Husky Energy Inc. v. Alberta, 2011 ABQB 268

Court of Queen ’ s Bench of Alberta Citation: Husky Energy Inc. v. Alberta, 2011 ABQB 268 Date: 20110418 Docket: 0901 13831 Registry: Calgary Between: Husky Energy Inc. Respondent - and - Her Majesty the Queen in Right of Alberta Appellant _______________________________________________________ Reasons for Judgment of the Honourable Madam Justice C. A. Kent _______________________________________________________ [ 1 ] For approximately two years - 2003 to 2005 - the corporate tax regime in Ontario was more advantageous than that in Alberta.

The Husky group of companies reorganized its corporate structure to take advantage of the Ontario tax regime. As a result it did not pay some Alberta tax that it had traditionally paid and it took some deductions on its Alberta income. The Minister of Finance of the Government of Alberta reassessed the Husky companies on the basis that in some cases the companies did not comply with the technical requirements of the relevant Alberta tax provisions or the reorganizations resulted in abusive avoidance pursuant to the general tax avoidance rule (GAAR). Husky appeals that reassessment. THE FACTS

[ 2 ] In 2003, the Husky group of companies reorganized its corporate structure under the name of Canadian Financing Strategy (CFS). There were three different financings - CFS I, CFS II and CFS III. CFS II and III were essentially the same other than the amount of money involved in each. [ 3 ] Before the restructuring, Husky Oil Limited, Husky Energy Marketing Inc. and HOI Resources, collectively referred to as Subsidiaries were financed in part by loans of $722 million from Husky Oil Operations Limited (Operations). The refinancing of that arrangement was CFS I.

In 2003, as detailed below, the source of those funds was refinanced. Secondly, Operations was partially financed by an equity investment from Husky Energy of more than $3.1 billion. The source of those funds were refinanced in December, 2003 and April, 2005. Those refinancings were CFS II and III. [ 4 ] The process for refinancing CFS I was as follows: 1. Operations incorporated two new subsidiaries, HEI Central Finance Ltd. (Central) and HEI West Finance Ltd. (West). Central was incorporated in the British Virgin Islands (BVI) and was a resident in Ontario. West was a resident of British Columbia. 2.

Subsidiaries borrowed from CIBC to repay the $722 million debt to Operations. 3. Operations invested $722 million in Central. 4. Central loaned $722 million to West. 5. West loaned $722 million to Subsidiaries. [ 5 ] As a result of that restructuring, Subsidiaries paid interest to West on the loans, West paid interest to Central and Central paid dividends to Operations when declared by the directors of Central. [ 6 ] In the tax filings pursuant to the Alberta Corporate Tax Act (ACTA) , Subsidiaries claimed a deduction for the interest paid to West pursuant to s. 20 (1) (

c) of the Income Tax Act ( ITA ), which has been adopted into ACTA [1] . Operations included the dividends in income and then claimed a deduction pursuant to s. 112 (1) (

c) of ITA . Central reported the interest income they received pursuant to ITA and Ontario Corporate Tax Act (OCTA) . That resulted in a payment under ITA pursuant to s. 12(1). However, under OCTA , the interest income was reported as non-taxable because the provisions of OCTA provided that if the corporation is incorporated outside Canada and a resident of Ontario, it is not taxed on interest income. West included the interest received and deducted the interest paid both under ITA and the B. C. Income Tax Act. [ 7 ] The process for refinancing CFS II was as follows: 1.

Operations issued redeemable preferred shares to Husky Energy. 2. Husky Energy incorporated two new subsidiaries, HEI Brae Finance Ltd. (Brae Finance) and HEI Brae Pacific Finance Ltd. (Brae Pacific). Brae Finance was incorporated in BVI and was resident in Ontario. Brae Pacific was a resident of British Columbia. 3. Husky Energy borrowed from CIBC to invest $1.7 billion in shares of Brae Finance.

4. Brae Finance loaned $1.7 billion to Brae Pacific. 5. Brae Pacific loaned $1.7 billion to Operations. 6. Operations paid Husky Energy the redemption price to redeem a portion of the preferred shares and Husky repaid CIBC. [8] As a result of the restructuring, Operations paid interest to Brae Pacific, Brae Pacific paid interest to Brae Finance and BraeFinance paid dividends to Husky Energy. The tax reporting for the various entities was the same as for CFS I. [9] The process for refinancing CFS III was the same as CFS II. The amount involved was $1.4 billion.

