Alberta Gas Ethylene Co. Ltd. v. The Queen, 89 DTC 5058, [1989] 1 CTC 135 (FCTD), aff'd 90 DT 6419 (FCA)

Reed, J.:—The main issue in this case concerns the extent to which the separate corporate identity of a subsidiary company can be ignored. This question is sometimes phrased by asking, "when do the courts lift the corporate veil”; or perhaps more appropriately "when will a subsidiary company be held to be the agent of its parent".

The facts which raise this question underpin the plaintiff's claim that the withholding taxes alleged to be payable by it, pursuant to Part XIII of the Income Tax Act, are not so payable. The defendant requires the plaintiff to remit withholding taxes in respect of certain interest payments made by the plaintiff to the Alberta Gas Ethylene Company Security Corporation (ASCO). The withholding tax was assessed pursuant to subsections 212(1) and 215(6) of the Income Tax Act:

212(1) Every non-resident person shall pay an income tax of 25% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account or on lieu of payment of, is in satisfaction of . . . (b) interest . . .

215(6) Where a person has failed to deduct or withhold any amount as required by this section from an amount paid or credited or deemed to have been paid or credited to a non-resident person, that person is liable to pay as tax under this Part on behalf of the non-resident person the whole of the amount that should have been deducted or withheld, and is entitled to deduct or withhold from any amount paid or credited by him to the non-resident person or otherwise recover from the non-resident person any amount paid by him as tax under this Part on behalf thereof.

ASCO is a non-resident corporation incorporated in the state of Delaware. Counsel for the plaintiff concedes that ASCO does not carry on business in Canada (in the sense in which that concept is used in income tax law). The funds being paid by the plaintiff to ASCO, from which the defendant requires that Part XIII taxes be withheld, are interest payments on a loan from ASCO to the plaintiff.

ASCO is a wholly owned subsidiary of the plaintiff. The plaintiff, an Alberta corporation, is a wholly owned subsidiary of Nova Corporation of Alberta. In the mid 1970s, Nova decided that a plant should be constructed near Red Deer Alberta to manufacture ethylene. The project also involved the construction of a pipeline for the distribution of the gas. The plaintiff (referred to in the evidence as AGEC) was created in order to construct and manage this project. The project was premised on an agreement by Dow Chemical of Canada (Dow) that it would purchase on a "cost of service basis" all the ethylene which would be produced at the plant. Under that agreement Dow was to pay all costs of constructing the plant, all operating costs (including financing charges) as well as a small percentage profit to the plaintiff.

Financing was needed for the project. The initial proposals contemplated that such financing might be obtained, by way of ten-year income debentures, from a consortium of Canada banks. These included the Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce, Toronto- Dominion Bank and the Royal Bank of Canada. However, the banks insisted on a variable rate interest; Dow and the plaintiff sought a longer term, fixed rate loan arrangement, to match their obligations with respect to the project.

Financing was then sought in the United States. It was arranged that from $325,000,000 to $375,750,000 U.S. would be borrowed for a 23-year period at a fixed rate of interest. In the course of arranging for that loan, the plaintiff was advised that it could obtain a more beneficial rate of interest (25 basis points) if the borrowing was done by a Delaware corporation rather than by the plaintiff directly. The U.S. lenders were insurance companies and restrictions existed with respect to the issuing of non-domestic loans. These restrictions resulted in a preferential interest rate being available for domestic corporations. ASCO was incorporated, therefore, for the purpose of obtaining the loan from the U.S. lenders.

The financing arrangements which were put in place were ones under which ASCO: borrowed the funds from the U.S. lenders; issued promissory notes therefor; deposited the borrowed funds with the Canadian banks and obtained certificates of deposit thereon. The loan from the U.S. lenders to ASCO was secured by: the assets and undertaking of the plaintiff (e.g., a mortgage on the assets of the Red Deer project as well as a floating charge on the plaintiff's undertaking); an assignment by the plaintiff of certain of the payments Dow was obligated to make under the ethylene purchase agreement; a performance guarantee by The Dow Chemical Company (the United States parent corporation which wholly owns Dow Chemical of Canada) of Dow's obligations under the ethylene purchase agreement; a direct guarantee of the loan by The Dow Chemical Company. The financing arrangements provided that once ASCO had deposited the borrowed funds with the Canadian banks, the banks would in turn loan funds to the plaintiff, by way of a purchase of income debentures. The principal security for this loan was the certificates of deposits, held by ASCO on the borrowed U.S. funds, which funds had been deposited in the banks.

