In Inter-Leasing, Inc. v. Ontario (Revenue), 2014 ONCA 575, rev’g 2013 ONSC 2927, the Ontario Court of Appeal (OCA) upheld an internal group financing arrangement which eliminated provincial income tax on interest paid by Alberta-based companies (Alberta Cos) to a BVI-incorporated company having a permanent establishment (PE) in Ontario (BVI Co).  The Alberta Cos deducted the interest for both federal and Alberta income tax purposes (on this point, see Husky Energy Inc. v. Alberta, 2012 ABCA 231, leave to appeal refused [2012] S.C.C.A. 411).  BVI Co paid federal tax on the interest received, but claimed it was exempt from any Ontario tax on that interest.  Ontario reassessed BVI Co for provincial income tax on the ground that either (1) its interest income was “income from a business” carried on in Ontario, or (2) the arrangement was abusive tax avoidance which could be set aside under Ontario’s general anti-avoidance rule (GAAR).  Ontario won at trial.  On appeal, the OCA soundly rejected both arguments:

  1. The interest income was not income from a business, but rather was income from property – having regard to the Supreme Court of Canada’s decisions in Canadian Marconi Company v. The Queen, [1986] 2 S.C.R. 522 and Ensite Ltd. v. The Queen, [1986] 2 S.C.R. 509.  The rebuttable presumption that a corporation carries on a business was “not helpful” (paragraph 31), and the activities associated with earning the interest income were virtually non-existent (paragraph 35).
  2. The internal financing did not result in abusive tax avoidance.  Prior to 2005, Ontario made a clear and deliberate choice to tax corporations based on place of incorporation – not residence (paragraph 55).  That is, under the applicable provision a corporation incorporated outside Canada (and having a PE in Ontario) was subject to tax on its income from business, but not on its income from property (paragraph 56).  Here was a clear example where the underlying rationale of the provision was no broader than the text itself (paragraph 61).  Accordingly, the internal financing arrangement did not produce a result that the provision sought to prevent, did not defeat the underlying rationale of the provision, and did not frustrate the object, spirit or purpose of the provision (paragraph 62).  The fact is that provincial tax systems can differ, and the risks of differential tax treatment which can arise as a result have long been recognized (paragraph 58).

The OCA also rejected Ontario’s claim for corporate minimum tax.  The debt instruments held by BVI Co were situated outside Canada, and the GAAR did not apply to alter that result.