Major Canadian Tax Avoidance Cases at Risk After Loblaw Ruling

The Canadian tax authority’s defeat at the Supreme Court in an offshore tax case involving grocery chain Loblaw will have a far-reaching impact on similar cases it is reviewing, and profoundly change corporate tax planning, practitioners said.

The Canada Revenue Agency had warned the court in June that defeat in its dispute with Loblaw Companies Ltd. would imperil the collection of C$1.18 billion (U.S. $920 million) in audits and objections with 14 corporate groups, including Loblaw. The court ruled in Loblaw’s favor Dec. 3.

The decision could have an even greater impact, reshaping legal advice across corporate tax planning in Canada, according to tax practitioners.

“The principles articulated in this case are of wide application and will apply in many, many cases,” Vern Krishna, tax counsel at TaxChambers LLP and professor of common law at the University of Ottawa, said in an interview.

The Loblaw case dealt with the application of rules on foreign accrual property income, or FAPI, a complex legal regime within the Income Tax Act that determines the tax treatment of passive income by the overseas entities of Canadian corporations.

The court found unanimously that C$473 million in income that a Barbados subsidiary of Loblaw Financial Holdings Inc., itself a subsidiary of Loblaw Companies Ltd., made between the 2001 and 2010 tax years, shouldn’t be repatriated to the parent firm in Canada.

Parliament didn’t give FAPI the aim of eliminating tax avoidance, the court said in its reasoning. The Canadian and Barbados firms operated at arm’s length from each other, because FAPI’s definitions should be read restrictively to mean that the oversight and capital infusions Loblaw provided don’t mean they conducted business together, the court added.

The arm’s length standard ensures related parties within a multinational group transact as if they were third parties.

Domino Effect

The agency had raised the specter of a domino effect on corporate tax disputes when it applied to appeal a Federal Court of Appeal judgment that sided with Loblaw on many of the same points. The agency did so to press its view that there was no need for any further clarity in this area of law, according to Krishna.

The tax dollars the agency sought in those cases remain in jeopardy and the Supreme Court ruling could even stop other disputes from getting off the ground, agency spokesman Etienne Biram said after the judgment.

“The files and amounts are still at risk and those cases are being reviewed,” Biram said in a statement Dec 10. “As a result, other potential cases may not be reassessed.”

The agency has not named the other firms that might be affected.

Revenue Canada’s application said the lower court ruling undercut its position in the other pending corporate cases, because the decision failed to properly articulate the anti-avoidance purpose permeating the FAPI rules. The agency also said the court ruling characterized the regime as incentivizing offshore investment and required courts to interpret the regime restrictively.

The pending cases are also linked because they have the same legal test to determine whether the relationship between a parent firm in Canada and an overseas subsidiary is arm’s length or not, it said.

Changes in Tax Planning

The Supreme Court’s decision was particularly notable because it took the rare step of delving into the fundamentals of Canadian tax law, practitioners said.

The justices clarified the tools used for deciphering the meaning of the Income Tax Act, known as the rules of statutory interpretation. They also referenced the Westminster principle, an idea first laid out in a 1936 U.K. decision that holds everyone has the right to avoid taxes within the law.

Both areas of law will take on a greater role in tax planning strategies and in talks with the agency, thanks to the top court’s mention, Krishna said.

The court’s finding that the arm’s length test doesn’t have the purpose of targeting tax avoidance will have a ripple effect on other laws that use the same test, such as rules for transfer pricing, debt forgiveness, butterfly transactions and transfers to non-arm’s length parties, said Dean Blachford, senior tax lawyer at Blachford Tax Law.

“That’s a very positive outcome,” Blachford said. All those applications would have become much more uncertain had the court decided the test has an anti-avoidance purpose, he said.

The Loblaw decision will likely embolden companies and tax planners, while making the agency less bold in challenging firms, Blachford said.

Policy Changes Needed

The ruling capped a rough year in the courts for the agency. It also comes at an awkward time for Prime Minister Justin Trudeau, who has vowed to continue increasing the agency’s budget so it can tackle international tax evasion and avoidance cases.

The top court sided with Alta Energy Luxembourg S.A.R.L. in November and rejected an appeal request in a dispute with uranium miner Cameco Corp. in February. Both cases dealt with Canadian firms’ offshore entities.

“The government is clearly reeling from these losses,” said Arthur Cockfield, tax professor and associate dean at Queen’s University.

The cases highlight the government’s need to highlight its transfer pricing policies, he said.

Current laws, including the General Anti-Avoidance Rules, don’t do enough to address perceived situations of aggressive international tax avoidance, Geoff Loomer, associate dean at the University of Victoria’s Faculty of Law, said.

The government must stay engaged in global efforts to reform corporate tax rules and introduce more specific legislation in response, he said.

“The unfortunate result, as always, will be more legislative complexity,” he said.