In ENMAX Energy Corporation v Alberta, 2016 ABQB 334, an Alberta court usefully confirmed that the arm’s length standard does not govern the interest rate on a loan made entirely within a Canadian corporate group.  The legal context involved of an Alberta statute which incorporated the interest deductibility test in s. 20(1)(c), which in part limits a deduction for interest to an amount that is “reasonable”.  The Court usefully summarized the relevant legal principles to be applied in this context (which principles could equally apply to other provisions using a reasonableness standard):

  1. The overall policy of Parliament is that tax law be certain, predictable and fair so that taxpayers can intelligently order their affairs.  In particular, courts should not interpret the substantive provisions based on concerns about tax avoidance, because taxpayers are fully entitled to structure their transactions in a manner that reduces taxes (see paragraph 84).
  2. Reasonableness must be measured with reference to the actual legal transaction undertaken between the group companies, not transactions that might have made in the open market (see paragraph 99).
  3. A deal that might have been struck in an arm’s length transaction may be a relevant factor to consider, but does not define what is reasonable (see paragraph 108).
  4. Reasonableness does not connote a precise, correct amount; rather, it allows for a range (see paragraph 114).  
  5. The CRA or a court can only intervene if no reasonable business person would have contracted to pay the interest in question (Gabco Ltd. v. MNR, [1968] 2 Ex. C.R. 511).  In this respect, a taxpayer’s own explanation and rationale in the circumstances of great import (see paragraphs 95, 115 and 116).
  6. There can easily exist non-arm’s length circumstances in which a decision to pay more (or presumably less) than fair market value is a perfectly reasonable decision (see paragraph 110; Petro-Canada v. The Queen, 2004 FCA 158 at paragraph 64). 

On the facts and evidence, the court found that the interest rate on inter-company debt was greater than an arm’s length rate, but this was not fatal (see paragraph 269).  Interest was paid pursuant to a documented arrangement specially constructed to meet the business policy objectives of the whole corporate group, which pursued a strategy of establishing a parent as the source of internal funding and external financing.  This gave rise to intangible benefits which were difficult to quantify (see paragraph 267).  Accordingly, the interest was not outside what any business would have contracted to pay in the circumstances of these subsidiaries (see paragraph 269).