Lehigh Cement: Favourable Canadian federal court decision on foreign affiliate anti-avoidance rule
The Canadian Federal Court of Appeal's decision in Lehigh Cement is significant because of what it says about anti-avoidance and the foreign affiliate structures of Canadian taxpayers.
After much anticipation, the Federal Court of Appeal (FCA) released its decision in Canada v Lehigh Cement Limited (Lehigh Cement), in which the FCA gives a narrow interpretation to the anti-avoidance rule in paragraph 95(6)(b) of the Income Tax Act (the Act). This decision is significant because the Canada Revenue Agency (CRA) for some time has shown an inclination to apply this provision broadly in assessing foreign affiliate structures of Canadian taxpayers.
Under paragraph 95(6)(b), where a person acquires or disposes of shares of a corporation and it can reasonably be considered that the principal purpose for the acquisition or disposition is to permit any person to avoid, reduce or defer the payment of tax or any other amount that would otherwise be payable under the Act, that acquisition or disposition is deemed not to have taken place.
The Lehigh Cement decision involved a refinancing that was implemented by two Canadian companies, Lehigh Cement Limited (Lehigh) and its wholly-owned subsidiary CBR Alberta Limited (CBR Alberta). Lehigh and CBR Alberta used borrowed funds to make an equity investment in a newly formed Delaware LLC, or limited liability corporation (LLC). After the implementation of various inter-company transactions, the LLC paid dividends to Lehigh and CBR Alberta. Based on the Canadian tax treatment accorded to foreign affiliate dividends - broadly to exclude dividends that originate directly or indirectly in business income earned by foreign affiliates, these dividends were not subject to Canadian tax. Lehigh was also able to obtain a deduction for the interest it paid on the borrowed funds. The CRA reassessed the taxpayers on the basis that paragraph 95(6)(b) applied to effectively ignore Lehigh's and CBR Alberta's acquisition of the LLC shares. In these circumstances, the LLC would not qualify as a foreign affiliate of either Lehigh or CBR Alberta and any dividends paid by LLC to these taxpayers would not benefit from the favourable tax treatment accorded to foreign affiliate dividends and would be subject to tax in Canada.
In the original trial, the Tax Court of Canada (TCC) ruled in favour of Lehigh and CBR Alberta based on the facts in their particular circumstances, but the TCC gave a very broad readingto paragraph 95(6)(b). In particular, the TCC imported a series of transactions concept to paragraph 95(6)(b). This effectively extended the principal purpose test from determining the purpose of the particular share acquisition or disposition to that of the entire series involving the acquisition or disposition. The TCCs interpretation of paragraph 95(6)(b) raised concerns among tax professionals as it was widely viewed as broadening the scope of the anti-avoidance rule.
Decision of FCA
The FCA upheld the TCCs decision that paragraph 95(6)(b) does not apply in these particular circumstances. However, the FCA disagreed with the TCCs interpretive approach regarding the scope and breadth of paragraph 95(6)(b).
The FCA found the statutory language of paragraph 95(6)(b) to be clear and unequivocal and rejected the view that a series of transactions test could be read into the provision. Rather, paragraph 95(6)(b) necessitates a consideration of the principal purpose of the particular share acquisition or disposition, which is a question of fact to be determined based on the surrounding circumstances. As part of this consideration, the FCA acknowledged that the series of transactions may be relevant in determining the principal purpose of the share acquisition or disposition.
The FCAs conclusion that paragraph 95(6)(b) could not be invoked as a broad general anti-avoidance rule to combat perceived abusive tax planning involving foreign corporations was significant. Rather, the purpose of the rule is to address the manipulation of share ownership of a non-resident corporation to meet or fail the relevant tests for foreign affiliate or controlled foreign affiliate status. In rejecting the notion that paragraph 95(6)(b) was akin to a general anti-avoidance rule, the court noted that the Act contains a number of specific targeted anti-avoidance measures. The court found that had the Canadian government intended for paragraph 95(6)(b) to counter all tax avoidance schemes involving non-residents, it would be unnecessary to include such specific anti-avoidance provisions in the Act.
Based on the foregoing and coupled with the TCCs finding that the principal purpose of Lehigh's and CBR Alberta's acquisition of the LLC shares was to achieve US tax savings, the FCA concluded that the purpose of the LLC share acquisition was not to avoid Canadian tax. Consequently, the FCA concluded that paragraph 95(6)(b) did not apply to the transaction in question.
The FCAs decision in Lehigh Cement offers welcome clarity to the interpretation of paragraph 95(6)(b), and when it properly can be invoked, in relation to what many would regard as typical arrangements involving foreign affiliates of Canadian taxpayers. The decision clearly supports a narrow interpretation of the scope of paragraph 95(6)(b). Unless the FCAs decision is overturned on appeal to the Supreme Court of Canada, it is reasonable to anticipate that the CRA will revisit its published administrative positions and assessment policies relating to paragraph 95(6)(b) to ensure that they accord with the FCAs conclusions. As an ancillary matter, the FCAs favourable approach to interpreting paragraph 95(6)(b) may also be instructive in determining the potential breadth of other specific anti-abuse provisions found in the Act.
Bill Maclagan (firstname.lastname@example.org) is a partner and
Soraya Jamal (email@example.com) is an associate in the Vancouver office of
Blake, Cassels & Graydon, the principal Canadian correspondents for the Tax Disputes channel of www.internationaltaxreview.com