Her Majesty the Queen v. Ensite Limited, [1983] CTC 296, 83 DTC 5315

Le Dain, J:—This is an appeal from a judgment of the Trial Division allowing an appeal from an income tax reassessment in respect of the respondent’s 1975 taxation year. For the reasons given in A-702-81, with reference to the reassessment in respect of the respondent’s 1976 taxation year, copy of which is attached, I would allow the appeal, set aside the judgment of the Trial Division and restore the Minister’s reassessment, with costs in both the Appeal and Trial Divisions.

Le Dain, J:—This is an appeal from a judgment of the Trial Division allowing an appeal from an income tax reassessment in respect of the respondent’s 1976 taxation year.

The issue is whether the interest earned on United States dollar deposits in banks in the Republic of the Philippines, which deposits were part of an arrangement to obtain and secure Philippine peso loans to finance the establishment and operation of a manufacturing plant, was foreign investment income for purposes of dividend refund under section 129 of the Income Tax Act, RSC 1952, c 148, as amended by SC 1970-71-72, c 63, s 1, the relevant provisions of which are as follows:

129. (1) Where a corporation was, at the end of any taxation year, a private corporation, if a return of its income for the year has been made within 4 years from the end of the year the Minister

(a) may, upon mailing the notice of assessment for the year, refund without application therefor an amount (in this Act referred to as its “dividend refund” for the year) equal to the lesser of

(i) / of all taxable dividends paid by it in the year on shares of its capital stock, and

(ii) its refundable dividend tax on hand at the end of the year; and

(b) shall make such a refund after mailing the notice of assessment if application therefor has been made in writing by the corporation within 4 years from the end of the year.

(2) ...

(3) In this section, “refundable dividend tax on hand” of a private corporation at the end of any particular taxation year means the aggregate of amounts each of which is an amount in respect of any taxation year commencing after it last became a private corporation and ending not later than the end of the particular taxation year, equal to the least of

(a) 25% of the amount, if any, by which the aggregate of its Canadian investment income for the year and its foreign investment income for the year exceeds the amount deductible under paragraph 111(1)(b) from the corporation’s income for the year,

(b) the amount, if any, by which the aggregate of

(i) 25% of the corporation’s Canadian investment income for the year, and

(ii) the amount, if any, by which 40% of the corporation’s foreign investment income for the year exceeds the aggregate of amounts deducted under subsection 126(1) from the tax for the year otherwise payable by it under this Part,

exceeds 25% of the amount deductible under paragraph 111(1)(b) from the corporation’s income for the year,

(c) 25% of the amount, if any, by which the corporation’s taxable income for the year exceeds the aggregate of

(i) 4 times the amount, if any, deductible under section 125,

(ii) % of the aggregate of amounts deducted under subsection 126(1), and

(iii) 2 times the aggregate of amounts deducted under subsection 126(2)

from the tax for the year otherwise payable by it under this Part, and

(d) the amount of the tax for the year otherwise payable by it under this Part,

plus the aggregate of the taxes under Part IV payable by the corporation for the particular taxation year and any previous taxation years ending after it last became a private corporation, and minus the aggregate of the corporation’s dividend refunds for taxation years ending after it last became a private corporation and before the particular taxation year.

(4) In subsection (3),

(a) “Canadian investment income” of a corporation for a taxation year means the amount, if any, by which the aggregate of

(i) the amount, if any, by which the aggregate of such of the corporation’s taxable capital gains for the year from dispositions of property as may reasonably be considered to be income from sources in Canada exceeds the aggregate of such of the corporation’s allowable capital losses for the year from dispositions of property as may reasonably be considered to be losses from sources in Canada,

(ii) all amounts each of which is the corporation’s income for the year (other than exempt income or any dividend the amount of which was deductible under section 112 from its income for the year) from a source in Canada that is a property (other than a property used or held by the corporation in the year in the course of carrying on a business), determined, for greater certainty, after deducting all outlays and expenses deductible in computing the corporation’s income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purpose of earning the income from that property,

(iii) all amounts each of which is the corporation’s income for the year (other than exempt income) from a source in Canada that is a business other than an active business, determined, for greater certainty, after deducting all outlays and expenses deductible in computing the corporation’s income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purpose of earning the income from that business,

exceeds the aggregate of amounts each of which is a loss of the corporation for the year from a source in Canada that is a property or business other than an active business; and

(b) “foreign investment income” of a corporation for a taxation year means the amount, if any, by which

(i) the amount that would be determined under paragraph (a) in respect of the corporation for the year if the references in paragraph (a) to “in Canada” were read as references to “outside Canada”,

exceeds

(ii) the aggregate of all amounts deductible under section 113 from the corporation’s income for the year.

