court of Appeal referred to this Court’s decision in Canadian Pioneer Management Ltd. v. Labour Relations Board of Saskatchewan, [1980] 1 S.C.R. 433, as rejecting any substantive approach to defining “banking business” and as mandating a formal, institutional approach instead. Pursuant to that formal approach, what matters is whether the institution represents itself as a bank and is formally considered as such, not what specific activities are conducted in practice. The Federal Court of Appeal was therefore of the opinion that the Tax Court judge should not have relied on the Barbados statutory definition of “international banking business” describing the business of a bank as comprising two aspects — the receipt and use of funds.
[23] In passing, the Federal Court of Appeal also criticized the Tax Court judge’s reliance on the purpose of fostering international competition in order to give greater weight to the receipt of funds, describing it as an inappropriate reliance on “an unexpressed legislative intent” that had no place in the interpretation of a scheme “drafted with mind-numbing detail” (para. 58).
[24] Thus, the Federal Court of Appeal preferred to rely on the traditional definition of “business” used in tax matters instead. That definition provides that “business” designates the activities that “occup[y] the time and attention and labour of a man for the purpose of profit” (para. 82, quoting Smith v. Anderson (1880), 15 Ch. D. 247 (C.A.), at p. 258, and referring to s. 248(1) “business” of the ITA). It followed that only Glenhuron’s income-earning activities had to be considered.
[25] The Federal Court of Appeal added that direction, support, and oversight by the parent corporation should not have been considered by the Tax Court judge, because these interactions are not income-earning activities and thus do not amount to “conducting business with” the CFA. Moreover, capital investments made by the Loblaw Group were not part of Glenhuron’s business as they did not occupy Glenhuron’s time and attention in any meaningful way. Their exclusion was “consistent with long-standing jurisprudence which draws a distinction between ‘capital to enable [people] to conduct their enterprises’ and ‘the activities by which they earn their income’” (para. 85, quoting Bennett & White Construction Co. v. Minister of National Revenue, [1949] S.C.R. 287, at p. 298 (text in brackets in original)).
[26] Having determined the scope of the business that must be considered for the purposes of the arm’s length requirement, the Federal Court of Appeal then analyzed Glenhuron’s income-earning activities and found that Glenhuron was dealing principally with arm’s length persons. Indeed, short-term debt securities, cross‑currency swaps, and interest swaps — all activities conducted with arm’s length persons — were the most lucrative activities undertaken by Glenhuron and those in which most of its assets were invested. Therefore, Loblaw Financial was entitled to the benefit of the financial institution exception and did not need to include Glenhuron’s income as FAPI. The only exception was the fee income earned from managing investments for non‑arm’s length persons, which the parties had conceded was FAPI as it was deemed by s. 95(2)(b) to be income from a “business other than an active business”. For these reasons, the court allowed the appeal and referred the reassessments back to the Minister for reconsideration on the basis that only the fee income earned by Glenhuron from its management of Loblaw Group’s assets was FAPI.
IV. Issue
[27] In this appeal, the sole issue is whether Glenhuron conducted business principally with persons with whom it was dealing at arm’s length during the taxation years in issue. If it did, Loblaw Financial can avail itself of the financial institution exception, and the portion of Glenhuron’s income that is not caught by s. 95(2)(b)(i) will not be FAPI. Since there is no dispute as to the activities carried on by Glenhuron, the appeal boils down to what it means to conduct business, a narrow question of statutory interpretation.
V. Analysis
A. FAPI Regime
[28] The FAPI regime is regarded as one of the most complex tax schemes, with hundreds of definitions, rules, and exceptions that shift regularly. Given this complexity, I will limit myself to a broad description of this regime, and some intricate subtleties will be omitted in the process.
[29] Some Canadian taxpayers find it more attractive to park their passive investments in low-tax jurisdictions and earn income there through non‑resident corporations, rather than to earn investment income directly in Canada and be subject to higher taxes (N. Pantaleo and M. Smart, “International Considerations”, in H. Kerr, K. McKenzie and J. Mintz, eds., Tax Policy in Canada (2012), 12:1, at p. 12:14). The FAPI regime seeks to remove this advantage by requiring Canadian taxpayers to include, as income from their shares, certain types of income earned by their CFAs[2] in their annual tax returns in Canada on an accrual basis (s. 91(1) of the ITA; B. Holmes and I. Gamble, The Foreign Affiliate Rules (2020), at p. 81). The ITA provides, however, for several mechanisms to prevent double taxation (e.g., ss. 91(4) and 91(5)).
[30] Because FAPI is calculated on an accrual basis, the regime creates an exception to the deferral approach to the taxation of shareholders. Shareholders do not ordinarily pay tax on income earned by the corporation whose shares they own until this income is distributed as dividends. Under the FAPI regime, however, shareholders are taxed on the undistributed income earned by their CFAs as it is earned. They are thus denied the benefit of deferral (V. Krishna, Halsbury’s Laws of Canada: Income Tax (International) (2019 Reissue), at HTI-15).
