Safeway Ontario Finance ULC v. Ontario – OSCt: Avoidance of Ontario tax using specialty debt situate in BVI not subject to GAAR

Bill Innes on Current Tax Cases

Safeway Ontario Finance ULC v. Ontario (Ministry of Finance) (September 12, 2014 – 2014 ONSC 5204, Gans J.).

Précis: The decision involved a tax plan under which Safeway Canada Ltd. paid interest to a related company, Safeway Ontario Finance ULC (“Safeway Ontario”). Safeway Ontario was incorporated under the laws of the British Virgin Islands (“BVI”) and had a permanent establishment in Ontario. The interest was paid by Safeway Canada on specialty debts which were physically present in BVI. Safeway Ontario took the position that it was not subject to tax in Ontario on income from property that did not have a situs in Ontario and the specialty debt had a situs in BVI. Ontario assessed Safeway Ontario under the GAAR rule contained in the Ontario Corporations Tax Act. The appeal was allowed on the basis of an earlier decision of the Ontario Court of Appeal which held, in essentially the same fact situation, that GAAR did not apply.

Decision: The underlying tax planning was somewhat complex:

[1] Canada Safeway Ltd. (“CSL”) is a well-known grocery retailer in Western Canada, whose assets were recently bought by Sobey’s Inc. At the relevant times, it had but a small presence in the province of Ontario, limited to a few northern locations. In 2001, CSL and related companies (the “Safeway Group”), on the advice of their accountants and lawyers, put into place a tax plan (“Plan”) by which they sought to minimize corporate tax payable by CSL in Alberta, and by a ‘related’ company, Safeway Ontario Finance ULC (“Safeway Ontario”), in Ontario, pursuant to the corporate taxing statutes of the two provinces.

[2] At its simplest, the Plan called for CSL to replace historically earned retained earnings with borrowings from another Safeway Group corporation, all of which were secured by six deeds of specialty debt (collectively, the “Specialty Debts”). The Specialty Debts were thereafter transferred to Safeway Ontario, which was a company incorporated pursuant to the laws of the British Virgin Islands (“BVIs”) as part of the Plan in 2001. From February 2002 to February 2005, CSL paid Safeway Ontario approximately $133 million of interest payments in respect of the debt obligation under the Specialty Debts, on a total debt obligation of $600 million.

[3] CSL deducted the interest payments made to Safeway Ontario on the Specialty Debts in computing its taxable net income for the purposes of calculating federal and provincial income tax payable. Safeway Ontario included the corresponding interest payments as income for federal tax purposes, but not for corporate income tax calculation purposes under the OCTA.

[Footnotes omitted]

CRA, as agent for Alberta, mounted GAAR based attacks in 2008 on two Alberta participants in the tax planning and was unsuccessful in each case. In 2007 Ontario mounted this mirror image GAAR based attack on Safeway Ontario claiming to tax the interest in Ontario.

The Ontario Superior Court allowed the appeal on the basis of the recent decision of the Ontario Court of Appeal in Inter-Leasing, Inc. v. Ontario (Minister of Revenue) 2014 ONCA 575, [2014] O.J. No. 3671:

[13] Respectfully to counsel who appeared before me in the instant appeal, and notwithstanding the work and effort that each side undertook in that regard, it would be presumptuous of me to engage in a review of the analysis that is found in the clear decision of Pardu J.A. on behalf of the Court. I find the analysis and conclusions to be applicable to the matters in issue in the instant appeal since the two tax plans are, as I indicated, virtually identical. Therefore, as was determined by the Court of Appeal in Inter-Leasing, I would hold that the income earned by Safeway Ontario is income from property and not income from business, as was urged upon me by the Minister.

[Footnote omitted]