Ensite Ltd. v. R., [1986] 2 S.C.R. 509
Ensite Limited Appellant
v.
Her Majesty The Queen Respondent
indexed as: ensite ltd. v. r.
File No.: 18005.
1986: May 21; 1986: November 6.
Present: Dickson C.J. and Beetz, McIntyre, Chouinard and Wilson JJ.
on appeal from the federal court of appeal
Income tax ‑‑ Calculation of “foreign investment income” for purposes of “dividend refund” ‑‑ Foreign currency required by Philippine law for establishment of plant there ‑‑ Elaborate plan to avoid peso devaluation and possibility of currency controls ‑‑ Plan involving U.S. dollar deposits in the Philippines ‑ Interest from these deposits included in calculation of “foreign investment income” ‑‑ Whether interest foreign investment income or income from property used in course of carrying on business ‑‑ Income Tax Act, S.C. 1970‑71‑72, c. 63, ss. 89(1), 125, 125.1, 129(1), (4).
Appellant, which had to finance its plant in the Philippines with foreign currency in order to comply with Philippine law, became involved in an elaborate arrangement to minimize the risks of devaluation and currency controls. Appellant made U.S. dollar deposits with the commercial banks, which then made the peso loans in an equivalent amount to appellant at its Philippine branch and in return received certificates of deposit for the U.S. dollar deposits which were then used to secure the peso loans. The certificates were "enforceable" against any branch of the commercial banks outside the United States. The pesos were obtained in exchange for U.S. dollars by the commercial banks from the Central Bank of the Philippines under agreements guaranteeing the rate of exchange of any conversion back to U.S. dollars.
In 1976, appellant claimed a "dividend refund" under s. 129(1)(a). The tax scheme contemplated that an increase in a corporation's "foreign investment income" might result in an increase in its "dividend refund". Appellant included the interest from its U.S. dollar deposits in the Philippines in the calculation of its "foreign investment income".
The Minister reassessed the return and refused to recognize the interest as "foreign investment income", as defined in s. 129(4)(b), because it was "income from property used or held by the corporation in the year in the course of carrying on a business". Appellant's dividend refund was therefore reduced. The Federal Court, Trial Division, allowed an appeal from that reassessment but its judgment was overturned on appeal.
Held: The appeal should be dismissed.
The test to distinguish income from carrying on a business from income derived from property is whether or not the property was used to fulfil a requirement which had to be met in order to do business and not whether or not the taxpayer was forced to use a particular property to do business. The property must be truly employed and risked in the business and "risk" must mean more than a remote risk and more than a business purpose for the use of property. The threshold of the test is met when the withdrawal of the property would "have a decidedly destabilizing effect on the corporate operations themselves". The investment of profits from trade in order to achieve some collateral purpose is therefore distinguishable from an investment made in order to fulfil a mandatory condition precedent to trade. Here, the property was not for any collateral purpose but rather was employed and risked in the taxpayer's business in the most intimate way. It was used or held in the business and fulfilled a mandatory condition precedent to trade.
Cases Cited
Considered: The Queen v. Marsh & McLennan, Ltd., [1984] 1 F.C. 609, reversing [1982] 2 F.C. 131; distinguished: Vancouver Pile Driving & Contracting Co. v. Minister of National Revenue, 63 D.T.C. 1007; referred to: March Shipping Ltd. v. Minister of National Revenue, 77 D.T.C. 371; Canadian Marconi Co. v. The Queen, [1986] 2 S.C.R. 522; Bank Line Ltd. v. Commissioner of Inland Revenue (1974), 49 T.C. 307; Liverpool and London and Globe Insurance Co. v. Bennett, [1913] A.C. 610; Owen v. Sassoon (1951), 32 T.C. 101; The Queen v. Brown Boveri Howden Inc., 83 D.T.C. 5319.
Statutes and Regulations Cited
Income Tax Act, S.C. 1970‑71‑72, c. 63, ss. 89(1), 125, 125.1, 129(1), (3), (4).
Income Tax Act, S.C. 1974‑75‑76, c. 26, s. 86(2).
Authors Cited
Scace, Arthur R. A. The Income Tax Law of Canada, 3rd ed. Toronto: Law Society of Upper Canada, 1976.