The tax reporting for theCFS III entities was the same as for CFS I and II. [10] The Minister reassessed the Husky entities involved in all three refinancings so that the dividend deduction taken by theAlberta parent taxpayers pursuant to s. 112 (1) was disallowed and the interest deduction taken by the Alberta borrowers pursuant to s.20 (1) (

c) was disallowed. For CFS I, it added back interest income that Operations would have declared pursuant to s. 12 (1) (

c) had therefinancing not occurred. THE ISSUES 1. Insofar as CFS II and III are concerned, is Operations entitled to a deduction under 20 (1) (

c) with respect to the interest paid onthe money borrowed to redeem the preferred shares? This has been framed as the technical issue since it asks whether there has beentechnical compliance with the Act and does not engage GAAR. 2. Does GAAR override the specific sections of ITA as adopted by ACTA so that the interest income earned by the Ontariotaxpayers is taken into the taxable income of Operations (CFS

I) a parent taxpayer or the deduction taken by the Alberta parent taxpayersin respect of dividends paid to them is denied or the deduction taken by the Alberta borrowers in respect of the interest paid is denied orall of those outcomes? THE LAW [11] There are several cases which both counsel cited in support of their arguments. Some are cases interpreting relevant sectionsof ITA. Others deal with GAAR. Because the principles enunciated in the cases address more than one of the issues, I summarize herethe facts of each case and pertinent portions of the reasoning.

I will then address each of the issues in the context of these cases. [12] In applying this jurisprudence to the facts before me, I need to be mindful of the role these decisions play in the tax planningprocess of Canadians. While trial judges must always heed precedent, in many areas of the law when applying precedent to the facts,there is a reasonable amount of latitude in how to use precedent. Not having decided any tax cases before, as counsel were taking methrough the cases, I was struck by the emphasis put on certainty by the judges as they did their analysis.

Tax planning must be foundedon a reasonably high degree of certainty. Taxpayers should be able to rely upon previous cases involving similar facts. Concepts ofconsistency, predictability and fairness are key in applying the reasoning of these cases. [13] The first relevant case is Trans-Prairie Pipelines Ltd. V. M.N.R., (1970), (CA EXC), 70 D.T.C. 6351 (Ex.Ct.). At its incorporation, Trans-Prairie raised $700,000 of its capital by an issue of redeemable preferred shares. Subsequently furthercapital of $300,000 was raised by the issue of common shares and $700,000 of borrowing.

At the same time the preferred shares wereredeemed by using the $300,000 raised by issuing the common shares and $400,000 of the borrowed money. The Minister argued that tothe extent that the borrowings were used to retire the preferred shares, the borrowings were not “used for the purpose of earning incomefrom a business”. According to President Jackett, the correct characterization of the transaction was that “...what the appellant was using

in its business to earn income was the $400,000 subscribed by common shareholders and the $700,000 of borrowed money.”(para. 7).President Jackett then explores what must be intended by the phrase “used for the purpose of earning income”. He says that “...whatmust have been intended by [then] Section 11 (1) (

c) was that the interest should be deductible for the years in which the borrowedcapital was employed in the business rather than that it should be deductible for the life of a loan as long as its first use was in thebusiness.” (para.11). He says that the $700,000 went in part to “fill the hole” left by the redemption of the preferred shares. [14] In Shell Canada Ltd. v. R., (SCC), [1999] 3 S.C.R. 622, Shell needed about $100 million for corporatepurposes. It instituted a complex financing scheme whereby it borrowed $150 million in N.Z. dollars, paying 15.4% interest.

If it hadborrowed in the market, the cost of borrowing would have been 9%. It took the N.Z. dollars and bought U.S. dollars. Then it deductedinterest at 15.4%, not 9%. The tax saving was the difference between the two borrowing rates. The Minister denied the higher rateinterest deduction. McLachlin, J. (as she then was) began her analysis by setting out the four elements of s. 20 (1) (c). The elementcentral to this case is the third: the borrowed money must be used for the purpose of earning non-exempt income from a business orproperty (para. 28).

She agrees with Dickson, C.J’s statement in Bronfman that the focus must be on what use the borrower intended forthe money and that the deduction is not available “... where the link between the borrowed money and the use is indirect” (para. 31).Dealing with the facts before her, she essentially found that money is money whether it is N.Z. dollars or U.S. dollars.

Even though therewas an exchange from one to the other, the New Zealand money was used directly for the purpose of producing income. [15] In addressing the objections of the Minister, McLachlin, J. says that the objections appeared to be grounded in the notion thattaxpayers are not permitted to rely on s. 20 (1) (

c) if the structure of the transaction is determined by a desire to minimize the amount oftax payable. To that she said at para. 39 and 40: This Court has repeatedly held that courts must be sensitive to the economic realities of a particular transaction, rather than being boundto what first appears to be its legal form: Bronfman Trust, supra, at pp.52-53, per Dickson C.J.; Tennant, supra, at para. 26, perIacobucci, J. But there are at least two caveats to this rule.

First, this Court has never held that the economic realities of the situation canbe used to recharacterize a taxpayer’s bona fide legal relationships. To the contrary, we have held that, absent a specific provision of theAct to the contrary or a finding that they are a sham, the taxpayer’s legal relationships must be respected in tax cases. Recharacterizationis only permissible if the label attached by the taxpayer to the particular transaction does not properly reflect its actual legal effect:Continental Bank of Canada v. R. (SCC), [1998] 2 S.C.R. 298 (S.C.C.) at para. 21, per Bastarache J.

