Federal Court Of Appeal Overturns Tax Court Decision And Clarifies The Arm's Length Requirement In The Foreign Bank Exclusion To The FAPI Rules

• Published date: 03 June 2020
• Author: Ms Kate Amirault and Jonathan Willson
• Subject Matter: Finance and Banking, Litigation, Mediation & Arbitration, Tax, Financial Services, Trials & Appeals & Compensation, Income Tax
• Law Firm: Stikeman Elliott LLP

The Federal Court of Appeal (FCA) recently rendered its decision in Loblaw Financial Holdings Inc. v. Her Majesty the Queen¹, which reversed the decision of the Tax Court of Canada (TCC). The FCA held that Glenhuron Bank Limited ("Glenhuron"), a subsidiary of Loblaw Financial, was a "foreign bank" and excluded from the "investment business" definition of the "foreign accrual property income" (FAPI) rules. The decision of the FCA provides interpretive guidance with respect to the FAPI exclusions and, more generally, on what aspects of a corporation's activities are relevant in determining whether it carries on a business for Canadian income tax purposes.

Facts and Case History

Loblaw Financial is a Canadian corporation that is wholly owned by Loblaws Companies Limited ("Loblaw"), a Canadian public corporation that is controlled by George Weston Limited ("Weston"). In the early 1990s, Loblaw Financial incorporated a new Barbadian subsidiary which was regulated by the Central Bank of Barbados. Prior to the taxation years at issue, Glenhuron's major source of funding was capital invested by corporations in the Loblaw group. During the taxation years at issue, Glenhuron's funding increased through its own retained earnings resulting from business activities, which according to expert evidence satisfied the requirements of the definition of "international banking business" under the applicable Barbadian laws.

The Minister of Finance reassessed the taxpayer on the basis that approximately $473 million of income earned by Glenhuron over seven years between 2001 and 2010 was FAPI. Loblaw Financial took the position that Glenhuron's income was not FAPI on the basis that Glenhuron was a "foreign bank" and was excluded from the "investment business" definition of the FAPI rules. Income from a business that qualifies for one of the exclusions from the "investment business" definition is generally considered income from an active business and, thereby, excluded from FAPI. One such exclusion applies to regulated foreign banks, which generally earn interest income in the context of an active business.

The taxpayer's appeal from the reassessments was initially unsuccessful - the TCC found that the foreign bank exclusion did not apply as Glenhuron did not conduct its business principally with arm's length persons, as required by the exclusion. The taxpayer appealed the decision to the FCA, except with respect to income earned by Glenhuron from the investment management...