Keybrand Foods – Federal Court of Appeal finds that a transaction with a financially subordinate company was a non-arm’s length transaction

The taxpayer (“Keybrand”) and its wholly-owning parent (“BWS”) were guarantors of loans made to a start-up company (“Vidabode”) by GE Capital. In order to fund the discharge of the GE Capital loans following a Vidabode default, Keybrand subscribed $19.5 million for Vidabode common shares (of which $14.3 million was funded with a bank borrowing), thereby resulting in Keybrand holding about 39% of the common shares of Vidabode in addition to the 41% already held at that point by BWS. A receiver was retained two weeks later by BWS in its capacity of a secured creditor of Vidabode, and on May 6, 2011, Vidabode filed for bankruptcy.

Webb JA confirmed that Keybrand did not generate an allowable business investment loss on its subsequent disposition (under s. 50(1)(b)(iii)) of its shares of Vidabode, on the basis that the share subscription transaction was one between persons not dealing at arm’s length – so that s. 69(1)(a) deemed the cost of those shares to Keybrand to be their nil fair market value.

Webb JA made note of the “directing mind” test applied in the Robson Leather case (whose facts revealed “a striking similarity,” as in both cases there was “substantial debt” owing by a company with poor prospects to the relevant family.) He then stated:

Given the degree of financial dependence of Vidabode on BWS and Keybrand and the lack of any negotiation with respect to the terms and conditions (including the price) related to the share subscription, it is more likely than not that Keybrand controlled both sides of the transaction related to the issue of shares by Vidabode to Keybrand.

Webb JA also confirmed that the interest on the bank loan to fund the shares subscription was non-deductible, given that the factual findings of the Tax Court supported its conclusion “that Keybrand did not have a reasonable expectation of income in acquiring the shares of Vidabode and hence did not borrow the money for the purpose of earning income from property.”

Neal Armstrong. Summaries of Keybrand Foods Inc. v. Canada, 2020 FCA 201 under s. 251(1)(c), s. 20(1)(c)(i) and General Concepts - Purpose/Intention.