Canada: Canadian Federal Court Of Appeal Finds Anti-Avoidance Rule Applicable To Foreign Affiliates Has Limited Scope

Last Updated: May 12 2014
Article by Lyne M. Gaulin

The Canadian Federal Court of Appeal (the "FCA") recently rendered its much anticipated decision in The Queen v. Lehigh Cement Ltd. et al. 1("Lehigh") which considered whether the anti-avoidance rule in paragraph 95(6)(b) of the Income Tax Act (Canada)2 (the "Tax Act") applied to deny tax benefits from a refinancing transaction involving a foreign affiliate3 ("FA"). The FCA agreed with the conclusion of the Tax Court of Canada ("TCC")4 that this anti-avoidance rule should not apply in this case but for very different reasons.


The anti-avoidance rule at issue in paragraph 95(6)(b) generally provides that, where it can reasonably be considered that the principal purpose for the acquisition or disposition of shares of a non-resident corporation is to permit a person to avoid, reduce or defer the payment of tax or any other amount that would otherwise be payable under the Tax Act, that acquisition or disposition is deemed not to have occurred. This anti-avoidance rule is part of the Canadian FA regime and where it applies it may prevent a Canadian resident taxpayer from taking advantage of the tax benefits of the FA regime in respect of an acquisition of shares of a non-resident corporation. Alternatively, this rule may prevent a Canadian resident taxpayer from avoiding certain negative aspects of the FA Regime by disposing of the shares of a non-resident corporation.

One tax benefit of the FA regime is that dividends received by a Canadian resident corporation from an FA that are paid out of exempt surplus of the FA can generally be deducted in computing the income of the Canadian resident corporation under paragraph 113(1)(a) of the Tax Act. The exempt surplus of an FA generally includes earnings from an active business carried on by the FA in a country or jurisdiction that has a comprehensive tax treaty or tax information exchange agreement with Canada. Passive income earned by an FA may also be treated as active business income if certain conditions are met. This is the tax benefit that was under review in Lehigh.


The taxpayers in this case are Lehigh Cement Ltd. ("Lehigh Canada") and CBR Alberta Ltd. ("CBR Canada"), two Canadian resident corporations that are part of a multi-national group (the "CBR Group") with cement manufacturing and selling operations in Europe, North America and Asia. The CBR Group is ultimately controlled by a Belgian company. The CBR Group undertook certain transactions in 1995 involving the taxpayers and other non-resident corporations in the CBR Group to refinance the debt and equity of CBR Cement Corporation ("CBR US"), a sister corporation of Lehigh Canada incorporated under the laws of the United States.

As part of the refinancing, the taxpayers formed CBR Developments NAM LLC ("NAM LLC"), a limited liability company under the laws of the State of Delaware, which was structured as an FA of both taxpayers. Lehigh Canada held a 99% interest in NAM LLC and CBR Canada held the remaining 1% interest.

Lehigh Canada borrowed money in two tranches of US$60 million and US$40 million from a third party lender bearing interest at rate of 6.7% and 6.84% per annum, respectively. Lehigh Canada used the borrowed funds to make capital contributions to NAM LLC in the amount of US$99 million and to subscribe for preferred shares of CBR Canada in the amount of US$1 million. CBR Canada used the proceeds from the preferred share subscription in the amount of US$1 million to make capital contributions to NAM LLC. NAM LLC in turn used the funds from these capital contributions to make two loans to CBR US in the amount of US$60 million and US$40 million bearing interest at a rate of 8.25% per annum.

The refinancing was expected to generate a tax benefit of approximately US$1.92 million per year in Canada and US$1.19 million per year in Belgium. The Canadian tax savings were dependent on NAM LLC being treated as an FA of the taxpayers. If NAM LLC was so treated, the taxpayers would be entitled to deduct in computing their income for Canadian tax purposes dividends paid by NAM LLC out of its exempt surplus under paragraph 113(1)(a) of the Tax Act. This would also mean that Lehigh Canada would be able to deduct interest paid on the money borrowed to purchase shares of NAM LLC and CBR Canada against other income.

The Minister of National Revenue (the "Minister") reassessed the taxpayers on the basis that the anti-avoidance rule in paragraph 95(6)(b) was applicable to the acquisition of the NAM LLC shares by Lehigh Canada and CBR Canada. As a result, the shares of NAM LLC were deemed not to have been acquired by Lehigh Canada and CBR Canada and the deduction claimed by the taxpayers for dividends paid by NAM LLC out of its exempt surplus under paragraph 113(1)(a) of the Tax Act was denied. The Minister also relied on the general anti-avoidance rule (the "GAAR") in section 245 of the Tax Act in reassessing the taxpayer but that position was abandoned before trial. The taxpayers appealed the Minister's decision to the TCC.


