The Queen v. Old HW-GW Ltd., 93 DTC 5199, [1993] 1 CTC 363 (FCA)

MacGuigan, J.A.:—The only issue on this appeal is whether a tax exemption granted by Puerto Rico to an affiliate of a Canadian corporation is an export incentive under Canadian income tax law. The trial judge (in Old HW- GW Ltd. v. Canada, [1991] 1 C.T.C. 460, 91 D.T.C. 5327) held that the exemption granted under section 252a (e)(37) of Puerto Rico's Industrial Incentives Act of 1963 was not an export incentive but rather an exemption from tax "to promote investments or projects in pursuance of a program of economic development," a concept drawn from subsection 5907(10) of the Canadian Income Tax Regulations (“the Regulations”) which may lead to an exemption from income tax on dividends repatriated to Canada as a so-called "tax-sparing relief” by which Canada foregoes the tax it would normally levy, out of consideration for the tax relief in the foreign country.

I

The respondent, a Canadian corporation, appealed to the Trial Division against three assessments made in respect of taxation years ending at various times in 1980 and 1981, seeking reassessments that would permit the deduction from its taxable income of portions of dividends received from a foreign affiliate, Bacardi Corporation ("Bacardi"), a Delaware company carrying on active business in Puerto Rico in the production and marketing of wines and spirits. The three matters were tried together, and are the subject of a single appeal.

At all relevant times the respondent owned approximately 12 per cent of the shares of Bacardi, which, because that proportion exceeded the ten per cent ownership level required by paragraph 95(1)(d) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), therefore constituted a foreign affiliate.

The respondent's claim was that it was entitled, under paragraph 113(1)(a) of the Act, to deduct the portion of the dividend it received from Bacardi which had been paid out of Bacardi's "exempt surplus”. "Exempt surplus” is defined by subparagraph 5907(1)(d)(v) of the Regulations to include "each amount that is included in the exempt earnings of the affiliate by virtue of subsection (10)”.

This case therefore revolves around the correct interpretation of subsection 5907(10) of the Regulations, which establishes what net earnings may be included in exempt earnings, as follows:

(10) Where

(a) the net earnings or net loss for a taxation year of a foreign affiliate of a corporation resident in Canada from an active business carried on in a country other than Canada would otherwise be included in the affiliate’s taxable earnings or taxable loss, as the case may be, for the year,

(b) the rate of the income or profits tax to which any earnings of that active business of the affiliate are subjected by the government of that country is by virtue of a special exemption from or reduction of tax (other than an export incentive) that is provided under a law of such country to promote investments or projects in pursuance of a program of economic development, less than the rate of such tax that would, but for such exemption or reduction, be paid by the affiliate, and

(c) the affiliate qualified for such exemption from or reduction of tax in respect of an investment made by it in that country before January 1, 1976 or in respect of an investment made by it or a project undertaken by it in that country pursuant to an agreement in writing entered into before January 1, 1976,

for the purposes of the Part, such net earnings or net loss shall be included in the affiliate's exempt earnings or exempt loss, as the case may be, for the year and not in the affiliate’s taxable earnings or taxable loss, as the case may be, for the year.

With one exception, the parties are agreed as to the application of this subsection to the facts in the case at bar. The issue between them is over whether the Puerto Rican tax incentive is "an export incentive”.

In the course of his interpretation of this provision, the trial judge found it necessary to consider the legal status of Puerto Rico and its relationship to the United States. As evidence, the respondents filed a certificate issued on behalf of the Secretary of State for External Affairs of Canada which states as follows (Appeal Book I at 137) :

I certify, pursuant to paragraph 14(1)(b) of the State Immunity Act, c. S-18, R.S.C., that Puerto Rico is an unincorporated territory of the United States of America, and as such is a political subdivision of the United States of America.

By subsection 14(1) of the State Immunity Act, such a certificate is admissible in evidence as conclusive proof of any matter stated in the certificate with respect to whether a particular area or territory of a foreign state is a political subdivision of that state. The trial judge accepted this certificate as conclusive of the question.

The trial judge grappled with the notions of "export" and "import" as between Puerto Rico and the United States. He said at page 468 (D.T.C. 5333):

In general it may be observed that U.S. federal laws now seem to avoid using the word "import" to describe goods coming from Puerto Rico to the United States, referring to them instead as being “brought into the United States”, "coming to the United States”, or being for “ shipment to the United States”. On the other hand Puerto Rican legislation frequently uses the term "export" to describe, compendiously, shipments to the United States and to foreign countries and on occasion the term "export" is used specifically to refer to shipments to the United States. The most relevant example of this is in the wording of the very tax exemption in question, paragraph 252(a)(e)(37) of its Industrial Incentives Act which provides the exemption on income earned from the production of

distilled spirits produced. . .in Puerto Rico, for export and shipment to the United States.

[Emphasis added.]

It would seem then that there is little clear guidance to be had from the U.S and Puerto Rican legislation as to the meaning of the term "import" or "export" in this context.

