Inter-Leasing, Inc. v. Ontario (Revenue), 2014 ONCA 575

In order to minimize Alberta corporate tax, the Precision group of companies reorganized, as a result of which:

1. Interest-bearing debts were owing by them to a newly-incorporated company ("Yukon");
2. Yukon owed equivalent interest-bearing debts to the taxpayer, which had been incorporated in the British Virgin Islands but had an Ontario-resident director, and had an Ontario permanent establishment by virtue of making a small investment in an Ontario LP (see 2000-0048685) and was a group subsidiary; such debts were in the form of deeds of specialty debt, which were physically transferred to the British Virgin Islands - this was done to avoid Ontario corporate minimum tax which, under the Corporations Tax Act s. 47(2)(b)(ii), applied only to "property situated in Canada;"
3. The taxpayer channeled the interest income received by it (net of federal tax) back to Precision by a combination of inter-corporate dividends (eligible for the inter-corporate dividend deduction under ITA s. 112 as the taxpayer was a controlled corporation resident in Canada) and interest-free loans.

As a corporation incorporated outside Canada but with a permanent establishment in Ontario, the taxpayer was subject to tax under s. 2(2) of the Corporations Tax Act, but only on income from business, not income from property.

In finding that the interest income of the taxpayer was exempt as income from property, Pardu JA stated (at para. 35) "that the level of activity associated with the once annual payment of interest on each of the four specialty debt instruments does not make this interest income from business," and (at para. 42) that "there was no other business in which income from the specialty debt instruments was employed or risked." Furthermore, the rebuttable presumption articulated in Marconi – that income earned by corporations acting consistently with their objects is income from a business – was not helpful here as "presumably corporations will act within their objects [and] the legislative scheme expressly contemplates a corporation earning income from property." (Para. 32.)

In order to minimize provincial income tax, a Canadian corporate group restructured so that various intercompany debts were owing (on a back-to-back basis through an intermediate company) to the taxpayer which, although it was resident in Canada and had a permanent establishment in Ontario for other tax reasons, was exempt from tax on the interest income by virtue of an exemption in the Corporations Tax Act (Ontario) for income from property earned by a corporation which had been incorporated outside Canada (here, the British Virgin Islands.) For more detail see under s. 115(1)(b) – and respecting the BVI situs issue, see summary under TA, s. 54(2)(b).

In finding found that Ontario's GAAR did not apply, as there was no abuse of the relevant provision, Pardu JA stated (at para. 55) that "in 1959, Ontario adopted the place of incorporation test [for residence], unlike the federal government and all other provinces," referred (at para. 60) to "the deliberate decision not to tax corporations incorporated outside Canada on income from property" and (at para. 61) noted that Copthorne stated that "in some cases the underlying rationale of a provision would be no broader than the text itself." She then stated (at paras. 62, 66):

Here, the purpose of s. 2(2) of the OCTA was to tax corporations incorporated outside Canada with a permanent establishment in Ontario on income from business but not on from income from property. Where such a corporation structures its affairs to earn income from property rather than income from business, it has not…defeated the underlying rationale of the provision… .

The approach taken by the appeal judge - to define the purpose of the provision as to raise revenue and to define the tax base as broadly as possible - renders "abusive" any transaction that has the effect of reducing tax. I do not accept that approach.

In rejecting an argument that situating the specialty debt instruments in the British Virgin Islands was an abusive transaction, Pardu JA noted (at paras. 95-7) that "the rule governing the situs of specialty debts instruments is a long-standing and well-established rule," "the situs for the instruments was not arbitrary, but was a place to which the corporation had some link, namely, its place of incorporation," and "the level of [the taxpayer's] activity in Ontario to generate the income from property was minimal."