A group of Canadian investors, including the taxpayers, invested in the shares of two Panamanian corporations (collectively, "Justinian") whose principal activity was investing in bonds. Each year Justinian paid an annual dividend equal to 1% of the original cost of the share subscriptions in its capital. It was contemplated that the Canadian investors would receive substantially all their return as a capital gain when their shares in Justinian were redeemed (which, in fact, occurred) and that, in the meantime, the earnings of Justinian after payment of the annual dividends would accumulate free of Canadian tax. Their shareholdings were limited to 9.9% so as to avoid the foreign accrual property income (FAPI) rules.
In finding that interest (equal to approximately 10 times the dividends received) on money borrowed by the taxpayer (which was traceable to the Justinian share investment) was deductible, Iacobucci J. stated (at paras. 51, 54) that:
[A]bsent a sham or window dressing or other vitiating circumstances, a taxpayer's ancillary purpose may be nonetheless a bona fide, actual, real and true objective of his or her investment, equally capable of providing the requisite purpose for interest deductibility in comparison with any more important or significant primary purpose.
...Having determined that an ancillary purpose to earn income can provide the requisite purpose for interest deductibility, ... the requisite test ... is whether, considering all the circumstances, the taxpayer had a reasonable expectation of income at the time the investment was made.
In the present case, even though deferral of income tax was the primary purpose, an ancillary purpose (objectively determined) for subscribing in Justinian with the borrowed money was the earning of (dividend) "income", which in the context of s. 20(1)(c)(i) referred not to net income, but to income subject to tax ("Amounts of income such as dividends which must be included in income ... do not cease to be income merely because they are exceeded by the cost of their production" (quoting Mark Resources at para. 60).)
With respect to one of the later taxation years in question, in which one of the taxpayers disposed of its shares of Justinian to a wholly-owned subsidiary on a rollover basis in consideration for both non-interest bearing notes and interest-earning assets (principally preferred shares), Iacobucci J. found that because the value of the income-earning assets received on this transaction exceeded the amount of the borrowed money, those income-producing replacement properties could be linked to the entire amount of the loan with the result that the purpose test continued to be satisfied.