GERBRO HOLDINGS COMPANY, Appellant, v. HER MAJESTY THE QUEEN,, 2016 TCC 173

Dockets: 2012-739(IT)G 2012-4194(IT)G BETWEEN: GERBRO HOLDINGS COMPANY, Appellant, and HER MAJESTY THE QUEEN, Respondent . Appeals heard on November 3, 4, and 5, 2014 and June 22, 23 and 24 at Toronto, Ontario and November 16, 2015, at Montreal, Quebec.

Before: The Honourable Lucie Lamarre, Associate Chief Justice Appearances : Counsel for the Appellant: Stéphane Eljarrat Joel Scheuerman Counsel for the Respondent: Naomi Goldstein Rita Araujo JUDGMENT The appeal from the reassessments made under the Income Tax Act ( ITA ), for the taxation years ended on December 31, 2005 and December 31, 2006, are allowed and the reassessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that Gerbro did not have to report for the taxation years ended on December 31, 2005 and December 31, 2006, income in the amounts of $841,803 and $754,210 respectively imputed to it under

section 94.1 of the ITA. If either of the parties requests to make submissions on costs, both parties shall file written submissions with the Registry on or before August 31, 2016. If no submissions are received, the Appellant will be awarded one set of costs for the two appeals (2012-739(IT)G and 2012-4194(IT)G). Signed at Ottawa, Canada, this 22nd day of July 2016. “Lucie Lamarre” Lamarre A.C.J. Citation: 2016 TCC 173 Date: 20160722

Dockets: 2012-739(IT)G 2012-4194(IT)G BETWEEN: GERBRO HOLDINGS COMPANY, Appellant, and HER MAJESTY THE QUEEN, Respondent. REASONS FOR JUDGMENT Lamarre A.C.J. 1 INTRODUCTION [ 1 ] The appellant, Gerbro Holdings Company ( Gerbro ), is appealing from two assessments made by the Minister of National Revenue ( Minister ) with respect to its taxation years ending on December 31, 2005 and December 31, 2006 ( Relevant Period ). The two appeals were heard on common evidence. The Minister's assessments imputed to Gerbro income of $841,803 for 2005 and $754,210 for 2006 under

section 94.1 of the Income Tax Act ( ITA ) in respect of Gerbro's investments in the following five offshore investment (hedge) funds (collectively, the Funds ): 1. The Raptor Global Fund Ltd. ( Raptor ); 2. Arden Endowment Advisors Ltd. ( Arden ); 3. M. Kingdon Offshore Ltd. ( Kingdon ); 4. Haussmann Holdings N.V. ( Haussmann ); and 5. Caxton Global Investments Ltd. ( Caxton ). [ 2 ]

Section 94.1 is an anti-avoidance provision which applies where (1) a taxpayer's interest in a non-resident entity derives its value, directly or indirectly, primarily from portfolio investments in listed assets, and (2) it may reasonably be concluded, having regard to all the circumstances, that one of the main reasons for the taxpayer acquiring, holding or having the interest in the non-resident entity was to pay significantly less

Part I taxes than would have been payable if the taxpayer had held the portfolio investments directly. I will refer to the rules set out in

section 94.1 as the offshore investment fund property rules ( OIFP Rules ). [ 3 ] The essence of the Respondent's position is that all the Funds derived their value primarily from portfolio investments and that Gerbro, being a sophisticated investor, invested with an intention to reduce or defer Canadian taxes, as contemplated by the concluding part of the subsection.

This position is premised on the low or non-existent taxation in the jurisdiction in which the investment vehicles of the Funds were located, on the fact that the hedge funds selected made no distributions to their shareholders, as well as on the existence of other tax-motivated transactions that Gerbro entered into over time. [ 4 ] The Appellant, on the other hand, argues that

section 94.1 does not apply since neither of the two above-stated requirements is met. It submits that (1) the Funds did not derive their value primarily from portfolio investments in listed assets, and (2) that none of Gerbro's main reasons for investing in the Funds was to reduce or defer Canadian taxes.

In its Amended Notice of Appeal, the Appellant stated that it invested in the Funds to complement its investments in traditional long equities, in order to meet its primary objective of capital preservation which is set out in its investment guidelines. [1] [ 5 ] The evidence adduced at trial does not support the Appellant's position that the Funds did not primarily derive their value, directly or indirectly, from portfolio investments in listed assets.

However, the appeal must succeed on the basis that, having regard to all the circumstances, it may reasonably be concluded that none of Gerbro's main reasons for investing in the Funds was to defer or avoid Canadian taxes as contemplated by the OIFP Rules. 2 FACTS [ 6 ] The parties have agreed on some of the relevant facts and these are set out in a Statement of Agreed Facts (Partial) which is attached as Appendix A to these reasons for judgment. I will summarize the key facts. 2.1 Appellant's

Interpretation of the Facts

[ 7 ] In 1986, the late Gerald Bronfman left a substantial inheritance for Marjorie Bronfman in a spousal trust ( MB Trust ) and Gerbro was established as a holding company tasked with investing the MB Trust's capital and income during Ms. Bronfman's lifetime. Gerald Bronfman's last will and testament further provided that the remaining capital and income would go to Marjorie's four children following her death. [2] In the Relevant Period, Ms. Bronfman had already reached the age of 88 years, which was why Gerbro's investments had to be liquid. [ 8 ] Ms. Nadine Gut held the position of president of Gerbro.

Before being appointed president, she had been a part-time (from the company's inception) and then full-time (as of June 1990) employee of Gerbro. [3] [ 9 ] Gerbro was a Canadian-controlled private corporation incorporated under the

Canada Business Corporations Act [4] with a fiscal year-end of December 31, and its sole shareholder was the MB Trust. [5] Gerbro chose to use independent money managers to manage its investments since it did not have the resources in-house to actively manage its own portfolio.

Nonetheless, Gerbro expended significant resources to make allocation decisions with respect to the MB Trust's capital in accordance with the applicable investment guidelines. 2.1.1 Investment Policies and Guidelines [ 10 ] Gerbro's board of directors adopted its first written investment guidelines in 1992, [6] in which they codified the capital preservation investment philosophy Gerbro already adhered to. Subsequent amendments to the 1992 investment guidelines did not change Gerbro's investment philosophy of capital preservation.

In essence, the amendments to the investment guidelines refined Gerbro's policies for selecting managers as well as its portfolio allocation guidelines. They also updated historical figures influencing the minimum expected return requirement for achieving capital preservation, such as the rate of inflation and Gerbro's operating costs.

A set of investment guidelines adopted in April 2002 ( 2002 Guidelines ) [7] was still in force at the beginning of the Relevant Period, but was updated by a new set of guidelines in April 2005 ( 2005 Guidelines ). [8] The 2002 Guidelines included an appendix that was a checklist for selecting and replacing investment managers. [ 11 ] Although Gerbro's main objective was capital preservation, like most investors, it had as a secondary objective earning a return consistent with prevailing market expectations.

This meant that if the markets were achieving good returns, Gerbro also wanted to benefit from the higher than normal returns, subject to the level of volatility being acceptable. [ 12 ] Moreover, the money Gerbro invested had to be allocated to investments that (

i) were liquid, (ii) provided Gerbro with sufficient cash to pay its yearly operating costs as well as its yearly tax liabilities, and (iii) provided Marjorie Bronfman with enough cash to sustain her lifestyle and to fully carry out her philanthropic endeavours. [9] [ 13 ] Gerbro referred to the applicable investment guidelines to make its investment allocation decisions. To achieve the objective of capital preservation, the 2005 Guidelines fixed a minimum return of 6.5%.

The prevailing rate of inflation, the operating expenses of Gerbro and the annual expenses of Marjorie Bronfman were considered in order to arrive at this target rate of return.

To this expected return criterion, the 2005 Guidelines attached a target volatility of 10%, which served as a gauge of risk. [10] [ 14 ] In addition, the 2005 Guidelines set upper and lower allocation percentages for five distinct asset classes as follows: [11] Minimum Allocation Maximum Allocation Cash 0% 5% Bonds [Fixed Income] 10% 30% Equities *** 30% 60% Directional [Hedge] Funds * 0% 30% Non-directional [Hedge] Funds 0% 30% * The maximum allocation for equities and directional funds combined is 60%. ** International equities as a sub group of equities could have an allocation of 0% to 30% of the combined portfolio. [ 15 ] Nadine Gut's testimony established that Gerbro rigorously followed its well-defined objectives set out in its investment guidelines.