He then continued with the consideration which he found decisive in the resolution of the matter, at pages 468-69 (D.T.C. 5333-34):

It is perhaps more useful to consider the purpose of the Puerto Rican tax exemption in question which II do on the basis of interpretative materials provided by the expert witnesses. When the exemption was adopted in 1975 it was explained that for the exemption to be earned it was necessary that there be an increase in production or processing of distilled spirits in Puerto Rico combined with their shipment and sale in the United States. The Treasury Committee report to the Puerto Rico House of Representatives on both the Senate bill and House bill in that legislature stated:

The purpose of this measure is to increase the revenues of the Treasury of Puerto Rico, [by] promoting the export of distilled spirits to the United States since the [federal tax] paid by our industry . . . [on] such. . . [exports] reverts to the general fund of the Commonwealth of Puerto Rico.

We recommend the measure because we understand that this type of exemption serves as an incentive to distillers in Puerto Rico to invest more resources in the promotion of their sales in the United States market, and on the other hand it induces other firms to import distilled spirits to terminate the processing and bottling in Puerto Rico with the purpose of [subsequently] exporting [such products] to the continental United States market.

. . .It [is] evident, that the industry needs an incentive that stimulates making new investments in necessary facilites [sic] [in order] to continue achieving an adequate penetration of the continental [United States] market of distilled spirits.

It is clear that this was not a typical export incentive to encourage domestic producers to sell outside of their domestic market for the purpose of earning more foreign exchange or improving the balance of payments of the producing country. Instead, it was to promote sales within essentially a domestic market, a common market including Puerto Rico and the United States between which, with very small exceptions, there are no customs duties or trade barriers. There is no question of earning foreign exchange as these two entities have a common currency and the balance of payments of Puerto Rico forms part of the balance of payments of the United States in terms of international trade. The essential purpose of the tax incentive is thus not to give Puerto Rican producers an advantage in selling in a non-domestic market but rather to increase the revenues of the Puerto Rican government by encouraging sales in the United States, a domestic market, where the excise taxes collected will revert to the Commonwealth treasury. It follows that such a tax incentive is not an "export incentive".

II

It will not be necessary to comment further on the reasons for decision of the trial judge since the argument as to statutory interpretation made by the appellant on appeal was not placed before or considered by the trial judge, but, if right, undercuts his reasons for deciding the case as he did.

The appellant's contention relates to the interpretation of paragraph 5907(10)(a), which was neither set out, nor referred to, by the trial judge, since it had not been raised in argument. Paragraph (a) contains the first of the three conditions (paragraphs (a), (b) and (c) of subsection 5907(10) required for net earnings to be included in an affiliate's exempt earnings.

The proper approach to construing the Income Tax Act was set out by this Court in Lor-Wes Contracting Ltd. v. The Queen, [1985] 2 C.T.C. 79, 85 D.T.C. 5310, at page 83 (D.T.C. 5313), where it was described as a words-in-total- context approach. In the case at bar that means taking account not only of paragraph 5907(10)(a) in interpreting paragraph (b) but also of the rest of section 5907.

The first contextual notion to be taken account of is the distinction between “listed” and"non-listed" countries created by subsection 5907(11), which reads as follows:

(11) The following countries are hereby listed for the purposes of paragraphs (1)(b) and (c):

(kk) United States of America, but for greater certainty, not including the Territories;

The listed countries appear to be largely those with which Canada has entered into tax conventions.

It would be, of course, of capital importance for the interpretation of subsection (10) if subsection (11) directly referred to it, since Puerto Rico, being excluded by subsection (11) as a Territory from the United States, would then be established for the purposes of subsection (10) as a separate country from the United States. Subsection (11) does not explicitly do so, but refers only to paragraphs (1)(b) and (c). Paragraph (1)(c) refers to "exempt loss" and need not be further considered.

Paragraph 5907(1)(b), is in any event the principal contextual reference point for both subsections (10) and (11), because both are extensions of paragraph 5907(1)(b), subsection (10) completing subparagraph (v) and subsection (11) completing subparagraph (iv). The relevant part of paragraph 5907(1)(b), which defines exempt earnings, is as follows:

5907(1) For the purposes of this Part and sections 95 and 113 of the Act,

(b)" exempt earnings” of a foreign affiliate of a corporation for a taxation year of the affiliate is the aggregate of all amounts each of which is

(iv) for the 1976 or any subsequent taxation year where the affiliate is

resident in a country listed in subsection (11), each amount that is

(A) the affiliate's net earnings for the year from an active business carried

on by it in Canada or in a country listed in subsection (11), or

(B) to the extent that they have not been included by virtue of clause (A) or deducted in determining an amount included in subparagraph

(C) (ii i), the earnings for the year from an active business of the affiliate to the extent that they derive from

(1) amounts determined under subparagraph 95(2)(a)(i) of the Act that pertains to or are incident to an active business carried on in a country listed in subsection II, or

