*This is an updated post that reflects helpful comments on the earlier post provided by a number of friends and colleagues who share my interest in this case and indeed the law more broadly.
"Loblaws" is an established Canadian grocer. It markets a comprehensive line of high quality products and services, including financial services, under the “President’s Choice” brand. The Loblaw corporate group headed by the Canadian public corporation Loblaw Companies Ltd., which is controlled by another Canadian corporation, George Weston Ltd., notably includes a chartered Canadian bank. We can add the “PC” brand to the “foreign affiliate” regime in the Income Tax Act (Canada) (Act). At the end of last week, the Supreme Court of Canada spoke.
Canadian Tax Law Grows By Leaps and Bounds In a Week
On Friday December 3, 2020, in its second major and considered tax foray in a week, indeed a week to the day after deciding the Alta Energy case, the Supreme Court of Canada carefully, methodically, and contextually parsed the foreign affiliate provisions of the Act dealing particularly with the meanings of “foreign bank” and “investment business”: The Queen v. Loblaw Financial Holdings Inc., 2021 SCC 51 (https://decisions.scc-csc.ca/scc-csc/scc-csc/en/item/19096/index.do) The Supreme Court dismissed the Crown’s appeal and concluded that Loblaws’ Barbadian bank, Glenhuron Bank Limited (Glenhuron), earned exempt foreign business income, and not investment income, from transactions conducted predominantly with arm’s length parties as a “foreign bank”.
Loblaw Financial Holdings and Glenhuron Bank Limited
The facts underlying the Supreme Court’s decision are relatively straightforward. The Loblaw group of companies had long ago established a Barbadian bank, Glenhuron (originally named Loblaw Inc.), under applicable Barbadian banking and financial services legislation respecting “offshore banks”. It had been materially capitalized by the Loblaw group, providing it with the financial wherewithal necessary to conduct largescale financial transactions. Glenhuron engaged in a large number of financial transactions common for contemporary financial institutions in a modern banking context, including profitable derivatives transactions. These were largely undertaken with third parties. It also engaged in a comparatively smaller number of less significant transactions that had connections to some supporting elements of Loblaw's Canadian business.
Relevant Aspects of The Foreign Affiliate Regime
The Canadian foreign affiliate rules, broadly, distinguish between “active business income” and investment income which may be “foreign accrual property income”. The latter is defined to include income of a financial nature, typical kinds of income from, and from trading, financial property, which may commercially be business income in an ordinary sense but arises or is derived from transactions conducted principally with non-arm’s length parties, that have certain Canadian connections, or for which transactions with foreign third parties are not the main focus of operations and sources of income.
This distinction is systemically important. Generally, active business income earned by foreign affiliates of Canadian corporate shareholders is exempt from Canadian tax as long as the business income remains in foreign or Canadian corporate solution. On the other hand, there is a general thread in the Act that Canadians ought not to be able to avoid tax by selectively putting their investment income offshore especially while being in the position to control how it is earned and when it is distributed to them. Accordingly, foreign investment income arising in these circumstances is determined for the most part according to the Act as the Act would ordinarily apply to income earned in Canada, and it is taxed currently, distributed or not, to Canadians for whom a foreign corporation is their “controlled foreign affiliate”.
Various kinds of financial income subsumed comprehensively in the definition of “investment business” are presumptively in the passive or investment income camp unless according to specific objective criteria a foreign affiliate is considered to conduct a foreign commercial business outside Canada. The Act sees this kind of income essentially as having been diverted via the selective assignment of that income and the means by which it is earned to a foreign affiliate controlled by Canadians who, alternatively, could have invested directly without the intervention of what amounts to a corporate intermediary. That income is therefore taxable on an imputed basis to the controlling Canadian taxpayers as “foreign accrual property income” unless it is established that the foreign affiliate’s foreign business activities are genuinely foreign as the Act specifies “foreign”. If the foreign business is “foreign” in the relevant perception of the Act, then the income is not to be considered diverted Canadian income within the contemplation of the internal subsystem in the Act for foreign affiliates.
In some cases, accordingly, unless an exception applies income of a foreign affiliate that may be business income in a commercial sense is nevertheless treated in the same way as passive investment income. Various statutory strictures apply essentially to determine in an objective way whether taxpayers should be considered to have directed income that would otherwise have a Canadian source or have been earned through endeavors in Canada, offshore to be branded as exempt foreign business income on the rebound.
