Document Your Reasons For Foreign Investing: Gerbro Holdings v. The Queen

Associate Chief Justice Lamarre of the Tax Court has provided her typically thoughtful analysis of a holding company’s investment in a portfolio of low-tax foreign hedge funds based in tax havens in Gerbro Holdings Company v. The Queen, 2016 TCC 173. The issue was whether Gerbro Holdings needed to impute income from its hedge fund holdings to its taxable income for the years in question (2005 and 2006) under the “offshore investment fund property” rules in section 94.1 of the Income Tax Act.

The investments in question were in hedge funds (that were constituted as companies) based in the Cayman Islands, the Netherlands Antilles, or the British Virgin Islands.

The central issues were whether Gerbro met two provisions within 94.1 crucial to the “charging provision” (for the layperson, that means the part of the law that creates an obligation to pay the tax):

  • whether these foreign funds were reasonably considered to “derive its value… primarily from portfolio investments”; and
  • whether “one of the main reasons for the taxpayer… having the interest in [the hedge funds] was to derive a benefit from portfolio investments… in such a manner that the taxes… from such assets for any particular year are significantly less than the tax that would have been applicable” if they had been directly earned by Gerbro.

Madam Justice Lamarre decided that the first consideration was reasonable, but that Gerbro didn’t have tax reduction as a main reason for making these investments. Therefore section 94.1 didn’t apply. The important takeaway here is that second point: tax motivations weren’t, in her view, a main reason for making these investments, although the reduced taxes (or, to be more precise, the tax deferral) were “an undisclosed secondary reason”. This was supported by extensive testimony from Gerbro’s CEO, a deep analysis of the history of its portfolio allocation, and, critically, two sets of explicit Investment Guidelines adopted by Gerbro’s board (in 2002 and revised in 2005). These investment guidelines, which do not discuss tax but instead focus on a risk/return combination and a desired allocation, were considered at length.

In reading the decision, it’s hard not to be struck by the degree to which this focus in the Investment Guidelines of Gerbro dominates the reasoning about its intention. This is perhaps all the more remarkable as the impact of the low foreign taxes paid in the tax haven jurisdictions on such returns is not extensively discussed, although clearly such low-tax operations are part and parcel of high-return portfolio investing. This supposed rupture between “tax” motivations and “commercial” motivations suggests a clear path for Canadian portfolio investors to take if they are concerned about the potential impact of the offshore investment fund property rules. Make sure your reasons for making your investment decisions are well-documented and make sure they focus not just on commercial motivations but on the commercial aspects of those commercial motivations.

The meager Canadian hedge fund market gets a mention in the decision, as forming and shaping the desires to seek investment opportunities in those foreign funds.

As always, a tax lawyer can assist you in preparing internal documentation to ensure your compliance with these rules.



Written by Craig Burley

Craig is a tax lawyer in private practice in Hamilton, Ontario. Call Craig at (905) 296-3378 to discuss issues that you think may need independent tax advice. In addition to tax, Craig writes and works publicly on a number of other issues related to law, justice, and public affairs.