Barejo Holdings ULC v. R. - TCC: Unusual security was “debt” for the purposes of the ITA

Barejo Holdings ULC v. R. - TCC:  Unusual security was “debt” for the purposes of the ITA

Barejo Holdings ULC v. The Queen (November 4, 2015 – 2015 TCC 274, Boyle J.).

Précis:   This decision involves one of the oddest procedures seen in the Tax Court in many years:

[1]             The question referred to the Court by the parties pursuant to Rule 58 is whether two contracts, entitled Notes and issued for US $998 million by affiliates of two Canadian banks and guaranteed by those banks, which are held by St. Lawrence Trading Inc. (“SLT”), an open-ended investment fund incorporated under the laws of the British Virgin Islands, constitute debt for purposes of the Income Tax Act (the Act).

The background to this question is a dispute about the application of the foreign affiliate rules or the offshore investment fund rules to the taxpayer:

[4]             The Appellant’s appeals are in respect of its 2004 through 2010 taxation years. By way of broader background context only, the issue raised by the Notices of Appeal that are relevant to this reference concern whether Barejo is required to include its share of SLT’s foreign accrual property income or FAPI pursuant to the section 94.1 offshore investment fund or OIF rules or the subsection 95(1) deemed interest accrual rules for “prescribed debt obligations” by virtue of SLT being a “controlled foreign affiliate” of Barejo. These provisions can apply only if the Notes in question constitute “debt obligations” in the case of subsection 95(1) or “debt” in the case of section 94.1. The French version of the Act uses the word “créance” for both of these terms. Prior to the hearing of this reference motion, the Crown abandoned its subsection 95(1)/12(3)/12(9)/Regulation 7000 prescribed debt obligation argument. It is understood that there are also a number of other Canadian shareholders in SLT with significant ongoing tax disputes which are proceeding separately from the Appellant’s tax appeals.

The parties did not however ask for a ruling whether the Notes were debt for the purposes of section 95 or 94.1 or the applicable Regulations.  Moreover the Court cautioned that with a question framed so broadly there was no guarantee the a different result might apply to specific provisions of the Act:

[13]        In short, the Court in this case is answering the particular question referred to it as best it can. However, the general meaning ascribed to the term debt herein will not necessarily apply in all cases. In the hearing of any other particular case, this Court may give a somewhat different or more nuanced meaning to the term debt depending upon the text and context of a particular provision or régime in the Act, specific provincial or other applicable laws that are relevant to the interpretation of a contract or the characterization of a relationship, or the possible relevance of purpose, objective or intention to the application of the provision or the interpretation or characterization of the contract or relationship, among other things.

The Notes arose as a result of a reorganization that contemplated the introduction of new Canadian rules regarding offshore investments:

[16]        The Appellant was a shareholder in GAM Diversity Inc. (“GAM Diversity”), a British Virgin Islands open-ended investment company, along with other Canadian and non-resident investors. The assets of GAM Diversity consisted primarily of interests in hedge funds and mutual funds. GAM Diversity’s investment manager was Global Asset Management (“GAM”), an independent third party Bermuda corporation.

[17]        GAM Diversity was reorganized in anticipation of announced Canadian tax changes to come into effect in 2002 that would have had substantial adverse tax consequences for Canadian shareholders of GAM Diversity, and which could in turn have led to redemption and liquidity issues for the fund itself as Canadians held approximately 49% of its shares.

[18]        In essence, in late 2001 the non-Canadian shareholders of GAM Diversity exchanged their shares for shares of a new similar investment company which ended up holding the non-resident shareholders’ pro-rata share of GAM Diversity’s underlying assets. GAM Diversity was left wholly-owned by Canadians and continued to hold the Canadian shareholders’ pro-rata share of GAM Diversity’s underlying assets. GAM Diversity was then renamed St. Lawrence Trading Inc.

[19]        SLT then sold all of its assets to non-resident affiliates of The Bank of Nova Scotia (“BNS”) and The Toronto-Dominion Bank (“TD”). Each of Scotiabank (Ireland) Limited and TD Global Finance purchased one-half undivided co-ownership interests in SLT’s assets.

[20]        SLT then used the sales proceeds of US $996 million to purchase one of the Notes from each of two other non-resident affiliates of BNS and TD, Bank of Nova Scotia International Limited and Toronto Dominion International Inc. TD and BNS guaranteed the obligations of their affiliates under the Notes.

[21]        As described in greater detail below and in the ASF, the Notes purchased by SLT from the TD and BNS affiliates remained very much intertwined, legally and economically, with the former SLT asset pool sold to the other TD and BNS affiliates. Further, the former SLT asset pool was required by the agreements entered into between SLT, the Canadian banks and the bank affiliates, to continue to be managed by GAM.