In the Relevant Period, the percentages Gerbro actually allocated to each of the five asset classes were consistent with the above-referenced allocation percentages. [12] 2.1.2 Evolution of Portfolio Allocation [ 16 ] At its inception, Gerbro retained SEI Investments, an investment management firm, to build a suitable portfolio. [13] Subsequently, Gerbro did much of the due diligence work preceding allocation decisions internally, and its allocation decisions were presented to and approved by its investment committee ( Investment Committee ). [ 17 ] From 1993 to 2001, Gerbro retained Sandra Manzke from Tremont (a consulting firm located in the state of New York) to act as

a consultant in searching for hedge fund managers. Ms. Manzke helped Gerbro identify potential hedge fund managers which had at least three years of proven positive returns and at least $100 million of assets under management. Most managers Tremont suggested to Gerbro were based in the United States. [14] [ 18 ] Gerbro argued forcefully that it did not restrict its search for managers to United States managers and supported this assertion with examples of some Canadian managers it had historically invested with.

From 2003 to 2006 it invested in Maple Key Limited Partnership, but divested itself of that investment due to disappointing returns.

Gerbro redeemed an investment it had made around the year 2000 with another Canadian manager, Boulder Capital Management, later renamed Silvercreek Limited Partnership, due to accounting fraud related to the Enron scandal. [15] [ 19 ] In the early 1990s, Gerbro invested amounts of $1 to $2 million with celebrity world hedge fund managers such as George Soros. [16] In those years Gerbro benefited from the exceptional returns those hedge fund managers produced on currency plays. [ 20 ] It appears from the minutes of Gerbro's board of directors' meeting held on January 28, 1993 that Gerbro considered adding hedge funds to its portfolio as a means of protecting itself from a potential meltdown of financial markets. [17] This suggestion originated from one director, Mr.

Schechter, who spoke about the benefits of increasing Gerbro's percentage allocation to hedge funds. 2.1.3 Similarities Among the Funds [ 21 ] The investments in the Funds ensued progressively. In 2005, Gerbro acquired and held shares in Raptor, Arden, Kingdon and Haussmann. In 2006, Gerbro acquired and held shares in Caxton, Raptor and Haussmann. [ 22 ] All the Funds were subject to annual management fees, ranging from 1% to 3%.

Moreover, all the Funds, aside from Haussmann, had to pay an incentive performance fee ranging from 10% to 30% above a high-water mark. [ 23 ] Another similarity is that all the Funds were located in low-tax jurisdictions and therefore paid only a nominal amount of tax, if any at all.

Raptor and Arden were registered as exempted companies under the Companies Law of the Cayman Islands. [18] Kingdon and Haussmann were incorporated in the Netherlands Antilles. [19] Lastly, Caxton was registered as an exempted company under the laws of the British Virgin Islands. [20] [ 24 ] Gerbro submitted that it could not replicate the investment strategies of the Funds for lack of exact knowledge about the investments each Fund carried and for want of the financial resources required to replicate sophisticated investment strategies.

The lack of exact knowledge also meant that it could not calculate the amount of

Part I tax that it would have paid if it had hypothetically held the Funds' investments directly. The competitive advantage of each Fund consisting in the research leading up to investment decisions and in the alternative trading strategies their respective managers used, the Funds did not disclose their basket of assets to investors. In some cases, notably Raptor, the managers provided information on select trades after the fact. [21] [ 25 ] Gerbro contends that it was never invited to invest in the onshore vehicles of the Funds.

It should be noted that all investments in the Funds had equivalent onshore investment vehicles in the United States, except for Haussmann. [22] When an investor was admitted to invest in the Funds, the manager would direct the investor to the appropriate investment vehicle. Given that the hedge funds were unregulated investments, the managers had full discretion to accept an investor, and if the investor was accepted, to decide in which investment vehicle that investor could subscribe for shares. [ 26 ] According to Ms.

Gut's testimony, the jurisdiction that the fund was located in was not relevant in deciding whether to invest in any of the Funds. [23] The information about the low-tax jurisdiction was in the offering memorandum of each Fund. The memoranda were only provided to Gerbro as a formality prior to it making an investment. At that point, the Investment Committee had already made the decision to subscribe for shares. [ 27 ] Although the managers of the Funds had a discretionary power to declare dividends, they did not declare any dividends for Raptor, Caxton, Arden and Kingdon in the Relevant Period.

Gerbro received relatively small dividends from Haussmann as compared to the size of its investment in that Fund, which exceeded $5 million at all times during the Relevant Period.

The dividends it received from Haussmann were in the amounts of $8,915.82 in 2005 and $26,311.44 in 2006. [24] 2.1.4 Particularities of each of the Funds [ 28 ] While they had many similarities, the Funds were distinct in the strategies that they employed and should be described separately in some detail. 2.1.4.1 Haussmann [ 29 ] Haussmann is a hedge fund of funds, which means that Haussmann achieved capital appreciation by building a portfolio composed of other hedge funds. The fund was managed by a group of advisors, including Mirabaud, a bank with which Gerbro transacted business.

Coincidentally, Haussmann also invested in Raptor and Kingdon. [25] Haussmann was able to invest in a multitude of funds since it pooled money from many investors.

[ 30 ] That investment fell within Gerbro's directional hedge fund asset class, and the hedge funds Haussmann invested with were allowed to buy and sell securities, options, commodity futures and foreign currencies. [26] The hedge funds were also allowed to engage in leveraging and in sophisticated trading strategies using derivatives. [ 31 ] Gerbro's stated reasons for investing in Haussmann were twofold. Firstly, it wanted to gain access to many hedge funds to which it could not have access on its own. Haussmann was able to get access to them because of the large amounts of money it invested.

At the time, the fund had $4 billion worth of assets under management. [27] Gerbro asserts that, due to this economic disparity alone, it could not have replicated Haussmann's strategy. [28] Secondly, by investing with Haussmann, Gerbro benefited from a wealth of knowledge about financial markets which Haussmann had acquired from speaking to many managers it had either invested with or considered investing with. [ 32 ] In addition, Haussmann is the only one of the Funds that is publicly traded.

Its stock traded on the Irish Stock Exchange. [29] The fact that it is publicly traded was relevant to the extent that Haussmann would have qualified as an exempt interest under the proposed foreign investment entity rules ( FIE Rules ), [30] which rules will be addressed later on in my reasons. 2.1.4.2 Raptor [ 33 ] Raptor was managed by James Pallotta and had approximately $9 billion worth of assets under management when Gerbro invested in 2005. The iconic Paul Tudor Jones brought James Pallotta into the Tudor Group, and Mr. Pallotta formed the Raptor fund under the umbrella of the Tudor Group.

Gerbro was never extended the opportunity to invest directly with Paul Tudor Jones, but Mirabaud brokered a sale of Raptor shares to Gerbro. [31] [ 34 ] This investment fell within Gerbro's directional hedge fund asset class and was primarily in equities, both long and short, and in related derivatives.

These types of investments included common stocks, preferred stocks, warrants, options, bonds, repurchase agreements, reverse repurchase agreements and contracts for differences. [32] [ 35 ] Gerbro's only stated reasons for investing were James Pallotta's past performance, his reputation in the industry and Raptor's low historical volatility. [33] These reasons appear in an internal memorandum dated February 28, 2005 from Daniel Conti, a Gerbro employee, to Ms.

Gut. [34] [ 36 ] The fund is set up as a master-feeder structure, where Raptor is an offshore feeder fund for Raptor Global Portfolio Ltd ( Global ), the master fund. [35] Global was the legal entity that traded in all of the assets, however, its objectives were aligned with those of Raptor.

James Pallotta offered investment advice to Global through the Tudor Investment Corporation, a Delaware company. [36] The Raptor Global Fund Limited Partnership ( Raptor LP ) was the onshore feeder fund for Global. [37] [ 37 ] Subject to limited exceptions, anyone with ties to the United States, whether an individual or a corporation, was excluded from holding shares in the Raptor feeder fund. [38] Instead, such persons could have been invited to invest in the onshore Raptor LP. 2.1.4.3 Arden [ 38 ] Arden was managed by Averell H. Mortimer and was a fund of funds. Mr.

Mortimer provided advice through Arden Asset Management Inc., a company incorporated under the laws of New York of which he was the president. [ 39 ] This investment fell within Gerbro's non-directional hedge fund asset class, that is, its focus was on finding investments with low correlation to equity financial markets.