An overarching limitation affecting how “foreign” the foreign business income of a foreign affiliate has to be, is that the foreign affiliate’s income cannot primarily arise from or be derived principally from non-arm’s length transactions: “business conducted principally with persons with whom the affiliate does not deal at arm’s length”. Undertaking transactions largely with non-arm’s length parties to earn what the Act treats as investment income of an “investment business” is an instance in which income with intrinsically passive or investment connotations, an inevitable kind of income for financial businesses of a bank or like-bank, is so treated even if earned through genuine commercial business operations. Reflecting the essence of how “foreign accrual property income” is determined and treated by the Act, income arising from and indeed dependent on circumstances within a narrow and discretionary community of interests is treated as having been earned directly by its controllers while still for other reasons the veil of corporate intermediation is not raised other than in this constructive sense.
A special such exception applies to regulated “foreign banks” which despite their foreign creation and operations conduct banking in the image of a Canadian bank as contemplated by Canadian Bank Act as if the foreign bank been Canadian. That exception was, as the Supreme Court noted, made more substantial and stricter legislatively in 2014, essentially confining it to highly capitalized Canadian financial institution groups in relation to how they conduct global business with third parties. But the new rules did not apply to this case.
Loblaw Financial Holdings and the Foreign Affiliate Regime: The Facts and the Law Joined
In their analysis the Supreme Court proceeded on the basis that Glenhuron was meant to be a “foreign bank”. It earned the kind of financial income that modern banks earn including from financial derivatives of various kinds. Most of its transactions were undertaken in market settings for transactions of the kind it undertook, with third parties. Loblaw Financial Holdings had been substantially capitalized by the Loblaw corporate group when it was created, and since then had also undertaken transactions, though comparatively few and relatively financially insignificant, that albeit indirectly could be seen as pertaining to the Canadian business interests of the Loblaw group. Also, as a member of a corporate group, not uncommonly for corporate families including "multinational enterprises", it was subject to over-arching corporate group policies and practices overseen by its Canadian parent and, more broadly the "Loblaw Group" (paragraph 63 of the Supreme Court's reasons). Neither of these features of Glenhuron’s creation and operations are surprising in relation to how subsidiaries within corporate groups are created and conduct their activities as group members.
Of concern, among other things, was whether and by what Canadian or Barbadian standards Loblaw Financial Holdings should be considered to be a “foreign bank” and assuming so whether by virtue of how it was capitalized it should be considered to have undertaken (to have conducted) its business primarily with non-arm’s length persons, namely its parent by reason of the act and degree of its capitalization as a group member and, ongoing, the oversight exercised by its parent and the Loblaw Group as a manifestation of group membership. In this vein the Crown’s signal argument in the Supreme Court was that the mere incorporation and capitalization of a subsidiary – in other words, the mere fragmentation of an “economic unit” into constituent legal pieces according to typical corporate law and elemental tax law – constituted carrying on business and therefore conducting that business inevitably not at arm’s length in so far as a subsidiary is inevitably the progeny of its parent. Arguments advanced by the Crown about the significance of ongoing oversight were connected to the underlying allegation that Glenhuron was ostensibly a manifestation of the Canadian taxpayer the business of which, in the Crown's view, the taxpayer effectively conducted.
At the Tax Court level, the Crown had unsuccessfully sought to ignore Glenhuron and consider its income to be that of its parent relying on the “General Anti-Avoidance Rule” (GAAR) in section 245 of the Act. Instead, the Tax Court, nevertheless in finding for the Crown, applied an analysis largely cut by it out of its own whole cloth to style the foreign affiliate’s income as “foreign accrual property income” arising largely from non-arm’s length transactions. The Federal Court of Appeal reversed the Tax Court in favour of the taxpayer. Somewhat brusquely and critical of the Tax Court, it applied an orthodox analysis of the pertinent provisions of the foreign affiliate regime in the Act which with the general law environment establish the Act’s “system” for dealing with foreign affiliates as a subset of how more broadly the income of corporations and their shareholders is taxed.
The Supreme Court dismissed the Crown’s appeal of the Federal Court of Appeal’s decision. It conducted a careful contextual analysis of the statutory provisions of the Act dealing most immediately with the significance of income as business or investment income for the foreign affiliate regime and in the circumstances the characteristics of “foreign banks” and most directly the meaning of “investment business”. The Supreme Court was obviously sensitive to the characteristics of modern banking and necessary refinements of the ambit of “investment business” needed for financial businesses not to be treated in the same way as passive or portfolio investors simply because of the kind of income they earn. The Supreme Court grounded is statutory analysis according to the fundamental distinction in the foreign affiliate regime between active and passive or investment income including the reasons for this distinction. While the Supreme Court could have expressly considered other specific elements that regime particularly attuned to the unique situations of “banks” and other financial institutions, all parts of a system which it characterized as complex, that would only have reinforced its decision in favour of the taxpayer and amplified the reasons for it.
