Loblaw Financial Holdings Inc. v. The Queen

Loblaw Financial Holdings Inc. v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2018-09-07
Neutral citation
2018 TCC 182
File numbers
2015-2998(IT)G
Judges and Taxing Officers
Campbell J. Miller
Subjects
Income Tax Act
Notes
A correction was made on September 13, 2018.
Decision Content
Docket: 2015-2998(IT)G
BETWEEN:
LOBLAW FINANCIAL HOLDINGS INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on April 23 to May 15, 2018, and July 17 and 18, 2018 at Toronto, Ontario
By: The Honourable Justice Campbell J. Miller
Appearances:
Counsel for the Appellant:
Mary Paterson, Mark Sheeley, Pooja Mihailovich, Al Meghji,
Lipi Mishra
Counsel for the Respondent:
Elizabeth Chasson, Isida Ranxi, Aleksandrs Zemdegs, Gary Edwards, Laurent Bartleman, Cherylyn Dickson
JUDGMENT
WHEREAS I have decided the following:
1. the large corporation rules in subsections 165(1.11) and 169(2.1) of the Income Tax Act of Canada (the “Act”) are not applicable to preclude the Appellant from making certain arguments.
2. Glenhuron Bank Limited (“GBL”) was a regulated foreign bank with the equivalent of greater than five full time employees in 2001 to 2005, 2008 and 2010 but was principally conducting business with non-arm’s length persons and consequently its income was from an investment business and is to be included in the Appellant’s income as foreign accrual property income (“FAPI”).
3. Pursuant to paragraph 95(2)(b) of the Act, GBL’s fees from managing assets for non-arm’s length persons is deemed to be income from a separate business other than an active business. The fees from Weston Acquisitions Inc., Weston Foods, Inc., Weston Foods US, Inc. and JFS Inc. are also FAPI as if not caught by paragraph 95(2)(b) of the Act they would otherwise be caught as part of GBL’s investment business.
4. The calculation of the foreign exchange gains/losses in respect of GBL’s investment in short term securities was on income account.
5. Although it is unnecessary to address the application of the general anti-avoidance rules (“GAAR”) given the above decisions, I do so for completeness’ sake:
The waivers for 2001 – 2005 taxation years preclude the Respondent from relying on GAAR in those years.
For the 2008 and 2010 taxation years, GAAR is not applicable because, while there was a tax benefit (the avoidance of FAPI) and transactions that could reasonably be considered to result in a misuse of the FAPI provisions, the transactions were not avoidance transactions as they could reasonably be considered to be undertaken primarily for bona fide purposes other than to obtain the tax benefit.
NOW THEREFORE it is ordered and adjudged:
1. The Respondent’s Motion pursuant to subsections 165(1.11) and 169(2.1) of the Act (the large corporation rules) is dismissed.
2. The Appeals for 2001 – 2005, 2008 and 2010 taxation years, are allowed and referred back to the Minister of National Revenue for reconsideration and reassessment on the limited basis that foreign exchange gains or losses arising on GBL’s investment in short term securities shall be on income account.
3. The Parties shall advise within one week of receipt of this Judgment whether or not they wish to make written representations on costs, and if so, they shall do so within 60 days of the date of this decision, limiting their written representations to a maximum of 15 pages. If they do not wish to make written representations, I make no award of costs.
Signed at Ottawa, Canada, this 7th day of September 2018.
“Campbell J. Miller”
C. Miller J.
Citation: 2018 TCC 182
Date: 20180907
Docket: 2015-2998(IT)G
BETWEEN:
LOBLAW FINANCIAL HOLDINGS INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
C. Miller J.
[1] It was suggested at the outset of this case by the Appellant’s counsel, reaffirmed in closing argument, that, at its core, this was a general anti-avoidance rule (“GAAR”) case. The Respondent appeared to take this opening salvo to heart as she proceeded to paint a picture of an organization intent on avoiding the foreign accrual property income (“FAPI”) rules found in subsection 95(1) of the Income Tax Act of Canada (the “Act”). After a lengthy trial, with lengthy expert evidence on foreign banks, followed by lengthy written argument and two days of oral argument, I have concluded this case is not, at its core, a GAAR case. It is a FAPI case.
