ENMAX Energy – Alberta Court of Queen’s Bench finds that an 11.5% interest rate on unsecured intercompany debt was reasonable under s. 20(1)(c) notwithstanding that this exceeded an arm’s length rate of around 8.5%

An Alberta utility (EEC) was required to make payments to the province equal to the provincial and federal income tax to which it would have been subject had it not been tax-exempt. In order to minimize this pseudo-tax liability of EEC, EEC's parent capitalized it mostly with a subordinated note bearing interest at 11.5%, whereas the Alberta government denied the interest deduction over 5.42% as being in excess of the “reasonable amount” referenced in s. 20(1)(c).

After listening to a slew of expert evidence on credit ratings and capital markets, Poelman J concluded that an arm’s length interest rate likely would have been in the range of 7.97% to 8.77% - so that you might have expected him to deny interest expense in excess of 8.77%.

Instead he applied a Gabco-derived test as to “whether no business would have contracted to pay that amount, having only its business considerations in mind and under the form of transaction pursuant to which the obligation was incurred,” and concluded that the interest was fully deductible. He also stated:

[I]ntercompany debt is not rated… . Further… the intercompany notes [here] were burdened with a number of conditions, such as the level of debt and stripping of cash flow to the parent, which would have made them very difficult to sell on the market without significant changes. These observations reinforce the weakness of putting too much emphasis on artificially constructed arm’s length comparators… .

Neal Armstrong. Summaries of ENMAX Energy Corp. v. Alberta, 2016 ABQB 334 under s. 20(1)(c) and s. 67.