At the TCC, the taxpayers put forth the argument that, based on a textual, contextual and purposive approach, the scope of paragraph 95(6)(b) should be limited to situations where an acquisition or disposition of shares of an FA is carried out to manipulate the ownership status as an FA and the principal purpose of the share acquisition or disposition in and of itself (not the purpose of the series of transactions of which the acquisition or disposition may form part) is to avoid tax. For its part, the Minister argued that this anti-avoidance rule should be given a broad interpretation using the same approach that is used for the interpretation of the GAAR in section 245 of the Tax Act.

The TCC did not agree with the taxpayers that the scope of paragraph 95(6)(b) should be so limited. Instead, the TCC decided to give the scope of this anti-avoidance rule a broad interpretation and made various findings in this regard. Of particular concern was the TCC's finding that the anti-avoidance rule in paragraph 95(6)(b) is broad enough to encompass "any acquisition or disposition of shares that is principally tax-motivated" and that the overall purpose of the "series of transactions" should be considered in making such a determination. The latter finding was particularly troubling since paragraph 95(6)(b) does not include the words "series of transactions".

The TCC ultimately decided in favour of the taxpayers based on the taxpayers' alternative argument that no Canadian taxes otherwise payable under the Tax Act were avoided as a result of the acquisition of the NAM LLC shares because the taxpayers could have obtained the same tax benefits in the form of interest deductions under paragraph 20(1)(c) of the Tax Act and dividend deductions under paragraph 113(1)(a) of the Tax Act by investing directly in the shares of CBR US. The Minister decided to appeal the TCC's decision to the FCA.


In reviewing the scope of the anti-avoidance rule in paragraph 95(6)(b) of the Tax Act, the FCA applied the governing principles of statutory interpretation established by the Supreme Court of Canada ("SCC") in Canada Trustco Mortgage Co. v. R ("Canada Trustco").5 Accordingly, the FCA's review was based on a textual, contextual and purposive analysis of this anti-avoidance rule to find a meaning that is harmonious with the Tax Act as whole. In particular, the FCA relied on the finding of the SCC in Canada Trustco that the ordinary meaning of the words of a provision must play a dominant role in the interpretative process where the words of the particular provision are precise and unequivocal.

Textual Analysis – Wording of Paragraph 95(6)(b) Precise and Unequivocal

The FCA found that the words used in paragraph 95(6)(b) were precise and unequivocal and therefore their ordinary meaning should be applied. The FCA was of the view that reading in the words "a series of transactions" in paragraph 95(6)(b), as argued by the Crown, would inject "intolerable uncertainty" into the Tax Act and undermine "consistency, predictability and fairness". Based on its textual analysis of paragraph 95(6)(b), the FCA held that it is the principal purpose for the acquisition or disposition of the shares of a non-resident corporation that is relevant in paragraph 95(6)(b) and not the principal purpose of the series of transactions of which the particular acquisition or disposition forms a part.

Contextual and Purposive Analysis – Supports Paragraph 95(6)(b) Precise and Unequivocal Wording

Contextual Analysis

The FCA conducted a review of certain contextual factors to confirm that the wider context of paragraph 95(6)(b) within the Tax Act supported its precise and unequivocal wording. The FCA considered various examples of tax provisions6 in the Tax Act that include the words "a series of transactions" where Parliament wanted the scope of certain provisions to be broad in order to catch tax benefits resulting from a series of transactions. In the case of paragraph 95(6)(b) of the Tax Act, the FCA noted that Parliament had knowingly chosen not to include these words.

The FCA also considered certain technical amendments7 to the Tax Act enacted after paragraph 95(6)(b) to address particular tax avoidance techniques involving FAs. According to the FCA, these amendments would not have been necessary if paragraph 95(6)(b) was a broad anti-avoidance rule as argued by the Minister. This constituted further evidence that paragraph 95(6)(b) is one of many anti-avoidance provisions aimed at specific tax avoidance techniques and should be interpreted as such.

The FCA focused on the architecture of the Tax Act in relation to where paragraph 95(6)(b) appears in the Tax Act. The FCA noted that paragraph 95(6)(b) appears in Subdivision i of the Tax Act ("Shareholders of Non-Resident Corporations") of Division B ("Computation of Income") of Part I of the Tax Act and not in more general parts of the Tax Act such as Part XVI ("Tax Avoidance"). In the FCA's view, this architecture supported the conclusion that paragraph 95(6)(b) is meant to address specific concerns about whether a particular acquisition or disposition of shares of a non-resident corporation should be considered when computing income rather than other transactions or more general tax avoidance concerns.