[Footnotes omitted]

The Notes were specifically not interest-bearing and payable only from the asset pool managed by GAM.

The Court held that the Notes were “debt” for the purposes of the ITA:

[134]   The Court determines for purposes of these two appeals that the two Notes held by SLT constitute debt for purposes of the Act.

Decision:   The taxpayer’s position in a nutshell was that a debt does not exist unless and until the principal amount payable is ascertained or ascertainable.  Thus the Notes were not debt until they matured.  The Court rejected this line of argument:

[48]        The Appellant’s principal position is that the generally accepted commercial law meaning of debt is (i) an obligation to pay a sum certain or sum reducible to a certainty, and (ii) that a debt cannot exist unless and until the amount to be paid is certain or can be made certain from facts which are known or knowable.

[49]        There is considerable support for the first part of the Appellant’s position. While helpful, it is not determinative. The supporting case law developed out of procedural rules not substantive concerns, namely whether an amount claimed in the court was an action for liquidated damages, sometimes referred to as an action for debt, or required an assessment of damages and was therefore an action in damages. That is, these cases largely characterize claims under contracts and do not characterize contracts. It can be noted in the case of the Notes in question that it is very clear that, at any time that a payment obligation could arise upon maturity, termination or default, or that an action for payment could be taken by the holder against the issuer, the amount payable under the terms of the Notes was ascertainable and would not require any further assessment by a Court.

[50]        As described below, some of this case law is capable of being read in a manner that is unhelpful to the Appellant.

[51]        The Court does not find the Appellant’s arguments in support of its position well-supported or persuasive. There was little persuasive support put forward by the Appellant for the second proposition that a debt cannot exist until the amount payable is ascertainable to a specific amount. In the circumstances of these Notes, if the Appellant’s position is correct, it would mean that the Notes are not debt prior to maturity even though they would clearly be debt for purposes of this test upon maturity. There is little to no support for an instrument, obligation or contract that is not debt prior to maturity becoming debt upon maturity. This is different than a claim under a contractual obligation that is not a debt being a claim in debt. None of the cases referred to by the Appellant, including the tax cases, set out or applied the rule in such circumstances or to such an extent.

While this decision is complex and scholarly it essentially boils down to one antepenultimate paragraph:

[133]   In the case of the Notes, the reference question must be answered in the affirmative – that the Notes are debt for purposes of the Act:

(i)                They are entitled Notes. In the Act the word notes is described as a debt obligation or indebtedness. It is also used ejusdem generis as a type of debt such as bonds, debentures and notes et cetera. A note is commonly used to describe a debt in business, commercial and financial markets.

(ii)             They have a maturity which can be triggered early in the event of default or at the Note holder’s option. Upon maturity there is a payment obligation that relates clearly, though in a complex fashion, to the amount for which the Notes were issued, and this payment satisfies the obligation in respect of the issue price.

(iii)           The documents giving rise to and referred to in the Notes describe the amount for which they are issued as a Principal Amount that is the amount advanced by the Note holder to purchase the Note from the issuer in each case, being US $499 million.

(iv)           At maturity, however and whenever triggered, that is whenever payment is required to be made, the amount payable by the issuer under the Notes to the Note holder is readily ascertainable with exact precision. Not only is the method of arriving at the amount clear and certain, the person responsible to the parties for arriving at that precise figure is also clearly set out.

(v)             The interest rate is stipulated in the Notes as it was in the Term Sheets. It is reasonable to consider zero to be an amount for these purposes; loans are often described as “no interest” or “interest‑free”. This was presumably set out to make it clear to the parties that there would be no current returns earned or payable. However, the parties did not choose to describe this by reference to distributions of any sort, but limited it to interest.

(vi)           The parties agreed in the Notes that they were to rank pari passu with other debt. The Notes evidence that the parties’ intention was that this be treated like other debt of the issuers. The Notes do not describe this ranking to apply only upon maturity of the Notes.

(vii)        The EAO Notes, which are also equity‑linked notes, are acknowledged in the Notes to be debt for purposes of permitted investments in Reference Assets.

(viii)      The Guarantees provide that the Guarantors would be liable as if they were the primary debtors. The Notes and related agreements do not suggest this is only effective upon maturity of the Notes.

Costs were reserved to the trial judge, subject to any submissions on costs the parties were to have 30 days to make:

[135]   Costs are left to the trial judge, subject to the Court exercising its discretion if written submissions requesting otherwise are received from the parties within 30 days.

Comment:  This decision is as thorough a review of the legal indicia of debt as one is likely to find.  However because it is cast in such a skewed manner as a result of the question asked by the parties it is difficult to know what precedential value it might have.