http://decisions.fca-caf.gc.ca/fca-caf/decisions/en/item/142788/index.do
TDL Group Co. v. Canada (March 4, 2016 – 2016 FCA 67, Dawson (author), Near, Boivin JJ. A.).
Précis: In a case blogged earlier on this site I reported that the Tax Court denied TDL Group Co. the deduction of interest on a large loan ($234 million) for a period of 7 months in 2002 on the basis that the funds (which were used to purchase shares of a US subsidiary) were ultimately used to advance an interest free loan to Wendy’s International Inc. (“Wendy’s”), the group parent. The loan to Wendy’s was interest free because of concerns about US state taxes and the thin capitalization rule in Canada. Those concerns were resolved and in November of 2002 the loan was restructured to make it interest bearing. CRA allowed the deduction of interest by TDL commencing in November but denied it for the preceding 7 months.
The Federal Court of Appeal adopted a pragmatic, business-like approach to the issue:
[18] Given that the appellant’s purpose is to be assessed at that one point in time, an unanswered paradox runs through the reasons of the Tax Court: how is it that there was no income earning purpose during the first seven months the additional common shares were owned by the appellant, but an income earning purpose thereafter?
That paradox was resolved in favour of TDL. The appeal was allowed with costs both in the Court of Appeal and the Tax Court.
Decision: The facts of this case were not complex:
[4] As the Tax Court noted, most of the relevant facts are not in dispute. A series of transactions began when Wendy’s International Inc. (Wendy’s), the ultimate parent corporation of the Wendy’s group of corporations, lent $234 million (Cdn) to a U.S. subsidiary, Delcan Inc., at a rate of interest not to exceed 7%. The same day, Delcan Inc. lent the full amount to the appellant taxpayer, at an interest rate of 7.125%. Next, the appellant used the full amount of the loan to purchase additional common shares in its wholly-owned U.S. subsidiary Tim Donut U.S. Limited, Inc. (Tim’s U.S.). The next day, March 27, 2002, Tim’s U.S. lent the monies received on account of the appellant’s share subscription to Wendy’s on an interest-free basis, evidenced by a promissory note.
[5] Counsel for the appellant accurately characterized this to be another “money in a circle case”. Thus, money that originated from Wendy’s, and was lent out by it at a 7% rate of return, wended its way back to Wendy’s on an interest-free basis.
[6] Of relevance, in my view, is that the loan to Wendy’s was originally intended to be on an interest bearing basis, although no rate of interest was specified. Concerns arose, however, with respect to the impact an interest bearing note would have on state taxes in the U.S. and on the Thin Capitalization and Foreign Accrual Property Income Rules in Canada. As a result, it was decided the loan would be advanced on an interest-free basis until these concerns could be addressed.
By November of 2002 the underlying problems were resolved and the loan to Wendy’s was restructured as interest bearing. CRA allowed the deduction of interest commencing in November of 2002 but denied it in the preceding 7 months.
The Court of Appeal found two fundamental errors in the Tax Court decision:
[20] The first error resulted from the Court importing into subparagraph 20(1)(c)(i) a requirement that the appellant have a reasonable expectation of receiving income on account of the newly acquired shares within the first seven months of ownership of those shares. Without importing this requirement, one cannot explain how thereafter the shares carried an income earning purpose.
[21] The second legal error flows from the Tax Court’s concern with tax avoidance, hence its conclusion that for the seven month period in question (a period the Tax Court found was intended to be shorter) the “sole purpose of the borrowed funds [was] to facilitate an interest free loan to Wendy’s while creating an interest deduction for the Appellant”.
[22] In Shell Canada Limited v. Canada, [1999] 3 S.C.R. 622, the Supreme Court concluded, at paragraph 47, that this Court’s “overriding concern with tax avoidance not only coloured its general approach to the case, but may also have led it to misread the clear and unambiguous terms of s. 20(1)(c)(i) itself”. In my view, the same error led the Tax Court to its conclusion with respect to the purpose for which the borrowed monies were used.
Similarly, the Court of Appeal rejected the Crown’s somewhat feeble argument that the amount of interest actually paid was “unreasonable”:
[25] In Shell, at paragraph 28, the Supreme Court observed that the reasonableness of the amount paid must be assessed by reference to the first three requirements of interest deductibility. That is, the reasonableness must be assessed by reference to the terms upon which the monies were lent and the purpose for which the borrower used the money.
[26] I have found that the temporary use of the subscription proceeds by Tim’s U.S. did not detract from the appellant’s income earning purpose behind its acquisition of additional shares in Tim’s U.S. The Minister accepted that the rate of interest on the loan from Delcan Inc. was reasonable after the interest-free loan was replaced with an interest bearing loan. On that basis, I accept that the interest paid during the period at issue was also reasonable.
As a result the appeal was allowed with costs both in the Court of Appeal and the Tax Court.
Comment: In my blog of the Tax Court decision I wrote:
TDL may have some hope on an appeal, possibly by asking the Federal Court of Appeal to consider the original interest free loan to Wendy’s and the subsequent interest bearing loan (where CRA allowed a deduction) as part of one transaction.
TDL changed counsel for the appeal and the new counsel seems to have had the same view of the matter as the one I expressed last year.