Loblaw Financial Holdings Inc. v. The Queen - FCA Holds Foreign Bank Taxpayer Satisfied Arm’s Length Test in the Foreign Accrual Property Income (“FAPI”) Rules

  • June 05, 2020
  • Brittany Greenberg

Summary

The taxpayer successfully appealed to the Federal Court of Appeal (“FCA”) in Loblaw Financial Holdings Inc. v. The Queen, 2020 FCA 79. The FCA overturned the TCC’s decision to include over $473 million in the taxpayer’s income as foreign accrual property income (“FAPI”). The TCC previously held that the taxpayer’s foreign subsidiary did not qualify for the foreign bank exception under subsection 95(1) of the Income Tax Act[1] (the “Act”), because the subsidiary conducted business principally with non-arm’s length persons, and thus carried on an “investment business”. The FCA, however, found that the subsidiary had conducted business principally with arm’s length persons and concluded it met the conditions for the foreign bank exception.

This case provides taxpayers with helpful principles to consider when determining whether its foreign affiliate is conducting business principally with arm’s length persons for the purposes of satisfying the foreign bank exception.

Legislative Framework

Generally, a taxpayer resident in Canada must include in income their respective share of FAPI earned by a controlled foreign affiliate (“CFA”) for each taxation year of the CFA under subsection 91(1) of the Act. As a result, a CFA’s FAPI is generally taxed in the hands of its Canadian shareholders.

FAPI includes passive income such as income from property (FAPI does not include income from an active business).[2] Income from property includes a CFA’s income from an “investment business.”[3] An “investment business” is defined to include, inter alia, a business the principal purpose of which is to derive income from property (including interest, dividends, rents, royalties, or similar returns).[4] The investment business definition also has specific exceptions for particular types of regulated businesses, such as foreign banks that earn passive income on an active basis. 

The foreign bank exception in the definition of investment business may be met where the foreign affiliate is a foreign bank regulated under the laws of the country in which the business is principally carried on, the foreign bank employs more than five full time employees in the active conduct of the business, and is not a business conducted principally with non-arm’s length persons.

It should be noted that additional conditions were added to the foreign bank exception by the 2014 federal budget, which significantly restricted the availability of the exception by requiring a Canadian financial institution be part of the corporate group and meet minimum equity or capitalization thresholds. (These conditions, however, are not relevant to this case as they apply to taxation years subsequent to the years in dispute).