To achieve this low correlation, Arden invested in other hedge funds that traded in, among other things, securities, fixed-income instruments, derivatives on the fixed-income instruments, commodity futures, options on futures, securities of companies undergoing extraordinary corporate transactions and securities of companies in difficulty. [39] [ 40 ] Gerbro's only stated reason for investing in Arden was Averell H. Mortimer's ability to achieve market-neutral returns which introduced diversification into, and reduced volatility in, Gerbro's portfolio. According to Ms.

Gut, adding Arden to its portfolio would significantly reduce the portfolio's volatility. [40] This statement was supported with statistical analyses that Gerbro conducted in 2005. [41] The investment was thus expected to contribute to achieving Gerbro's target volatility of 10%. [ 41 ] On December 1, 2005, in response to the proposed FIE Rules, Gerbro entered into a year-end transaction whereby it sold all of its Arden shares to its wholly-owned subsidiary Woodrock Canada Inc. ( Woodrock ) by way of a reduction of capital. [42] The purpose of this transaction was to efficiently comply with the proposed FIE Rules.

Selling the Arden shares to Woodrock allowed Gerbro to remain exposed to Arden while optimizing its Canadian tax structure in light of the FIE Rules. [43] This year-end transaction triggered a capital gain of $523,689 in Gerbro's 2005 fiscal year. [44] 2.1.4.4 Kingdon [ 42 ] Gerbro made its first investment in Kingdon in 1994, and did so because of the reputation and performance of its manager,

Mark Kingdon.

Gerbro's management team was impressed with Mark Kingdon's credibility and integrity. [ 43 ] The investment in Kingdon fell within Gerbro's directional hedge fund asset class. [ 44 ] In 2005, Kingdon was structured as a stand-alone fund and received investment advice from Kingdon Capital Management LLC, a Delaware company. [45] Kingdon used an internally developed asset allocation model to allocate its assets primarily among investments in common stock and bonds. [46] [ 45 ] On December 1, 2005, Gerbro entered into a year-end transaction whereby it sold all of its shares of Kingdon to Woodrock by way of a reduction of capital in response to the proposed FIE Rules. [47] This year-end transaction triggered a capital gain of $1,769,977 in Gerbro's 2005 fiscal year. [48] 2.1.4.5 Caxton [ 46 ] In 2006, when given the opportunity to subscribe for shares in Caxton, Gerbro invested because of Caxton's performance and the fund's low correlation with other investments in Gerbro's portfolio.

The low correlation was due to the fact that Caxton traded primarily in commodities and that commodities had low correlation with equity markets. Gerbro attributed Caxton's success to its manager Bruce Kovner. [49] [ 47 ] The fund was set up as part of a master-feeder structure in which Caxton was an offshore feeder fund for Caxton International Limited ( Caxton Limited ), the master fund. [50] Caxton Limited was a subsidiary of Caxton, and was the legal entity that purchased, held and sold all of the assets. Its objectives were aligned with those of Caxton.

Bruce Kovner offered investment advice to Caxton Limited through Caxton Associates LLC, a Delaware company. Caxton Global Investments (USA) LLC was the onshore feeder fund for Caxton Limited. [51] 2.1.5 Calculation of

Part I Tax Otherwise Payable in the Auditor’s Report [ 48 ] Gerbro submits that, in the auditor’s report, Mr. Joseph Armanious incorrectly calculated tax that would otherwise have been payable if Gerbro had held the Funds’ investments directly. The auditor did not have an exhaustive list of the trades with the adjusted cost base and proceeds of disposition for each asset, nor did he have any information about the timing of the dispositions during the year. To make up for the lack of information, the auditor calculated the taxes otherwise payable using information available in the Funds' financial statements.

He looked at the total amount of realized gains in the year for each of the Funds, which were expressed in United States dollars, regardless of when the gains were realized during the year. He pursued his calculation by converting the realized gains appearing on the financial statements into Canadian dollar gains using the Bank of Canada average exchange rate for each fiscal year.

Finally, the auditor multiplied the converted Canadian dollar gain by Gerbro's tax rate for the Relevant Period to obtain the amount of taxes otherwise payable with respect to each Fund. [52] The auditor compared these amounts with the negligible amount of tax each Fund paid offshore and arrived at the conclusion that the Funds paid significantly less tax than would have been payable if Gerbro had held the Funds' investments directly.

Joseph Armanious, the auditor for the CRA, testified at trial that this was the process he followed. [ 49 ] The Appellant vigorously defends the position that the calculation of Canadian income taxes otherwise payable contained in the auditor's report is flawed. In that regard, the Appellant emphasizes that the auditor's calculation was legally inaccurate since it is at odds with the recognized method set out in Gaynor (H.R.) v.

M.N.R . [53] [ 50 ] Gerbro further argues that the practical impossibility, due to the nature of investments in hedge funds, of calculating the amount of tax otherwise payable points up the fact that this factor should not be given a great deal of weight in inferring an intention to avoid or defer taxes.

As previously explained, hedge funds, in order to maintain their competitive advantage, do not disclose the nature and timing of specific trades. 2.2 Facts Added by the Respondent [ 51 ] The Respondent added the fact that Gerbro's directors were knowledgeable about tax matters, given their professional backgrounds, and therefore could not have been unaware of the significant tax benefits associated with investing in the Funds when they approved them. Ms. Gut and David G. Broadhurst held a chartered accountant’s professional designation, while Samuel Minzberg and Hillel W.

Rosen were lawyers with a leading law firm.

Of these lawyers, the former had a practice in taxation and the latter in mergers and acquisitions. [54] [ 52 ] Moreover, the Respondent lists numerous documents that allegedly prove that Gerbro always considered the reduction or avoidance of tax when investing in hedge funds, which involved discussions about the efficient reallocation of assets from one manager to another in segregated accounts, tax-motivated transactions to respond to the FIE Rules or judgments on the tax efficiency of existing or potential investments. [55] [ 53 ] She adds that the “one of the main reasons” test is applied not only to the reasons for investing at the moment at which the investment is made, but also to the reasons for continuing to hold the investment in the non-resident entity.

[ 54 ] In addition, the Respondent points to the Funds' policy of reinvesting income rather than making distributions to its shareholders as an indicator that the managers of the Funds considered the Canadian tax aspect. [56] [ 55 ] The Respondent also criticizes Gerbro for having called only Ms. Gut to testify regarding Gerbro's main reasons for investing in the Funds, rather than calling other employees to corroborate Ms. Gut's version.

She asks the Court to draw a negative inference from this. [ 56 ] On the topic of equivalent Canadian investments, the Respondent rejects Gerbro's assertion that they did not limit their search for hedge funds to United States hedge funds, as well as the broader assertion that there were no comparable Canadian hedge funds with equivalent characteristics to those of the Funds. [ 57 ] While the Appellant called Mr. Luis Seco to testify as to the accuracy of that opinion, the Respondent urges the Court to discard his expert report.

The reason put forward is that the report is non-compliant with the Code of Conduct for Expert Witnesses,

Schedule III to the Tax Court of Canada Rules ( General Procedure ). [ 58 ] As regards the qualification of the Funds' investments as portfolio investments in listed assets, the Respondent summarized, to the extent of her understanding, the type of investments each Fund primarily derived its value from.

On the assumption that the term “portfolio investments” is more encompassing than the type of passive investments that would trigger the foreign accrual property income ( FAPI) rules, the respondent asks that the Court conclude that the Funds derived their value primarily from portfolio investments in listed assets. [ 59 ] Finally, the Respondent brought it to the Court's attention that, when Gerbro communicated in writing with the CRA in response to certain requests for information during the audit stage, Gerbro referred to the nature of the investment in each of the Funds as being “[a]sset appreciation through portfolio investments”. [57] In cross-examination Ms.

