DEML Investments – Tax Court of Canada finds that the generation of a capital loss on a partnership interest representing a successful investment was a GAAR abuse

In early 2008, the sale of petroleum and natural gas (PNG) rights by an arm’s length vendor (Transglobe) to the parent (Direct Energy) of the taxpayer (DEML) was structured on the basis that Transglobe transferred 99% and 1% of the PNG rights, at a nominal s. 85(1) elected amount, to two wholly-owned Newcos (137 and 138, respectively), which then transferred the rights on an s. 97(2) rollover basis to a newly-formed partnership (DERP2). Direct Enery then acquired the shares of 137 and 138 for $51 million and $0.5 million, respectively.

A year later, Direct Energy transferred the shares of 137 to DEML on an s. 85(1) rollover basis, with 137 then distributing its partnership interest in DERP2 to DEML on its winding up, with the ACB of that partnership interest being bumped under s. 88(1)(d).

DERP2 then distributed its resource properties to DEML as a return of capital, thereby increasing the COGPE balance of DEML and reducing the ACB of DEML’s partnership interest by the FMV of the rights (higher than the value a year earlier) – but with these items effectively being approximately reversed at the partnership year end as a result of DERP2’s proceeds of the distribution of the PNG rights being allocated to its partners.

After then reseeding DERP2 with a small resource property that was of interest to a third-party purchaser, DEML sold its partnership interest to that purchaser, thereby realizing a capital loss. In confirming CRA’s GAAR assessment to deny the capital loss, Russell J stated:

Here the substantial Capital Loss was claimed where there was no economic loss or impoverishment, thus per Triad Gestco breaching the OSP [object, spirit and purpose] of the Act’s capital loss provisions, including paragraph 39(1)(b). …

As the purpose of the capital loss provisions is to recognize real losses, there is clear abuse where artificial losses are deducted. That is even more so when those losses are based on non-capital CRP [Canadian resource property], that will also be deducted through CCOGPE pools at a 100% inclusion rate thus creating a double deduction.

Similarly, regarding the use of the s. 88(1)(d) bump to effectively create most of the quantum of the loss, he stated:

[I]t seems incomprehensible that an artificial loss would signal misuse of capital loss provisions of the Act without equally indicating misuse of the very “bump” provisions of the Act used to achieve the artificial loss through the “bumping” of an ACB.

Neal Armstrong. Summary of DEML Investments Limited v. The King, 2024 TCC 27 under s. 245(4).