Second, it is well established in this Court’s tax jurisprudence that a searching inquiry for either the “economic realities” of a particulartransaction or the general object and spirit of the provision at issue can never supplant a court’s duty to apply an unambiguous provisionof the Act to a taxpayer’s transaction. [16] Finally, she notes that the Minister’s objections appeared to be coloured by a concern with tax avoidance.

To that she says atpara. 47: The Federal Court of Appeal’s overriding concern with tax avoidance not only coloured its general approach to this case, but may alsohave led it to misread the clear and unambiguous terms of s. 20 (1) (c) (

i) itself. In his reasons, Linden, J.A. emphasized that Shell onlydecided to borrow NZ$ from the foreign lenders because it sought to take advantage of the higher interest rate applicable to NZ$. Yet, asDickson C.J. made clear in Bronfman Trust, supra, at p. 46, the reason for a particular method of borrowing is irrelevant to a properconsideration of s. 20 (1) (c) (i). The issue is the use to which the borrowed funds are put.

It is irrelevant why the borrowing arrangementwas structured the way that it was or, indeed, why the funds were borrowed at all. [17] The decision in Trans-Prairie was not considered by Justice McLachlin. [18] Trans-Prairie and Shell were considered in Singleton v. R., 2001 SCC 61 , [2001] S.C.J. No. 59. Mr. Singleton wasa partner in a law firm. His capital account was at least $300,000. Mr. Singleton wanted to use $300,000 of his capital account topurchase a house. He took that money out of his capital account and borrowed the same amount to refinance his capital account.

Mr.Singleton deducted the interest he paid on the $300,000 loan. The Minister denied the interest deduction on the grounds that theborrowed money was used to purchase a home. [19] The issue before the court was whether the borrowed money was used for the purpose of earning income in the business.

Major, J., writing for the majority, confirmed the statement in Shell that the focus of the inquiry must be on the use to which the taxpayerput the borrowed funds. A direct link between the borrowed money and an eligible use must be found. He says at para. 32: The Tax Court Judge found that the purpose in using the money was to purchase a house and that this purpose could not be altered by the“shuffle of cheques” that occurred on October 27, 1988. I respectfully disagree. It is this “shuffle of cheques” that defines the legalrelationship which must be given effect.

The respondent had at least $300,000 of his own money in the law firm. Surely it follows thatthe $300,000 invested in the law firm was not frozen for all time in the form of its original investment. The respondent was free tochange his mind and decide whether to use his own money or borrowed money to finance the business of his law firm. In reviewing whatthe respondent did, it is clear that the relevant cheques were deposited and honoured. There is no suggestion that the transaction was asham.

Giving effect to the legal relationships in this case, it is clear that the respondent used the borrowed funds to refinance his capitalaccount. [20] Major, J. then says that it does not matter that the withdrawn funds were used to buy a house or that the transactions alloccurred on the same day. And, he says at para. 34: In my respectful opinion, it is an error to treat this as one simultaneous transaction. In order to give effect to the legal relationships, thetransactions must be viewed independently.

When viewed that way, on either version of the facts (i.e. regardless of the sequence), whatthe respondent did in this case was use the borrowed funds for the purpose of refinancing his partnership capital account with debt. [21] He says at para. 35 that the fact “... that the money was borrowed in order to allow the respondent to use his own money topurchase the house is of no moment.” He refers to President Jackett’s description in Trans-Prairie, that the borrowed money was fillingthe hole that the redemption of shares created. [22] Finally, Major, J says at para. 43: “... it is irrelevant that by his own admission the respondent structured the transaction for tax purposes.

Courts cannot search for the“economic reality” or the “bona fide” purpose of the transaction in this case. In giving effect to the legal relationships underlying thetransactions here, it is obvious that the borrowed money was used directly to refinance the respondent’s capital account.” [23] It should be noted that in dissent, Lebel, J. said that what Dickson, C.J. said in Bronfman Trust about economic realities wasnot overruled by Shell and should not be “... dismissed as mere obiter dicta”. [24] In Bronfman Trust v.

R. (SCC), [1987] 1 S.C.R. 32, under a trust deed, the trustees were empowered to makeallocations to the beneficiary from the capital of the trust. In three successive years, the trustees made such allocations, not by liquidatingcapital assets but rather by borrowing funds from a bank. The Minister took the position that the interest paid on the loans was notdeductible. The Supreme Court agreed with the Minister. Chief Justice Dickson says that to accept the taxpayer’s argument could resultin unfairness as between taxpayers.

Taxpayers who own income-producing assets could use the proceeds of the loan for all manner ofineligible uses while less wealthy taxpayers who do not have access to income-earning assets could not do so. He says that the decisionof Trans-Prairie stands on its own in allowing an interest deduction in similar circumstances because the reasons given were“inadequate” to support the trust’s position. The Chief Justice then notes a trend away from strict construction of taxation statutes and atrend towards “... attempting to ascertain the true commercial and practical nature of the taxpayer’s transactions.” (para. 48).