[2] The primary issue in this dispute is whether, during the 2001 to 2005 and 2008 and 2010 taxation years, the income of Glenhuron Bank Limited (“GBL”) was FAPI and, therefore, taxable in its parent Loblaw Financial Holdings Inc.’s (“Loblaw Financial”) hands. FAPI includes income from an investment business. The definition of “investment business” in the Act exempts a business, other than a business conducted principally with non-arm’s length persons, of a regulated foreign bank with greater than five full-time employees or the equivalent thereof.
[3] In a nutshell, on the FAPI issue, Loblaw Financial’s position is that the Government of Canada made a policy decision to exempt income from a regulated foreign bank (as that term had already been defined under the Bank Act of Canada) from being FAPI, and that GBL was a regulated foreign bank that met the added conditions. The Respondent’s position, put concisely, is that GBL was not a foreign bank and, even if it was, it did not meet the added requirements of greater than five full time employees and not conducting business principally with non-arm’s length persons, as it was simply not in competition with anyone.
[4] If I find that GBL meets the requirements of a qualified regulated foreign bank, and consequently does not carry on an investment business, only then does the case morph into a GAAR case – from my reading of the evidence this is very much a secondary issue. The Respondent argues that Loblaw Financial is caught by the GAAR (section 245 of the Act), as it received a tax benefit (not having to pay tax on FAPI) arising from an avoidance transaction, (the incorporation of GBL, its name change, licensing etc.) constituting an abuse of the FAPI provisions in the Act. The Appellant counters there was no tax benefit (as no diversion of capital), no avoidance transaction (as how do you intend to avoid a law that is unknown at the time) and no misuse (as Government policy was to relieve these banks from FAPI).
[5] It may be disconcerting to readers of this decision, other than the Parties themselves, who presumably will understand, that a great deal will be written on the issues raised by them that ultimately has had little or no impact on my decision, given the narrow basis upon which I am hanging my hat. I do not apologize. The Parties deserve a comprehensive review of all the matters they deemed important. Who knows how it might assist down the road. There are many twists and turns in this case so I felt it useful to provide a roadmap outlining how I intend to render this decision.
I. FACTS
A. List of persons involved
B. Corporate structure and background prior to the years in issue (1992 – 2000)
C. What was the nature of GBL’s activities in 2001 to 2010
(1) Receipt of funds
(2) Short-term debt securities and asset management
(3) Distributor or independent operator loans (“I/O Loans”)
(4) Intercompany loans
(5) Equity forwards
(6) Cross-currency and interest swaps
(7) Reporting income from activities
D. How did GBL operate in 2001 to 2010
(1) Introduction/Office Structure
(2) Employees and responsibilities
(3) Board meetings
E. Central Bank of Barbados involvement
F. Waivers
G. Assessments and objection
H. Expert evidence
II. ISSUES
A. Is Loblaw Financial precluded from relying on certain arguments due to the application of the large corporation rule (subsections 165(1.11) and 169 (2.1) of the Act)
B. Was income earned by GBL in 2001-2005, 2008 and 2010 FAPI pursuant to subsection 95(1) of the Act
(1) Was GBL carrying on an investment business as defined in the preamble to the definition in subsection 95(1) of the Act?
(2) Was GBL exempted out of the definition?
(a) Was it a foreign bank?
(i) Pursuant to the definition in subsection 2(a) of the Bank Act of Canada?
(ii) Pursuant to the definition in subsection 2(c) of the Bank Act of Canada?
(b) Was it conducting business principally with persons with whom it did not deal at arm’s length?
(c) Was it regulated under the laws of Barbados?
(d) Did it employ more than five full time employees or the equivalent thereof full time in the active conduct of the business?
C. If Loblaw Financial received FAPI from GBL has it been correctly calculated?
(1) Were the foreign exchange gains/losses arising on GBL’s investments in short term securities on income or capital account?
(2) Does the inclusion in FAPI arising from the deemed separate business provision in paragraph 95(2)(b) of the Act include the fees received from Weston Acquisitions Inc., Weston Funds, Inc., Weston Foods US, Inc. and JFS Inc. (the “Disputed Entities”)?
D. If GBL was not carrying on an investment business is Loblaw Financial caught by the application of the GAAR?
(1) Do the waivers for the taxation years 2001 to 2005 preclude the Respondent from relying on the GAAR for those years?
