Off-Shore Investments and Section 94.1 – Primary purposes test

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Off-Shore Investments and Section 94.1 – Primary purposes test

Gerbo Holdings Company v Canada, 2016 TCC 172

At issue was whether the anti-avoidance provision, Income Tax Act section 94.1, applied to the taxpayer’s (wholly owned by a Bronfman trust) circumstances given its investments in five off-shore investment funds. Note that this section was only examined once in Walton v. The Queen, 98 DTC 1780 (TCC).

The Court permitted the appeal because it found that none of the taxpayer’s main reasons for investing in the funds was to defer or avoid Canadian taxes. Rather, the reason was to preserve its capital and complement its investments in long equities.

NOTE – the court held that the drafting in 94.1 is sloppy. This can be easily corrected by providing a definition of “portfolio investment” by reference to one or more of the listed assets, in any proportion, whether directly or indirectly, with or without factual or legal control.  The Motive Test must also be re-written by moving from “one of the main reasons” to “one of the reasons”.


The taxpayer is a Canadian Controlled Private Corporation with investments in five offshore hedge funds located in low/no-tax jurisdictions.  The Canada Revenue Agency reassessed the taxpayer under section 94.1 of the ITA to include amounts in income.

The Appellant used independent money managers to actively manage the portfolio but also expenses resources to make allocation decisions on the basis of applicable investment guidelines as adopted by the Appellant’s board.


Section 94.1 applies where two conditions are satisfied:

  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 regards 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 that would have been payable if the taxpayer held the portfolio investments directly.

Value Test

The Offshore Investment Property Rules, in Division B subdivision i or part I of the ITA were enacted in 1984 to fill a gap in the FAPI rules.  This is one part of the foreign affiliate regime made up of the FAPI rules applicable to Controlled Foreign Affiliates (CFAs), and the Foreign Affiliate (FA) dividend regime. Thus a Canadian resident can benefit from deferral in passive investment in a FA so long as the OIFP rules don’t apply.  However, taxpayers can easily manipulate the tax status of non-resident corporations to achieve their desired status (Lehigh Cement Ltd. v. Canada, 2014 FCA 103, para 19), which paragraph 95(6)(b) is meant to counter.

The Court went on to define “portfolio investments” pursuant to a textual, contextual, and purposive analysis (Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54).  A “portfolio investment” must be different than an “investment” or “investment portfolio” (para 90). The value test in must first determine whether the value is primarily derived, directly or indirectly, from portfolio investments and, only if the answer is yes, determine whether those investments are primarily made up of listed assets (para 89).

The Court looked at various definitions in Black’s Law Dictionary, the Oxford English Dictionary, the CICA handbook, Moneyterms online, the IMF Manual, and the IBFD International Tax Glossary. The common thread was that “they consider portfolio investment to be investments over which the investor does not exercise significant control, but merely wishes to passively benefit from an appreciation in value ” (para 100) or “an investment in which the investor (non-resident entity) is not able to exercise significant control or influence over the property invested in (para 101).  The Court held that a controlling interest would usually be between 10-25% ownership, though a small group could control with less than 10%. Also, investments that are bought and sold over short periods are more in line with portfolio investments (para 103). The definition “could be classified differently with respect to different persons” and assets (paras 104-105).

The purpose of the OIFP rules is to achieve capital export neutrality (investment decisions between on and off shore not influenced by tax considerations)  with respect to non-controlling interests in foreign entities (para 110), making Canadian residents subject to all inherently passive and tax-motivated off-shore investments through non-controlled foreign intermediaries (para 111).  They are not merely a backstop to the FAPI rules (para 114), and rightly includes investments that may also give rise to FAPI (para 115) and rightly includes an inventory of an active investment business (para 116).

The Funds in question need only primarily derive their value from portfolio investments (para 119), meaning “most important” (Will-Kare Paving & Contracting Ltd. v. R., [2000] 3 C.T.C. 200 (FCA), at paragraph 8, aff’d [2000] 1 S.C.R. 915), or more than 50%  of the value (para 120).

Motive Test

The Court highlighted the difference between hedge funds and traditional long equity of fixed-income investments (para 128), because the latter seeks to actively produce returns not correlated to markets and tied to the pedigree of the manager (para 129).  They are non-regulated and aim at maximizing absolute returns.

The requisite tax-avoidance motivation for section 94.1 is that (i) one of the main reasons (ii) for investing in the non-resident entity (iii) was to derive a significant reduction or deferral of Part I tax on portfolio investments.  This requires a comparison to be made between the foreign taxes paid by the non-resident entity and Part I taxes that would have been payable in the same year if the investor earned the income, gains, or profits directly from the portfolio investments (para 135).  Whether or not the taxpayer could in fact hold the underlying investment is not important.  All that is needed is that it is objectively reasonable that such a benefit was contemplated as a main reason as opposed to an ancillary one – The Queen v. Wu, 98 DTC 6004 at page 6006 (para 139). Whether or not the benefit was actually obtained is only a factor to be considered and not conclusive (para 139).