He goes onto say at para. 49: Assessment of taxpayers’ transactions with an eye to commercial and economic realities, rather than juristic classification of form, mayhelp to avoid the inequity of tax liability being dependent upon the taxpayer’s sophistication at manipulating a sequence of events toachieve a patina of compliance with the apparent prerequisites for a tax deduction. [25] He also says the following at para. 53:

Before concluding, I wish to address one final argument raised by counsel of the trust. It was submitted - and the Crown generouslyconceded - that the trust would have obtained an interest deduction if it had sold assets to make the capital allocation and borrowed toreplace them. ... I admit to some doubt about the premise conceded by the Crown.

If, for example, the trust had sold a particular income-producing asset, made the capital allocation to the beneficiary and repurchased the same asset, all within a brief interval of time, thecourts might well consider the sale and repurchase to constitute a formality or a sham designed to conceal the essence of the transaction,namely that money was borrowed and used to fund a capital allocation to the beneficiary. [26] Canada Trustco Mortgage Co. v. R., 2005 SCC 54 , [2005] 2 S.C.R. 601 was the first case to consider the interplaybetween GAAR and specific provisions of ITA.

Canada Trustco purchased some trailers which it then leased back to the vendor.Canada Trustco received back its money but still claimed CCA on the amount it originally paid for the trailers.

The Minister appliedGAAR to the transaction on the basis that in economic terms Canada Trustco paid nothing but acquired a CCA deduction whichpermitted tax deferral. [27] The court introduces its analysis at para. 1: The Act continues to permit legitimate tax minimization; traditionally, this has involved determining whether the taxpayer brought itselfwithin the wording of the specific provisions relied on for the tax benefit.

Onto this scheme, the GAAR has superimposed a prohibitionon abusive tax avoidance, with the effect that the literal application of provisions of the Act may be seen as abusive in light of theircontext and purpose. The task in this appeal is to unite these two approaches in a framework that reflects the intention of Parliament inenacting the GAAR and achieves consistent, predictable and fair results. [28] At para. 11, because the Duke of Westminster principle (Inland Revenue Commissioners v. Duke of Westminster (1935) ,[1936] A.

C. 1 (U.K.H.L.)) permits taxpayers to arrange their affairs to minimize tax, the Court noted that Canadian tax legislation hasreceived a strict

interpretation. The Court goes on to say at para. 11 and 12: Where Parliament has specified precisely what conditions must be satisfied to achieve a particular result, it is reasonable to assume thatParliament intended that taxpayers would rely on such provisions to achieve the result they prescribe. The provisions of the Income Tax Act must be interpreted in order to achieve consistency, predictability and fairness so that taxpayersmay manage their affairs intelligently. As stated at para. 45 of Shell Canada Ltd. v.

R., (SCC), [1999] 3 S.C.R. 622(S.C.C.): [A]bsent a specific provision to the contrary, it is not the courts’ role to prevent taxpayers from relying on the sophisticated structure oftheir transactions, arranged in such a way that the particular provisions of the Act are met, on the basis that it would be inequitable tothose taxpayers who have not chosen to structure their transactions that way. [emphasis added] [29] The court sets out a three step process when applying GAAR. The first step is to determine if there is a tax benefit from thetransaction.

S. 245 (1) defines a tax benefit as “ a reduction, avoidance or deferral of tax” or “an increase in a refund of tax or otheramount.” At para. 20, the court notes that while a deduction against income is clearly a tax benefit, for some transactions, the existence of a taxbenefit can only be established by comparison with an alternate arrangement. [30] The second step is to determine whether the transaction is an avoidance transaction.

S. 245 (3) defines an avoidancetransaction as a transaction that results in a tax benefit, either by itself or as a part of a series of transactions unless it has been undertakenprimarily for bona fide purposes. [31] The third step is to determine if the avoidance transaction is abusive. In interpreting the intent of the legislators, the courtsmust take a “ ... unified, textual, contextual, and purposive approach to interpreting the specific provisions that give rise to the taxbenefit.”(para. 40).

The court recognized that one of the reasons to apply such an approach was that it supports the overall policy that taxlaw be “ ... certain, predictable and fair ...” (para. 42).

[ 32 ] The above analysis has two stages; first, to interpret the provisions giving rise to the tax benefit to determine their object, spirit and purpose, and second, to determine if the transaction either falls within or frustrates that purpose. [ 33 ] There are two evidentiary issues included in the court’s analysis. First, the burden is on the taxpayer to refute steps one and two of the analysis and the burden on the Minister to establish abuse. Second, the existence of abusive tax avoidance must be clear. (para. 66). [ 34 ] In Lipson v.

