ENMAX – Alberta Court of Appeal finds that interest on a loan from a tax-exempt parent should be at an arm’s length rate reflecting implicit parental credit support

A wholly-owned subsidiary (ENMAX) of the City of Calgary made 10-year subordinated term loans to ENMAX power-distribution subsidiaries at interest rates mostly of 11.5% and 10.3%. Although ENMAX itself was tax exempt, the borrowing subs were required to make “Balancing Pool Payments” equivalent to the income tax that would be payable had they not been tax exempt.

The Court confirmed the Alberta Minister of Finance’s reassessments, made on the basis that the reasonable rates of interest required by s. 20(1)(c)(i) on the above respective loans was 5.42% and 5.26%, and stated:

A parent of a municipal entity is not entitled to gain an advantage over its private competitors by arranging its subsidiaries’ affairs in a way that causes a hypothetical arm’s length loan to appear riskier than it would have been had any reasonable municipal entity actually gone into the market to borrow the funds. Hence the need under the Balancing Pool Payments regime to ensure that the structure of the loan transaction is also objectively reasonable to the extent it would affect a market interest rate.

In also accepting the Minister’s submission that the hypothetical arm’s length loan (in addition to not reflecting the “junk bond” way in which the actual loan had been structured) should reflect implicit credit support by ENMAX (to whom these subs were key assets), the Court stated:

[A]ny third party lender would look at the entire corporate structure and see that ENMAX’s viability could not be separated from that of its subsidiaries. An external lender would therefore assume implicit parental support.

The Court was clear that it was significantly affected by the apparent legislative policy of the Balancing Pool Payments regime of avoiding any tax advantage to municipally-owned power companies, so that it is unclear how relevant this case is to income fund or cross-border loans.

Neal Armstrong. Summaries of Alberta v ENMAX Energy Corporation, 2018 ABCA 147 under s. 20(1)(c)(i), General Concepts – Tax Avoidance, Statutory Interpretation – Hansard, and s. 67.