(2) Was there a tax benefit?
(3) Were there avoidance transactions?
(4) Was there an abuse of the FAPI provisions, specifically subsection 95(1) of the Act?
E. If the GAAR applies how is Loblaw Financial to be taxed?
III. REASONS (following order of issues as set out in Section II)
IV. CONCLUSION
I. FACTS
A. List of persons involved
[6] It is helpful to set out at the outset the cast of players, and there are many, both individual and corporate. Reference should be made to this list for noting the abbreviated names I have attached to many of the entities, as well as a brief description of their role. I therefore attach Appendix A breaking down the entities into the following categories:
a) Corporate entities
b) Corporation’s with assets under management by GBL
Later in these Reasons, I will review investment management agreements that GBL had with several related parties. Suffice it to say at this introductory stage, that each of these related parties whose assets were managed by GBL, was:
Both a foreign affiliate and non-resident, directly or indirectly wholly-owned subsidiary of Weston Foods Inc., Weston Foods (Canada) Inc., George Weston Limited (“GWL”), Provigo Distribution Inc., Loblaw Inc. (“LINC”), and/or Loblaw Companies Limited (“LCL”); and
A controlled foreign affiliate of the above companies other than Provigo Distribution Inc.
c) GBL directors and employees
d) Loblaw officers
e) Experts
f) Others
B. Corporate structure and background prior to years in issue (1992 – 2000)
[7] By way of brief overview, GBL was incorporated in Barbados on September 28, 1992, as Loblaw Inc., a wholly-owned subsidiary of Loblaw Financial. During the years assessed, Loblaw Financial was a direct wholly-owned subsidiary of LINC, a Canadian company (unfortunately with the same name as the Barbadian company), which in turn was a wholly-owned subsidiary of LCL, a public company traded on the Toronto Stock Exchange, the controlling shareholder of whom was GWL. GWL’s shares also traded on the Toronto Stock Exchange. It owned the majority (60%) of shares of LCL. LCL concentrated on the grocery business.
[8] Loblaw Financial held several Canadian and foreign subsidiaries including GBL.
[9] Mr. Zoetmulder, a former director of GBL, provided evidence surrounding the incorporation of GBL. In 1992 he was also a director of GOBV, a Dutch subsidiary of Loblaw Financial. He described the business of GOBV as a passive business used to finance Loblaw’s (when I use that term, I refer generally to the overall Loblaw Group: where it is critical to identify a specific entity within the group, I will do so) US operations by borrowing interest free from Canada and lending at interest in the United States. For example, in 1992 GOBV had interest free loans from Loblaw Financial (then called Loblaw International Holdings Inc. (“LIHI”)) of approximately $133 million and lent the same amount to NHI at 9% or 10%. It held all of the preferred shares in NHI while Loblaw Financial held all the common shares. NHI owned National TEA Company which operated supermarkets in the United States. According to Mr. Zoetmulder, Loblaw was not the only major Canadian company to have a Dutch company serve as a holding company. He explained this was primarily due to the attractive withholding rates and treaty treatment.
[10] Mr. Mavrinac, as Vice-president of tax at Loblaw (which title applied to all the subsidiaries as well) attended GOBV’s board meetings in late 1980s and early 1990s. He also described GOBV as the vehicle for financing Loblaw’s US operations, acknowledging that the structure provided a tax advantage, one that was never questioned by Revenue Canada. He further indicated that the US operation was not a strong business in the early 1990s and it had been Loblaw’s intention to sell since the late 1980’s, not an easy task given the business was not doing well.
[11] In the early 1990s, the favourable regime for Canadian companies to establish Dutch holding companies was put in peril due to negotiation of the Dutch-US Treaty and, to a lesser extent, the Canada-Dutch Treaty. Loblaw explored the possibility of establishing a Barbados corporation which, unlike the passive nature of GOBV, was intended to be an active operation. Mr. Mavrinac’s memory of the organizational meeting of GBL was that the focus was on establishing a captive reinsurance company that would benefit the US operations by relieving the cost of workers’ compensation issues then insured by third parties. According to Mr. Mavrinac, the financial vehicle (GBL) was not a well‑developed idea, a twinkle in the eye, as he put it. He explained that GOBV simply lent money to the US operations, all done in accordance with the foreign affiliate rules at the time. He believed that the Barbados company could replace GOBV in that regard, but that the foreign affiliate rules required that the Barbados financial vehicle would have to be an active business, unlike GOBV. Mr. Mavrinac described the active business contemplated as that of a treasury centre involved in a finance type business. Though GBL was seen as a replacement to GOBV in a low tax jurisdiction, he believed that Barbados had people with the right skill set, was in the right time zone and that the Barbados tax regime was simpler than some of the alternatives. He put it this way:
… what we were doing is we were positioning ourselves that, in the event that the rules changed and we no longer had the benefit of a reduced tax rate in our offshore structure, that we would be able to either replicate that structure or come up with a new structure that fit within the foreign affiliate regime at the time, that's what we were trying to do….
