In Canada v. Loblaw Financial Holdings Inc., the Supreme Court of Canada (SCC) unanimously sided with Loblaw Financial Holdings Inc. (Loblaw Financial) and confirmed that Canada’s foreign accrual property income (FAPI) regime did not apply to its foreign subsidiary’s income.
Loblaw Financial, a Canadian resident corporation, incorporated a subsidiary in Barbados, Glenhuron Bank Limited (Glenhuron). The Central Bank of Barbados issued a license to Glenhuron, allowing it to operate as an offshore bank. Between 1992 and 2000, Loblaw Financial and its affiliated entities made capital investments in Glenhuron. Subsequently, between 2001 and 2010, Glenhuron earned income from financial activities, and Loblaw Financial did not include this income as FAPI on its Canadian tax returns as it believed the financial institution exception to the FAPI rules applied.
The FAPI regime is intended to prevent Canadian taxpayers from avoiding Canadian income tax on investment income that is earned by a foreign subsidiary. To achieve this purpose, Canadian taxpayers must include, on an accrual basis, in their annual Canadian tax returns, their foreign subsidiaries’ FAPI. However, certain activities are excepted from the FAPI rules. These exceptions include certain financial institutions that conduct business principally with arm’s length persons.
Loblaw Financial claimed that Glenhuron’s activities met the financial institution exception to the FAPI rules.
However, the Minister and the Tax Court of Canada (TCC) disagreed. The TCC held that the financial institution exception could not apply because Glenhuron’s business was conducted principally with non‑arm’s length persons. In reaching this decision, the TCC determined that a proper interpretation of the arm’s-length test in a banking context requires an examination of both the receipt and use of funds. As such, while Glenhuron dealt mainly with arm’s length entities related to the use of funds, the receipt of funds (the capital investments) from non-arm’s length entities caused Loblaw Financial to not meet the arm’s length condition. As such, Minister issued reassessments to include the FAPI in Loblaw Financial’s Canadian income.
Loblaw Financial appealed to the FCA and was successful at both the FCA and SCC. The FCA and SCC disagreed with the TCC and stated it erred when it factored in the receipts to determine that Glenhuron was conducting its busines principally with parties that were not-arm’s length. The SCC observed that raising capital is a necessary part of any business, but one would not generally speak of capitalization itself as the conduct of the business. The statutory expression “business conducted” does not encompass an assessment of capital contributions or corporate oversight. If capital and corporate oversight are excluded from consideration, the vast majority of Glenhuron’s business was conducted with persons with whom it was dealing at arm’s length and therefore such income should not be FAPI.
In light of the government’s recent push to crack down on foreign investments, this case provides MNEs welcome clarification on the application of FAPI rules and exceptions to complex cross-border financing structures.