Enmax Energy Corporation (“EEC”) was a wholly owned subsidiary of Enmax Corporation (“EC”), which in turn was wholly-owned by the City of Calgary. EEC distributed electricity to residential and commercial customers in the Calgary area. The Payment in Lieu of Tax Regulations made under Alberta’s Electric Utilities Act provided for payments by various government-owned entities to the provincial government equal to the amount that would have been payable by them as federal and provincial income tax if they had not been exempt. EEC had borrowed $497 million from EC pursuant to an unsecured subordinated note bearing interest at 11.5% (the “2004 note”), which resulted in EEC’s capitalization being 91% debt to 9% equity. EEC was reassessed by the Alberta Minister of Finance on the basis that interest on the 2004 note in excess of 5.42% was unreasonable. Also at issue were similar loans (bearing interest at 10.3% and 9.9%) made by EEC to a wholly-owned subsidiary of EEC in 2006 and 2007, which were treated by Poelman J similarly to the 2004 note.
Poelman J found (at para. 240) that the imputed credit rating of EEC (otherwise no higher than BB-) should not:
allow consideration of implicit support to influence opinions about reasonable interest rates… . The intercompany notes allow for no parental support, because the lender and the implicit supporter are the same.
He also accepted submissions that various qualitative “fundamental factors” and savings in transactions costs should increase the benchmark arm’s length interest rate by 50 and 44 basis points, respectively, so that an arm’s length interest rate for the 2004 note might fall in the range of 7.97% to 8.77%.
After having stated (at para. 264) 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,” Poelman J concluded (at para. 266) that the interest on the 2004 note (as well as the 2006 and 2007 notes) was fully deductible as having a reasonable amount notwithstanding that the rate exceeded “what the evidence shows would probably have been paid under a similar arm’s length transaction.” In this regard, he stated (at paras. 267-8):
There are many benefits to a borrower in having access to all its capital requirements from its parent, some of which are intangible and difficult to quantify.
…[I]ntercompany debt is not rated… . Further… the intercompany notes 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 in this case. Furthermore, none of the Crown’s experts expressed the opinion that bonds comparable to the intercompany notes, without parental support, could have been sold in the market at interest rates less than those set out in the notes.