R. [2009], S.C.R. 3, Earl and Johanna Lipson purchased a home in Toronto for $750, 000. Mrs. Lipson borrowed $562,500 from the bank to purchase shares in Lipson Family Investments Limited. Mrs Lipson paid the borrowed money to her husband who transferred the shares to her. Mr. and Mrs Lipson obtained a mortgage on their home for $562, 000. That money paid off the loan obtained to purchase the shares. Mr. Lipson claimed a deduction the interest paid on the mortgage loan. One of the provisions of the ITA upon which Mr. Lipson relied was s. 20 (1) (c). The Minister reassessed Mr. Lipson relying on GAAR.

The deduction were ultimately disallowed but it had nothing to do with the s. 20(1) (

c) argument, but with sections not relevant to this case. [ 35 ] Dealing with the 20 (1) (

c) argument, LeBel, J., writing for the majority says at para. 41: First of all, in accordance with the analytical approach described above, we must consider the tax benefit conferred on Mrs. Lipson by ss. 20 (1) (

c) and 20 (3), namely the entitlement to deduct of interest. In my opinion, the respondent has not established that in view of their purpose, these provisions have been misused and abused. Mr. Lipson sold his shares to his wife and bought the residence with the proceeds of that sale (see Statement of Agreed Facts and Conclusion, at para.12). In the result, Mrs. Lipson financed the purchase of income-producing property with debt, whereas Mr. Lipson financed the purchase of the residence with equity.

To this point, the transactions were unimpeachable. [ 36 ] Binnie, J., dissenting in the result, described the way in which GAAR must be considered. At para. 55 he says: The GAAR is a weapon that, unless contained by the jurisprudence, could have a widespread, serious and unpredictable effect on the legitimate tax planning. At the same time, of course, the GAAR must be given a meaningful role. [ 37 ] With respect to the 20 (1) (

c) issue, he says at para. 60: It is true that by means of a series of transactions, the appellant turned the equity in his shares into the part purchase (with his wife) of a house, but as stated, Singleton illustrates the proposition that there is nothing abusive in principle for a taxpayer to rearrange his or her capital (borrowed or non-borrowed) in a tax efficient manner. THE TECHNICAL ISSUE [ 38 ] This issue applies only to CFS II and III. The Crown says that the loan used to redeem the preferred shares is not in compliance with s. 20 (1) (c) (

i) so that Operations is not entitled to the interest deduction. S. 20 (1) (c) (

i) provides as follows: 20.

(1) Notwithstanding paragraphs 18 (1) (a), (

b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto: .... (

c) an amount paid in the year or payable in respect of the year (depending on the method regularly followed by the taxpayer in computing the taxpayer’s income), pursuant to a legal obligation to pay interest on

(

i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquireproperty the income from which would be exempt or to acquire a life insurance policy) THE POSITION OF THE PARTIES [39] The Crown makes two arguments. First, it says that the borrowing did not meet the direct use requirement because there is nodirect link between the borrowing and an eligible use, namely for the purpose of earning income. [40] Second, the Crown says that the money was used to avoid tax, not earn income.

It says that Trans-Prairie is distinguishablebecause in Trans-Prairie the transaction was motivated by a plan to expand the business. As a result after the transaction, the taxpayerhad additional assets. At the completion of CFS II and III, there was no increase in capital and there was no business need attached to theborrowing. It was done simply to avoid tax. The Crown characterizes Trans-Prairie as a case where there were exceptionalcircumstances.

It says that in Lipson and Singleton, the taxpayer acquired an asset with the potential to earn income. [41] Husky says that the decision in Trans-Prairie is a complete answer. Furthermore, the facts in Trans-Prairie are like those inSingleton except that in Singleton, the money was taken out of the capital account for a personal use. The facts which the Crown saysmake Trans-Prairie distinguishable have nothing to do with the principle which is the same for both.

Furthermore, Shell, Singleton andLipson say that the fact that the motivation for the transaction in tax avoidance is irrelevant to whether interest is deductible. [42] Husky cites IT-533 paragraph 23 which reads in part: Interest expense on borrowed money used to redeem shares or return capital can be an exception to the direct use test.

In connection withthis use, the purpose test will be met if the borrowed money replaces capital (contributed capital or accumulated profits) that was beingused for purposes that would have qualified for interest deductibility had the capital been borrowed money (eligible purposes).Consistent with the concept of filling the hole, contributed capital generally means the funds provided by the shareholders to commence,or otherwise further, the carrying on of the business.

While in most situations the legal or stated capital for corporate law purposes wouldbe the best measurement of contributed capital for this purpose, other measurements may be more appropriate depending on thecircumstances. In situations where some proportion of shares is being replaced with borrowed money, only the capital of those shares,computed on a pro-rata basis, would be considered to be replaced with the borrowed money.

A corporation’s deficit does not reducecontributed capital for purposes of this exception. [43] Husky says that while not determinative, a court may consider such bulletins (Placer Dome Canada v. Ontario, 2006 SCC 20, 2006 S.C.C. 20). ANALYSIS [44] I begin my analysis by applying what Major, J. said in Singleton. Just as Mr. Singleton’s capital account equity was not‘frozen’ for all time, neither was equity that Husky had in Operations. Operations was free to change its mind and run its business withborrowed money.

