On May 17, 2010, the Federal Court of Appeal delivered its unanimous decision, (see attached), allowing the taxpayer’s appeal in Lehigh Cement Limited. Lehigh is a cross-border interest strip case. Five years of interest payments on a debt owing by a Canadian resident to a related non-resident were stripped by the related non-resident and sold to an arm’s length Belgian bank. CRA disallowed significant portions of the Canadian borrower’s interest expense and sought to impose Canadian withholding tax. The Tax Court found in favour of the taxpayer on interest deductibility, which the Crown did not appeal, and in favour of the Crown in imposing withholding tax on interest paid to the Belgian bank. As the Crown admitted that the interest payments qualified for the technical requirements of the exemption from withholding tax under subparagraph 212(1)(b)(vii) of the Act and the taxpayer admitted the presence of a tax benefit and avoidance transaction, the sole issue before the Federal Court of Appeal was whether there was a misuse or abuse of the Act for purposes of subsection 245(4).
Referring to the text of the exemption and academic analysis, the Tax Court had held in favour of the Crown, holding that the exemption applied to transactions with a specific commercial purpose, being arm’s length borrowing of capital from a non-resident lender. As the Canadian resident had not borrowed money from the Belgian bank, the Tax Court inferred an abuse of the exemption. Further, the Tax Court found the relationship between the Belgian bank and the non-resident coupon vendor and Canadian borrower was wholly dissimilar to the arm’s length borrower/lender relationship contemplated by the exemption.
The Federal Court of Appeal unanimously reversed this finding, holding that a brief reference in the Department of Finance Budget papers and the articles referred to by the Tax Court provided insufficient support for the finding of abuse, which must be determined on the basis of a textual, contextual and purposive interpretation of the statutory exemption itself. The Federal Court of Appeal cited a provision of the Act, not referred to by the Tax Court, requiring the stamping of interest coupons as exempt or subject to withholding tax, in observing that interest strips had long been a normal aspect of commercial financing transactions and “if there had been a fiscal policy concern requiring the exemption . . be available only where the same person was entitled to be paid the interest and the principal amount, it would have been simple to say so.” The Federal Court of Appeal also noted the Crown’s admission that the exemption would have applied had the Belgian bank purchased the entitlement to repayment of principal together with the coupons and was unable to discern any relevant distinction between the two transactions in terms of the underlying rationale for the exemption alleged by the Crown.
The subparagraph of the Act at issue in Lehigh was repealed effective 2008 as part of the extension of the withholding tax exemption to all arm’s length non-participating interest. Thus, the specific point at issue before the Court may be of largely historical interest. Yet, the Lehigh decision may be significant for what it suggests as to the Federal Court of Appeal’s reconciliation of the Supreme Court’s decision in Lipson with the earlier decisions of that Court in Canada Trustco and Kaulius. The Tax Court heard the case prior to and delivered its decision after the release of the Supreme Court decision in Lipson and noted that Lipson did not affect its finding for the Crown on section 245 (GAAR). The decision of the Federal Court of Appeal appeals directly to the precedent of Canada Trustco, emphasizing in particular that the taxpayer is entitled to the benefit of any doubt as to issue of misuse and that misuse or abuse must be grounded in the textual, contextual and purposive interpretation of the provision of the Act in question. Pending further decisions from the Supreme Court (Copthorne Holdings Ltd., a GAAR case, is currently on appeal to the Supreme Court), Lehigh suggests that the Federal Court of Appeal may not read Lipson as adding appreciable qualification or nuance to these requirements for the application of GAAR set out by the Supreme Court in Canada Trustco. It remains to be seen whether the Crown will seek leave to appeal the Lehigh decision to the Supreme Court.