Gut stated that Gerbro's characterization likely mirrored words used in the Funds' offering memoranda and that she understood “portfolio investment” to mean a group of investments. [58] 3 APPLICABLE LAW [ 60 ]

Section 94.1 of the ITA is the applicable provision in the case at bar, and it reads as follows: 94.1(1) If in a taxation year a taxpayer holds or has an interest in property (referred to in this

section as an “offshore investment fund property”) (

a) that is a share of the capital stock of, an interest in, or a debt of, a non-resident entity (other than a controlled foreign affiliate of the taxpayer or a prescribed non-resident entity) or an interest in or a right or option to acquire such a share, interest or debt, and (

b) that may reasonably be considered to derive its value, directly or indirectly, primarily from portfolio investments of that or any other non-resident entity in (

i) shares of the capital stock of one or more corporations, (ii) indebtedness or annuities, (iii) interests in one or more corporations, trusts, partnerships, organizations, funds or entities, (iv) commodities, (

v) real estate, (vi) Canadian or foreign resource properties, (vii) currency of a country other than Canada, (viii) rights or options to acquire or dispose of any of the foregoing, or (ix) any combination of the foregoing, and it may reasonably be concluded, having regard to all the circumstances, including (

c) the nature, organization and operation of any non-resident entity and the form of, and the terms and conditions governing, the taxpayer’s interest in, or connection with, any non-resident entity, (

d) the extent to which any income, profits and gains that may reasonably be considered to be earned or accrued, whether directly or indirectly, for the benefit of any non-resident entity are subject to an income or profits tax that is significantly less than the income tax that would be applicable to such income, profits and gains if they were earned directly by the taxpayer, and (

e) the extent to which the income, profits and gains of any non-resident entity for any fiscal period are distributed in that or the immediately following fiscal period, that one of the main reasons for the taxpayer acquiring, holding or having the interest in such property was to derive a benefit from portfolio investments in assets described in any of subparagraphs 94.1(1)( b )(

i) to 94.1(1)( b )(ix) in such a manner that the taxes, if any, on

the income, profits and gains from such assets for any particular year are significantly less than the tax that would have been applicable under this

Part if the income, profits and gains had been earned directly by the taxpayer, there shall be included in computing the taxpayer’s income for the year the amount, if any, by which (

f) the total of all amounts each of which is the product obtained when (

i) the designated cost to the taxpayer of the offshore investment fund property at the end of a month in the year is multiplied by (ii) 1/12 of the total of (

A) the prescribed rate of interest for the period that includes that month, and (

B) two per cent exceeds (

g) the taxpayer’s income for the year (other than a capital gain) from the offshore investment fund property determined without reference to this subsection. 4 ISSUES [ 61 ] The first issue in this appeal is whether the Funds derived their value, either directly or indirectly, primarily from “portfolio investments” in listed assets ( Value Test ). To answer this question the Court will define the term portfolio investment and then determine if the Funds primarily derived their value from such investments. If they did, the Court will ascertain whether the portfolio investments are investments in assets listed in subparagraphs 94.1(1)( b )(

i) to (ix). [ 62 ] The second issue is whether it may reasonably be concluded, having regard to all the circumstances, including those mentioned in paragraphs 94.1(1)(

c) to ( e ), that one of Gerbro's main reasons for investing in the Funds was to pay less tax than would have been payable under

Part I of the ITA if the portfolio investment had been held directly ( Motive Test ). [ 63 ] In its Amended Notice of Appeal, the Appellant disagreed as to the calculation of the imputed income in the event that the Court should conclude that both the Value Test and the Motive Test have been met. However, this question was not argued before me in either the written submissions or in open court. I therefore conclude that this last point is no longer at issue. [ 64 ] Before dissecting each issue, I will first address the question of the burden of proof with respect to the respondent's assumptions of mixed fact and law. I will then give an overview of the foreign affiliate regime,

section 94.1 and the proposed FIE Rules, which were never adopted. 5 A NALYSIS 5.1 Preliminary Remarks: Respondent's Assumptions of Mixed Fact and Law [ 65 ] It is trite law that in tax appeals a taxpayer has the onus of proving on a balance of probabilities that the Minister's assumptions of fact are not true, and that, absent such evidence, the assumptions will stand. [59] [ 66 ] The assumptions of fact must be “precise and accurate so that the taxpayer knows exactly the case it has to meet”: Anchor Pointe Energy Ltd. v. Canada , 2003 FCA 294 , [2003] F.C.J.

No. 1045 (QL), at paragraph 23 . [ 67 ] Assumptions of law or mixed fact and law are not binding on this Court, regardless of the fact that they could have or should have been stricken from the pleadings. To hold otherwise would be to divest this Court of its power to rule on questions of law. In Kopstein et al. v.

The Queen , 2010 TCC 448 , 2010 DTC 1307, Justice Jorré, ruling on a motion to strike, enunciated this proposition in the following way: [67] In assessing whether it is appropriate to strike a paragraph of a pleading one must bear in mind the practical effect of the paragraph. [68] In this context one must bear in mind that an invalid or irrelevant assumption does not cast an onus upon an appellant just because it was pleaded.

For example, if on discovery it turns out that an assumption was never made then there is no onus on the appellant to disprove it; if the respondent wishes to rely on that particular fact, the respondent will have to prove it.

Similarly, if what is pleaded as an assumption of fact is simply a conclusion of law and no underlying facts for that conclusion of law have been assumed elsewhere then there is no obligation on an appellant to disprove that. [ 68 ] Furthermore, this Court should not be required to extract the factual components from assumptions of mixed fact and law when these assumptions are incorrectly pleaded. See Anchor Pointe , supra , at paragraph 27. Properly pleading assumptions of fact is incumbent on the Respondent when drafting her reply. [ 69 ] By order dated May 27, 2014 in the present appeals, ( Gerbro Inc. v.

R. , 2014 TCC 179 , [2014] 6 C.T.C. 2010), Woods J. denied

the Appellant's motion to strike the assumptions in paragraphs 19 (ff), (zz), (ttt) and (pppp) of the Reply in respect of the 2005 taxationyear, and paragraphs 14.35, 14.73 and 14.94 in the Reply in respect of the 2006 taxation year.[60] It is clear from her reasons for orderthat she denied the motion because of the “fresh step” rule, in

section 8 of the Tax Court of Canada Rules (General Procedure). Indisallowing Gerbro's motion to strike, Justice Woods enforced the policy behind the “fresh step” rule, which is to ensure that the appealprocess moves forward, and not backwards as that would risk unduly prolonging the appeal process.

Allowing the motion to strike wouldhave resulted in the Crown being granted leave to amend its reply to extract the factual assumptions underlying its assumption of mixedfact and law, and that in turn would have necessitated further discovery. [70] Justice Woods did not make any legal findings as to the effect of the inappropriate assumptions at trial. She noted that thestrategy of Gerbro's counsel of waiting to bring the motion to strike might have worked against Gerbro, since it was now barred fromhaving the assumptions struck.

This does not address the matter of the effect of those assumptions at trial, which, according to Kopstein,should not have the effect of placing the onus on Gerbro. As a matter of fact, Justice Woods stated, at paragraph 31 of her order, that “[i]fit were not for the potential application of the fresh step rule, the purpose test assumptions should be struck out with leave to amend toextricate the factual elements.” [71] The Supreme Court in Canada (Director of Investigation and Research) v.

Southam Inc., (SCC), [1997]1 S.C.R. 748 distinguished questions of mixed law and fact from purely factual or legal questions with the following example: 35. . . . Briefly stated, questions of law are questions about what the correct legal test is; questions of fact are questions about whatactually took place between the parties; and questions of mixed law and fact are questions about whether the facts satisfy the legal tests.A simple example will illustrate these concepts. In the law of tort, the question what “negligence” means is a question of law.

Thequestion whether the defendant did this or that is a question of fact. And, once it has been decided that the applicable standard is one ofnegligence, the question whether the defendant satisfied the appropriate standard of care is a question of mixed law and fact. I recognize,however, that the distinction between law on the one hand and mixed law and fact on the other is difficult.

On occasion, what appears tobe mixed law and fact turns out to be law or vice versa. [Emphasis added.] [72] Thus, it can be concluded that the assumptions in paragraphs 19 (ff), (zz), (ttt), and (pppp) of the 2005 reply are assumptions ofmixed fact and law. The same is true for the assumptions in paragraphs 14.35, 14.73 and 14.94 of the 2006 reply.

Justice Woods pointedout the existence of at least two legal questions in the Minister's assumptions, namely: “What is a portfolio investment?" and "When dotax considerations satisfy the purpose test?” (Gerbro, supra, at paragraph 30.) I agree. [73] The Respondent must now cope with assumptions of mixed fact and law in her reply that are for all intents and purposesineffective in placing on the Appellant the burden of proving that its investments in the Funds were portfolio investments or that theMotive Test was met.

