In this Update:
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On
- In particular, the decision focuses on the foreign accrual property income (FAPI) regime, which, if applicable, would impose Canadian tax on income earned in another country by a controlled foreign affiliate of a Canadian company
- The
Supreme Court rejected the government's argument and concluded that a Canadian parent corporation does not conduct business with its controlled foreign affiliate when it provides capital and exercises corporate oversight - The
Supreme Court also rejected the government's position that additional requirements should effectively be read into the provision at issue because it should be viewed and interpreted as an anti-avoidance provision - In addition to a detailed legal analysis, the
Supreme Court noted that practical difficulties would arise from the government's arguments - The reasons contain useful guidance on how to interpret detailed and complex tax provisions such as the FAPI regime
In a decision released earlier today, the
This decision provides rare guidance from our highest court on how to interpret and apply important elements of the foreign affiliate rules in the Income Tax Act (the Tax Act). The decision is directly relevant to Canadian financial institutions and other Canadian companies with subsidiaries carrying on banking and other financial businesses outside of
Background to the appeal
After a four-week trial involving 14 witnesses, extensive documentary evidence and numerous disputed issues, the
The Tax Court was of the view that a banking business necessarily involves two components: the receipt and use of funds. The Tax Court also found that the arm's length component of the financial institution exception imposed an unexpressed requirement for competition that justified an emphasis on the "receipts" side of the equation. Glenhuron's non-arm's length sources of capital, particularly equity capital, led the TCC to conclude that Glenhuron was not conducting its business as a foreign bank principally with arm's length persons.
In allowing
For a more detailed discussion of the
Unanimous decision in favour of the taxpayer
The fundamental premise of the Crown's case before the SCC was that Parliament intended Glenhuron's business income to be subject to tax in
A unanimous
Justice Côté, writing for the Court, characterized the FAPI regime as "one of the most complex tax schemes, with hundreds of definitions, rules, and exceptions that shift regularly." Given the particularity of the provisions found in this regime, Côté J held that courts should "focus carefully on the text and context in assessing the broader purpose of the scheme."
This interpretive approach echoes the majority reasons in the context of tax treaty interpretation in the recently released Alta Energy decision (for more details of this decision, please see the Osler Update dated
Applying this approach to the financial institution exception at issue, Côté J held that a parent corporation does not conduct business with its controlled foreign affiliate when it provides capital and exercises corporate oversight.
The grammatical and ordinary meaning of the words "business conducted", read in the context and light of the purpose of the FAPI regime, clearly shows that
The SCC also rejected the Crown's argument that the financial institution exception had an anti-avoidance purpose or imposed a requirement for competitiveness. Acknowledging that there was no direct evidence that specifically spoke to the purpose of the arm's length requirement, the Court concluded that the purpose was the same as the FAPI regime overall: an attempt to balance the conflicting goals of preserving the ability of Canadian companies to compete abroad and preventing the erosion of
Since a significant majority of Glenhuron's income-generating activities were conducted with arm's length persons, Glenhuron qualified for the financial institution exception and its income was not included in FAPI (or included in the income of
Implications and takeaways
The financial institution exception has been amended since the taxation years at issue in this case to restrict the class of Canadian taxpayers that can claim the exception. However, the decision has broader implications for tax planning because it offers guidance on how to approach the tension between interpreting tax provisions purposively while respecting their precise language. The decision also provides comfort to taxpayers that courts may take into account prior published administrative practices of the CRA in situations where the CRA tries to repudiate them at a later date.
As a practical matter, this appeal highlights not only the need to create and preserve the necessary evidence to establish the requisite facts, but also the importance of successfully establishing them at trial. Of the many lessons to be learned from this appeal, it is clear that the earlier evidentiary issues are considered — preferably at the time the relevant planning is undertaken — the fewer challenges taxpayers may face at a later time should a tax dispute arise.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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