The transactions should not be looked at as one simultaneous transaction, rather be viewed independently. Viewing thetransactions individually, what Operations did was fund its business with borrowed money. [45] Looking at it through the lens of Shell, searching for an economic reality in what Operations did must not replace theapplication of an unambiguous provision of the act. Second, it is irrelevant why the funds were borrowed. Care must be taken not tocolour a transaction with a concern over tax avoidance.

I have pulled these words and phrases because I cannot see any differencebetween this transaction and those of Shell, Singleton and Trans-Prairie. [46] It is true that in Trans-Prairie, some of the borrowing was done to expand the business. But, if that was a significant factor,

then only the interest for that portion of the borrowing would have been allowed. There is nothing in 20 (1) (

c) that requires an increasein capital. All that is required is that the borrowed money be used for the purpose of earning income. Just as Mr. Singleton usedborrowed money in running a law firm, Operations used borrowed money to engage in the oil and gas business. APPLICATION OF THE GAAR [47] Husky concedes the first two steps of the GAAR analysis for CFS II and III. It does not concede these issues for CFS I.However, I begin with the analysis of the question of abuse for all three financings. The onus is in the Crown to show abuse. The Crownsays that the results of CFS II and III are abusive of ss. 20 (1) (

c) and 112 (1). For CFS I, the Crown also alleges abusive avoidance of s.12 (1) (c). Dealing generally with abuse analysis, the Crown cautions against fixating on the literal wording of specific provisions.Rather, the Court in Canada Trustco held that the provisions of the ITA were intended to apply to transactions with economic substance.The Husky transactions had no real economic substance and had no impact on Husky’s operations. Rather the Crown says, therestructuring was done to avoid tax. SECTION 20 (1) (c) [48] This

section applies to CFS I for Subsidiaries and CFS II and II for Operations. [49] Husky agrees with the Crown’s characterization of the object, spirit and purpose of the section: if money is borrowed andused in the business, a deduction of the interest expense is available. Husky does not agree with the Crown’s position that CFS II and IIIare abusive avoidance. [50] The Crown argues that to find that these transactions were not abusive would read GAAR out of the ITA.

The Crown relieson the following from Lebel, J’s decision in Lipson at para. 52: The appellants argue that to maintain certainty for taxpayers, the direct use of the borrowed funds - as determined by tracing - should bedeterminative of whether the GAAR applies to deductions claimed under s. 20 (1) (c) (Appellants’ Factum, at para. 82). As I mentionedabove, such an approach would effectively read the GAAR out of the ITA, since the “direct use” test applies only to determine whetherinterest is deductible under s. 20 (1) (

c) and involves an inquiry that is distinct from the one under s. 245, in which it must be askedwhether otherwise valid transactions, such as those in Singleton and in the present case, frustrate the object, spirit and purpose of theprovisions relied on. Indeed, contrary to the judgments in Canada Trustco and Kaulius, my colleague Binnie J. essentially guts theGAAR and reads it out of the ITA under the guise of an exercise in legal

interpretation. To the extent that it may not always be obviouswhether the purpose of a provision is frustrated by an avoidance transaction, the GAAR may introduce a degree of uncertainty into taxplanning, but such uncertainty is inherent in all situations in which the law must be applied to unique facts. The GAAR is neither a penalprovision nor a hammer to pound taxpayers into submission. It is designed, in the complex context of the ITA, to restrain abusive taxavoidance and to make sure that the fairness of the tax system is preserved.

A desire to avoid uncertainty cannot justify ignoring aprovision of the ITA that is clearly intended to apply to transactions that would otherwise be valid on their face. [51] The Crown then argues that Husky cannot rely on the finding in Lipson that the transactions were not abusive of s. 20 (1) (c)because the facts were different. Mrs. Lispon acquired an investment - the shares - with the money she borrowed. That investment hadthe potential to accumulate taxable income. In Lipson and Singleton the borrowings were used to acquire capital.

The Crown also pulls aphrase from Canada Trustco where the court said at para. 60 that a transaction may be artificial if it “lacks substance”. The Crown saysthat the Husky transactions were only paper transactions that lacked any substance. The Crown also looks to Husky’s motivation whichwas only to avoid tax. That motivation defeats the spirit and purpose of s. 20 (1) (c). [52] Next, the Crown says that at the end of the days Husky had no more capital than before the transaction. There was noaccumulation of capital.

Finally, the Crown also argues that tax avoidance is not within the object, spirit and purpose of s. 20 (1) (c). [53] The Crown cited 722540 Ontario Inc. v. R. (sub nom Novapharm), 2003 FCA 112 , 2003 F.C.A. 112 whereRothstein, J. A. (as he then was) says at para. 41: “... solely engaging in tax avoidance, ... [is] not acting in accordance with the objectand spirit of subparagraph 20 (1) (c) (i).