APPEAL from a judgment of the Federal Court of Appeal, 83 D.T.C. 5315, [1983] C.T.C. 296, allowing the Crown's appeal from a judgment of Jerome A.C.J., 81 D.T.C. 5326, [1981] C.T.C. 445, allowing an appeal from reassessment by the Minister of National Revenue under the Income Tax Act. Appeal dismissed.
John T. Morin, Q.C., and Stephen S. Ruby, for the appellant.
Ian MacGregor and Gaston Jorré, for the respondent.
The judgment of the Court was delivered by
1. Wilson J.‑‑The issue to be determined in this appeal is whether interest earned by the appellant, Ensite Limited ("Ensite"), from United States dollar deposits in the Philippines qualifies as "foreign investment income" within the meaning of s. 129(4) of the Income Tax Act, R.S.C. 1952, c. 148, as amended by S.C. 1970‑71‑72, c. 63, s. 1, and S.C. 1974‑75‑76, c. 26, s. 86(2), for the purposes of the "dividend refund" under s. 129(1) of the Act.
1. The Facts
2. Ensite, which carries on the business of manufacturing and selling automobile engines, is a private corporation within the meaning of s. 89(1) of the Income Tax Act. In 1972 Ensite decided to invest in a stamping plant in the Philippines. In order to comply with Philippine law it had to bring foreign currency into the Philippines to finance the stamping plant. In case the Philippine peso might be devalued or the Philippine government might prevent Ensite from taking foreign funds out of the Philippines, an elaborate arrangement was made in an attempt to minimize these risks while at the same time satisfying Philippine law. It involved the investment by Ensite of up to $5 million of its own money in the stamping plant and the obtaining of loans to provide the balance of the capital requirement for the plant. The precise details of the arrangements implemented by Ensite, which are important to the disposition of the appeal, are set out in the reasons for judgment of Le Dain J. in the Federal Court of Appeal, 83 D.T.C. 5315, at p. 5317:
The loans were made available through "swap arrangements" between the Central Bank of the Philippines and the commercial banks which made the loans to the Philippine branch of Ensite. The commercial banks obtained Philippine pesos from the Central Bank at the prevailing exchange rate upon depositing U.S. dollars with the Central Bank under arrangements that ensured that the pesos could be reconverted to U.S. dollars in the future at an agreed exchange rate, thus affording protection against the risk of devaluation. Ensite made U.S. dollar deposits with the commercial banks, which then made the peso loans in an equivalent amount to the Philippine branch. Ensite received certificates of deposit for the U.S. dollar deposits with the commercial banks which it turned over to the banks as security for repayment of the peso loans. The schedule for repayment or withdrawal of the U.S. dollar deposits corresponded to the schedule for repayment of the peso loans, which was to begin at the end of an initial period of five years and continue in six annual instalments. The certificates were declared to be "enforceable" against any branch of the commercial banks outside of the United States thus ensuring against the risk of foreign exchange controls that would prevent U.S. dollars from being taken out of the Philippines. It was not essential to the swap arrangements that Ensite make the U.S. dollar deposits with the commercial banks. The required U.S. dollars could have been made available by the commercial banks on other terms. But the U.S. dollar deposits permitted Ensite to obtain interest rates that reduced the net cost of the borrowing.
3. In its return for the 1976 taxation year Ensite claimed a "dividend refund" under s. 129(1)(a) of the Income Tax Act. The amount of the refund is, according to the section:
... equal to the lesser of
(i) 1/3 of all taxable dividends paid by it in the year on shares of its capital stock, and
(ii) its refundable dividend tax on hand at the end of the year; ...