The Supreme Court artfully and thoughtfully focused on the essence of the foreign affiliate regime in reaching its conclusion. The Supreme Court’s reasons reflect an awareness and understanding of the careful weave of the Canadian statutory context to make and in various settings to test that distinction, made more difficult by the inherent nature of financial businesses of financial institutions giving rise among the provisions of the foreign affiliate regime to unique statutory responses because the quality of income earned by financial institutions from or otherwise associated with transactions in financial property , is of course, financial - income from property that without adjusting for the nature of financial businesses, of banks, as genuine businesses would be foreign accrual property income. This is reflected in the Court’s digest of what it considered and how it considered it: “As I said above, we must discern the Parliament of Canada’s intent [in relation to what it means to conduct business] by examining the text of the ITA in its entire context and in its grammatical and ordinary sense, alongside the statute’s scheme and objects.” (Paragraph 44 of the Supreme Court’s reasons)
At both levels of Courts below and in the Supreme Court, underlying questions were raised about what “banking” and the conduct of a banking business entail and by what standards, Canadian or Barbadian, the relevant nature of banking should be determined in this case. The Crown contended, essentially, that Glenhuron was not a full service bank in the nature of a domestic Barbadian bank, and in particular did not conduct the kinds of banking operations common, for example, in connection with services provided to ordinary retail and commercial customers of full service money-center banks. The Crown argued that Barbadian law should determine whether Glenhuron was conducting business as a bank. At the Tax Court level, indeed, the notion of banking that seemingly influenced that Court’s decision reflected arcane, even quaint vestiges of a nineteenth century conception of banking, despite dramatic advances in what banks do and how, why and for whose benefit they do it to provide services to customers in this day and age. As much to the point those advances are obviously reflected in what even modern banking regulation envisages and contemplates as part of its regulatory responsibility. The Supreme Court clearly has a more expansive and commercially realistic understanding of banking and also, explicitly, that what it means to “conduct” business and the business of banking, and in light of the questions presented by this case about what law applies to establish the standards for answering them. The Supreme Court said:
"[44] The Crown argues that the meaning of conducting business can be understood by reference to Barbadian law. Section 4(2) of the Barbados IFSA and s. 4 of the Barbados OSBA define the business of an international bank as including both the receipt of foreign funds and the use of such foreign funds to provide financial services. However, we are not concerned with Barbadian law in this case. Our task is to discern what the Parliament of Canada intended by the words “other than any business conducted principally with persons with whom the affiliate does not deal at arm’s length”. The Crown has failed to provide any persuasive reason why the Barbados Parliament’s understanding of international banking business is in any way reflective of the Parliament of Canada’s understanding of conducting business. As I said above, we must discern the Parliament of Canada’s intent by examining the text of the ITA in its entire context and in its grammatical and ordinary sense, alongside the statute’s scheme and objects."
It should be said that the existence within the Loblaws group of a Canadian bank, a seemingly undisputed relevant aspect of the analysis of the foreign affiliate regime as it applied and should be understood in this case, was not lost on the Supreme Court:
"[39] It is not disputed that s. 95(2)(l) does not preclude Loblaw Financial from availing itself of the financial institution exception [in respect of Glenhuron] because Loblaw Financial is the parent of a Canadian bank, the President’s Choice Bank. Nor are the financial institution, oversight, and activity level requirements of that exception disputed. Therefore, this appeal concerns only the interpretation and application of the arm’slength requirement under s. 95(1)."
Pointedly and indeed interestingly, as already mentioned, Glenhuron was not the only regulated financial institution in the Loblaw universe.
