On December 3, 2021, a unanimous Supreme Court of Canada (“SCC”) dismissed the Crown’s appeal in Canada v. Loblaw Financial Holdings Inc. (2021 SCC 51). In doing so, the Court held that capital contributions and corporate oversight are not relevant to determining whether a controlled foreign affiliate conducts business with arm’s length parties. Matthew Williams, Robert Carvalho, and Michael Colborne of Thorsteinssons LLP represented the intervener Canadian Bankers’ Association.
Loblaw Financial Holdings Inc. (“Loblaw Financial”) is a Canadian corporation and part of the Loblaw Group of corporations. In 1992, Loblaw Financial incorporated Glenhuron Bank Limited (“Glenhuron”), a bank incorporated, licensed and regulated in Barbados. The Loblaw Group made capital investments in Glenhuron between 1992 and 2000 in excess of $750 million.
Although most of the assets managed by Glenhuron came from related parties, eighty-six percent of its income came from third parties through various elements of its investment business. Glenhuron was dissolved in 2013 to provide Loblaw Companies Ltd., its parent corporation, with funds for a major acquisition.
Under the foreign accrual property income (“FAPI”) rules in the federal Income Tax Act (the “Act”), Canadian taxpayers must generally include passive income earned by controlled foreign affiliates (“CFAs”) in their Canadian tax returns on a current basis unless it fits into one of the specific exceptions in the Act. One of those exceptions is for CFAs that operate as “financial institutions” that meet specific requirements found in the definition of “investment business”.
Loblaw Financial’s position was that Glenhuron qualified for the exception. The position of the Minister of National Revenue (the “Minister”) was that Glenhuron did not qualify for the exception because it did not conduct its business principally with arm’s-length persons. On that basis, the Minister reassessed Loblaw Financial for approximately $470 million of unreported income over the seven years.
The Tax Court ruled against Loblaw Financial, finding that Glenhuron conducted business principally with non-arm’s length persons because: (i) most of its capital contributions came from corporations within the Loblaw Group; and (ii) Glenhuron was subject to significant oversight from its parent company. The Federal Court of Appeal (“FCA”) allowed the appeal, holding that the Tax Court misinterpreted the FAPI rules when it decided that capital contributions and corporate oversight are relevant to whether a CFA conducts business principally with non-arm’s length persons.
Principles of Statutory Interpretation
The SCC’s task was to interpret a complex set of rules to resolve a discrete question: what does it mean to conduct business? Does conducting business in this context include capitalization and oversight?
Justice Côté, writing for a unanimous Court, started by affirming the basic principles that govern statutory interpretation of taxation statutes. While the unified textual, contextual, and purposive analysis governs, the particularity and detail of many tax provisions, coupled with the Duke of Westminster principle that taxpayers are entitled to arrange their affairs to minimize the amount of tax payable, means that text and context attract special focus. This is especially true for regimes like the FAPI rules, which have been drafted (and extensively amended) with “mind-numbing detail”.
Justice Côté explained that the FAPI regime has an equalizing effect by removing advantages that taxpayers might otherwise gain by “park[ing] their passive investments in low-tax jurisdictions and earn[ing] income there through non‑resident corporations.” This is generally accomplished by defining FAPI to include passive income earned by CFAs and exclude active income earned by CFAs (subject to other rules that may recharacterize active income as passive or vice versa in certain circumstances). The active/passive income distinction on which the FAPI regime is generally based is consistent with the conclusion that the arm’s length analysis is concerned with income-generating activities rather than capitalization since it looks to the CFA’s activities, not the source of its funds.
Ultimately, the SCC did not need to positively determine the purpose of the arm’s length requirement in the financial institution exception. Justice Côté did, however, note (in agreement with the FCA) that the Tax Court was wrong to impute an unexpressed legislative intention that “financial institutions” must compete for customers with other players in the relevant market. Justice Côté was equally critical of the Crown’s argument that the Court should impute an anti-avoidance purpose into the arm’s-length requirement. Where Parliament has specified precise conditions that, when satisfied, lead to a particular result, it is reasonable to assume that Parliament intended that taxpayers would rely on those conditions to achieve that result.
The SCC’s analysis of the context and purpose of the provision at issue affirmed longstanding jurisprudence that, for purposes of Canadian income tax law, the capitalization of a business is distinct from the conduct of a business.
The SCC also disagreed with the Tax Court about the relevance of corporate oversight. Whereas the Tax Court considered a parent’s oversight of its affiliate tantamount to conducting business with the affiliate, the SCC recognized that Parliament would not have required the absence of conduct that is inherent in a parent-subsidiary relationship. This conclusion was encapsulated in the intervener Canadian Bankers’ Association’s factum, which the Court quoted:
It is incongruous to posit that Parliament has consistently provided a safe harbour for Canada’s largest multinational financial enterprises since 1995, yet intended to undermine that safe harbour if the oversight, cooperation, and coordination that is to be expected in such a group is present.
Application and Disposition
Once corporate oversight and capitalization were removed from the analysis, only Glenhuron’s investment business activities remained in considering the application of the arm’s length requirement. As held by the FCA, the vast majority of those activities were conducted with arm’s length persons. Accordingly, Glenhuron’s income was not FAPI.
It should be noted that the legislative scheme under consideration in this appeal was amended in 2014 to narrow the availability of the financial institution exception. The direct impact of this case will thus be limited and have to be examined on a case-by-case basis. The principles articulated by the SCC for interpretation of the Act, however, remain generally applicable and reliable in all instances.