The arrangements put in place, by the concurrent execution of the various documents, were such that the interest received monthly by ASCO from the Canadian banks, on the certificates of deposit, mirrored "to a penny" the payment of principal and interest owed to the U.S. lenders on the loan. These payments were made directly by the Canadian banks to the paying agent in New York. They did not go, as an actual transfer, to ASCO although, of course, the receipt of the interest and the payments to the U.S. lenders are properly recorded on ASCO's financial statements.

The loan to ASCO from the U.S. lenders had a 23-year term. The loan from the Canadian banks to the plaintiff, by way of the income debentures, had a ten-year term. A loan agreement between ASCO and the plaintiff, dated September 15, 1977, which was signed as part of the financing arrangements, provided that upon expiry of the ten-year term, or upon earlier prepayment by the plaintiff to the Canadian banks of the amounts owing with respect to the income debentures, the banks would pay to ASCO a corresponding amount of money and the certificates of deposits relating thereto would be redeemed. ASCO, in turn, was to loan the exact same sum of money directly to the plaintiff. On May 28, 1987 the plaintiff prepaid the income debentures in the amount of $165,244,369.86. The Canadian banks repaid the certificates of deposit and ASCO, in turn, made a loan of that amount to the plaintiff as had been agreed. The September 15, 1977 loan agreement provided for payments of principal and interest by the plaintiff to ASCO which mirrored the payments of principal and interest payable by ASCO on the debt to the U.S. lenders. Again, payments on the loan were made directly to the paying agent in New York, not to ASCO. It is the interest components of these payments from the plaintiff to ASCO which the defendant asserts are taxable.

It should be noted that when the financing arrangements were first put in place on September 15, 1977, interest payments of this kind, from the plaintiff to ASCO, would not have been taxable. The exemption provided for in subparagraph 212(1)(b)(vii) of the Income Tax Act would have applied. That subparagraph exempts from Part XIII taxes:

(vii) interest payable by a corporation resident in Canada to a person with whom that corporation is dealing at arm's length on any obligation where the evidence of indebtedness was issued by that corporation after June 23, 1975 and before 1989 if, under the terms of the obligation or any agreement relating thereto, the corporation may not, under any circumstances, be obliged to pay more than 25% of, . . . the principal amount of the obligation, within 5 years from the date of issue of that single debt issue or that obligation, as the case may be . . .

ASCO in September of 1977 would have been considered a resident Canadian corporation. At that time it was possible for a corporation to have dual residences and ASCO would have had such. As of May 1985, however subsection 250(5) of the Income Tax Act was added. It provided:

Notwithstanding subsection (4), for the purposes of this Act, a corporation, other than a prescribed corporation, shall be deemed to be not resident in Canada at any time if, by virtue of an agreement or convention between the Government of Canada and the government of another country that has the force of law in Canada, it would at that time, if it had income from a source outside Canada, not be subject to tax on that income under Part I.

This subsection, when read together with the Canada-U.S. Income Tax Convention (1980), Article IV, made ASCO a resident of the United States (its country of incorporation) and not a resident of Canada (the country of its management and control). See: D.T. Dalsin, Canada-U.S. Dual Resident Corporation: Tax Planning Restricted, (1986), 34 Can. Tax J. 621 for a discussion of this change in the law.

Despite the fact that ASCO is no longer under the Act a resident of Canada, counsel for the plaintiff argues that the plaintiff should not be required to withhold the taxes on payment of the interest to ASCO. It is argued that: ASCO has no existence independent of the plaintiff; ASCO is "a straw man”, “a shell company", no more than a borrowing arm of the plaintiff. Counsel contends that one should “lift the corporate veil” and look at the substance of the loan transaction in question; that when this is done, it becomes obvious, that ASCO is doing nothing more than carrying on the business of the plaintiff. Alternatively, it is argued that ASCO is an agent, a mere nominee of the plaintiff. If one accepts either of these analyses then, it is argued, the payments of interest, with respect to the loan, should be treated as being made by the plaintiff, not to ASCO, but to the U.S. lenders from whom the funds were borrowed. As such, the interest payments would be exempt from withholding tax pursuant to subparagraph 212(1)(b)(vii) of the Income Tax Act, because those lenders unlike ASCO are arm's length entities.