Given the analysis below, the ineffective assumptions are of no consequence. 5.2 The Mischief the OIFP Rules Sought to Resolve 5.2.1 Historical and Statutory Overview of the Foreign AffiliateRegime [74] The foreign affiliate rules in Division B, subdivision i of

Part I of the ITA existed for over a decade before the OIFP Rules were enacted in 1984.[61] Since their inception in 1972, the foreign affiliate rules have been modified substantially over the years, both beforeand after the OIFP Rules were enacted. [75] In brief, the foreign affiliate regime is made up of two components.

Those components are the current inclusion of foreignaccrual property income of a controlled foreign affiliate (CFA) of a taxpayer resident in Canada (subsections 91(1) and 95(1)), and theforeign affiliate dividend regime (FA dividend regime), which deals with the taxation of dividends when they are received by Canadian residents from foreign corporations (sections 90 and 113).[62] [76] The two components produce various tax outcomes on two main axes.

Simply put, the taxation outcomes will depend on whether the foreign corporation in which the interest is held is a foreign affiliate or a CFA,[63] and whether the income earned is active orpassive.

The FAPI rules apply when a controlled foreign affiliate earns FAPI (passive investment income, such as interest, rent, royaltiesor dividends.) The FA dividend rules apply as long as the foreign corporation is a foreign affiliate, not necessarily controlled byCanadian residents.[64] A CFA, on the other hand, will have to determine, with regard to passive income, if it has FAPI, which will betaxed on an imputation basis.

Subsequently, if the CFA pays a dividend it will still be subject to the FA dividend regime. [77] A first observation is that a Canadian taxpayer stands to benefit through income deferral from an investment in a non-controlledforeign affiliate earning passive income, as long as the taxpayer does not receive dividends, the caveat being that the OIFP Rules do notapply. The Canadian taxpayer will instead be taxed annually on non-distributed FAPI of a CFA.

In substance, the ITA will ignore theforeign legal construct in arriving at the net income of the Canadian taxpayer, thereby effectively bringing the income earned by the non- resident corporation into the Canadian tax base.[65] [78] The Federal Court of Appeal in Lehigh Cement Ltd. v. Canada, 2014 FCA 103, [2015] 3 F.C.R. 117, [2014] 4 C.T.C. 107 atparagraph 19, aff'g 2013 TCC 176, [2013] 5 C.T.C. 2010, highlighted the fact that Canadian taxpayers can easily manipulate the taxstatus of a non-resident corporation they invest in so as to obtain the desired tax savings.

In anticipation of this mischief, the foreignaffiliate regime includes at paragraph 95(6)(

b) an anti-avoidance provision which denies the benefit of acquiring or disposing of shares in

a non-resident entity when the principal purpose of those actions is to reduce or defer the payment of tax.

It should be noted that prior tothe facts that arose in the Lehigh decision and prior to a technical amendment in 2001, the applicable test was a “one of the main reasons” test rather than a “principal purpose” one.[66] The following passage summarizes the findings of the Court on the manipulationof the tax status of non-resident corporations: 19 The “foreign affiliate” status of a non-resident corporation, which is dependent on the non-resident corporation's ownershipstatus, can give rise to tax savings for a Canadian taxpayer because of the ability to claim a deduction offsetting the amount of thedividends included into income.

And often the Canadian taxpayer can easily manipulate that status to get those tax savings. For example,it can transform a non-resident corporation into a “foreign affiliate” by acquiring more shares in it. Or it can dispose of shares to avoidthe non-resident corporation from becoming a “controlled foreign affiliate.” In this context, “taxpayers jockey to get on the right side ofthe distinctions to take advantage of the rules”: Vern Krishna, The Fundamentals of Canadian Income Tax (9th ed., 2006) at page 1327. [79] In Trans World Oil & Gas Ltd v.

Canada, (TCC), [1995] 1 C.T.C. 2087 (TCC), aff'd, (FCA), [1998] 3 C.T.C. 37 (FCA),[67] Judge Bowman, as he then was, held that Trans World U.S. could not deduct the active businesslosses incurred by it when it was a CFA of the Appellant's majority shareholder, Mr. Phillips, against the FAPI it generated in subsequentyears when it was a CFA of the Appellant corporation, Trans World Oil & Gas Ltd. In passing Judge Bowman summarized the objectiveof the FAPI regime as follows: . . .

The object behind the FAPI rules was to discourage Canadians from parking investments in offshore companies (usually tax havens),or, if they did, at least to require them to pay taxes currently on the income so generated. . . . [80] The decision of the Federal Court of Canada – Trial Division in Canada Trustco Mortgage Co. v. Minister of National Revenue, (FC), [1999] 2 C.T.C. 308, aff'g (TCC), [1991] 2 C.T.C. 2728 (TCC) reiterated the purpose ofFAPI and the elementary fact that the FAPI regime does not capture income from an active business.

In 1995, amendments were adoptedto carve out investment business income from active business income, which amendments were not applicable when the facts of that case occurred.[68] That decision is important as it was the first time that the courts were called upon to explore the meaning of “active business” in respect of FAPI.[69] The following passages are relevant: 18 Under the Act provision is made, in relation to the computation of income, in Division B, concerning Computation of Income,Subdivision i, concerning Shareholders of corporations not resident in Canada, for certain income to be included as income of a Canadianshareholder.

Within that subdivision, ss. 90 and 91 provide that income of a Canadian taxpayer is to include certain amounts in respect ofdividends received or other payments on behalf of shares held in a corporation not resident in Canada. Other sections deal with aspects ofthe earnings from foreign corporations, and s. 95 deals with “foreign accrual property income”, here called “FAPI”.

The statutoryprovisions are complex, but it is agreed, and it is clear, that FAPI as provided for in that section, for the years in question, did not includeincome from an active business. . . . . . . 25 At the relevant time there was no definition of “active business” as that term is used in paragraph 95(1)(b). It has since beendefined for purposes of FAPI by amendment of the Act in 1995, following the decision of the Tax Court in this case. That amendmentexpressly excluded from “active business” of a controlled foreign affiliate an “investment business carried on by the affiliate...”.

Thus theamendment would appear to exclude the income in issue here from income gained from an active business. From the amendment itseems the income here in question would now be FAPI. That amendment has no application in this case. [Emphasis added.] [81] Parliament enacted

section 94.1 in 1984 to fill the void caused by the fact that only a direct interest in a CFA could give rise toan imputation of FAPI. As indicated in paragraph (1)(

a) of

section 94.1, the OIFP Rules apply only to an interest in a non-resident entityother than a CFA or a prescribed non-resident entity. 5.2.2 Historical Overview of OIFP and FIE Rules [82] The enactment of

section 94.1 of the ITA in 1984 was Parliament's reaction to the marketing to the Canadian population at large of interest roll-up funds, which avoided FAPI.[70] However, it is contentious whether the OIFP Rules capture only the types of income that would be considered FAPI if the non-resident entity in which the interest was held was a CFA[71] or whether they can apply to other types of income (including active income).[72] [83] Reportedly as early as the beginning of the 1980s, brokers started selling to Canadian taxpayers investments in interest roll-upfunds the sole purpose of which was to help Canadian taxpayers minimize their tax liability on returns from risk-free investments in government bonds.[73] The schemes were variations of the following scheme: promoters would set up in known tax havens a mutual fundwhich invested exclusively in government of Canada bonds or similar assets.

The reason for investing in government bonds was that interest routinely paid to the offshore mutual fund was exempted from Canadian withholding tax.[74] In addition, the brokers marketed themutual funds in such a way that Canadian investors would not be subject to FAPI. Successfully avoiding the FAPI regime meant that theyearly interest income could accrue tax-free within the offshore mutual fund. Canadian taxpayers therefore obtained a tax deferral benefitand would only be taxed upon the disposition of their mutual fund interest many years later.

More often than not, the disposition of themutual fund interest gave rise to capital gains. [84] After the coming into force of

section 94.1 in 1984, there was general consensus that the OIFP Rules ended the spread ofinterest roll-up funds.

[85] To remedy the continued use of offshore investment funds to defer Canadian taxes, Parliament proposed the first iteration of the FIE Rules in 1999 following the publication of the Report of the Technical Committee on Business Taxation.[75] The critics of theexisting

section 94.1 pointed to the lack of information about taxpayers' offshore arrangements, difficulty in establishing the requisite intent, and an arbitrary mechanism for imputing income.[76] [86] After a long process of revisions and public consultations, the proposed FIE rules were ultimately never adopted.[77] As a resultof the abandonment of the FIE Rules, the ITA reverted to the long-forgotten OIFP Rules. It is worth noting that the OIFP Rules were enhanced through various measures shortly after the abandonment of the FIE Rules.[78] [87]

Section 94.1 has been examined but once, in Walton v. The Queen, 98 DTC 1780 (TCC). 5.3 Defining Portfolio Investments [88] The breadth of the OIFP Rules and their relationship to the foreign affiliate regime will be determined largely by the meaningthat is attributed to the expression “portfolio investment”. Absent a definition in the ITA, the meaning to be assigned to this expressionmust be determined pursuant to a textual, contextual and purposive analysis: Canada Trustco Mortgage Co. v.