Reflecting the directness with which a number of the Supreme Court Justices expressed themselves at the hearing of this appeal, the Court rejected more or less out of hand the Crown’s main if not only argument that the capitalization of a subsidiary, in this case that the foreign affiliate Glenhuron by the Loblaw corporate family, should be considered a transaction conducted in the ordinary course of carrying on business. The Crown then had contended that regardless of Glenhuron’s status as a financial institution, the nature and relative amount of the capitalization as the Crown presented as a commercial business transaction submerged the affiliate’s other transactions so as to justify treating its income as “investment business” income, as “foreign accrual property income”, and consequently income taxable directly as earned to its Canadian parent. In addressing this, the Supreme Court reached back to quite old but still sound Canadian law of the highest judicial order in this country as well as a statement of the Canada Revenue Agency’s own relevant interpretation to explain why capitalizing a subsidiary is not in the nature of a customer transaction, the latter being what the notion of conducting business targets. The Supreme Court said:
"[46] Raising capital is a necessary part of any business, and capital enables business to be conducted. But one would not generally speak of capitalization itself as the conduct of the business. Our Court has repeatedly affirmed that there is a distinction between capitalization and the conduct of a business. As Justice Rand wrote, “[t]he capital machinery within and by means of which the business earning the income is carried on is distinct from that business itself” (Tip Top Tailors Ltd. v. Minister of National Revenue, [1957] S.C.R. 703, at p. 710; see also, Bennett & White Construction Co., at pp. 290-92). In Montreal Coke and Manufacturing Co. v. Minister of National Revenue, [1944] A.C. 126 (P.C.), Lord Macmillan similarly stated: “Of course, like other business people, they must have capital to enable them to conduct their enterprises, but their financial arrangements are quite distinct from the activities by which they earn their income” (at p. 134). In fact, it would be quite unnatural to speak of a corporation as conducting business with its shareholders or lenders. A more natural reading of the phrase was provided by the Canada Revenue Agency’s (“CRA”) Rulings Directorate in 2000, when it said: . . . we consider business generally to be conducted with business clients and business clients are generally persons for whom services are performed or to whom products are sold in exchange for monetary consideration. A person who invests funds in the shares of a corporation or loans funds to the corporation is generally not considered a client of the corporation’s business.” [Emphasis added.] (Foreign Affiliates — Investment Business, Ruling No. 2000-0006565, June 22, 2000 "[Emphasis added]
In light of the law to which the Supreme Court referred as well as the Crown’s (via the Canada Revenue Agency) own stated view on the core of the Crown’s argument in this case, it might be wondered how that argument even came to be made.
The Court also rejected the Crown’s companion argument that the interest of the parent in the affairs and operations of its subsidiary and in that connection its exercise of corporate oversight justified treating the subsidiary’s ongoing business and income essentially as those of the parent.
In fact, the Supreme Court said very clearly that once these factors, capitalization and oversight, were excluded from the mix of legally relevant considerations there was essentially nothing was left to decide.
The Court touched twice on the GAAR, to observe that it did not arise to be considered in this appeal. At least not in so many words. But the sense and sensibility of the Supreme Court’s reasons suggest that the “text, context, and purpose” (TCP) discipline to detect impugnable abusive tax avoidance that is a GAAR analysis was very much in the consciousness of the Supreme Court as a guiding influence. The analytical undercurrents of the statutory construction analysis undertaken by the Court are precisely what the GAAR calls for when it is applied. The Court’s encapsulation of its analysis bears repeating: “As I said above, we must discern the Parliament of Canada’s intent [in relation to what it means to conduct business] by examining the text of the ITA in its entire context and in its grammatical and ordinary sense, alongside the statute’s scheme and objects.” (Paragraph 44 of the Court’s reasons). This is the TCP analysis that is the GAAR analysis, whatever label may be attached to it. This is important for discerning whether it would be fair or accurate to interpret the Court’s acknowledgment that GAAR as such was not addressed in this appeal as some kind of indication that had it been, that might have been influential. While section 245 of the Act, as a statutory provision, was not in play, its essence was evident and manifest in the systematic and systemic statutory analysis undertaken by the Supreme Court and, notably, in the Court’s decision.
Detecting Important Themes Arising Out of This and Other Recent Supreme Court Cases
The Supreme Court’s analysis, if not expressly though certainly thematically, also touches on elements of the two others of its recent trio notable tax cases also decided in favour of the affected taxpayers, Alta Energy in the prior week (my comments are posted at (https://tax.osgoode.yorku.ca/2021/11/the-taxpayer-is-successful-tody-at-the-supreme-court-in-the-important-alta-energy-treaty-shopping-case/) and Cameco Corporation earlier in 2021 (my comments are posted at https://tax.osgoode.yorku.ca/2021/02/the-cameco-transfer-pricing-appeal-ends-today-2/). The Court did not choose to hear an appeal in the Cameco Corporation case. But that is as much a decision as any other, taken in full view of the consistent, carefully reasoned, and forceful decisions favouring the taxpayer of the Tax Court of Canada and Federal Court of Appeal decisions on which the application by the Crown for leave to appeal rested.