The "refundable dividend tax on hand" of a corporation is calculated following the formula set out in s. 129(3). One of the amounts included in this complex formula is a corporation's "foreign investment income", defined in s. 129(4) as follows:
(4) In subsection (3),
(a) "Canadian investment income" of a corporation for a taxation year means the amount, if any, by which the aggregate of
(i) the amount, if any, by which the aggregate of such of the corporation's taxable capital gains for the year from dispositions of property as may reasonably be considered to be income from sources in Canada exceeds the aggregate of such of the corporation's allowable capital losses for the year from dispositions of property as may reasonably be considered to be losses from sources in Canada,
(ii) all amounts each of which is the corporation's income for the year (other than exempt income or any dividend the amount of which was deductible under section 112 from its income for the year) from a source in Canada that is a property (other than a property used or held by the corporation in the year in the course of carrying on a business), determined, for greater certainty, after deducting all outlays and expenses deductible in computing the corporation's income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purpose of earning the income from that property,
(iii) all amounts each of which is the corporation's income for the year (other than exempt income) from a source in Canada that is a business other than an active business, determined, for greater certainty, after deducting all outlays and expenses deductible in computing the corporation's income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purpose of earning the income from that business,
exceeds the aggregate of amounts each of which is a loss of the corporation for the year from a source in Canada that is a property or business other than an active business; and
(b) "foreign investment income" of a corporation for a taxation year means the amount, if any, by which
(i) the amounts that would be determined under paragraph (a) in respect of the corporation for the year if the references in paragraph (a) to "in Canada" were read as references to "outside Canada",
exceeds
(ii) the aggregate of all amounts deductible under section 113 from the corporation's income for the year.
4. As can be seen from this legislative framework an addition made to a corporation's "foreign investment income" may well increase the "refundable dividend tax on hand" of a corporation which may result in an increase in the size of the "dividend refund" under s. 129(1)(a).
5. In this case Ensite included interest of $2,323,140 from its U.S. dollar deposits in the Philippines in its calculation of "foreign investment income" for the 1976 taxation year. This inclusion made the amount calculated under paragraph (i) of s. 129(1)(a) less than the amount under paragraph (ii) of the subsection and so it claimed a refund of $2,498,931. The Minister, in his reassessment, refused to recognize the interest as "foreign investment income" as defined in s. 129(4)(b) because it was income from an active business or was "income from property used or held by the corporation in the year in the course of carrying on a business". Ensite's dividend refund was therefore reduced by $972,860. Ensite appealed the Minister's reassessment.
2. The Courts Below
6. Jerome A.C.J. (81 D.T.C. 5326) allowed the taxpayer's appeal to the Federal Court, Trial Division. He held on the facts (at p. 5331) that "the earning of the [interest] income certainly would not require such activity on the part of the Plaintiff, as would support, ... the concept of an active business" and so the interest receipts were income from property. He also held that that property was not "used or held by the corporation in the year in the course of carrying on business". For this conclusion he relied primarily on the reasoning of the Tax Review Board in March Shipping Ltd. v. Minister of National Revenue, 77 D.T.C. 371 (T.R.B.), and on his own reasoning in The Queen v. Marsh & McLennan, Ltd., [1982] 2 F.C. 131 (T.D.), reversed [1984] 1 F.C. 609 (C.A.) In holding that the U.S. dollar deposits were not property used or held by the corporation in the course of carrying on its business he stated at pp. 5332‑33:
... I am of the view that these benefits were not sufficient to integrate the transaction with the taxpayer's main business, or to use the language of the statute, to warrant a finding that these funds were "property used or held by the corporation in the year in the course of carrying on a business". It is, to me, extremely significant that the return from these investments would carry on at the negotiated rate, independent entirely of success or failure of the plant and that the taxpayer enjoyed the right to recall the invested funds at any time and to do so in American currency and through offshore rather than Philippines branches of the banks concerned. These were prima facie investment transactions. As a result of these precautions, they were insulated from the taxpayer's main business. In terms of the attention required to manage them or their effect on the total income, they remain clearly secondary or incidental to the taxpayer's main business.
7. The Federal Court of Appeal (83 D.T.C. 5315) allowed the Crown's appeal on the issue whether the dollar deposits were property used or held by the corporation in the course of carrying on its business. Le Dain J., with whom Heald J. and Clement D.J. agreed, based his reasons on the Federal Court of Appeal's decision in The Queen v. Marsh & McLennan, Ltd., supra, which had reversed Jerome A.C.J.'s decision below. Le Dain J. was of the view that the case at hand was analogous to that case. He stated at p. 5319:
For the reasons which I briefly indicated in Marsh & McLennan I am of the opinion that the same view must be taken of the interest on the U.S. dollar deposits in the present case. Whether or not it was essential to do so, the fund represented by the U.S. dollar deposits was in fact committed to the carrying on of Ensite's business in the Philippines. It was employed and risked in the business because it was an integral part of the arrangements by which the business was being financed. The U.S. dollar deposits were the means by which the peso loans were obtained on the most favourable terms, including a reduced cost of borrowing, and they were security for the repayment of the loans. For these reasons they were in my opinion property used or held by Ensite in the carrying on of its business, and the interest earned on them was, therefore, not foreign investment income within the meaning of section 129.
