CIT Group Securities (Canada) Inc. v. The Queen

The decision in CIT Group Securities (Canada) Inc. v. The Queen is the first to deal with the interpretation of paragraph 95(2)(l) of the Income Tax Act, a complex provision found in the foreign accrual property income (FAPI) rules. This provision deals with the taxation of interest income earned by a foreign affiliate of a Canadian taxpayer as passive income. The provision does not apply if certain conditions are met. First, the Canadian taxpayer must be a regulated financial institution. Second, its foreign affiliate must be a regulated financial institution that carries on the business of a financial institution in that foreign jurisdiction.

The taxpayer succeeded in its appeal. No appeal was taken by the federal government to the Federal Court of Appeal. The Tax Court of Canada determined that the interest income earned by a Barbadian affiliate of CIT Group was not subject to tax by the CRA. The Barbadian affiliate qualified as a “foreign bank” under the Canadian Bank Act and its lending activities were regulated by the Central Bank of Barbados. In such circumstances, the Canadian Income Tax Act could not treat the offshore income as passive income or FAPI.

Canadian taxpayers who have set up offshore subsidiaries to earn interest income will benefit from interpretive guidance regarding the effectiveness of such planning. Moreover, the decision affirms the inability of the CRA to tax in the absence of raising specific statutory provisions which would prevent such taxation. In this regard, the Tax Court of Canada stated the following:

“[170] Second, the Respondent raised neither the general anti-avoidance rule in section 245 nor paragraph 247(2)(b) of the transfer pricing rules. Instead, the Respondent relied solely on the very specific text of paragraph 95(2)(l). The Supreme Court of Canada has long since put to rest the notion that the sophistication of the tax planning alters the manner in which one should interpret specific provisions in the ITA such as paragraph 95(2)(l). In Shell Canada Ltd. v. Canada, the Supreme Court stated:

‘[45] However, this Court has made it clear in more recent decisions that, absent a specific provision to the contrary, it is not the courts’ role to prevent taxpayers from relying on the sophisticated structure of their transactions, arranged in such a way that the particular provisions of the Act are met, on the basis that it would be inequitable to those taxpayers who have not chosen to structure their transactions that way. This issue was specifically addressed by this Court in Duha Printers (Western) Ltd. v. Canada, [1998] 1 S.C.R. 795, at para. 88, per Iacobucci J. See also Neuman v. M.N.R., [1998] 1 S.C.R. 770, at para. 63, per Iacobucci J. The courts’ role is to interpret and apply the Act as it was adopted by Parliament. Obiter statements in earlier cases that might be said to support a broader and less certain interpretive principle have therefore been overtaken by our developing tax jurisprudence. Unless the Act provides otherwise, a taxpayer is entitled to be taxed based on what it actually did, not based on what it could have done, and certainly not based on what a less sophisticated taxpayer might have done.

‘[46] Inquiring into the “economic realities” of a particular situation, instead of simply applying clear and unambiguous provisions of the Act to the taxpayer’s legal transactions, has an unfortunate practical effect. This approach wrongly invites a rule that where there are two ways to structure a transaction with the same economic effect, the court must have regard only to the one without tax advantages. With respect, this approach fails to give appropriate weight to the jurisprudence of this Court providing that, in the absence of a specific statutory bar to the contrary, taxpayers are entitled to structure their affairs in a manner that reduces the tax payable: Stubart, supra, at p. 540, per Wilson J., and at p. 557, per Estey J.; Hickman Motors Ltd. v. Canada, [1997] 2 S.C.R. 336, at para. 8, per McLachlin J.; Duha, supra, at para. 88, per Iacobucci J.; Neuman, supra, at para. 63, per Iacobucci J. An unrestricted application of an “economic effects” approach does indirectly what this Court has consistently held Parliament did not intend the Act to do directly.”

Blake, Cassels & Graydon LLP represented CIT Group before the Tax Court of Canada with a tax team led by Edwin Kroft, QC, and included Paul Tamaki, Deborah Toaze and Casey Richardson-Scott.

The Canadian government was represented by Elizabeth Chasson, Darren Prevost and Leonard Elias.