There are three main important effects of these three cases which are amplified and reinforced by considering them together.
The Law Matters
First, we live and operate within the parameters of a legal system on which taxpayers are entitled to rely when determining tax liability. Indeed, this observation is even more forceful when it is understood to apply to the significance of law more generally as the framework within which citizens do most things and, even, countries reconcile the intersection of their legal system when their citizens act in ways that invoke more than one country’s legal systems simultaneously. This is not mere legal theory; it is not a moral or political platitude though civic decisions mastered by the political system no doubt provide the impetus and the outcome for the law we have. These reliable, enforceable parameters we call the law are necessary to orchestrate all manner of personal and commercial life, without chaos and mayhem and with objective accountability. The law is not whatever this day or the next we or some of us might imagine it should be.
Quite clearly and evidently with no patience for a contrary view, this animates the Supreme Court’s deference to the law once it has been properly construed. It would not be too strong to characterize the Supreme Court’s view of the contrary as repugnant to the law.
This sounds very grand for tax, maybe, but tax manifests the convergence of fiscal regulation and private and public law affecting most personal and commercial undertakings, offering a relief map of sorts to understand this important point. In the Supreme Court’s mind, the drift away from the law occasioned by undue influence assigned to “general” anti-avoidance notions should be contained.
Taking this to ground, provided that the evidence of taxpayers’ conduct is consistent with the intrinsic legal and commercial expectations of the private law legal constructions they choose to organize and conduct their affairs, those arrangements are respectable and reliable, and ought to be respected.
This is not, in itself, a case or a defense of strained or tortured tax compliance. The architecture of the Act in so many ways is only consistent with the fact that we do not disregard taxpayers’ organizational and transactional choices. It cannot be more fundamental to the system in the Act for taxing the income of corporations and their shareholders, that there are, distinctly in a legal sense, corporations and their shareholders. It is not hard to imagine the two as comporting with an economic unity, but the Act is nor formed that way, reacting as it does to how the pervasive private law determines legal personality and relevant separations of legal interest. The same can be said about how the Act deals with capitalization transactions; interest on money borrowed to invest in shares is generally deductible under paragraph 20(1)(c) of the Act and related provisions, and ancillary or collateral financing expenses, too, are deductible under paragraph 20(1)(e) of the Act and its related provisions.
The list could go on - not merely or even at all as a list of tax calculations but a reflection of the whole system of the Act that exists simply because capitalization is what Lord MacMillan said it is in the Montreal Coke case, capitalization and not carrying on business. Expenses of the sort just mentioned are capitalization expenses, requiring in our tax law a specific permission to be recognized as deductions in computing income because they are not qualitatively according to the law as the Act frames it "business expenses" ordinarily deductible as such.
When the Act does not like an outcome, it alters how affected income is taxed, sometimes in relation and according to an organizational or transactional analogue found in the architecture of the Act that projecgs how the affected income is meant to be taxed systemically. Again, the architecture of the act is replete with examples - important structural examples for the construction of the Act as a legal system informed by all of its provisions as contextual elements. For example, we have a plethora of "preferred share" rules to rein in, and commonly deny, the intercorporate dividend deduction when, in economic terms, shares and the circumstances in which they are issued have debt-like characteristics and are held by shareholders who have only an interest in the issuers of those shares that is that of a disinterested financier. We have another group of "preferred share" rules to control “sales" of existing and future losses or utilizable deductions of the share issuer, again shares that have fixed attributes more akin to debt than common equity, and the object is the same, to deny the intercorporate dividend deduction to mostly disinterested (in the business contrasted with tax attributes) shareholders. The famous or infamous SIFT ("specified investment flow through" regime that came into existence on a memorable Halloween many year ago, generally aligns the treatment of public trusts and partnerships and their interest holders to the orthodox treatment in the Act for corporations and their shareholders to ensure that the appropriate degree of taxation of the economic unit that comprised the legally distinct trust or partnership and interest holder pieces on income that originated with corporations engaged in financial transactions with them, applied. The trusts remain trusts with unitholders the partnerships remain partnerships with partners, but the system of the Act that frames corporate income taxation is superimposed.
But what the Act does not do is “recharacterize” something to be what an evidence based legal analysis sustains it is not, to recall the findings in the Cameco Corporation case and implicitly the Alta Energy case too. What taxpayers “do” should not be displaced by assertions of undue tax avoidance grounded mainly if not solely in the obvious recognition that economically equivalent outcomes may be achieved often with quite different regulatory, including tax, consequences depending on the legal formulation taxpayers select – as long as the taxpayers themselves respect in more than a merely mechanical way the constructs they have adopted.