Canada, 2005 SCC 54,[2005] 2 S.C.R. 601, at paragraph 10. 5.3.1 The Plain Commercial Meaning of Portfolio Investment inan International Investment Context [89] The use of the word portfolio to qualify the term investment implies that the meaning of portfolio investment must be distinctfrom that of the term investment without that qualifier, that much is clear. On this premise, investments in assets listed insubparagraphs 94.1(1)(b)(

i) to (ix), which include shares and bonds, do not automatically constitute portfolio investments. The ValueTest, which involves determining if the non-resident entity derives its value primarily from portfolio investments in listed assets, is atwo-step test. Firstly, it must be determined whether the non-resident entity derives its value, either directly or indirectly, primarily fromportfolio investments. Upon a finding that it does not, the OIFP Rules cannot apply.

In the contrary case, it must be determined whetherthe portfolio investments were made in listed assets. [90] It is worth noting that the meaning of the more commonly used expression “investment portfolio” should not be identified with that of “portfolio investment” in

section 94.1.[79] [91] The Respondent refers me to the Black's Law Dictionary

definitions of the words “portfolio” and “investment”, which are substantially the same as the

definitions appearing in the Concise Oxford English Dictionary (12th ed.) and Canadian Oxford Dictionary.Those individual terms are defined in Black's Law Dictionary as follows: portfolio. . . . 1. The various securities or other investments held by an investor at any given time. An investor will often hold severaldifferent types of investments in a portfolio for the purpose of diversifying risk. investment. . . . 1. An expenditure to acquire property or assets to produce revenue; a capital outlay. . . . 2.

The asset acquired or the sum invested. [80] [92] Both parties refer me to the definition of “placement de portefeuille”, the equivalent expression to portfolio investment in the French version of the ITA, in the Dictionnaire de la comptabilité et de la gestion financière.[81] However, the parties disagree as to theinterpretation thereof. The definition reads as follows: Portfolio Investment Placement de portefeuille Syn. et var. valeur de portefeuille;

titre en portefeuille;

titre immobilisé de l'activité de portefeuille (fr); TIAP (FR) Finance. Placement à long terme ne visant pas à créer des liens d'association avec l'entité émettrice des titres en cause.[82] [93] The definition in the “Dictionnaire de la comptabilité et de la gestion financière” is most similar to the since deleted definitionfound in the CICA Handbook when

section 94.1 was enacted. I accept the Respondent's point that the definition in the CICA Handbook serves a different purpose and should not be blindly imported in the

section 94.1 context.[83] The purpose of the CICA Handbook is tocreate an accounting standard for the reporting of long-term investments in financial statements, whereas the purpose of the ITA is tolevy tax. The CICA Handbook is a useful reference tool for accountants, but should only be regarded as an interpretative aid in relationto tax legislation: Canderel Ltd. v. Canada, (SCC), [1998] 1 S.C.R. 147 at paragraphs 32-42. [94] The Respondent further quotes the Moneyterms online definition, which defines “portfolio investments” as an “investment made by investors who are not particularly interested in involvement in the management of a company”.[84] (Respondent's Book of

Authorities, Tab 43.) [ 95 ] I have come across two other

definitions of the term “portfolio investment” as used in the international investment context. The first is the definition of the International Monetary Fund in its 1977 Balance of Payments Manual ( Manual ), [85] and the second is from the International Bureau of Fiscal Documentation, IBFD International Tax Glossary ( IBFD ). [ 96 ] The Manual defines portfolio investment in a negative sense as an investment other than a foreign direct investment: 423. The category for portfolio investment adopted for this Manual covers long-term bonds and corporate equities other than those included in the categories for direct investment and reserves. The

definitions of those instruments, which are adapted from the

definitions in the United Nations’ A System of National Accounts (SNA) are as follows . . . [ 97 ] Because portfolio investment is defined in a negative sense, understanding the concept of foreign direct investment is necessary. The Manual defines foreign direct investments as foreign investments that are made with the intention to exercise “significant influence over the operations of the enterprises”.

This is contrasted with portfolio investments, which are primarily acquired because of the “likelihood of an appreciation in … value”. [86] Recognizing the difficulty in classifying property in one or the other category, the Manual provides the following guidance: 412. When foreign ownership is concentrated in the hands of one investor or group of associates, the percentage chosen as providing evidence of direct investment is typically quite low – frequently ranging from 25 per cent down to 10 per cent.

Since the previous edition of the Manual was prepared, the apparent tendency has been toward adopting percentages at the lower end of that range. That tendency seems to have developed in growing recognition of the fact that – especially for large corporations of the type that are likely to engage in multinational operations – a small, organized group of stockholders may well have an influence in management that is much more than proportionate to its share in the equity capital. [87] [ 98 ] The IBFD definition also includes thresholds of ownership in classifying an investment as a portfolio investment.

The definition reads as follows: Portfolio Investment

(1) Term in fairly common use, typically for a relatively small shareholding in a company, e.g. below 10%, held without regard to the underlying business of the company and its relationship with that of the shareholder.

Often used in the context of tax treaties where such shareholdings, in contrast with direct investment, are generally subject to a higher rate of withhold tax. . . . [88] [ 99 ] A last definition, provided by counsel for the Respondent during oral argument, is that of the eminent tax scholar Vern Krishna and reads as follows: Portfolio Investments Debt or equity investments in a corporation that do not provide the investor with substantial ownership or influence in the management of the corporation.

Typically, equity ownership of less than 10% of a corporation is considered to be a portfolio investment. [89] [ 100 ] The common thread between the various

definitions is that they consider portfolio investments to be investments over which the investor does not exercise significant control, but merely wishes to passively benefit from an appreciation in value. [ 101 ] I therefore find that the ordinary commercial meaning of portfolio investment in the international investment context is an investment in which the investor (non-resident entity) is not able to exercise significant control or influence over the property invested in. [ 102 ] Since the OIFP Rules do not specify thresholds for determining whether or not a non-resident entity is taking a controlling interest, this determination will have to be made on the facts. Taken as a whole, the

definitions suggest thresholds ranging from 10% to 25% ownership. However, one should be cognizant of the fact that a small group of well-organized investors could have a controlling interest while having less than 10% ownership, especially in the case of sizeable investments. [ 103 ] A helpful indicator of a controlling interest is that the investments are usually long-term investments acquired at a premium to gain access to some level of control.

This suggests that portfolio investments are passive investments that do not entail active management of, or control over, the operations of the underlying investment in any manner whatsoever. Investments that are bought and sold within a short time are more compatible with portfolio investment classification. [ 104 ] The only difficulty with these

definitions of portfolio investment is that they are awkward to apply to investments in some of the assets listed in paragraph 94.1(1)( b ), notably investments in foreign currency. For instance, what is a substantial or controlling interest in foreign currency? The drafting of the OIFP Rules is sloppy in this respect, but insufficient on its own for there to be any derogation from the commercial meaning of portfolio investment.

This is not particularly problematic, since investments in foreign currency are unlikely to be a primary income-generating source for a bona fide business other than an investment business. The application of the controlling interest test to real estate is even less problematic since a portfolio of wholly owned buildings would not be caught by the definition of portfolio investment. [ 105 ] According to the definition I have accepted, the same investment could be classified differently with respect to different persons.

For example, a minority shareholder with a small block of shares may be deriving value from a portfolio investment, whereas another shareholder, who has a controlling interest, will not be. 5.3.2 Contextual Analysis of OIFP Rules Is Inconclusive [ 106 ] The contextual

interpretation of “portfolio investment” is inconclusive since it adds nothing more than the fact that there is a link

between the OIFP Rules and the foreign affiliate regime. [107] This being said, the OIFP and FAPI regimes are intertwined.

The OIFP Rules only apply when the FAPI regime does not sincethey suppose that the non-resident entity in which the interest is held is not a CFA. [108] The regimes are further intertwined since the computation of FAPI as defined in subsection 95(1) requires the inclusion of theamount determined under variable C of the definition, and this involves the application of a look-through rule in certain circumstances in which a CFA is interposed between the Canadian investor and a non-resident entity to which the OIFP Rules would apply.[90] 5.3.3.