… Because the FAPI rules were quite, I won't say they were simple, in their application, they were complex, but the principles were pretty simple. If you had an active business in the treaty country, right, you had the benefit of exempt surplus….
[12] Mr. Zoetmulder confirmed that Loblaw was considering establishing a Barbadian subsidiary in the insurance business which it in fact did under the name Glenmaple Reinsurance Company Limited (“GRCL”), as a subsidiary of GBL. The Director of Insurance for LCL, Glen Leroux, had suggested Barbados for the re-insurance business. GRCL was incorporated in January 1993 pursuant to the Exempt Insurance Act of Barbados licensed to conduct business as an exempt insurance company, not required to pay Barbadian tax on insurance income or capital gains.
[13] Mr. Zoetmulder confirmed that Loblaw was indeed turning to Barbados as it had a reliable legal system, proper tax system and appropriate infrastructure. Advice was sought from local legal counsel, Mr. David King. At the November 12, 1992 Directors’ Operational meeting of GBL (then still Loblaw Inc.) Mr. King reported:
… that the Company had been incorporated as an International Business Company on the 28th day of September, 1992 and was in the process of applying for a licence under the International Business Companies Act No. 24 of 1991. Such a licence would empower the Company to hold foreign currency accounts, transact international business and would also exempt it from the provisions of the Exchange Control Act.
[14] It was determined that the Barbadian companies would be capitalized to the extent of $20 million U.S., $15 million of which was intended for the GRCL’s reinsurance business. The Appellant subscribed for 1000 common shares for $100,000. In February 1993, GOBV subscribed for non-voting preferred shares for $20 million U.S., for another $12 million U.S. worth in June and another $35 million U.S. worth in August. (unless otherwise noted dollars are U.S. dollars)
[15] Mr. Zoetmulder testified that Canadian tax played no role in these subscriptions. Mr. Mavrinac confirmed the initial $20 million was invested primarily for the insurance business and was not an avoidance of Canadian tax. In the organizational meeting of November 12, 1992, it was discussed in general terms that the new company would carry on the business of entering into financial transactions, including interest rate and foreign exchange swap transactions. Initially, GBL hired PricewaterhouseCoopers to manage these affairs until it hired its own staff.
[16] Mr. Welch, who was hired in 1993, and Mr. DiFilippo, later the president of GBL, both claimed that to the best of their knowledge there were no Canadian tax considerations during the incorporation of GBL or the subsequent obtaining of the licence under the Offshore Banking Act (“OSBA”). Mr. Mavrinac acknowledged that he was certainly aware at the time of the 2.5% Barbados tax rate, though he looked to Barbados counsel, Mr. King, for advice generally with respect to Barbados law.
[17] On October 15, 1993, Mr. King wrote to the Central Bank of Barbados (“CBB”) seeking a meeting to discuss setting up an offshore bank, describing his client as a major Canadian food retailer that has in place an international business company and an exempt insurance company. On November 12, 1993, Mr. King again wrote to the CBB as follows:
My client is now of the view that the financial activities which they propose to engage in ought properly to be conducted through the vehicle of a Barbados off-shore bank, rather than through the International Business Company (IBC) as was originally contemplated. Accordingly I submit to you on behalf of my client a proposal herein contained for the abovenamed Company Glenhuron Bank Limited to become licensed as a Barbados off-shore bank.