8. Leave to appeal was granted by the Supreme Court of Canada on December 15, 1983.
3. The Issue
9. As is apparent from the above, the learned judges in the courts below placed considerable reliance on The Queen v. Marsh & McLennan, Ltd., [1982] 2 F.C. 131 (T.D.), reversed [1984] 1 F.C. 609 (C.A.) In that case the taxpayer was in business as an insurance broker. When the taxpayer was told by an insurer that it was prepared to accept an insured's risk, the taxpayer sent a bill to his client, the insured. Remittance to the insurer from the broker did not have to be made until sixty days after the end of the month in which the risk was accepted. There was often a period of time between payment of premiums by insured persons to the broker and remittances by the broker to the insurer, during which time the broker used the sums to invest in short‑term bank certificates. The issue was whether the money invested was "property used or held in the course of carrying on a business" within the meaning of the exclusion in s. 129(4)(a)(ii) of the Income Tax Act. A majority of the Court held that the exclusion did apply.
10. In the course of his reasons for judgment Clement D.J. stated at p. 638:
To use words employed by Rowlatt J. in Scales (H.M. Inspector of Taxes) v. George Thompson & Company, Limited (1927), 13 T.C. 83 (Eng. Q.B.) [sic], on the facts of this case there was between the Broker's business and the investments an interconnection, an interlacing, an interdependence, a unity embracing the investments and the business.
Le Dain J. concurred in the result but proposed at p. 621 a differently worded test:
Was the fund employed and risked in the business? In my opinion it was, because an amount equivalent to this notional fund was committed to the carrying on of the business in order to meet the company's obligations to the insurers.
Thurlow C.J., dissenting, employed a test which on its face appears to be slightly more restrictive. He stated at pp. 619‑20:
... it is only property that is in one way or another employed in the carrying on of the business and thus in the earning of the profits of that business that falls within the exception.
...
The investing was not part of the arranging of insurance contracts or the collection or remitting of premiums. It was, as I view it, an unrelated activity that could happen or not happen without affecting the respondent's insurance‑brokerage business in any way.
...
Not only were they not made in the course of carrying on the business, they were not used to pay its obligations. Nor were they capital invested in or at risk in the business.
11. The precise difference in substance between the test employed by Le Dain J. and that of Clement D.J. is not easy to discern. In many instances property which is "employed or risked" in the business will be "interconnected, interlaced and interdependent" with the business. However, the wording of the test employed by Le Dain J. seems more specific and therefore preferable because it emphasizes that the holding or using of the property must be linked to some definite obligation or liability of the business. The test applied by Clement D.J., on the other hand, is worded so broadly that it might prevent the exception from applying where a company simply failed to put in place certain organizational and accounting mechanisms in order to create the formal appearance of a separate and distinct concern.
