HER MAJESTY THE QUEEN,
heard on May 15, 2007, at Toronto, Ontario.
Before: The Honourable
Justice B. Paris
Counsel for the Appellant:
Louise R. Summerhill
Counsel for the Respondent:
The appeal from the assessment
made under the Income Tax Act for the 1994 taxation year is allowed with
costs and the assessment is referred back to the Minister of National Revenue
for reconsideration and reassessment on the basis that the Appellant is entitled to deduct a terminal loss of
Signed at Ottawa, Canada,
this 2nd day of May 2008.
HER MAJESTY THE QUEEN,
REASONS FOR JUDGMENT
The Appellant was a limited
partner in the Roseland Park II Limited Partnership (“Roseland II”), which was
formed in 1989 to acquire a newly built condominium building in London,
Ontario. Another newly built condominium building, adjacent to the Roseland II
property, was acquired by the Roseland Park I Limited Partnership (“Roseland
I”). Due to a general downturn in the real estate market in Southern Ontario,
the value of the Roseland I and II properties dropped substantially in the
years following their acquisition.
In a series of transactions
undertaken in December 1994, Roseland I and Roseland II sold all of their
assets to a new limited partnership, Roseland Park Master Limited Partnership
(“RPM") and the limited partners of Roseland I and II received partnership
interests in RPM.
The dispositions triggered
terminal losses to Roseland I and II under subsection 20(16) of the Income
(the “Act”), since there was still a positive Undepreciated Capital Cost
(“UCC”) balance after the disposition. These losses were allocated to the
limited partners. The Appellant deducted $29,130 as his share of the terminal
loss of Roseland II in computing his income for the 1994 taxation year.
The Minister of National Revenue (“Minister”)
used the general anti-avoidance rule (“GAAR”) in section 245 of the Act
to deny the deduction of the terminal loss.
In general terms, the GAAR applies
in circumstances where a taxpayer obtains a tax benefit as a result of a
transaction which is not arranged primarily for bona fide purposes other
than to obtain the tax benefit and the transaction amounts to abusive tax
Since the Appellant has conceded
that there was a tax benefit, the issues in this appeal are whether the assets
of Roseland II were transferred to RPM primarily to obtain the tax benefit, and
if so, whether this constituted abusive tax avoidance. If both conditions are
met, the GAAR would apply, and the Appellant concedes that the Minister would
be entitled to deny the terminal loss deduction pursuant to subsection 245(5) of
A partial agreed statement of
facts and joint book of documents were filed by the parties at the hearing. The
Appellant also called four witnesses: Mr. Gary Landrus, the
Appellant, Mr. Joseph Froio, a limited partner in Roseland I, Mr. Wayne Jacobs,
an executive of Allied Canadian Corporation, the corporation (“Allied”) that
became the general partner of Roseland II in 1993 and who devised the
restructuring proposal, and Mr. Ralph Neville, a partner at BDO Dunwoody, who
provided accounting advice on the transaction.
Roseland I was formed in 1988 to
acquire and operate a 94 unit residential condominium building located at 858
Commissioners Road East, London, Ontario. A total of 94 partnership interests
in the limited partnership were sold to the public. The general partner was Roseland Park
(I) General Partner Limited.
Roseland II was formed in 1989 to
acquire and operate a 110 unit residential condominium building located at 860 Commissioners Road East, London,
Ontario. A total of 110 partnership
interests in Roseland II were sold to the public. The general partner was
Roseland Park (II) General Partner Limited.
Roseland I acquired the property
at 858 Commissioners Road East on December 30, 1988 at the following cost:
(a) Land $476,000
(b) Building $5,495,845
(c) Furniture and Equipment $515,100
(d) Landscaping $27,137
(e) Paving $78,614
Roseland II acquired the property
at 860 Commissioners Road East on January 31, 1990 for the following cost:
Furniture and Equipment $653,400
The buildings at 858 and 860 Commissioners Road East were part of a development that was to consist of
four residential condominium towers and an amenities centre with two levels of
parking, a swimming pool, clubhouse, community centre and tennis court. Due to
the slowdown in the real estate market, only three towers (including the Roseland
I and II properties) and the amenities centre were built. The development was
located next to a hospital in what was said to be a good area of the city, and
had views over the Grand River.