[18] At the GOBV board meeting on November 18, 1993, it was reported that “as yet, there is no follow-up on the Auditor General’s report concerning the loopholes in Canadian tax law with respect to the international activities of Canadian multinationals.” Mr. Mavrinac testified he was likely aware of the Auditor General’s report (about which I will have more to say later in these Reasons) but claimed neither it nor the Standing Committee on Public Accounts report published in April 1993 impacted on the interaction with the Barbados subsidiary. He also testified that neither report played into the decision to obtain a licence under OBSA.
[19] On the same day, November 18, 1993, the directors of GBL (at that point still called Loblaw Inc.) also met and discussed GBL’s status as an international business company, agreeing that “the nature of the company’s actual business was more in keeping with that of a bank.” Mr. Zoetmulder suggested this related to the financial swapping business and dealing with other multinational banks on the counterparty side. The directors also agreed the company’s name would be changed “as required under Barbados banking legislation.” Again, Mr. Zoetmulder testified that Canadian tax was not a factor in this decision.
[20] The shareholders of GBL also held a three minute meeting on November 18, 1993, in the presence of Mr. Thompson (a GOBV director and executive vice-president of Loblaw), Mr. Reid (CFO Loblaw), Mr. Mavrinac (VP tax Loblaw, representing LIHI), and Jurriaan Zoetmulder, Mr. Durtsche and Mr. Mann, representing GOBV, with Neil Walker and David King, who initiated the request for a license, according to Mr. Mavrinac, also present. It was resolved that the company obtain an OSBA licence and amend its articles to change its name to Glenhuron Bank.
[21] Mr. Walker reported to the GBL board in May 1994 that the company had changed it status from that of an international business company to that of an offshore bank and added the company obtained its licence from the Central Bank of Barbados on December 22, 1993, under OSBA.
[22] In applying for that OSBA licence in late 1993, GBL described its business as follows:
The bank will focus primarily on investment banking together with selected commercial banking activities involving third party financial institutions of superior credit rating. No retail or deposit taking banking activities are currently planned.
Investment banking activities will initially be in the area of secondary investments where the bank, as principal, will concentrate on holding or trading derivative products such as interest rate swaps, cross currency swaps and options. The bank will undertake all derivative transactions as a stand alone credit based on the strength of its own capitalization, all of which will be in-house. Other investment banking transactions such as equity and debt instrument trading and investment, merger and acquisitions activity and advisory services may be considered in future.
Commercial banking activities will be initially limited to secured mortgage lending, initially in North America. Expanded commercial activities such as leasing and commercial leans may be considered in the future.
[23] On December 20, 1993, Mr. King again writes to the CBB indicating “we require the licence dated prior to December 31, 1993”.
[24] On May 5, 1994, Mr. King wrote to the CBB as follows:
You will be aware that proposed changes to Canada’s Income Tax Act will require subsidiaries of Canadian companies doing investment business in Barbados to increase employment to more than five (5) persons in order to retain certain tax exemptions under the Canadian Income Tax Act. Partly to justify this increase in staff, the Bank intends to expand its present business to include processing such items as payroll, credit card applications and investment data for companies with which the Bank is related through its Canadian parent company.
[25] With the introduction of the International Financial Services Act in 2002 (“IFSA”) the licence under the OSBA simply transferred from one Act to the other. According to Mr. Berry, President of GBL at the time, it remained business as usual.
[26] In February 1994, the Canadian government released its 1994 budget which introduced the “investment business” definition and included an exception to the FAPI inclusion for regulated financial institutions. In a GOBV board meeting of May 26, 1994, it was reported:
This budget introduced major amendments to the foreign affiliate provisions of the Canadian Income Tax Act, in response to the report of the Auditor General to the House of Commons in 1992 and the report of the House of Commons Standing Committee on Public Accounts delivered in June 1993. Based on the budget proposals as they stand today, it would appear that the proposed Loblaw’s franchisees interest swap program would have to be cancelled as being no longer feasible. ...it would appear that budget proposals, as they stand today, would not affect the finance operations of GBL or the claim handling of GRCL.
[27] The Auditor General Report referred to was released in November 1992 and it examined interest deductibility, taxable dividends from foreign affiliates and other related problems including FAPI. The report of the Standing Committee on Public Accounts released in April 1993, recommended that the Department of Finance immediately clarify what constitutes active business income in the context of the rules on FAPI.