The facts underlying this argument are as follows: ASCO had no business premises of its own, no employees; its officers and directors are the nominees of the plaintiff as well as being officers and directors of that company; ASCO had no stationery, no telephone, no bank account. As noted, ASCO did not and does not itself actually deal with the moneys paid to it as interest nor with the amounts remitted to the U.S. lenders. These amounts were remitted directly, first by the Canadian banks and then by the plaintiff, to the New York paying agent. ASCO is obligated not to incur any indebtedness other than that permitted by the September 15, 1977 agreements (section 7.05 of the Deed of Trust and Mortgage, the parties to which are the plaintiff, ASCO, the National Trust Company and the Morgan Guarantee Trust Company of New York and section 13.16 of the Income Debenture Purchase Agreement between the plaintiff and the Canadian banks). ASCO is obligated not to engage in any business activity or make any investments other than those required under the September 1977 financing documents (section 7.05 of the Deed of Trust, supra, and section 16.9 of the Income Debenture Purchase Agreement, supra). The scheme is set up so that ASCO cannot make a net profit. As counsel stated: “its financial statements are a wash”. ASCO has no assets other than the certificates of deposits and a minimal amount of what might be called "petty cash”.

Counsel for the plaintiff cites in support of his argument: Smith, Stone and Knight, Ltd. v. Lord Mayor, Aldermen and Citizens of the City of Birmingham, [1939] 4 All E.R. 116 (K.B.); City of Toronto v. Famous Players Canadian Corporation Ltd., [1936] S.C.R. 141 affirming [1935] 3 D.L.R. 327 (O.C.A.); Aluminum Company of Canada Limited v. Corporation of the City of Toronto, [1944] S.C.R. 267; [1944] C.T.C. 155; Dominion Bridge Company Limited v. The Queen, [1975] C.T.C 263; 75 D.T.C. 5150 (F.C.T.D.); affirmed [1977] C.T.C. 554; 77 D.T.C. 5367; The Queen v. Mer Ban Capital Corporation Limited et al., [1985] C.T.C. 1; 85 D.T.C. 5014 (F.C.T.D.).

The Smith case, cited by counsel for the plaintiff, sets out six criteria which have been used in cases when determining whether to disregard the separate legal entity of a subsidiary corporation and depart from the principle set out in Salomon v. Salomon & Co., Salomon & Co. v. Salomon, [1897] A.C. 22 (H.L.). Those six criteria are: whether the profits of the subsidiary are treated as the profits of the parent; whether the persons conducting the business of the subsidiary were appointed by the parent company; whether the parent was the head and brains of the subsidiary; whether the parent governed the adventure (of the subsidiary); whether the subsidiary made its profits by its own skill and direction, or by that of its parent; whether the parent was in effectual and constant control of the subsidiary. (There is obviously some redundancy in this list.) While not a tax case, the Smith case purported to draw the six criteria from revenue cases.

I have difficulty with counsel's argument. As I read the jurisprudence, it does not establish that it is sufficient to consider the six criteria and when they are all met (as they are in the present case) to ignore the separate legal existence of the subsidiary company. One has to ask for what purpose and in what context is the subsidiary being ignored. What is more, I do not intepret the jurisprudence as ignoring the existence of subsidiary corporations per se. Rather, it seems to me that the jurisprudence proceeds on the basis that in certain circumstances, consequences will be drawn despite the legal existence of separate subsidiary corporations. Thus, in cases where business expenses or business losses are being determined, it has been held that despite the existence of a separate subsidiary corporation, losses incurred by the subsidiary may, in certain circumstances, properly be characterized as losses of the parent.

The Smith case dealt with a claim to compensation for expropriated property. The business in question was run by the parent although the business assets (including a tenancy of the premises being expropriated) technically belonged to the subsidiary. On the facts of that case it was held that the parent could appropriately claim compensation for the losses which would arise as a result of the expropriation of the business because the subsidiary, to the extent that it had any independent legal existence at all, was the agent of the parent. The Mer Ban case dealt with the proper characterization of business losses. The parent company claimed as a business expense an amount of money which it had paid to honour a guarantee it had given with respect to a bank loan made to a corporation twice removed in the corporate chain from it. Mr. Justice Joyal looked at the associated group of companies in question and concluded that, on the facts, the whole enterprise was the parents'. He concluded that in reality the parent was primarily liable for the debt owed regardless of the fact that it had been described as a guarantor and regardless of the legal interposition of two corporate entities.

In the Dominion Bridge case, Mr. Justice Décary refused to allow a taxpayer to claim certain expenses relating to a subsidiary because he found the subsidiary to be a sham (decision affirmed by the Federal Court of Appeal, supra). Mr. Justice Décary determined that the subsidiary in question had been created offshore (Bahama Islands) to resell offshore steel to the Canadian parent at 95 per cent of the domestic (i.e., North American) price, thereby permitting the parent to effect an overall saving in costs while leaving profits in the subsidiary which could then be repatriated tax free by way of dividends. The Minister assessed the profits of the subsidiary as being those of the parent. The other two cases cited by counsel for the plaintiff, the Famous Players case and the Aluminum Company case, deal with the determination of income for the purpose of assessing municipal business taxes. I do not think they add anything to the analysis required in this case.