[ 54 ] Husky says that these transactions are no different than in Singleton . Husky admits that both Shell and Singleton were decided before the GAAR provisions were inserted in the ITA . However, two cases of relevance that dealt with GAAR are Lipson and Canadian Pacific Ltd v. R. [2002] 3 F. C. (Fed. C.A.). Husky said that the transaction in Canadian Pacific is identical to that in Shell .

The Federal Court of Appeal upheld the Tax Court Judge who said that the Minister had improperly recharacterized interest payments as capital payments. [ 55 ] Husky says that Lipson also supports its position when LeBel said expressly at para. 41 that the transaction where Mrs. Lipson financed the purchase of income-producing property with debt while Mr. Lipson purchased the home with equity was unimpeachable. [ 56 ] Husky says that the argument that there has been no accumulation of capital was considered and rejected in both Trans- Prairie and Singleton .

The money borrowed from the Ontario entities was deployed in the business. That is all that is required. [ 57 ] Husky says that the Crown is attacking Husky’s motive which in the case of CFS II and III is tax avoidance. Motive, Husky says, is irrelevant.

Husky says that like the Federal Court of Appeal in Shell , the Crown’s position is coloured with its “overriding concern with tax avoidance”. [ 58 ] Finally, Husky says that even if Novapharm stands for the proposition that tax avoidance in contrary to s. 20 (1) (c), it is no answer to Lipson , Shell and Singleton . [ 59 ] I repeat what I said when dealing with the technical issue. It cannot be abusive for corporations to reorganize and refinance.

To find that Subsidiaries and Operations cannot change the way they finance their operations when the motivation is tax avoidance would mean that they are chained to Alberta. Attaching a chain to any corporation who engages in tax avoidance is nowhere within the object, spirit and purpose of s. 20 (1) (c). It cannot be the case when a fundamental principle of tax law is that taxpayers may arrange their affairs to minimize tax. Moreover, with the exception of one sentence in Novapharm , the cases do not say that.

To the extent that Novapharm says the contrary, it cannot stand in the face of Canada Trustco and Lipson . Finally, to argue that this is only a paper transaction is equivalent to saying this is only a shuffle of cheques. In the words of Major, J. the paper transactions define the legal relations between these entities. I must give effect to those legal relations. There is nothing abusive in deducting the interest paid by Subsidiaries and by Operations. SECTION 112 (1) [ 60 ] This

section applies to Operations in CFS I and Husky Energy in CFS II and III. S. 112 (1) provides as follows: Deductions of taxable dividends received by corporation resident in Canada Where a corporation in a taxation year has received a taxable dividend from (

a) a taxable Canadian corporation, or (

b) a corporation resident in Canada (other than a non-resident-owned investment corporation or a corporation exempt from tax under this Part) and controlled by it, an amount equal to the dividend may be deducted from the income of the receiving corporation for the year for the purpose of computing its taxable income. [ 61 ] The Crown does not dispute that paying the dividends to Operations (CFS

I) and to Husky (CFS II and III) complies technically with s. 112 (1). The Crown says that the purpose of the

section is to avoid multiple taxation of income as it passes through a chain of corporations. Husky agrees that that is the purpose. The Crown says that the abuse by the Husky transaction is that the Ontario government did not impose tax on the income and s. 112 (1) is only for income that has already been taxed.

[62] More specifically, the Crown’s objection is that the Ontario taxpayers are hybrids : BVI corporations that are taxed asresidents and non-residents. The brief says the following at para. 194: In the CFSs, subsection 112 (1) did not work the way it was supposed to when a corporation resident in Canada under the ITA and theACTA was taxed provincially as a non-resident and federally as a resident. Neither the ACTA nor the ITA contemplates the specialfederal/provincial “hybrid” structure implemented by the Appellants. [63] The Crown cites OGT Holdings Ltd. v. Québec (Sous-ministre du Revenu) 2009 QCCA 191 (Que.

C.A.). In that case, aQuébec corporation sold shares to an Ontario corporation using s. 85 of the ITA with the result that the Québec corporation only paidfederal on the capital gain. Under OCTA, the corporation was not required to pay tax. The Québec Court of Appeal held that there wasabusive tax avoidance since it twisted the provisions of the Québec Taxation Act. [64] Husky says that Parliament could have chosen a model where the taxpayer receiving dividend income would be required todemonstrate that the income had already been taxed.

Instead, Parliament chose a model where s. (112) (1) applies so long as thecorporation is within the Canadian tax net. Husky submits that the choice made by Parliament makes sense particularly in a federationwhere different provinces make different policy choices about taxation. [65] Husky cites Antosko v. R., (SCC), [1994] 2 C.T.C. 25 (S.C.C), a case involving a different

section of theITA, which also has as its objective the avoidance of double taxation. In Antosko, Iacobucci, J. rejected the Crown’s argument that thesection would only apply if otherwise the amounts at issue would be taxed twice (para. 41). [66] In my view, the purpose of s. 112 (1) is to avoid multiple taxation of income. Its purpose is not to ensure that income is taxedat least once. Operations and Husky chose to employ an Ontario entity to collect interest on a loan that it had made to a related entity. Itdid not pay provincial tax on that interest income. It then paid dividends to Operations or Husky.