[28] In February 1994, revisions to the FAPI were proposed by the Department of Finance: such revisions included the financial institution exemption. Draft legislation with such proposals was introduced in June 1994, followed by some amendments in January 1995 and the final enactment in June 1995.
[29] The February revisions also included a minimum employee requirement for the regulated financial institution exemption. Mr. Zoetmulder testified he was not aware this had been proposed and stated that employee requirements were dictated by what the business needed, not any legal provision. Three employees were hired in April and May, 1994: Wendel Mason, Donna Rogers and Antoinette Patel.
[30] Mr. Berry joined GBL on January 1, 1997, as Vice-President and Chief Investment Officer (“CIO”), bringing with him considerable financial experience primarily in the fixed income markets. His mandate was to create an investment department, bringing in-house the portfolio then being managed by Wilmington Trust Company. He became President of GBL in February 2002 and remained with GBL until its liquidation in 2013. His view on joining GBL was that it wanted to secure funds and grow them within the parameters of reasonable return and low risk.
[31] While I will go into greater detail later as to GBL’s activities during the years in issue, Mr. Berry provided a good summary of those activities by referring me to the chart attached as Appendix B. The top level (Intercompany Loans, USD Short–Term Debt Securities and Distributor (I/O) Loans) represents a deployment from a treasury perspective of GBL’s assets, investing in the USD Short-Term Debt Securities, the US loans to several thousand independent driver operators distributing Weston Baked Goods in the US and intercorporate loans. This all produced US dollar revenue. Mr. Berry indicated that better returns could be had by using swaps to change the nature of the floating rate US dollar income into fixed rate Canadian dollar income. This involved using the money from the investments to enter cross-currency swaps which would yield Canadian income, and then use interest rate swaps to exchange Canadian floating rate payments for Canadian fixed rate payments. It was the swap activity that yielded greater income. The profits from the activities at the top level were intended to cover the swap activity at the bottom level. Mr. Berry also described two other pieces of GBL’s business being managing other entities’ assets for a fee and equity forwards.
[32] With respect to the short-term US deposits, some were held as security for counterparties in the swaps and some were unencumbered. This overall strategy was guided by statements of investment policy and guidelines (“SIPG”) which limited investments to US treasury bills, issues from supranational agencies (for example, World Bank), US government guarantees or implied guarantees with government sponsored entities (for example, Federal Home Loan Bank) and A1 Corporate Securities, limited to under 183 days, or, with US treasury bonds, under two years. It appears the average term was not greater than 120 days. This would keep the portfolio fairly liquid in the event projects came along in which GBL would want to invest, for example, the I/O Loans.
[33] Briefly, a cross-currency swap is an agreement between two counterparties (GBL and a global bank with whom GBL had an international swap and derivatives association (“ISDA”) agreement), in which GBL agreed to pay three month US Dollar LIBOR (London interbank offered rate) and the counterparty paid GBL a three month Canadian dollar B.A. (Banker’s Acceptance) rate. These rates were calculated quarterly and paid semi-annually.
[34] Under the ISDA agreements, GBL was required to post security (initially cash deposits, later using securities as collateral), though the counter-parties were not required to do the same.
[35] Mr. Berry described the interest rate swaps as swapping the Canadian B.A. income for a fixed rate of return akin to investing in a long-term loan. In effect, the income from the short-term securities was used by GBL as much as possible to fund the cross-currency swaps. Mr. Berry testified that no one from Loblaw head office was involved in authorizing or approving the swaps though he did acknowledge that GBL was subject to certain provisions of the Loblaw companies’ derivative policy.
[36] Mr. Berry drafted the SIPGs, being operating manuals for the investment managers, initially being just himself, to lay out boundaries as to how the money could be invested, including the kind of securities, the minimum credit ratings and the maximum maturity length. One element of the policy was to minimize or eliminate payment of withholding tax. There was also a constraint in some of the SIPGs entered prior to 2000, that read:
Constraints implicit in the FAPI rules pertaining to the Income Tax Act of Canada which may prescribe investments and obligations, direct or otherwise, of Canadian persons.
[37] Mr. Berry attempted to explain this constraint as follows:
Well, to be honest with you, I didn’t actually know really what FAPI was back in those days, and I certainly wouldn’t count myself as an expert today. And I am not sure what I was trying to do here in terms of FAPI, because FAPI didn’t have any direct bearing on the bank. We weren’t investing in Canadian securities anyway. We weren’t permitted to. …I am not sure where this came from or why it was stuck in. But, in any event, I submit humbly, Your Honour, that was probably put there to sound good or to try and sound intelligent and impress people.