This is not an endorsement, by the Court or for that matter by me, of the “motor mechanics” school of tax planning, which often takes significant liberties with the essential meaning of the oft cited Duke of Westminster case and within it Lord Tomlin’s famous but in my view misunderstood dictum about taxpayers’ entitlement to minimize their tax liabilities in accordance with applicable law. The Duke is a substance case, really. The Law Lords evaluated evidence about the conduct of the affected parties and judged it to be consistent with the intrinsic expectations of the legal formulation selected by the parties, in the context of the necessary intersection of both tax and private law. They used the word “substance”, and their speeches reflect their understanding of that notion as comporting an evidence-based determination of whether the intrinsic requirements of the law had been substantively satisfied by the kinds of conduct the chosen legal construction required. Their internal debate on the point reflects difficult legal judgments and a legal analysis sometimes entails, and ultimately for that reason that there may be an agreement to disagree.
Regrettably, and even in Loblaw Financial Holdings, the Duke is trotted out regularly as being emblematic of a low standard by which colourable tax avoidance is presumptively excused if it is bolted together correctly in a mechanical legal sense. A careful construction of the Duke does not justify such a conclusion. That said, we might wonder if it is time to move on beyond the Duke and the continuing not very useful debates “he” provokes. Though the Court does acknowledge the ghost of the Duke, their substantive analysis shows that they in fact have moved on without needing an elaborate requiem. They do this by demonstrating the importance of a thorough understanding of the relevant regime in the Act, in itself and as an element of the system that the Act is, and that that system is not merely a compilation of tax rules but at every juncture engages the private and public law. This is evident consistently in all three cases.
It is clear in all three cases that the Court was only satisfied to rely on what the taxpayers did as established by evidence, not what it could be imagined they could or on some basis ought to have done. Considering evidence to understand economic events in the legal framework hosting them, is a legal, not an economic, analysis. And even then, only where the conduct was more than merely mechanical or formalistic within the relevant legislative context. The Supreme Court’s approach in Loblaw Financial Holdings, for example, reflects their appreciation of the foreign affiliate regime in the Act and for that matter all elements of the Act that apply to the taxation of corporations and their shareholders as a subsystem of the system that is the Act which is focused on the time when their collective income should be considered fully taxed and why in some cases the shareholder level of tax will be deferred. This is a suitable reference point for emphasizing why legal constructions cannot be ignored simply because they are legal constructions that frame an undeniable underlying economic reality in particular and relatively distinctive ways, even if none of them is the only way to achieve that economic reality. They are what they are for good and often non-tax reasons and with well-established connotations; the Supreme Court had to explain in the Loblaw Financial Holdings case in the most elemental way with reference to the Montreal Coke case.
Obviously, legal fragmentation - creating a subsidiary to conduct activities that just as readily could be conducted by a single Canadian company, the parent, operating through branches – lies at the core of many legal constructions. The Act, however, is built on these; it does not determine them, it reacts to them and where necessary conditions the tax law to reflect characteristics it either does or does not like. It is not for the Act to select how taxpayers organize themselves, in the absence of clear evidence that the taxpayers did not respect the intrinsic substantive expectations of the organizational and transactional arrangements they purported to adopt. In fact, the Act does not eliminate the possibility and indeed contemplates it, that alternative legal formulation of business activity are possible to common economic effect.
The Act, accessory as it is to necessary private law constructions, not only recognizes but is constructed to recognize separate legal personalities that collectively could be, but are not, legal as well as economic unities. The system in the Act for taxing the income of corporations and shareholders, in so many ways, speaks to this. It determines the degree and timing of the suitable tax liability by considering the integrated circumstances of the corporations and their shareholders realizing that a corporation simply manifests the legal separation of the owners of capital used in a business (shareholders) and the use, which is their continuing use as shareholders, of that capital (in a separate legal personality that is the corporation), even though all the activities and persons conducting them would be the same with or without that simple act of fiscal cell division. The separate legal existence of corporations and their shareholders – subsidiaries and parents - ought not be impugnable simply because it exists. The Supreme Court speaks very directly about this in Loblaw Financial Holdings. The Court in fact is dismissive of the argument that the mere coming into separate existence of a subsidiary by being capitalized by its parent amounts to conducting a commercial business transaction which justifies imputing the subsidiary’s income to the parent as if the subsidiary had not been incorporated. Incorporation, the creation of a taxable personality, is at the core of legal subsystem in the Act for how corporations and their shareholders are taxed. It is that point, fundamentally about the intersection of tax and private law, which is the Loblaw Financial Holdings case, and equally, in different contexts but with similar undercurrents Cameco Corporation and Alta Energy.
