By Thien Hoang
On April 23, 2020, the Federal Court of Appeal (FCA) rendered its judgement in Loblaw Financial Holdings Inc. v. Canada, 2020 FCA 79, a case involving Loblaw Companies Ltd., Canada’s largest food and pharmacy chain. In its unanimous decision, the FCA reversed the judgement of the Tax Court of Canada (TCC) and concluded that the income earned by a Barbados-based subsidiary of Loblaw Financial Holdings Inc. (Loblaw) was not foreign accrual property income (FAPI) and therefore should not be taxed. Overall, the case was a demonstration of well-established statutory interpretation guidelines which clarified the Income Tax Act’s (ITA) FAPI scheme.
The Loblaw subsidiary in question was Glenhuron Bank Limited (Glenhuron), a Barbados-based corporation that was licensed under and subject to Barbados banking regulations. In its early operating years, Glenhuron primarily obtained funds through equity capital investments by members of the Loblaw group. During the taxation years at issue, the subsidiary’s primary income generating activities consisted of investments in short-term debt securities, cross-currency swaps, and interest rate swaps which helped grow its retained earnings.
In 2015, the Minister of National Revenue (Minister) reassessed Loblaw’s tax returns, requiring it to pay tax on Glenhuron’s income on the basis that it was FAPI. The TCC agreed with the Minister that the foreign bank exclusion rule, in the definition of “investment business” in subsection 95(1) of the ITA, did not apply. In doing so, the TCC concluded that Glenhuron conducted business principally with affiliated corporations and therefore did not conduct business principally with arm’s length persons, a requirement of the applicable ITA provisions.
In her decision, Woods J.A. found that the TCC’s conclusions on the arm’s length issue were built on “an interpretation of the applicable legislation which significantly overreaches and contains errors of law” (para 51). First, the FCA found the TCC’s interpretation of the arm’s length test in a banking context, requiring the examination of both the receipt and use of funds, to be at odds with Canadian Pioneer Management Ltd. v. Saskatchewan (Labour Relations Board) (1979),  1 S.C.R. 433, 107 D.L.R. (3d) 1 (S.C.C.), which details that a formal, institutional approach should be taken to define a banking business. The FCA also saw the TCC’s focus on competition being an implicit proviso to the FAPI rules as “an example of a court inferring a purposive interpretation from unexpressed legislative intent” (para 58). Given Parliament’s overwhelming attention to detail in drafting the FAPI scheme and examples of explicit competition requirements in other FAPI provisions, the FCA found it was inappropriate to read-in an unexpressed competition requirement.
Applying the plain meaning of the word “business”, the FCA found there was no reason to conclude that the capital invested by the Loblaw group would have occupied the time and attention of Glenhuron in any meaningful way for the purpose of generating profit. This approach 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). Furthermore, it was determined that the management support provided by Loblaw to Glenhuron should not be given significant weight in the arm’s length analysis because it could not have been Parliament’s intent to deny the foreign bank exclusion simply on account of a parent corporation engaged in oversight of a subsidiary.
On a review of the facts, the FCA concluded that Glenhuron’s business was conducted primarily with arm’s length parties and that it qualified for the foreign bank exclusion. While the FCA acknowledged the Crown’s concern that accepting Loblaw’s position would exempt the very target of the FAPI legislation (offshore investment portfolios), it noted that the gap in the legislation was a matter for the legislative branch to address. Although this decision considered the arm’s length test in the context of the foreign bank exclusion, the “investment business” definition contains exclusions for other types of businesses which also rely on the arm’s length test. The decision could therefore be relevant to foreign subsidiaries engaged in other types of business operations.
On June 19, 2020, the Department of Justice filed an application to appeal this tax case to the Supreme Court of Canada (SCC). There is no doubt that Canada is highly invested in the matter, as the case concerns millions of dollars in potential government revenue both within the present case and in Canada’s general efforts to curb offshore tax avoidance. Whether the SCC ultimately decides to weigh in on the FCA’s ruling remains to be seen.