[38] As will be seen when discussing the business activity during the years in question in more detail, GBL managed its own money in a very similar manner to how GBL managed others’ assets in accordance with the SIPGs.
[39] Where did GBL get its funds in the early years? There were subscriptions from GOBV for preferred shares in 1993 totalling $67 million. In 1994, GOBV subscribed for additional preferred shares throughout the year totalling close to $48 million. In 1995, GOBV subscribed for another $10 million worth of preferred shares. In 1997, GBL redeemed $94 million worth of the preferred shares, while in the same year a further $111 million worth of preferred shares were issued. Also, in 1997, GBL received $133 million in cash for an assignment of promissory notes from GOBV, representing interest-free loans from Canada. Mr. Holland explained this was to take the cash that was in GOBV and contribute it to GBL. He also explained it was unlikely the funds would have been repaid to Canada as it would have triggered a foreign exchange gain and that money was simply not needed in Canada.
[40] In 1998, GBL realized over $8 million of gain on its disposition of GRCL. Loblaw Financial subscribed for 420,000 common shares in 1998 for $42 million, in answer to a concern from the Central Bank of Barbados regarding GBL’s capital adequacy issue.
[41] In 2000 there was a significant injection (approximately $292 million) of capital from Loblaw Financial as part of the wrapping-up of the US operations run through National TEA, which requires further explanation.
[42] Loblaw Financial held all the common shares of NHI, while GOBV held the preferred shares. NHI was the parent of National TEA which operated the grocery business in the US, the business which was struggling in the late 1980’s and early 1990’s, as indicated earlier. Indeed, a purchaser was ultimately found and an agreement to sell substantially all of the assets of National TEA was finalized in 1995, resulting in a cash receipt by National TEA of approximately $440 million. It was determined at a GOBV board meeting in late 1994 that rather than invest the money in GBL preferred shares or repay the funds by way of repayment of capital to Loblaw Financial (at that point still LIHI), the funds would be held in NHI “in anticipation of alternative US investment opportunities.” In January 1995, NHI repaid $111 million that it owed to GOBV. Wilmington was hired to manage the proceeds to invest on a short-term basis. The resulting income was FAPI. Also in 1995, NHI contributed $207 million to Glendel, its wholly-owned subsidiary, which invested on a short-term basis, also triggering FAPI. Glendel was also subject to US tax. Mr. Holland indicated Glendel’s Canadian tax was only 10% of the US tax.
[43] In June 2000, Glendel was dissolved into NHI and a few days later, GBL issued 291,786 common shares to Loblaw Financial in exchange for all the issued and outstanding shares of NHI, which was subsequently dissolved, resulting in GBL receiving approximately $291 million cash. Mr. Holland, who structured the transaction, admitted Canadian tax was a factor in undertaking the transaction but denied that FAPI was the primary driver, rather “the primary driver was … to put cash that was in the US into GBL for use in its business.” He also indicated that structuring in this manner avoided US withholding tax on liquidating into GBL. Loblaw had sought an advance ruling regarding these transactions, receiving a letter dated December 31, 1999 from the Canada Revenue Agency (the “CRA”) permitting the rollover treatment sought and confirming that GAAR was not applicable, though also stipulating that nothing in the letter “should be construed as implying Revenue Canada has reviewed, accepted or otherwise agreed to the nature of any business.”
[44] Also in 2000, Loblaw Financial converted its 142,099 preferred shares in GBL, which previously it acquired on the wind up of GOBV in early 1999, into common shares. In effect, the preferred shares were paid off by GBL and GBL received $142 million worth of NHI’s assets. Together these amounts ($291 million and $142 million) equate closely to the $440 million sale proceeds of the National TEA sale.
[45] To round out the picture of revenues received in the years prior to the years in issue, GBL was making money through its short-term investments and through its swap program. In 1993, just before being licensed under OSBA, GBL was investing in short term debt securities and entering both the cross currency swaps and interest rate swaps. In 1994, for example, revenues from interest swaps was $18 million compared to $1.5 million in 1993 and revenues from cross‑currency swaps went from a few hundred thousand dollars in 1993 to over $13 million in 1994, with corresponding increases in associated expenses. Mr. Welch described this increase in the early years as requiring much more work.
