Tax Court: BlackBerry’s Payments to US Affiliates Not Services FAPI Under Section 95

In BlackBerry Limited v The King (2024 TCC 123; under appeal to the Federal Court of Appeal), the Tax Court of Canada found that the payments made by BlackBerry Limited (“BlackBerry Canada”) to its US affiliates for research and development (“R&D”) services were not foreign accrual property income (“FAPI”) under section 95 of the Income Tax Act (Canada).

There are three issues in this case:

1. Whether the US $17.1 million earned by the US affiliates from R&D services rendered to BlackBerry Canada is FAPI under paragraph 95(2)(b);
2. If so, whether the exceptions under paragraph 95(3)(b) or (d) apply; and
3. If the amount is FAPI and the exceptions do not apply, whether any foreign accrual tax (“FAT”) can be deducted against FAPI under subsection 91(4).

Paragraph 95(2)(b) prevents base erosion through the provision of related-party services; when applicable, it deems a portion of a foreign affiliate’s services-related business income to be income from a business other than an active business and therefore FAPI.[1] The Minister argued for a plain reading of 95(2)(b) that captures the amount in issue as FAPI. The taxpayer, however, asserted an “ambiguity” revealed by applying the plain meaning of 95(2)(b) to the facts of this case; according to the taxpayer, this ambiguity will be resolved through contextual and purposive analysis. The taxpayer also asserted that the Minister’s interpretation incentivizes taxpayers to “sacrifice commercial rationality to avoid the FAPI rules”, which is the very economic distortions that the FAPI regime is supposed to prevent.

On the first issue, the Court agreed with the taxpayer that paragraph 95(2)(b) is “unclear whether only the R&D services paid for by the taxpayer are to be considered or whether all services provided between the foreign affiliate and the taxpayer should be considered”. The Court then adopted a purposive interpretation “to designate only the net income paid to the foreign affiliate as FAPI”. In other words, all services between the taxpayer and the foreign affiliates as well as payment for those services are aggregated and considered. According to the Court, this aggregated approach captures as FAPI only unreciprocated arrangement that erodes the Canadian tax base, which is the very mischief to be prevented. If FAPI provisions are applied to reciprocal arrangements (where the foreign affiliate is also making payments to the taxpayer and these payments are more than the payments made by the taxpayer to the foreign affiliate) as in this case, it will countermand the two main objects of FAPI provisions: base erosion prevention and competitive advantage.

On the second issue, the Court found that the exceptions in paragraphs 95(3)(b) and (d) apply. With respect to paragraph 95(3)(b), the Court agreed with the taxpayer’s broad interpretation of “in connection with” and found that the US R&D services were performed in connection with the sale of goods. With respect to paragraph 95(3)(d), the Court found that in BlackBerry’s overall operations, the R&D services were conjunctively essential to manufacturing and processing.

On the third issue, the Court agreed with the Minister that there was no FAT deduction under subsection 91(4). The Court found that the US tax paid by the US affiliates related to credit for increasing research activities and net operating losses, which reduced the aggregate amount of US income tax paid by the US affiliates as a whole to nil. As a result, no portion of income tax paid in the US and attributable to a US affiliate was “on a reasonable basis” applicable to the R&D services provided to BlackBerry Canada. The Minister correctly reduced the FAT to nil.

About the author

Julia (Zhuying) Zhuo, Torys LLP, Toronto: jzhuo@torys.com

 

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