Emergis financed a U.S. acquisition through a tower structure under which:
- it made an interest-bearing loan to a subsidiary Canadian partnership (“USGP”);
- USGP funded such interest payments out of dividends received from a wholly-owned Nova Scotia ULC (“NSULC”);
- NSULC, in turn, received dividends out of the exempt surplus of a wholly-owned LLC; and
- the LLC received s. 95(2)(a)-recharacterized interest on the acquisition-financing loan made to the successor by amalgamation (“US Amalco”) to the U.S. acquisitionco of Emergis.
Emergis’ 99.9% effective share of the interest deduction of USGP for the loan largely offset its interest income from that loan and, in addition, it claimed the s. 112(1) deduction for its effective share of the dividend income from NSULC. From a U.S. perspective, the interest on the loan owing by USGP was deductible interest paid by a U.S. corporation (USGP) to a Canadian resident (Emergis), and was subject to U.S. withholding tax.
In reversing the finding below that Emergis could not deduct such tax because such tax could (in accordance with the exception at the end of s. 20(12)) “reasonably be regarded as having been paid by a corporation [Emergis] in respect of income from a share … of a foreign affiliate [the LLC],” Webb JA and Goyette JA indicated:
- “[I]t would not be reasonable to regard the US Government as imposing a tax in respect of the income from the shares of LLC, as the US Government did not recognize the separate existence of LLC” (para. 28).
- The text of s. 20(12) was "insufficient to displace the general rule that the assets and income of a corporation are not the assets and income of its shareholders” (para. 35), i.e., s. 20(12) did not provide “that NSULC’s income from its LLC shares should be treated as the income of Emergis, and hence as the income on which Emergis paid the taxes to the US Government” (para. 36).
- The interest on which Emergis paid the U.S. withholding tax was calculated as a percentage of the principal of the loan and “was not based on the income from the shares of LLC” nor was it “a distribution or allocation of income earned directly or indirectly by Emergis from the shares of LLC” (para. 38).
- It appeared that s. 20(12) was enacted “(a) because foreign taxes, not being incurred to earn income, are not deductible (paragraph 18(1)(a) …); and (b) to address the limitations in subsection 126(1) …, one of them being the unavailability of a credit when the income on which the tax imposed by the foreign government has no foreign source” – so that here, as Emergis did not have a source of income in the US “[a]llowing it to benefit from the subsection 20(12) deduction would therefore be in line with the purpose of this provision.”