Indirect US operating subsidiaries of a Canadian insurance company were funded (or their acquisition was funded) in part through an indirect Canadian subsidiary (Canco 2) of the insurance company subscribing for mandatory redeemable preferred shares (MRPS) of a Luxembourg subsidiary of Canco 2 (“Luxco 1”) which, in turn, lent the funds to such US subsidiaries (except that Canco 2 also acquired MRPS made under similar transactions by its immediate Canadian parent, Canco 1, on an s. 85(1) rollover basis). The activities of Canco 2 were limited to providing a guarantee (for guarantee fees) to US Ops Holdco (the parent of a US borrower) and holding the shares of US Ops Holdco and Luxco 1.
Because Canco 2 was a specified financial institution and the MRPS were term preferred shares, s. 258(3) would have denied the s. 113(1)(a) deduction to Canco 2 for the MRPS dividends unless (per s. 258(4)(a)) the MRPS had not been “acquired in the ordinary course of the business carried on by [Canco 2].” In finding that the s. 258(4)(a) exception applied, the Directorate stated:
In order to constitute “carrying on” a business, it normally requires some continuity, frequency and regularity of the commercial activities. It is arguable that the acquisition of the … MRPS is not considered part of the ordinary course of business carried on by [Canco 2], but rather the acquisition may be considered an isolated and special transaction that is not part of a course of conduct that involves repeated dealings of a similar nature. …
[I]t is also important to consider whether the arrangement in the current case, at its core, more closely resembles a debt financing arrangement or a capital investment. …[W]e are more inclined to conclude that the arrangement more closely resembles a capital investment. … [Canco 2] is not in the business of lending money to the general public or to any disinterested third parties and the loans it made were limited to its foreign related corporations. All of the proceeds from the issue of the … MRPS were used by Luxco 1 to make loans to … US foreign affiliates for their US operations. …