Arm’s Length Transaction or Not? Canada v Loblaw Financial Holdings Inc.
In Canada v Loblaw Financial Holdings Inc., 2021 SCC 51 [“Loblaw”], the Supreme Court of Canada (“SCC”) examines “one of the most complex tax schemes, with hundreds of definitions, rules, and exceptions that shift regularly” (Loblaw, para 28). The vital, yet straightforward, question being decided in the appeal is “does a parent corporation conduct business [in an arm’s length capacity] within its controlled foreign affiliates (“CFAs”) when it provides capital and exercises corporate oversight?” (Loblaw, para 2). The ultimate answer to this question is no, but we shall delve into the nuances and controversies surrounding the issue within this post.
Foreign Accrual Property Regime
Before delving into the complex jurisprudence, it is imperative that readers understand the foreign accrual property income regime (“FAPI”) as per Canada’s Income Tax Act, RSC 1985 C 1. Under the regime, investors are forced to pay an equivalent amount of tax on income from a foreign investment in par with income from domestic investments (Loblaw, para 31). Thus, any corporate foreign affiliate will be taxed in a similar manner to domestic corporations, and this includes four categories of income: “(1) income from property, (2) income from a business other than an active business, (2) 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’) (Loblaw, para 33).
In this appeal the controversy surrounds income that is alleged to qualify for a further exception to the FAPI regime. If the following four requirements are met, then income from a CFA is exempted:
“(1) Type of financial institution: The CFA carries on business as a foreign bank, 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’”.
In other words this requirement necessitates that the entities be understood as independent without influence from the other.
In this case, the respondent, Loblaw Financial Holdings Inc (“Loblaw Financial”) is a domestic Canadian corporation that incorporated a subsidiary in the country of Barbados, later renamed Glenhuron Bank Ltd (“Glenhuron Bank”) (Loblaws, para 6). Between 1992 and 2000 Loblaw Financial made a $500 million investment by “subscribing shares” and providing $133 million in interest-free loans. In 2013, Glenhuron Bank was dissolved, and its assets liquidated for a major acquisition. The Tax dispute then arose in 2015 as Loblaw Financial had not included any investment into Glenhuron Bank since it presumed the CFA was exempted under the FAPI regime. The Minister of National Revenue disagreed with Loblaw Financial and in 2015, reassessed tax amounts. Loblaw Financial was being held to owe amounts of tax on the following years : 2001 ($84,145,457), 2002 ($95,522,133), 2003 ($63,898,088), 2004 ($43,602,018), 2005 ($43,468,016), 2008 ($128,948,511) and 2010 ($13,838,390) (Loblaw, para 12). Thereafter, Loblaw Financial filed a notice of objection and appealed to the Tax Court of Canada.
Decisions of the Lower Courts
Tax Court of Canada
The issue decided before the Tax Court of Canada was whether the financial institution exception applied during the years at issue. The court found that the FAPI exception did not apply, principally because it did not meet the arm’s length requirement (Loblaw, para 16). Justice Miller decided to examine the scope of Glenhuron Bank based upon Barbados law, in which it is split into two categories – the receipt of funds and the use of funds (please note this categorization is later rejected by the SCC). He found that on the receipt side of investments greater emphasis should be given because the purpose of the FAPI regime is to promote competition between foreign affiliates and other businesses in foreign markets (Loblaw, para 16). However, this was problematic because all receipts of funds were included without distinction, thereby treating capital injections by shareholders and lenders like any other funds (Loblaw, para 17). With regard to the use, management of the funds was perceived to have been done on behalf of Loblaw Financial and the company had influence on Glenhuron Bank’s investments through corporate oversight (Loblaw, para 18).
Federal Court of Appeal
Loblaw Financial then appealed the decision regarding the controversy surrounding the arm’s length requirement (Loblaw, para 21). The Federal Court of Appeal unanimously disagreed with the Tax Court judge’s findings and found that the arm’s length requirement was met. Particularly, the court found that the reliance on Barbados statutory definition, which splits a bank into two aspects – the receipt and use of funds – was incorrect. To further add to this, “direction, support and oversight by the parent corporation should not have been considered by the Tax Court judge” because these interactions are not incoming-earning activities and do not amount to conducting business with the CFA (Loblaw, para 25). Hence, the Federal Court of Appeal ruled that Loblaw Financial was entitled to rely on the FAPI exception.
The only issue in this appeal is: whether Glenhuron Bank conducted business with persons who were at arm’s length?
The Arm’s Length Requirement
The Supreme Court of Canada finds that the arm’s length controversy can be reduced to examining whether “providing corporate capital and exercising corporate oversight amount[ed] to conducting business with a foreign affiliate” (Loblaw, para 40). To do this, statutory interpretation becomes key and “discerning legislative intent by examining statutory text in its entire context and in its grammatical and ordinary sense, in harmony with the statute’s scheme and objects” (Loblaw, para 41). The Crown’s main argument rested on the fact that the word – conducting business- could be understood through the examination of Barbadian law. The SCC rejected this by finding that its task is to discern what the Parliament of Canada intended rather than focus on the intention of another jurisdiction (Loblaw, para 44). To add to this, raising capital is understood to be a “necessary part of any business” and can be separately understood from the conduct of business (Loblaw, para 46). This is evidenced by the fact that the parliament of Canada created the FAPI regime to classify a foreign affiliate’s income and its main purpose is to engage in the analysis of how different streams of money should be categorized (Loblaw, para 48) Thus, the SCC finds that the FAPI regime entails examining how Canadian jurisdictions define the arm’s length requirement and not Barbados law.
Furthermore, the SCC found that the Tax Court erred in finding that Loblaw Financial provided close oversight over Glenhuron Bank’s investment activities (Loblaw, para 63). The SCC states they “cannot find any basis in the text, context or purpose of the arm’s length requirement to support the Tax Court judge’s considerations of corporate oversight as part of conducting business” (Loblaw, para 64). The FAPI regime only applies where there is a controlled foreign affiliate and in any case corporate oversight is expected. The court notes “parliament does not speak in vain; it would not have added an arm’s length requirement if it could never be met” (Loblaw, para 64).
The SCC in its application examined whether Glenhuron Bank’s investment business was done with an arm’s length person or not (Loblaw, para 66). In the analysis, the business will not be considered piecemeal but will be taken as a whole (Loblaw, para 66). This makes the determination a balancing activity between both arm’s length and non-arm’s length activities, wherein one side is more prevalent (Loblaw, para 66). The court ultimately finds that a vast majority of the activities were done in arm’s length transactions including short term debt securities, cross currency swaps, and interest swaps (Loblaw, para 68). These were the most lucrative activities and amounted to 86 percent of Glenhuron Bank’s income. These transactions overshadowed loans made to individual truck drivers, purchase of Loblaw shares and inter-corporate loans that involved non-arm’s length parties (Loblaw, para 70). Therefore, the arm’s length requirement was ultimately met by Loblaw Financial, and the corporation qualified for the FAPI exception.
In conclusion, the SCC dismissed the appeal with costs and Loblaw Financial activities were determined to be arm’s length activities, thereby falling within the four FAPI exceptions. Although the question in this situation has been settled, the court noted at paragraph 66 that a “different approach could perhaps also be warranted” and this will be left for another day when the court hears competing arguments (Loblaw, para 66). This means that the question as to what activities will be considered arm’s length continues to remain uncertain and vague. Rather a case-by-case approach will continue to dominate and lead to future problems. For this reason, the legislature must step-up and reduce confusion within the FAPI regime by setting forth concrete and clear criteria.