12. The substance of these tests seems to be in accordance with the statutory framework. Section 125 allows a Canadian‑controlled private corporation with income from an active business to obtain a deduction from the tax otherwise payable under Part I of the Income Tax Act. The effect is to tax the active business income of small businesses at a rate lower than the normal corporate rate. Similarly, s. 125.1 provides a deduction from tax payable in respect of a company's Canadian manufacturing and processing profits which are defined in s. 125.1(3) as including only active business income. On the other hand, s. 129(1) permits a corporation to receive a refund of tax paid on "investment income" when it pays dividends in order to achieve a partial integration of personal and corporate taxes on investment income received by a taxpayer from a corporation. As already mentioned, this refund is equal to the lesser of one‑third of all taxable dividends paid during the year and the "refundable dividend tax on hand", defined as including a percentage of the "Canadian investment income" and "foreign investment income" of the corporation for the year. These two types of investment income, before amendment by S.C. 1974‑75‑76, c. 26, s. 86(2), were made up of three components: net taxable gains, income from property and income from a business other than an active business: see s. 129(4) of the Act. The legislative scheme was thus to draw a distinction between active business income which would fall under ss. 125 and 125.1 and other sources of income which would fall under s. 129. However, it was clearly arguable that income from property which was immersed in the trading activity of the corporation could qualify as active business income. The aforementioned amendment which added the words "other than a property used or held by the corporation in the year in the course of carrying on a business" in parentheses after the words "that is a property" removed this argument and preserved the distinction between active business income and other sources of income: see Arthur R. A. Scace, The Income Tax Law of Canada (3rd ed. 1976), at p. 257. The rebuttable presumption that corporate income is income from a business (see: Canadian Marconi Co. v. The Queen, [1986] 2 S.C.R. 522, released concurrently herewith) is of no application here as it would tend to collapse the distinction between active business income and other sources of income which Parliament clearly intended to preserve in its amendment of s. 129(4) of the Act.
13. It would seem to follow that the legislative intention underlying the amendment was to catch income from property that is employed or risked in the taxpayer's business to such an extent that the income from it could be characterized as active business income. The use of words such as "employed" and "risked" appropriately implement Parliament's intention.
14. Counsel for the appellant argued that in this case the dollar deposits could be said to be "risked" in the sense that if the business failed they could be seized. He submitted that this demonstrated that the test is too wide. If "risked" was the right test, then all property would meet the test since ultimately all property is available to the creditors of a corporation. But "risked" means more than a remote risk. A business purpose for the use of the property is not enough. The threshold of the test is met when the withdrawal of the property would "have a decidedly destabilizing effect on the corporate operations themselves": March Shipping Ltd. v. Minister of National Revenue, supra, at p. 374. This would distinguish the investment of profits from trade in order to achieve some collateral purpose such as the replacement of a capital asset in the long term (see, for example, Bank Line Ltd. v. Commissioner of Inland Revenue (1974), 49 T.C. 307 (Scot. Ct. of Session)) from an investment made in order to fulfil a mandatory condition precedent to trade (see, for example, Liverpool and London and Globe Insurance Co. v. Bennett, [1913] A.C. 610 (H.L.), and Owen v. Sassoon (1951), 32 T.C. 101 (Eng. H.C.J.) Only in the latter case would the withdrawal of the property from that use significantly affect the operation of the business. The same can be said for a condition that is not mandatory but is nevertheless vitally associated with that trade such as the need to meet certain recurring claims from that trade: see, for example, The Queen v. Marsh & McLennan, Ltd., supra, and The Queen v. Brown Boveri Howden Inc., 83 D.T.C. 5319 (F.C.A.)
15. It is true that in this case the taxpayer could have done business and fulfilled the Philippine requirement that foreign currency be brought into the country by a means not involving the use of property. It could have borrowed the U.S. currency abroad and brought it into the Philippines. But this consideration is irrelevant to our inquiry. The test is not whether the taxpayer was forced to use a particular property to do business; the test is whether the property was used to fulfil a requirement which had to be met in order to do business. Such property is then truly employed and risked in the business. Here the property was used to fulfil a mandatory condition precedent to trade; it is not collateral, but is employed and risked in the business of the taxpayer in the most intimate way. It is property used or held in the business.
16. Counsel for the appellant also referred us to Vancouver Pile Driving & Contracting Co. v. Minister of National Revenue, 63 D.T.C. 1007 (Ex. Ct.), which suggests that bonds put up as security are not trading income. There the security was required by the government if the taxpayer was to be allowed to do construction work. But the issue in that case was simply whether the proceeds from the sale of the bonds were capital or income. It was correctly held that they constituted capital. The issue whether these bonds were used or held in the taxpayer's business was not in issue. I do not see therefore how the appellant draws any comfort from that decision.
4. Disposition
17. For the reasons given I would dismiss the appeal with costs.
Appeal dismissed with costs.
Solicitors for the appellant: Campbell, Godfrey & Lewtas, Toronto.
Solicitor for the respondent: Roger Tassé, Ottawa.