The facts before me do not involve entitlement to compensation on expropriation, the proper characterization of business profits, business expenses or business losses for tax purposes. More importantly however, in the jurisprudence cited the focus is on the characterization of the losses, expenses or profits of the parent as such, not on the existence of the subsidiary corporation per se. The argument put to me, in this case, is qualitatively different. It is the very existence of the corporation which I am being asked to ignore. I am not being asked to “lift the corporate" veil, I am being asked to deny that it exists. I do not think the present fact situation falls within the jurisprudence cited.

Perhaps my difficulty in accepting counsel's argument can best be illustrated by reference to his agency argument. Indeed, I note that Welling, Corporate Law in Canada (1984) at 139-40, is of the opinion that all "corporate veil” cases are best analyzed in terms of agency or partnership analyses:

It seems clear that nearly all conclusions reached in cases where judges have "pierced the corporate veil” could probably have been reached through an agency, partnership or similarly legitimate analysis. Had these analyses been used consistently over the past 50 years, we should now have some clear precedents establishing the dividing line between Salomon's case, whose conclusion and reasoning are now irrefutable, and cases like Wallersteiner v. Moir [[1974] 1 W.L.R. 991 (C.A.)] and D.H.N. Food Distributors Ltd. v. Tower Hamlets London Borough Council; Bronze Investments v. Same [[1976] 1 W.L.R. 852 (C.A.)], whose raw conclusions make sense, but whose reasoning make distinguishing Salomon a difficult proposition.

In any event, an agent cannot accomplish on behalf of a principal that which the principal itself could not legally accomplish: Denison Mines Limited v. M.N.R., [1971] F.C. 295; [1971] C.T.C. 640, affirmed [1972] F.C. 1324; [1972] C.T.C. 521 (F.C.A.). The plaintiff itself could not have obtained the loan which ASCO obtained from the U.S. lenders. The plaintiff would have had to pay a higher interest rate. In such circumstances ASCO cannot be said to be merely the agent of the plaintiff vis-à-vis the U.S. lenders. For the same reason ASCO's business vis-à-vis the U.S. lenders cannot be said to be merely the business of the plaintiff. Accordingly, I think it would be incorrect to ignore the existence of ASCO for Part XIII taxes and find as a fact that the loan in question was between the plaintiff and the U.S. lenders directly.

Counsel for the defendant argues that ASCO, while a passive company, is not a sham; that the plaintiff having set up the corporation cannot now be allowed to treat it as a ghost or as non-existent (see The Queen v. Curd's Products Company Limited, [1985] 2 C.T.C. 85 (F.C.A.) at 94; 85 D.T.C. 5314 at 5321). Counsel argues that accepting the plaintiff's argument with respect to the lifting of the corporate veil would create a loophole in Part XIII of the Income Tax Act.

The plaintiff's argument that ASCO is “a sham", cannot succeed. In the first place ASCO was not constructed to create a false impression. It, therefore, would not fall within the concept of sham as set out in Stubart Investments Limited v. The Queen, [1984] 1S.C.R. 536; [1984] C.T.C. 294. Secondly, the decision of the Federal Court of Appeal in Massey Ferguson Limited v. The Queen, [1977] 1 F.C. 760; [1977] C.T.C. 6 is directly on point. At pages 771-2 (C.T.C. 16), Mr. Justice Urie in writing for the Court said:

. . . The condition necessary to find a transaction to be a sham, namely not in fact to have created the legal rights and obligations which appear to have been created, thus was not present, with the result that the learned Trial Judge erred, in my view, in finding that it was a sham. The legal rights and obligations having been created and the bona tides of Perkins need for the money advanced not having been challenged the loan to Verity by the Appellant took it outside the purview of section 19(1).

As I see it, reading this conclusion is not inconsistent with the decision of this Court in Minister of National Revenue v. Anthony Thomas Leon [76 D.T.C. 6299], Court No. A-232-74. In that case it was held that there was no bona fide business purpose, merely a tax purpose for the interposition of the management company

In the present case, not only was there no deception or false impression sought to be created but ASCO was set up for and did actually serve a valid business purpose: to obtain a lower rate of interest from the U.S. lenders. ASCO is not a sham. Nor can it be said to be merely the agent of the plaintiff in so far as the loan transaction is concerned.

For the reasons given the plaintiff's claim is dismissed. The defendant shall have her costs of the action.

Claim dismissed.