These are two distinct transactions. Onehas nothing legally to do with the other. So, when dividends were paid to Operations or Husky, the Ontario interest income taxationsituation was of no relevance. There is no abuse of s. 112 (1). SECTION 12 (1) (c) [67] Consideration of this issue applies only to Operations in CFS I. [68] S. 12 (1) (

c) reads: Income inclusions - There shall be included in computing the income of a taxpayer in the year for a taxation year as income from abusiness or property such of the following amounts as applicable: ... (

c) subject to subsections (3) and (4.1), any amount received or receivable by the taxpayer in the year (depending on the methodregularly followed by the taxpayer in computing the taxpayer’s income) as, on account of, in lieu of payment of or in satisfaction of,interest to the extent that the interest was not included in computing the taxpayer’s income for a preceding taxation year ... [69] The Crown and Husky agree that the purpose of the

section is to cause interest received or receivable by a taxpayer in a yearbe included in taxable income. The Crown says that Operations circumvented 12 (1) (

c) by transferring the income to an Ontariotaxpayer which was not required to pay provincial tax. The Crown says that that is the abuse. [70] Husky’s answer is that it cannot be abusive for a taxpayer to move from one province to another to benefit from a lower taxrate. If it was the case, the move of many taxpayers from the East to Alberta would be suspect. The Crown’s other argument is that theinterest really returned to Alberta because of the dividend payments. Husky’s answer is that that argument requires a recharacterization ofthe facts which is not permitted. So says Canada Trustco at para. 30:

The courts must examine the relationships between the parties and the actual transactions that were executed between them. The facts of the transactions are central to determining whether there was an avoidance transaction. It is useful to consider what will not suffice to establish an avoidance transaction under s. 245 (3). The Explanatory Notes state, at p. 464: Subsection 245 (3) does not permit the “recharacterization” of a transaction for the purposes of determining whether or not it is avoidance transaction.

In other words, it does not permit a transaction to be considered to be an avoidance transaction because some alternative transaction that might have achieved an equivalent result would have resulted in higher taxes. [ 71 ] The simple answer is that tax avoidance by itself is not abuse. I echo the words in Shell as cited in Canada Trustco . If there is nothing in the statutes preventing it, taxpayers may rely in a sophisticated structure of financing to minimize the tax payable. Operations refinanced its business and took advantage of a difference in provincial taxing policy.

There is nothing abusive in that. [ 72 ] I conclude with reasons which address the allegations of abuse of all three sections. I agree with Husky that the Crown’s fundamental objection is that Husky refinanced its business to take advantage of Ontario tax policy which resulted in a tax reduction for Husky and a loss of tax revenues for Alberta. Each province is sovereign and has the right to set its own tax policy. Although harmonization of those policies may reduce or eliminate some of the consequences noted by the 1966 Royal Commission on Taxation, for 2 years from 2003 - 2005, Ontario chose to tax differently.

There is no principle, constitutional or otherwise, that says that a province may prevent corporations doing business within the province from taking advantage of another province’s tax policy. The reassessments of the Husky from entities attempt to do precisely that. [ 73 ] Corporations in Canada decide how they want to conduct their business subject, of course, to the legal framework established by the federal and provincial governments. That framework includes corporate, securities, environmental and tax regulation.

Within the framework, corporations decide what business to do, how big or small that business will be and where to do business. We collectively have given them that freedom because we have decided that that is how they will thrive to the benefit of all. There is nothing in the tax legislation that I see that is intended to restrict that freedom. To accept the Crown’s argument would. [ 74 ] Finally, I consider what Justice Lebel said in Lipson as he spoke of the purpose of GAAR.

He said that GAAR was intended to restrain abusive tax avoidance and “... to make sure that the fairness of tax system is preserved.” If fairness is an important measure of abuse, I find nothing unfair in Husky’s refinancing. [ 75 ] There are two matters that I need not address. First with respect to CFS I, since I have found no abuse, I need not deal with the first two parts of the GAAR analysis. [ 76 ] Second, Husky argued that the application of GAAR on the facts of this is outside the province’s jurisdiction.

I need not decide that constitutional issue given my decision above. [ 77 ] The appeal is allowed and the reassessments are vacated. Heard on the 22 nd , 23 rd and 24 th days of March, 2011. Dated at the City of Calgary, Alberta this 18 th day of April, 2011.

C.A. Kent J.C.Q.B.A. Appearances: Mr. Alnasir Meghji, Mr. Gerald A. Grenon Mr. Patrick L. Lindsay Osler, Hoskin & Harcourt LLP for the Appellant Mr. Clyde R. Davis Mr. Tim Hay Mr. Scott Chen Davis Law for the Respondent [1] For clarity, I will refer to the ITA

section numbers throughout. Each ITA

section has been adopted into ACTA .