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2 November 2020

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Supreme Court of Canada Agrees to Hear Case Involving Eligibility for Exclusion of Income Earned by Foreign Subsidiary Bank

On 29 October 2020, the Supreme Court of Canada issued a release to announce that it has granted the application for leave to appeal from the judgment of the Federal Court of Appeal, Number A-321-18, 2002020 FCA 79, dated 23 April 2020 in the case of Her Majesty the Queen v. Loblaw Financial Holdings Inc. (F.C.) (Civil) (By Leave) (39220).

During the taxable years at issue, the taxpayer was a Canadian company that was a parent company of a Barbados-based subsidiary. The subsidiary was a bank licensed in Barbados and was initially funded by capital investments from its affiliates. The subsidiary earned income mostly by entering into investment transactions with arms' length persons. The subsidiary also managed investments for its related persons to a limited extent.

The issue in dispute is whether the subsidiary's income was foreign accrual property income (FAPI), which was required to be included in the taxpayer's income under the FAPI provisions. FAPI income includes income earned by a controlled foreign affiliate from an "investment business". The definition of investment business, however, exempts a business of a regulated foreign bank with greater than five full-time employees, other than a business conducted principally with non-arm's length persons.  

The Tax Court held that the subsidiary could not benefit from the exemption because the subsidiary conducted business principally with related persons. The Tax Court held that a bank's business necessarily involves two sides - receipts and uses of funds, and that almost all of the subsidiary's funds were received from non-arm's length persons.

The Court of Appeals subsequently set aside the Tax Court's decision on the basis that the subsidiary's FAPI consists only of income from investment services provided to non-arm's length parties. The Court of Appeals held that the receipts side of banking should not be considered in determining whether the investment business was conducted principally with non-arm's length parties because the capital investments by the taxpayer's group were not part of the subsidiary's conduct of business.

The Canadian government requested the Supreme Court to hear the case, and the Supreme Court granted the request.

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