Words and Phrases - "portfolio investment"

The Canadian-resident taxpayers were shareholders of a BVI company (“SLT”) which, in turn, held notes issued by two foreign subsidiaries of two Canadian banks (“BNSIL” and “TDII”). The notes were payable in 15 years' time and the amount payable was calculated by reference to the performance of a reference portfolio of equities or bonds.

CRA considered that there was a requirement to recognize deemed interest income on the notes under Reg. 7000(2)(d) given that, in contrast to the usual equity-linked notes that were available to investors at the time, these notes had “internal puts,” i.e., SLT had the right to terminate the notes at any time, on 367 days’ notice, at the market value of the reference assets. On this basis, it considered that the “the maximum amount of interest thereon that could be payable thereunder in respect of that year” was the difference between the maximum value of the reference assets at the end of the year and the maximum value in the prior years, and assessed accordingly, to treat such annual increase as foreign accrual property income of SLT under element C of the s. 95(1) FAPI definition.

Hamilton JCS rejected the taxpayers’ submissions that it was unreasonable of CRA to assess on the basis that the notes were “portfolio investments” within the meaning of s. 94.1, stating (at paras. 364-366):

[T]he term “portfolio investments” describes the nature of the investments as opposed to the number of investments (that would be “portfolio of investments”) or the number of trades. …

[T]he Notes… are investments by SLT in debt instruments of BNSIL and TDII, which are non-resident entities. SLT does not exercise any influence or control over the Notes or the issuers of the Notes. Rather, SLT wishes to passively benefit from the appreciation in value of the Notes.

In any event, the SLT shares are OIF caught by Section 94.1 ITA if they may “reasonably be considered to derive [their] value, directly or indirectly, primarily from portfolio investments of that or any other non-resident entity”. It is clear that the shares of SLT derive their value indirectly from the Reference Assets.

In also considering that it was reasonable for CRA to consider that the tax motive referenced in s. 94.1 was present, he noted that the shareholders of SLT, a BVI company, were Canadian residents, and that they had participated in a 2001 reorganization to avoid adverse Canadian tax consequences of proposed “FIE” rules, and stated (at para. 382):

It is difficult to understand what exactly the Plaintiffs would argue to say that tax consequences were not one of the reasons for the original incorporation in the British Virgin Islands or the 2001 reorganization. They have had ample opportunity to present any relevant evidence and they have not done so.

However, in nonetheless going on to find that these assessments were unreasonable, Hamilton JCS found that, in its previous published positions, CRA had “never suggested that the [mere] possibility of locking-in the bonus means that an amount can be accrued based on the highest value of the index in the year” (para. 439). It was also unreasonable for CRA to assess all of the increase in value of the Note in the taxation years prior to 2005 (which were statute-barred) in its reassessments for the 2005 taxation year.