The appellant contends that the interest on the US dollar deposits was income from a source outside Canada that was property used or held by the respondent in the course of carrying on business, within the meaning of the exclusion in subparagraph (ii) of paragraph 129(4)(a) above.

The respondent company, Ensite Limited (“Ensite”), was incorporated under the laws of Canada and is a private corporation within the meaning of subsection 89(1) of the Income Tax Act. It is a subsidiary of the Ford Motor Company of Dearborn, Michigan, and it carries on the business, in Windsor, Ontario, of manufacturing and selling automobile engines, mainly for Ford companies. In 1972 its directors decided that because of its strong cash position it should finance the establishment of a stamping plant in the Philippines as part of the Ford participation in the “Progressive Car Manufacturing Program of the Philippines”, an objective of which was to increase Philippine exports. Philippine policy required that foreign exchange be brought into the country for such an investment. It was decided that Ensite would commit up to $5 million of its own money in direct, long-term investment in the stamping plant and provide the rest of the capital requirements, up to $40 million, by loans.

The loans were made available through “swap arrangements” between the Central Bank of the Philippines and the commercial banks which made the loans to the Philippine branch of Ensite. The commercial banks obtained Philippine pesos from the Central Bank at the prevailing exchange rate upon depositing US dollars with the Central Bank under arrangements that ensured that the pesos could be reconverted to US dollars in the future at an agreed exchange rate, thus affording protection against the risk of devaluation. Ensite made US dollar deposits with the commercial banks, which then made the peso loans in an equivalent amount to the Philippine branch. Ensite received certificates of deposit for the US dollar deposits with the commercial banks which it turned over to the banks as security for repayment of the peso loans. The schedule for repayment or withdrawal of the US dollar deposits corresponded to the schedule for repayment of the peso loans, which was to begin at the end of an initial period of five years and continue in six annual instalments. The certificates were declared to be “enforceable” against any branch of the commercial banks outside of the United States thus ensuring against the risk of foreign exchange controls that would prevent US dollars from being taken out of the Philippines. It was not essential to the swap arrangements that Ensite make the US dollar deposits with the commercial banks. The required US dollars could have been made available by the commercial banks on other terms. But the US dollar deposits permitted Ensite to obtain interest rates that reduced the net cost of the borrowing.

The US dollar deposits with the commercial banks were made by Ensite out of surplus cash retained from its operations. Ensite always had large amounts of cash invested in short-term deposits. The peso loans to its Philippine branch were used to finance not only the construction, equipping and start-up of the stamping plant but its current operations as well.

In its return for the 1976 taxation year Ensite included interest in the amount of $2,323,140 earned on its US dollar deposits in the Philippines in computing its foreign investment income and its refundable dividend tax on hand at the end of the year for purposes of section 129. During 1976 it paid a taxable dividend in the amount of $7,496,794* and in its 1976 return it claimed a dividend refund of $2,498,931. In his reassessment in respect of the 1976 taxation year the Minister took the position that the sum of $2,323,140 was not foreign investment income within the meaning of section 129 for the reason that it was “income from property used or held by the corporation in the year in the course of carrying on a business”, and he reduced the amount of dividend refund to which Ensite was entitled by $972,860. The amount of refundable dividend tax on hand at the end of the 1976 taxation year depends also on whether the interest on Ensite’s US dollar deposits earned in its 1975 taxation year was properly included in computing its foreign investment income for purposes of section 129. The Minister’s reassessment in respect of the 1975 taxation year in which he ruled for the same reasons that a sum of $1,944,710 was not foreign investment income and reduced the refundable dividend tax on hand at the end of the 1975 taxation year by $486,178 was also appealed. Ensite did not make a claim for dividend refund for 1975 so that the 1975 reassessment did not affect its tax liability in that year but it appealed the reassessment because of its possible effect on the cumulative refundable dividend tax on hand. The judgment of the Trial Division with respect to the 1975 reassessment was the subject of a separate appeal to this Court in A-701-81, which was heard at the same time as this appeal. It was said, however, by counsel for the Crown to be academic. Counsel for Ensite did not dispute this contention, presumably because of the understanding expressed in the Trial Division that if Ensite succeeded in respect of the 1976 reassessment effect would be given to that result in determining what should be included in foreign investment income in respect of the 1975 taxation year for purposes of determining the refundable dividend tax credit on hand as at the end of the 1976 taxation year and the dividend refund payable for 1976. Thus while Ensite’s statement of claim in respect of the 1976 reassessment asks for a determination of the refundable dividend tax credit on hand at the end of 1976 and the amount of dividend refund payable, the issue that will be determined on this appeal is whether the sum of $2,323,140 earned by Ensite in 1976 on its US dollar deposits in connection with the peso loans to its Philippine branch was foreign investment income within the meaning of section 129.