The Policy Behind the OIFP Rules [109] The purpose of the OIFP Rules is compatible with the ordinary commercial meaning of portfolio investment, as it achieves the objective of capital export neutrality.[91] [110] While the obvious policy objective in 1984 was to put an end to certain financial arrangements, notably interest roll-up funds, onecan also say that

section 94.1 was adopted to achieve better capital export neutrality with respect to non-controlling interests in foreignentities. For the purposes of the latter objective, it is appropriate that the OIFP Rules be more extensive than the FAPI rules. This is sobecause the Canadian resident is not presumed to have acquired its interest in the non-resident entity in order to exercise significantinfluence over important management decisions.

Such an intention would be more compatible with an interest in a foreign entity whichfalls within the definition of a CFA. [111] The underlying policy of the OIFP rules is to make Canadian residents subject to income tax on all inherently passive and tax-motivated offshore investments made through non-controlled foreign intermediaries.[92] The objective is to ensure that capital export neutrality is achieved.[93] In theory, capital export neutrality means that the decision of a taxpayer to make investments offshore shouldbe a neutral decision which is not tax-driven.

The arguments in favour of capital export neutrality for portfolio investments as a matter offairness are particularly compelling, and all the more so as the concern about the need for Canadian businesses to maintaincompetitiveness abroad is less convincing for portfolio investments over which the non-resident entity does not exercise any significantlevel of influence or control.

The oft-cited counter-argument to capital export neutrality is most persuasive for investments in controlled foreign entities that are operating in a free-market environment with other competitors.[94] [112] Moreover, one cannot overlook the fact that the

section 94.1 regime is called the offshore investment fund property regime. Thisis no coincidence, as I find that it confirms the intention of Parliament to achieve better capital export neutrality for non-controllinginvestments in investment funds. 5.3.4 The OIFP Rules Are Not Merely a Backstop to the FAPIRules [113] The Appellant points to statements of the then Minister of Finance, the Honourable Marc Lalonde, to convince the Court that the OIFP Rules were not meant to apply to non-resident entities engaging in a bona fide active business.[95] The Supreme Court of Canadastated in Doré v.

Verdun (City), (SCC), [1997] 2 S.C.R. 862, at paragraph 14, that a Minister's comments could be usedto support an

interpretation, but cautioned that such comments “are not binding on the courts, and their weight can vary, inter alia in lightof other factors that may assist in interpreting . . .” Minister Lalonde's statement, while true in most factual circumstances, will prove tobe false where the underlying investments of a foreign investment business are nonetheless portfolio investments. [114] To interpret the OIFP as being a mere backstop to the FAPI rules, as argued for by the Appellant, is problematic. It isproblematic from the standpoint of the principles of statutory

interpretation since there is an insufficient link between the relevantprovisions for the clear commercial meaning of “portfolio investment” to be overridden. I observe with regard to the FAPI and OIFPprovisions (

i) that they are found in the same subdivision of the ITA and (ii) that one applies when the interest in the non-resident entitydoes not qualify as a CFA. A major difference, however, is that the FAPI definition refers to, among other things, income from an activebusiness and includes various deeming rules, whereas the OIFP Rules refer to an altogether different term: portfolio investments. [115] The Appellant's arguments for limiting the application of

section 94.1 such that it serves as a backstop to the FAPI rules appear tobe contradictory. The Appellant submits that “portfolio investment” should only include investments that could otherwise give rise toFAPI, and then proceeds to state that, due to the imputation mechanism that is based on a prescribed rate, portfolio investments should be limited to risk-free investments.[96] The contradiction lies in the fact that the FAPI definition is not limited to risk-free investments; it iscircumscribed in a very detailed manner on the basis of active versus passive income.

I presume that the Appellant's argument is basedon an undue narrowing of the OIFP policy objective of ending the propagation of interest roll-up funds. I am not persuaded by thisargument. [116] Moreover, the architecture of the ITA leads me to conclude that the term portfolio investment can include inventory of an active investment business since actively trading in such inventory does not turn a non-controlling interest into a controlling one.[97] The factthat the investment business uses sophisticated investment instruments or strategies does not alter this conclusion.

Neither does theinterposing of other corporations or entities to hold these types of investments, since the value of the fund would continue to indirectlyderive its value from portfolio investments. If Parliament had wanted to exclude inventory of investment businesses it would have usedanalogous language to that of the foreign affiliate rules prior to the amendments carving out investment businesses. As a matter of fact,there was a recommendation made in 1986 by the Joint Committee on Taxation of the Canadian Bar Association and the Canadian

Institute of Chartered Accountants that the Department of Finance clarify the meaning of the phrase “portfolio investments” such that it would “not include property held as inventory, for resale.”[98] This recommendation was never adopted. In fact, the concept of “portfolioinvestments” relates to the different types of property listed in

section 94.1, which may very well include property held as inventory of anactive investment business. I am of the view that Parliament's choice of words in the OIFP Rules works against the Appellant. [117] For all these reasons, I find that the FAPI rules and the OIFP Rules have different criteria for their application and that theycannot apply simultaneously. However, the fact that certain types of investments would not generate FAPI does not automatically meanthat the OIFP Rules do not apply.

To ascertain that neither regime applies, one must conduct two distinct analyses, taking into accountthe characteristics of each regime. 5.4 The Funds Derived Their Value Primarily From PortfolioInvestments in Listed Assets [118] After reviewing the facts of the case, I find on balance that the Funds derived their value primarily from portfolio investments andthat, absent evidence to the contrary, those investments were made primarily in listed assets. [119] The Funds need only primarily derive their value from portfolio investments.

This means that holding a minimal amount ofcontrolling interests that are not portfolio investments or that are portfolio investments in non-listed assets is insufficient to result in theValue Test not being met. [120] The case law has interpreted “primarily” to mean “most important” in the context of the ITA: Will-Kare Paving & ContractingLtd. v. R., (FCA), [2000] 3 C.T.C. 200 (FCA), at paragraph 8, aff'd 2000 SCC 36 , [2000] 1 S.C.R. 915. Thismeaning should be imported into the OIFP Rules, which would mean that the Funds must derive more than 50% of their value fromportfolio investments.

The reason for importing the meaning of “primarily” from Will-Kare, supra (which dealt with the definition of“qualified property” in subsection 127(9) of the ITA for the purpose of the investment tax credit in subsection 127(5)), is that the samewords are presumed to have the same meaning throughout a statute: R. v.

Zeolkowski, (SCC), [1989] 1 S.C.R. 1378, at 1387; Ruth Sullivan, Sullivan on the Construction of Statutes, 6th ed. (Markham Ont.: LexisNexis, 2014), at pages 217 to 218. [121] Even though the Respondent cannot rely on her assumptions, as drafted, that the Funds derived their value primarily fromportfolio investments in listed assets, the evidence before me has convinced me on balance that such was the case.

While most of theevidence adduced at trial pertained to the Motive Test, the Statement of Agreed Facts (Partial) and the offering memoranda for the Funds(Exhibit A-1, Tabs 3 and 5 to 13) assist me in this finding. [122] According to that evidence, the Funds did not take controlling interests with a view to exercising significant influence or controlover the operations of the companies or entities they invested in, the investments being, to a large extent, in publicly traded securities orcommodities.

The investments the Funds acquired, either directly or indirectly, were made strictly with a view to capital appreciation,which is more compatible with a portfolio investment classification. [123] A brief overview of each Fund's strategy demonstrates this. Raptor and Kingdon invested predominantly in equities and relatedderivatives. Caxton on the other hand, invested heavily in commodities and currencies. Finally, Arden and Haussmann invested in non-controlling interests in other hedge funds to obtain diversification benefits.

The Funds were investment businesses and their investmentsfall squarely into the portfolio investment classification. [124] I come to the same conclusion on the second aspect of the Value Test, which consists in determining whether the portfolioinvestments were made in assets listed in subparagraphs 94.1(1)(b)(

i) to (ix). Shares, debt, options and currencies are explicitlymentioned therein. Futures or warrants fall under the catch-all subparagraph 94.1(1)(b)(viii) that lists “rights or options to acquire ordispose of any of the foregoing”. The only investments that might not fit snugly into these categories are cash-settled derivatives, such asswaps or contracts for differences, if they are not directly or indirectly linked to the other listed assets. [125] According to the tax literature, hedge funds make use of swaps and other derivatives for various purposes.