[31] Importantly, the FAPI regime does not apply to all types of income. Broadly speaking, the ITA considers passive income (e.g., dividends, interests, royalties, and capital gains) to be FAPI and active income not to be FAPI. The interplay between the principle of capital export neutrality and the protection of the competitiveness of Canadian businesses operating internationally explains this distinction (Office of the Auditor General, Report of the Auditor General of Canada to the House of Commons, 1992 (1992), at pp. 51‑52). Capital export neutrality seeks to make “[i]nvestors . . . pay the same rate of tax on income from foreign investment as on income from domestic investment” (Pantaleo and Smart, at p. 12:25). As a consequence, taxpayers face neither an advantage nor a disadvantage in investing locally or abroad, as the two are fiscally equivalent. If this principle were applied absolutely, however, it would cripple the competitiveness of Canadian businesses and weaken Canada’s economic prosperity. Indeed, imposing an extra layer of Canadian taxes in addition to foreign taxes on Canadian corporations conducting business abroad could place them at a competitive disadvantage in comparison to other foreign corporations paying only local, foreign taxes (Department of Finance, Tax Measures: Supplementary Information (1994), at p. 33).
[32] However, this distinction between active and passive income is not watertight, with certain active income considered to be FAPI and certain passive income excluded (Pantaleo and Smart, at pp. 12:11 and 12:13). Moreover, the ITA provides detailed definitions of types of income, whose meaning may sometimes differ from their ordinary meaning (Holmes and Gamble, at p. 187). It is therefore crucial to focus the analysis on the specific requirements that apply under the relevant definitions and exclusions to determine whether income is FAPI (CIT Group Securities (Canada) Inc. v. The Queen, 2016 TCC 163, [2016] 6 C.T.C. 2013, at para. 89 (CanLII)).
[33] FAPI encompasses four broad categories of income earned by CFAs: (1) income from property; (2) income from a business other than an active business; (3) income from a non‑qualifying business; and (4) taxable capital gains realized on the disposition of non‑excluded property (s. 95(1) “foreign accrual property income”). The relevant categories here are the first two.
[34] The category of “income from a business other than an active business” covers any business that is deemed by s. 95(2) not to be active (s. 95(1) “income from an active business”). The only relevant deeming provision here is s. 95(2)(b)(i), which deems the provision of services to related entities for a fee to be a separate business and the income derived from that business to be FAPI. Managing assets of related entities for a fee would be captured by this rule (s. 95(3)). The purpose of this deeming provision is “to eliminate any tax advantage that might otherwise be obtained by (i) having a foreign affiliate provide services to a Canadian business, thereby shifting a portion of the business’s profits to another jurisdiction, or (ii) having one foreign affiliate provide services to another foreign affiliate that earns FAPI, thereby reducing the FAPI” (Holmes and Gamble, at p. 274).
[35] The main category at issue in this appeal is “income from property”, which includes a CFA’s income from an investment business (s. 95(1) “income from property”). The definition of “investment business” was added in 1995 amendments to the FAPI regime. Prior to the amendments, the distinction between active and passive income was left to the courts to define, a situation that was criticized in a 1992 Auditor General Report as providing “no reasonable assurance that the [FAPI] rules will apply in all circumstances where they should” (Office of the Auditor General, at pp. 48-49). Parliament responded by introducing the concept of “investment business”, the income from which would be included in income from property. What constitutes an investment business is defined broadly, encompassing any “business carried on by the affiliate . . . the principal purpose of which is to derive income from property (including interest, dividends, rents, royalties or any similar returns or substitutes therefor)” (s. 95(1), definition of “investment business”).
[36] Parliament created safe harbours or exceptions to this broad definition of “investment business”, including the financial institution exception at issue in this appeal. As I will discuss further below, Parliament must have been aware, however, that treating all income earned from an investment business carried on by a CFA as FAPI risked crippling the international competitiveness of Canadian financial institutions. Therefore, Parliament enacted the financial institution exception to exclude investment income realized by a CFA that is a financial institution from FAPI, provided that the following requirements are met:
1. Type of financial institution: The CFA carries on business as a foreign bank, a trust company, a credit union, an insurance corporation, or a trader or dealer in securities or commodities.
2. Oversight by a regulatory body: The CFA’s activities are regulated under foreign law.
3. Threshold level of activity: The CFA employs more than five full‑time employees or the equivalent thereof in the active conduct of the business.
4. Arm’s length requirement: The CFA’s business is not “conducted principally with persons with whom the [CFA] does not deal at arm’s length”.
(Section 95(1), definition of “investment business”)
[37] When these four requirements are met, the income from the investment business retains its character as active business income and is therefore not FAPI. However, satisfying these four requirements may not always be sufficient to avail oneself of the financial institution exception. Where the CFA is a regulated financial institution and carries on a business the principal purpose of which is to derive income from trading or dealing in indebtedness, the income derived from these activities is deemed to be income from property and thus FAPI, unless the Canadian taxpayer is a financial institution resident in Canada or the parent or subsidiary of such a Canadian financial institution (s. 95(2)(l)(iv); see J. Yeung, “Trading or Dealing in Indebtedness Offshore: Paragraph 95(2)(l) Revisited” (2011), 59 Can. Tax J. 85, at pp. 89-90). In effect, only CFAs related to Canadian financial institutions are permitted to deal in indebtedness without attracting the FAPI rules.
[38] In 2014, Parliament revisited the financial institution exception and preferred to toughen its requirements instead of repealing it (s. 95(2.11); see Holmes and Gamble, at pp. 1361-65). The condition that the taxpayer be a Canadian financial institution, or be related to such an institution, that was applicable only when the CFA was trading or dealing in indebtedness was extended to every case where a taxpayer invokes the exception. Additionally, the Canadian financial institution must either (1) have a minimum of $2 billion in equity, or (2) have more than 50 percent of its taxable capital employed in Canada in business activities regulated by a financial authority. This