In his memorandum counsel for the Crown relied on both the exclusion from foreign investment income in subparagraph (ii) of paragraph 129(4)(a)

— income from a source outside Canada that is “property used or held by the corporation in the year in the course of carrying on a business” — and on the exclusion in subparagraph (iii) — income from a source outside Canada that is income from an active business — but in his oral submissions he rested his case squarely on the first exclusion. That is in my view the only arguable basis for exclusion on the facts of this case. That was the view of the Trial Division in allowing Ensite’s appeal from the reassessment. In concluding that the interest on the US dollar deposits was not income from a source that was property used or held by Ensite in the course of carrying on its business, the learned Trial Judge said:

The stamping plant operation in the Philippines is consistent with the taxpayer’s main business. In committing itself to this project, it seems to me that the taxpayer made two financial decisions: the first, to authorize a direct capital expenditure of $45,000,000.00, $5,000,000.00 in cash and up to a further $40,000,000.00 borrowed; the second, and in my opinion, different kind of decision was to make use of its Canadian cash surplus by removing it from investments in Canada and placing it in investments in the Philippines. It is true that in doing so, it satisfied a condition precedent to the establishment of the plant and facilitated the negotiation of credit, but in the light of the several other aspects in which the transactions were kept separate and distinct, I am of the view that these benefits were not sufficient to integrate the transaction with the taxpayer’s main business, or to use the language of the statute, to warrant a finding that these funds were “property used or held by the corporation in the year in the course of carrying on a business”. It is, to me, extremely significant that the return from these investments would carry on at the negotiated rate, independent entirely of success or failure of the plant and that the taxpayer enjoyed the right to recall the invested funds at any time and to do so in American currency and through offshore rather than Philippines branches of the banks concerned. These were prima facie investment transactions. As a result of these precautions, they were insulated from the taxpayer’s main business. In terms of the attention required to manage them or their effect on the total income, they remain clearly secondary or incidental to the taxpayer’s main business.

In The Queen v Marsh & McLennan, Limited, Court File A-675-81, Judgment April 11, 1983, this Court had to consider the exclusions from Canadian investment income as defined by section 129 in relation to interest earned by an insurance broker on the short term deposit of unremitted premiums — that is, the total amount from time to time of premiums (after deduction of the broker’s commission) that had been collected from insured but had not yet been remitted to the insurers. The amount of interest attributable to unremitted premiums had been estimated by the taxpayer in his return and was not in issue. A majority of this Court concluded that the interest was not Canadian investment income within the meaning of section 129. Although they differed somewhat in their approach to the issue the members of the majority agreed that the interest was income from a source that was property used or held by the taxpayer in the course of carrying on its business.

For the reasons which I briefly indicated in Marsh & McLennan I am of the Opinion that the same view must be taken of the interest on the US dollar deposits in the present case. Whether or not it was essential to do so, the fund represented by the US dollar deposits was in fact committed to the carrying on of Ensite’s business in the Philippines. It was employed and risked in the business because it was an integral part of the arrangements by which the business was being financed. The US dollar deposits were the means by which the peso loans were obtained on the most favourable terms, including a reduced cost of borrowing, and they were security for the repayment of the loans. For these reasons they were in my opinion property used or held by Ensite in the carrying on of its business, and the interest earned on them was, therefore, not foreign investment income within the meaning of section 129.

I would accordingly allow the appeal, set aside the judgment of the Trial Division and restore the Minister’s reassessment with costs in both the Appeal and Trial Divisions.