(Il) amounts determined under subparagraph 95(2)(a)(ii) of the Act that are paid or payable to it by another foreign affiliate of the corporation or any other non-resident corporation with which the corporation does not deal at arm's length, to the extent that they are or would be, if the non-resident corporation were a foreign affiliate of the corporation, deductible in computing its exempt earnings, or

(v) for the 1976 or any subsequent taxation year, each amount that is included in the exempt earnings of the affiliate by virtue of subsection (10),

minus such portion of any income or profits tax paid to the government of a country for the year by the affiliate as may reasonably be regarded as tax in respect of the earnings referred to in subparagraph (iii) or in clause (iv)(B):

The respondent was correct in pointing out that subparagraph (v), which refers to subsection (10), does not on its face, incorporate the notion of listed or nonlisted countries. Only subparagraph (iv) does that, and it does not refer to subsection (10).

But the appellant on her side, was, I believe, also correct in contending that subparagraph (iv) nevertheless implicitly does have a direct consequence for the interpretation of subsection (10). Subparagraph 5907(1)(b)(iv) provides that where listed countries like the United States are in question, a dividend paid out of earnings from an active business carried on by a foreign affiliate resident in and carrying on such business in the United States would be exempt from Canadian income tax. Subparagraph (v) could on its face also include such dividends from listed countries. If subparagraph (v) is to constitute a different category from subparagraph (iv), as was acknowledged to be the case by the respondent itself in its memorandum of fact and law, it must also incorporate the distinction between listed and non-listed countries.

In other words, the express reference to listed countries in subparagraph (iv) indicates that the countries which are expressly included in or excluded from the list are different countries: e.g., the United States and Puerto Rico. Because of the implied reference to listed countries in subparagraph (v), the Same assumption must be made for the purposes of that subparagraph.

The effect on subsection (10), which is referred to in subparagraph (v), and which cannot therefore be taken independently of it, is immediate. Paragraph (10)(a) must also incorporate the same distinction since it is, in effect, a part of subparagraph (v).

The simplest way of stating the result is to say that the country referred to in paragraph 10(a) cannot on the facts here, where the earnings have taken place in Puerto Rico, be the United States, but must be Puerto Rico, as urged by the appellant, since the distinction drawn from subsection (11) makes it clear that they are different countries.

If Puerto Rico is the country referred to in paragraph (10)(a), it must also be the country referred to in paragraphs (b) and (c), because all subsequent references are to“ "that" country or "such" country. It is in my opinion impossible to sever paragraphs (b) and (c) from (a) and to read into the latter paragraphs, as the appellant would have it, the words of subsection (4) that "government of a country includes the government of a state, province or other political subdivision of that country,” in such a way as to merge the United States and Puerto Rico in paragraph (b) where the words "government of that country" appear. These latter words are not a reference to an indefinite country, but must be taken as the same country as in paragraph (a).

The respondent correctly pointed out that subsections (10) and (11) are not parallel relief provisions. Subsection (10) is restricted to pre-1976 investments, and also contains the significant exception as to export incentives. But there is nothing inconsistent or illogical in Parliament's providing more limited tax relief in some cases than in others.

Given that Puerto Rico must therefore be taken to be distinct from the United States under subsection (10), the respondent runs afoul of the category of export incentives, which subsection (10) makes an exception to the benefits therein.

The term "export incentive” is not defined by the Act, but it was conceded in the respondent's memorandum of fact and law that export means transportation of goods from one country to another. Indeed, the respondent's whole argument that the tax exemption received by Bacardi was not an export incentive was based on the notion that Puerto Rico and the United States were the same country, a concept that in the light of the interpretation of subsection

(10) have adopted cannot assist the respondent in claiming a benefit under subsection 5907(10) of the Regulations.

It will be apparent that this holding limits the application of the certificate given by the Secretary of State for External Affairs that Puerto Rico is a political subdivision of the United States. That certificate was, however, provided under the State Immunity Act, and has application only to the question of state immunity in Canadian courts: such a certificate is by paragraph 14 (1)(a) said to be admissible as evidence "whether a country is a foreign state for purposes of this Act" (emphasis added). Moreover, even if such a certificate were issued, not under a particular statute, but under the royal prerogative, it is doubtful that it could be taken as resolving matters such as that in the case at bar which are of a fiscal rather than of a political nature. [1] It is worth noting that the Canada-U.S. Income Tax Convention in effect at the time, [2] as well as that of 1980, expressly provided that the term "United States” did not include Puerto Rico.

In a parallel case, the Canadian International Trade Tribunal in Seaboard Lumber Sales Co. v. M.N.R. (1992), 5 T.C.T. 1378, held that the words exported to the United States" in the Softwood Lumber Products Exports Charge Act did not include Puerto Rico, and pointed out that related legislation explicitly defined the United States to include Puerto Rico.

Ill

In the result, the respondent is denied the benefit of both subsections 5907 (10 and (11) of the Regulations.

The appeal must therefore be allowed with costs both in this Court and in the Trial Division, the judgment of the trial judge of April 17,1991, set aside, and the Minister's assessments restored.

Appeal allowed.