A collateral implication of this trio of cases is that current initiatives in the international tax arena to apply what amounts to “substance over form” or “economic substance” notions to “accurately delineate”, to determine the “commercial rationality” of, and / or to establish where “value creation” occurs and ought to be attributed respecting, transactions – to borrow contemporary transfer pricing notions – may be destined for some heavy weather at least in Canada. These cases are something of a conscience and a compass. I commented last week to the same effect with respect to the implications of the Alta Energy case for the “Principal Purpose Test” incorporated in the Multilateral Instrument that has grown out of the Organisation for Economic Co-operation and Development’s “Base Erosion and Profit Shifting” (BEPS) project including its Pillars extensions. The undercurrents of the Cameco Corporation case, which the Supreme Court of Canada effectively decided by deciding not to hear an appeal of the Tax Court of Canada and Federal Court of Appeal decisions upholding the taxpayer’s tax reporting, and the explicit reasoning of the Court in the Alta Energy case, provide a convincing and forceful basis on which to conclude, now bolstered by the reasoning in Loblaw Financial Holdings that the legal system, properly relied on, cannot be shunted to the side in pursuit of notions of perceived or imagined “economic justice”, no matter how worthy, perhaps, which cannot be found in the tax law properly understood with necessary due regard to embedded or collateral private and public law.
The Law Is What It Is, Not What It Is Alleged It Ought to Be
Second, the Supreme Court in Loblaw Financial Holdings again explicitly, as it did also explicitly in the majority’s Alta Energy reasons, makes it clear beyond clear that it is not within the judicial remit to embellish the law – effectively to apply the law according to provisions that are not there. The denial by the Tax Court and the Federal Court of Appeal in the Cameco Corporation case of the proposition that paragraphs 247(2)(b) and (d) of the Act hosts a “recharacterization” authority in transfer pricing, has an equivalent effect. Similarly, the Supreme Court refused to replace the Canada – Luxembourg tax treaty that exists with one, for the moment of the case, the Canadian tax authorities wish would be in place, focusing there on a contract of nations no one party to which can reimagine or change at will. In all cases, this was not in any sense a philosophical, moral or political conclusion but is based on “hard” and rigorous statutory and more broadly legal analysis. Allegations of tax avoidance based on an imperfect taxing statute, whether relying on the GAAR in section 245 of the Act or the like provisions of the transfer pricing rule in section 247 of the Act, or merely as an animating argument or undertone as in the Loblaw Financial Holdings case, are not sufficient to warrant or justify extra-statutory judicial intervention to create law that does not exist. The Supreme Court has said in no uncertain terms that the GAAR is not some sort of universal constant that replaces, displaces, or offers open ended remediation of the Act. This is reminder, for those who need it, of the relentlessly rigorous inherently interpretative exercise that applying the Act always is no matter how from time to time it may be labelled. I refer below to Justice Estey’s reasons in the Stubart Investments case and the “gaar” he expressed as parameters of statutory analysis and interpretation, which looks very much like but did not require the GAAR or an ensuing urge to treat it as creating a parallel tax universe in the Act.
Relieving a Shibboleth – The Implications of Corporate Policies, Governance, and Oversight
International tax advisers worry constantly about the exercise of over-arching corporate oversight by a parent corporation according to policies and practices that apply to all members of a corporate group, whether that oversight might be seen to be excessive, and therefore as a prophylactic how the reality of the oversight should be tempered by explicit governance limitations suitably memorialized. The concern about excessive oversight raises the possibilities that either the parent will be considered to carry on business - the business of its subsidiaries or its own business – or otherwise be taxably present in the jurisdictions where its subsidiaries are constituted and / or active, or, correspondingly, those subsidiaries will have some kind of taxable Canadian business presence manifest in the parent. A great deal of tax planning attention typically is paid to ensuring that parental oversight and group policies do not breach the border between “good” and “bad” oversight to yield perverse and unintended consequences. There is rarely any clear or bright-line guidance to direct reliable determinations. Much is left to judgment and resulting careful governance processes and contemporary documentation.
A similar situation has been the urgent need for guidance during the COVID pandemic when multinational enterprises conceivably found themselves to be in places where they did not intend to be and otherwise would not be, because of stranded employees or the inability to conduct typical governance where the governed had its corporate seat and operations.