[46] By 2001, GBL was earning about $49 million on interest swaps, $24 million on cross-currency swaps and $31 million on short-term investments and security deposits.
C. What was the nature of GBL’s activities in 2001 to 2010
(1) Receipt of funds
[47] For the years in issue, GBL grew its asset base primarily through an increase in its retained earnings which went from approximately $100 million at the end of the 2000 taxation to approximately $700 million at the end of the 2010 taxation year. The share capital at the end of 2000 was $476 million and at the end of 2010 was $443 million, though there had been some capital distributions as well as injections to capital over that time period.
[48] As indicated on the chart on Appendix B, the business of GBL can be broken into a few components: short term debt securities, assets under management, intercorporate loans, I/O Loans, swaps and equity forwards. While there was considerable evidence in relation to each of these business activities, some of which I have already described for the 1992-2000 period, I intend to condense it to the essential elements for the years in issue.
(2) Short term debt securities and asset management
[49] The policy of obtaining US short term debt securities with short maturity dates continued from the 1990s into the years in issue. Only US securities were acquired, as Mr. Berry described the US market as the deepest, most liquid and most efficient. Also, GBL identified five types of debt securities in which it remained invested (see paragraph 32).
[50] GBL invested in short term debt securities on its own account and also had investment management agreements with companies whose assets it managed. The agreements stipulated how the investment manager may effect transactions, the standard of care imposed on the investment manager, when the agreement will commence and when it will terminate. The agreement contained three schedules: the SIPG, the fee schedule and the custodial option.
[51] As indicated earlier, Mr. Berry developed the SIPGs that specified the kind of securities that could be held, the minimum credit ratings, maximum maturity lengths and constraints. Every party with assets under management was related to GBL, except Waterman Insurance (see Appendix A for a list of these related companies). Mr. Holland testified that five of these companies, Weston Acquisitions Inc., Weston Foods Inc., Weston Foods US, Inc., JFS Inc. and GRCL, carried on active businesses and did not earn FAPI on assets managed by GBL.
[52] The fee schedule set out the fees. Waterman Insurance paid a fee of 30 to 36 basis points, while the related companies paid 17 basis points. Some related companies had their fee paid by another related company. The fees earned by GBL would be a few hundred thousand dollars a year in the early 2000s, peaking at approximately $1.7 million in 2009. Assets under management ranged from approximately $175 million in 2001 to $1.2 billion in 2008. This compares to GBL’s portfolio growth of $708 million in 2000 to $977 million in 2010.
[53] The custodial option indicated the account’s assets would be held at CitiBank unless another custodian was specified.
[54] There was a detailed process for the purchasing and settling of new short term debt securities, regardless of whether the securities were for GBL’s own account or for the companies with assets under management. Sometimes GBL bought a security and split it amongst different entities’ portfolios.
[55] With respect to the short term debt securities, the investment team would discuss their research and decide what to buy, ensuring it would comply with the SIPG. The investment analyst or manager would then contact brokers to determine availability: normally there would be no negotiation as a broker (for example, Solomon or Merryl Lynch) would make it a take it or leave it offer. If the product sought was not available at the price sought, Mr. Berry indicated they might have to modify the plan. Once the security was bought, the broker would send a confirmation which would trigger GBL’s investment team to write a “triplicate ticket.” What followed was a three part settlement process before GBL paid for the security. This became the back office’s responsibility. One employee input the transaction into GBL’s CitiBank settlement platform, a second employee verified such input against the ticket and a third employee authorized the trade. Once GBL released the funds, the broker delivered the security to GBL’s CitiBank custody account. The back office also then entered the purchase into GBL’s accounting ledger and swap investment management system (“SIMS”). SIMS displayed each SIPG ensuring that only authorized short term debt securities were actually purchased.
(3) Distributor or independent operator loans – I/O Loans
[56] In 2001, GWL purchased Best Foods Baking Co. (“Best Foods”) from Unilever, who, along with Bank of America and SunTrust held and financed the I/O Loans, being loans to distributors. The distributors were individual drivers who had purchased the rights to distribute Best Foods baked products along specified routes in the Unite