The reasons must be objectively reasonable in the surrounding circumstances of the investment in the fund (including the factors in paragraph 94.1(1)(c)) (para 153).  The principles of the “one of the main reasons” test was set out:

[157]   The case law applying the “one of the main reasons” test and the “one of the main purposes” test is instructive as to the legal principles applicable in making an appropriate factual determination. Those principles, as adapted for the purpose of the OIFP Rules, can be summarized as follows:

(1) A taxpayer’s reasons for investing can be disclosed or undisclosed, and the fact that a tax-avoidance reason is undisclosed, as is often the case, does not prevent a court from inferring that such a reason existed; Symes v. Canada, [1993] 4 S.C.R. 695 at 736;

(2) There can be more than one main reason for investing in a non-resident entity: Groupe Honco Inc v. The Queen, 2013 FCA 128, 2014 DTC 5006, at paragraph 24, aff’g 2012 TCC 305, 2013 DTC 1032;

(3) The Motive Test is not a sine qua non test under which the Court must conclude that tax avoidance was not a main reason for investing if it is convinced that the taxpayer would have invested notwithstanding the absence of any tax benefit: Continental Stores Ltd. v. The Queen, 79 DTC 5213 (FCTD) at 5217; Honeywood Ltd. et al. v. The Queen, [1981] C.T.C. 38 (FCTD); contraJordans Rugs Ltd. et al. v. M.N.R., [1969] C.T.C. 445 (Ex. Ct.).

(4) It is improper to conclude that resulting tax savings automatically lead to the inference that obtaining those tax savings must have been a main reason for investing: Les Installations de l’Est Inc. v. Canada, [1990] 2 C.T.C. 503 (FCTD), at 509‑10; Saratoga Building Corp. v. M.N.R., [1993] 2 C.T.C. 2074 (TCC), at 2086; and

(5) Choosing to invest in a non-resident entity when there was the possibility of investing in another vehicle triggering a larger tax liability is not necessarily determinative of a tax benefit main reason; Alpine Furniture Co. Ltd. et al. v. M.N.R., 68 DTC 5338 (Ex. Ct.), at 5345.

The Court differentiated between “main” and “ancillary” reasons and recognized that the line is difficult to draw (para 161).  The classification looks at the importance of the various reasons, relative to each other (para 165), so as to distil the main reasons for the decision to invest (para 167).


The Court held that the Appellant had a long-standing capital preservation strategy but, like most investors, had a secondary intention of obtaining a consistent return in prevailing market conditions. The Board, in line with the investment guidelines, set target rates of return, determined target volatility, and had ranges of  capital allocation percentages.

The search for and ultimate use of hedge funds was based on return histories and the lack of knowledge to invest as the funds did (as well as other competitive advantages).  The Appellant, because of the lack of knowledge, could not know how to calculate the amount of Part I tax it would have paid if it would have hypothetically invested in the funds directly (para 24).  The unregulated nature of the funds meant that the managers could choose who to accept and where to direct the investments (para 25), and the Appellant stated that the jurisdiction of the fund was not a relevant consideration in the decision to invest (para 26).

The Court also noted that a taxpayer only has the burden of demolishing the Minister’s assumptions of fact, which must be precise and accurate (Anchor Pointe Energy Ltd. v. Canada, 2003 FCA 294), and that assumptions of mixed fact and law are not binding on the court whether they could or should have been struck from the pleadings  (Kopstein et al. v. The Queen, 2010 TCC 448) (para 67). The Court also does not have to extract the factual components from mixed assumptions when they are incorrectly pleaded (para 68).  The Court noted:

[71]        The Supreme Court in Canada (Director of Investigation and Research) v. Southam Inc., [1997] 1 S.C.R. 748 distinguished questions of mixed law and fact from purely factual or legal questions with the following example:

  1. . . . Briefly stated, questions of law are questions about what the correct legal test is; questions of fact are questions about what actually 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. The question whether the defendant did this or that is a question of fact. And, once it has been decided that the applicable standard is one of negligence, 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 to be mixed law and fact turns out to be law or vice versa.

[Emphasis added.]

The Court concluded that tax deferral was an ancillary reason, the main reason was the business reasons and the managers’ reputation.  Here the business reasons overshadowed the tax reasons (which were incidental to the decision) (para 199).

Sas Ansari, BSc BEd PC JD LLM PhD (exp) CPA In-Depth Tax 1, 2 &3

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