Even though hedgefunds seem to make extensive use of such derivatives, there is evidence before me to establish that such instruments were not primary income-generating sources for the Funds.[99] The offering memoranda state that the amount actually invested in such assets was minimal.On the evidence provided, I conclude that the Funds derived their value primarily from sophisticated trading strategies involving stocksand bonds, futures, currency, options and related investments. [126] Moreover, Gerbro's argument that the Funds did not derive their value from portfolio investments is a legal one and hinges on anarrow reading of the meaning of portfolio investment, which I have rejected. [127] I now turn to the thorny Motive Test. 5.5 One of the Main Reasons 5.5.1 Preliminary Remarks About Hedge Funds [128] This appeal raises the novel issue of applying the Motive Test in

section 94.1 to hedge funds located in low-tax jurisdictions.Subject to the foregoing comments, hedge funds or funds of funds will meet the Value Test. The application of the OIFP Rules thereforehinges on the Motive Test. In applying the Motive Test, one should not lose sight of the particular characteristics that distinguish hedge

funds from traditional long equity or fixed-income investments. [129] The following basic information on hedge funds may be drawn from the evidence, including the testimony of Ms. Gut and of Mr. Luis Seco, the expert called by the Appellant.[100] The term hedge fund refers to a wide range of unregulated investments that offeralternative patterns of returns to those of traditional fixed-income instruments, such as corporate bonds or government bonds, and stocks.Hedge funds are diametrically opposed to exchange-traded funds (ETFs), a type of investment merely replicating market indices or otherpatterns of returns.

Hedge funds, on the other hand, seek to actively produce returns that are not correlated with the market as measuredby stock indices such as the S&P 500, the Dow Jones Industrial Average or the NASDAQ Composite. These uncorrelated returns arereferred to in investment jargon as absolute returns. The ability of a hedge fund to consistently produce absolute returns is tied to thepedigree of the manager. [130] Hedge funds are not regulated. There is no prescribed legal form to be adhered to in order for a pooled investment vehicle toqualify as a hedge fund.

Thus the investment vehicle of the hedge fund might be structured as a corporation having legal personality,such as the Funds, or be a fiscally transparent partnership, such as Maple Key, Maple Key Plus and Silvercreek. [131] Achieving absolute returns goes beyond using sophisticated investment strategies such as short-selling or convertible debtarbitrage, or using derivative products. It requires the outlay of millions of dollars in market research.

These large fixed costs and theexpertise required make it prohibitive for most investors to replicate the returns, and this makes hedge funds that have historically beensuccessful in producing large risk-adjusted returns very attractive investments. [132] Furthermore, the fee structure creates an incentive for investment managers to operate under the hedge fund model, as it rewardsthem for producing high returns.

The fee structure is made up of a fixed percentage of the assets under management, generally between1% and 3%, and a substantial performance fee, generally in the range of 10% to 30%, for returns above the high-watermark. A manager'slevel of compensation is directly correlated with his success in consistently producing high returns.

Over time, a manager's ability toproduce high risk-adjusted returns will increase his ability to raise capital, which will sustain an upward trend in the manager’scompensation. [133] A direct implication of the incentive for managers to operate under a hedge fund model is that access to such managers is oftenonly possible under such a model, rather than under a more traditional segregated investment account model. 5.5.2 What is the Requisite Tax Avoidance Intention for theMotive Test? [134] Broadly speaking, the Motive Test is concerned with whether one of the Canadian investor's main reasons for investing in thenon-resident entity was to derive a benefit therefrom.

The type of benefit that is contemplated is a significant reduction in, or deferral of,Part I Canadian taxes on the income, profits or gains derived from the portfolio investment. [135] The wording of the test is unequivocal in requiring that a comparison be made. This comparison involves looking at the amountof foreign taxes paid by the non-resident entity in a given year on the income, profits and gains realized from portfolio investments. Theamount of foreign taxes paid, if any, must be compared to the

Part I Canadian taxes that would be payable in that same year if theinvestor earned the income, profits or gains from the portfolio investments directly. The test uses a fiction to make the comparison and ispurely hypothetical. The investor being able to hold the underlying investments is thus of no consequence for the purpose of thecomparison. [136] Using the same reference year for determining if there is a benefit for the purpose of the Motive Test is crucial, because of thetime-related value of money.

A fundamental idea in finance is that money available at the present time is worth more than the sameamount in the future due to its potential earning capacity. Therefore, a dollar today is worth more than a dollar in the future. Deferringincome tax is a benefit (a dollar of tax paid today is more valuable to the public purse than a dollar of tax paid many years down theroad.

This is the very essence of an income tax deferral benefit.) I mention this because it was argued more than once that Gerbro did not obtain a significant tax benefit since it would pay more Canadian tax when it redeemed its shares in the Funds at a later date.[101] Thismay very well be true, but is simply not relevant for determining the requisite benefit for purpose of the Motive Test. In fact, Gerbro'sposition would severely undermine the OIFP Rules in their application to any tax deferral benefit that they seek to capture.

Its position isuntenable. [137] The correct comparison is the amount of foreign tax paid in either 2005 or 2006 on the profit, income and gains realized from theportfolio investments versus the amount of Canadian

Part I tax that Gerbro would have paid in 2005 and 2006 if it had held the portfolioinvestments directly. A significant difference, in any given year, between these amounts is the type of benefit contemplated. The MotiveTest does not require an exact calculation of the benefit as it is a test of intention. In light of the words “it may reasonably be concluded”preceding the description of the Motive Test in

section 94.1, what is to be considered is whether it is objectively reasonable to concludethat such a benefit was contemplated. (See The Queen v. Wu, (FCA), 98 DTC 6004 at page 6006.) [138] Contrary to Gerbro's submission,[102] the amount of foreign tax paid is a relevant consideration under the OIFP Rules because thisamount, or the absence of such amount, will dictate whether or not there is a deferral benefit to begin with. If the foreign taxes paid aresimilar to the taxes that would be payable on the income in Canada, there is no deferral benefit and it would be superfluous to look atintention.

This is not the case in the present appeal since the Funds were all located in low-tax jurisdictions. In the present appeal, theMotive Test plays an important role. [139] The factual question is then quite simply whether it can reasonably be concluded that one of Gerbro's main reasons for investingor holding its interests in the Funds was to obtain the benefit in question. Whether it may reasonably be considered that Gerbro in factobtained the contemplated benefit is a factor to be taken into account under paragraph 94.1(1)(d), but is not the only factor. One must still

scrutinize the circumstances to determine if obtaining the benefit was a main reason or an ancillary one. 5.5.3 Giving No Weight to the Conclusion in Mr. Seco's Expert Report [ 140 ] The Court has the discretion to exclude the portion of Mr. Luis Seco's expert report comparing the returns of the Funds with those of other, Canadian hedge funds as it is technically non-compliant with the new Code of Conduct for Expert Witnesses in

Schedule III to the Tax Court of Canada Rules (General Procedure) ( Code of Conduct ). Subsection 145(3) of the Rules gives the Court this power and uses the word “may” in introducing the possibility of excluding an expert report. The new subsection 145(3) reads as follows:

(3) If an expert fails to comply with the Code of Conduct for Expert Witnesses, the Court may exclude some or all of their expert report. [ 141 ] In addition, the new Code of Conduct is explicit as to the contents of any expert report. Such reports should include “the facts and assumptions on which the opinions in the report are based”, as well as “any literature or other materials specifically relied on in support of the opinions”. According to paragraph 145(2)(

a) of the Rules, the expert report shall “set out in full the evidence of the expert”. (Emphasis added.) The amended

section 145 and the new Code of Conduct have been in effect since February 7, 2014. [103] The current version now mirrors the Federal Courts Rules , sections 52.1 to 52.6 and 279 to 280. [ 142 ] In Bekesinski v. Canada , 2014 TCC 35 , [2014] T.C.J. No. 33 (QL), at paragra ph s 27 and 28 , it was ruled that the plain and obvious meaning of “full statement” of the evidence in the former version of

section 145 required that “the underlying data collected, quantitative analysis employed and the ratios calculated to support [the expert’s] opinion” be specifically included in the expert report. This was thus a requirement even before the recent amendments to

section 145 of the Rules, and remains one today in light of the amendments. [ 143 ] In Bekesinski , at paragraph 13 , Justice Campbell also cites Judge Dussault's decision in Mathew et al. v. The Queen , 2001

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