The comments by the Supreme Court effectively direct us to the essential tax issues that jurisdictional and related income character and source considerations and properly should be directed. This is rarely, in and of itself, a ballet of legal constructions which in a commonly controlled legal group is easily choreographed in any event. Based on the trio of cases, it is difficult to conclude other than the Supreme Court understands, and even takes for granted, the reality of corporate oversight and what it really means for the principles underlying jurisdiction to tax. It does not carry with it the implication that the corporate veil on subsidiaries will have been raised or otherwise a subsidiary will be seen as the alter ego of its parent. This provides welcome recognition of how international business is conducted in light of what tax jurisdiction rules are really aimed at. The thoughtful reaction of the Court to the significance of such oversight will be reassuring to those called upon to make those often hard calls. The same analytical insights, grounded nevertheless in the law, are particularly evident, too, in how the Tax Court and the Federal Court of Appeal considered – with the benefit of evidence and an awareness of the relevant private law - the various services and other arrangements animating the commercial arrangements of the Cameco corporate group in their decisions of the Cameco Corporation case.
Leading Canadian Law from a Leading Court in the International Judicial Universe
Each for its own reasons, the Cameco Corporation, Alta Energy, and Loblaw Financial Holdings, cases are important. Together, interestingly, they deal with the full international tax landscape. Most of the key elements of international taxation, not only in Canada but elsewhere, are found in these cases: respectively, transfer pricing, treaty interpretation in light of domestic law limitations on tax avoidance (so-called “treaty shopping”), and controlled foreign corporation (in the Canadian image, foreign affiliate) rules. In international tax, there’s not much left. While there are many specific elements of each of those areas of tax interest which are not directly in issue in these cases, what is of irresistible notice is the consistent force of the Supreme Court’s decisions with respect to the legitimate scope and preservation of Canada’s tax base in the face of intersecting other countries’ tax claims. It is hard to resist the conclusion that general contentions of unjustifiable tax avoidance joined with assertions of what the law ought to be are insufficient to ground actionable interventions in how the Act applies. There is no substitute for “hard” contextually sound legal analysis in relation to an evidence-based determination of what taxpayers have actually done with reference to the intrinsic expectations of the legal formulations on which they rely in organizing themselves and conducting business.
“Business Purpose” and "Back to the Future"
I wondered in an earlier post (https://tax.osgoode.yorku.ca/2020/11/the-supreme-courts-accumulating-tax-brief-to-what-end/) when all three cases were in gestation before the Supreme Court, whether the Supreme Court might be interested in fashioning a coherent “business purpose” test as a direct and so expressed brake on tax planning. Whatever the Court may have been thinking when deciding how to respond to these three cases, the answer seems at a superrficial level to be no – at least in terms of how a “business purpose” test might be imagined as a discrete statutory prescription. Why? Possibly ecaue tax awareness in crafting private law based forumations of how to accomplish business outcomes is not only not unusual, it is a reality, and generally ought not to be impugnable if undertaken according to intrinsic legal and commercial expectations of those forumolations.
A no answer, though, that takes us back to the seminal reasoning of Justice Estey over thirty years ago in the Stubart Investments case about when and how it is appropriate to redetermine events that undeniably happened and intervene to counter undue tax avoidance. Where we are is largely where we started before the GAAR, with Justice Estey’s “gaar” – a statement of interpretative guidance, with detecting contrivance not facilitating untethered reconstruction in mind. This is how I commented on recently announced and possibly ongoing consultations to recalibrate the GAAR and transfer pricing regulation: https://tax.osgoode.yorku.ca/2021/06/hiding-in-plain-sight-changes-to-transfer-pricing-and-the-gaar/, and https://tax.osgoode.yorku.ca/2021/07/a-couple-of-more-thoughts-on-hiding-in-plain-sight-changes-to-transfer-pricing-and-the-gaar/.
This is, I think, where we are – which I hasten to say is not a bad place. We are here possibly with much more focus on the Act as a system of law, not just a manual of tax provisions, and consequently what in that sense of the law undue or unwarranted “tax avoidance” means.
The essential analysis to address whether tax avoidance is untoward requires us to understand the whole Act and its relevant provisions in light of how they came about, which is the essence of statutory interpretation even without the specific reminder to do this that is section 245 of the Act and why it is there.
Scott Wilkie
Distinguished Profess of Practice, Osgoode Hall Law School, York University