The Supreme Court of Canada recently ruled unanimously in Loblaws’ favour that income generated by a Barbados subsidiary of Loblaws was not taxable in Canada because it fell within an exception to the Foreign Accrual Property Income (“FAPI”) rules. In dispute, was about $470 million of unreported income that the Canada Revenue Agency (“CRA”) said was taxable in Canada.
Click here to read my earlier article discussing the FAPI rules
The facts are that in 1992 Loblaws Financial Holdings Inc. (“Loblaws Financial”) incorporated a subsidiary in Barbados which operated as an offshore bank licensed by the Barbados Government. It carried on business under the name Glenhuron Bank Ltd. Between 2001 and 2010, Loblaws Financial did not include income earned by Genhuron on its Canadian tax returns for several tax years.
Under the FAPI rules of the Income Tax Act, Canadian taxpayers must generally include passive income earned by their foreign controlled affiliates on their Canadian tax returns unless it falls within one of the exceptions to the FAPI rules. Financial institutions that meet certain criteria fall within an exception to the FAPI rules.
This exception is available if the following conditions are met: 1) the controlled foreign affiliate must be a foreign bank or other financial institution; 2) the activities must be regulated by foreign law; 3) the controlled foreign affiliate must employ more than 5 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. CRA assessed Loblaws on the basis that Glenhuron did not meet the 4th condition. The Supreme Court of Canada disagreed and sided with Loblaws.
The Supreme Court ruled that the majority of Glenhuron’s business was conducted with arm’s-length parties, so the exception did apply. The Court found that 86% of its income came from investments in short-term debt securities, cross-currency swaps, and interest swaps with arm’s-length parties.
In reaching its decision, the Supreme Court also referred to what has been described as the “Duke of Westminster principle” from the famous House of Lords case, that taxpayers are entitled to arrange their affairs so as to minimize the amount of tax payable.
“Every man is entitled, if he can, to order his affairs, so 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 Commissioner 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 Duke of Westminster[1936] A.C. 1 ).
The Supreme Court also emphasised the importance of taxpayer certainty in taxing statutes. Writing for the Court, Justice Cote described the FAPI provisions of the Income Tax Act as “one of the most complex tax schemes, with hundreds of definitions, rules, and exceptions, that shift regularly.” She concluded that “if taxpayers are to act with any degree of certainty… then full effect should be given to Parliament’s precise and unequivocal words”.
Apart from the Supreme Court re-affirming the “certainty” principle in applying the Income Tax Act, I see this decision as being very fact specific. Essentially the Court determined that the specific facts of this case fell within the FAPI exception. For this reason, I think it is extremely important for taxpayers to implement a practise right from the start, of documenting and preserving evidence to establish the facts that they may need to prove at a later date, should they be assessed or re-assessed by the CRA.
Click here to read the full Supreme Court of Canada judgement