Loblaw Financial Holdings: Court Of Appeal Clarifies The Foreign Bank Exception In The FAPI Rules

• Published date: 11 May 2020
• Author: Amanda Heale and Chris Van Loan
• Subject Matter: Finance and Banking, Litigation, Mediation & Arbitration, Tax, Financial Services, Trials & Appeals & Compensation, Income Tax
• Law Firm: Blake, Cassels & Graydon LLP

On April 23, 2020, the Federal Court of Appeal (FCA) allowed the taxpayer's appeal of the Tax Court of Canada (Tax Court) decision in Loblaw Financial Holdings Inc. v. The Queen. The case involved almost C$475-million of income earned in 2001-2010 by Glenhuron Bank Limited (Glenhuron), a wholly-owned Barbados bank subsidiary of the taxpayer (Loblaw). The Crown had contended that such income was 'foreign accrual property income' (FAPI) that should be taxed in the hands of the taxpayer on a current basis. The FCA decision provides guidance on the interpretation of the 'investment business' definition in the FAPI rules, and reaffirms long-standing jurisprudence about the distinction between the capital that enables an enterprise to conduct its business, and the conduct of the business itself.

BACKGROUND

Glenhuron was a Barbados-resident corporation that was licensed and regulated in Barbados as an international bank. Its activities included holding U.S. dollar short-term debt, making loans to third party U.S. persons who distributed baked goods made by a company in the Loblaw group, entering into interest rate swaps, cross-currency swaps and equity forwards with third parties and providing investment management services to members of the Loblaw group. Most of Glenhuron's funds were obtained by way of equity capital invested by members of the Loblaw group.

If Glenhuron's income from the above activities was considered to be from an 'investment business,' as defined in subsection 95(1) of the Income Tax Act (Canada) (Act), then such income would have been FAPI. Glenhuron was a controlled foreign affiliate of Loblaw and any FAPI earned by it would have been taxed on a current basis in Loblaw's hands, whether or not it was distributed to the taxpayer.

Generally, if the principal purpose of a business undertaken by a foreign affiliate is to earn income from property'such as interest, dividends, rents and royalties'then the income from that business will be considered to be from an 'investment business' and will be included in FAPI. The 'investment business' definition has an exception for a foreign bank that is regulated under foreign law, and has more than five full-time employees or equivalents, provided the business is conducted principally with arm's length parties.

TAX COURT DECISION

The Tax Court found, amongst other things, that the income from the activities carried on by Glenhuron was earned in a business conducted principally with non-arm's length...