Based on its contextual analysis, the FCA concluded that the specific tax avoidance addressed by paragraph 95(6)(b) is the "manipulation of share ownership of the non-resident corporation to meet or fail the relevant tests for foreign affiliate, controlled foreign affiliate or related-corporation status[...]."8 In support of its conclusion, the FCA stated that:

"Taxpayers can easily manipulate [FA] status by acquiring or disposing
of shares. Paragraph 95(6)(b) creates a fix by requiring in appropriate cases
that the acquisition or disposition be ignored. Under this interpretation
the fix fits the problem. It would take clearer wording to lead to the
conclusion that the fix in paragraph 95(6)(b) is aimed at a broader problem."9

Purposive Analysis

The FCA thought it useful to examine the underlying purpose of paragraph 95(6)(b) by considering the tax implications associated with the Minister's interpretation of this paragraph. The Minister gave a broad interpretation to the scope of paragraph 95(6)(b) and argued that it can be applied in a variety of circumstances where a taxpayer has engaged in what the Minister considers to be abusive tax planning even where there is no manipulation of share ownership. The Minister also expressed the view that paragraph 95(6)(b) would only be applied where the tax avoidance is "unacceptable".

The FCA gave a hypothetical common example of what would be the tax implications if the Minister's broad interpretation of paragraph 95(6)(b) was adopted. The scenario involved a Canadian resident taxpayer that borrows money to buy shares in a non-resident corporation. In this situation, the tax benefits (i.e., deductibility of interest on borrowings and deduction for dividends paid by FA) will generally always be taken into account in the taxpayer's decision-making process.

The FCA was concerned that if the Minister's interpretation was adopted, it would mean that the application of paragraph 95(6)(b) may always be an issue in this common scenario. Since there is no limiting factor on the Minister's discretion in paragraph 95(6)(b) like in section 245[10], this could lead to the indiscriminate use of paragraph 95(6)(b) whenever the Minister considers based on its subjective judgment that a situation involving an FA is "unacceptable".

In rejecting the Minister's interpretation, the FCA expressed its disapproval as follows:

"Absent clear wording, I would be loath to interpret paragraph 95(6)(b)
in a way that gives the Minister such a broad and ill-defined discretion
- a standardless sweep – as to whether or not a tax is owing limited only
by her view of unacceptability. It would be contrary to fundamental principle.
It would also promote arbitrary application, the bane of consistency,
predictability and fairness."11


Although the FCA disagreed with the TCC's broad interpretation of the scope of paragraph 95(6)(b), it concluded that the TCC had not erred in principle because it had in substance rejected the submission that the taxpayers' principal purpose was to manipulate the share ownership of NAM LLC. The FCA agreed with the taxpayer's narrow interpretation of the scope of paragraph 95(6)(b) and dismissed the Minister's appeal.

The FCA's decision to limit the scope of paragraph 95(6)(b) to specific tax avoidance is welcome news for taxpayers. In particular, the FCA's refusal to treat an anti-avoidance rule as a general anti-avoidance rule where such rule does not expressly include factors that would limit the Minister's discretion. This decision includes many findings that should assist taxpayers and their advisors in determining the scope of other anti-avoidance rules in the Tax Act.


1.2014 FCA 103.

2.R.S.C. 1985, c.1 (5th Supplement), as amended.

3.A foreign affiliate of a Canadian resident taxpayer generally means a non-resident corporation in which the Canadian resident taxpayer's direct or indirect ownership interest in any class of shares is at least 1 percent and the total direct or indirect ownership interest of the Canadian resident taxpayer and related persons in any class of shares is at least 10 percent.

4. Lehigh Cement Ltd. v. The Queen (2013 TCC 176). Please click on following link for article on the TCC decision: Lyne M. Gaulin and Patrick Déziel, "Anti-Avoidance Rule Does Not Apply to Tax Benefit from Refinancing Transactions Involving Foreign Affiliate - At Least this Time", Practical International Tax Strategies, Volume 17, Number 13 (August 31, 2013) at pp. 7 to 10.

5. [2005] 2 SCR 601.

6. For example, subsections 55(2), 83(2.1), 129(1.2), the definition of "term preferred share" in section 248 and section 245.

7. Subsection 17(2) in 1999, section 18 in 2007, and section 212.3 in 2013.

8. Supra note 1 at paragraph 56.

9. Supra note 1 at paragraph 55.

10. The application of the GAAR in section 245 of the Tax Act is subject to, among other things, the misuse or abuse test in subsection 245(4).

11. Supra Note 1 at paragraph 67.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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