Each partnership interest in
Roseland I and II had referenced to it a particular condominium unit in the
respective buildings. Upon withdrawal from the partnerships, each partner
became entitled to receive the referenced unit. The size of the unit and its
location in the building determined the cost of the partnership interest and
the partner’s percentage interest in the partnership. The limited partner
selected the referenced unit at the time of acquiring his or her interest in
the limited partnership.
The rental income from all of the
units was pooled for each building, respectively, and net profit was allocated
to each limited partner based on his or her percentage interest in the
Financing for the partnership
units had been arranged by the promoter and was available in part by means of a
mortgage from the Royal Bank registered against the referenced unit selected by
the purchaser of the partnership interest.
On May 10, 1989, the
Appellant purchased his interest in Roseland II for $107,650 which he
financed as follows:
Royal Bank mortgage: $70,725
Second mortgage: $30,295
The Appellant chose Unit 1005A as
the condominium unit available to him upon withdrawal from the partnership.
Roseland I began rental
operations in February 1989 and Roseland II in February, 1990. They faced
a difficult rental market almost from the outset. According to a note sent to
the investors in Roseland II by the General Partner in May 1991, London had the highest
vacancy rate in Ontario due to the completion of almost 4,500 new rental
apartments in the area between 1988 and 1990. The vacancy rate for apartment
buildings in London, completed after 1985, was said to be 10.4% in
October 1990. Also, unemployment in the region was increasing.
It is clear from the evidence that
the financial performance of Roseland I and II in the initial years was
disappointing to the investors. Cash flow was less than anticipated and resale
prices for condominium units in both buildings were well below the prices paid
originally for the partnership interests to which the units were referenced.
According to Mr. Froio, the value
of the condominium units had “plummeted like a rock.” He also said that a
number of units in Roseland I had been foreclosed by the Royal Bank in the
first few years of operation and that the units had been resold for as little
as half their original price.
The Appellant said that he had the
impression from one visit to the property in 1990 or 1991 that Roseland I and
II were in competition with each other for rentals and resales, although he had
thought that the two buildings were supposed to be part of a common enterprise.
He also saw a “downward spiral” in the resale prices of units in the building.
The Appellant felt that the
management of Roseland II was inadequate. At first he talked a couple of times
a year with a representative of the general partner and received regular mail
outs about Roseland II, but he said that after 1991, mail outs were irregular
and that he had difficulty keeping up with what was going on with the property.
He also thought the general partner or property manager could be doing more to
coordinate resales of the units.
In early 1993, against this
backdrop of investor dissatisfaction, Allied was approached about taking over
as the general partner of Roseland II.
Mr. Wayne Jacobs, an executive
with Allied, testified that, during that period, the company was developing a
niche in the property management market in Southern
Ontario dealing with real estate owned
by limited partnerships. He said:
The niche was the tumbling real estate market of the early '90s and
there were a lot of limited partnerships in the marketplace where the general
partner or property manager hadn't performed to the expectation of these
investors and so these investors felt that that there was a need to try and do
something about the value of their property and the asset that they owned.
Mr. Jacobs testified that Allied
was first approached by certain limited partners in Roseland II, whereas the
first reporting letter sent out to the limited partners in Roseland II by
Allied in 1993 said that Mr. Tom Borromeo, who was the director and an officer
of the general partner of Roseland II at the time, approached Allied. The
. . . Mr.
Borromeo recently came to the conclusion that the Limited Partnership would be
better served by an organization with comprehensive syndicate management and
property management expertise. As a result, he approached Allied Canadian
Corporation. . .
In June 1993, Allied acquired
the one outstanding share of Roseland Park (II) General Partner Limited, and
Allied personnel were elected as directors and appointed as officers of the
general partner. In September 1993, Allied Canadian Management Corporation (a
company related to Allied) took over as property manager of Roseland II.
Once Allied took over, Mr. Jacobs
said that he felt the financial results could be improved by combining the
operations of Roseland I and II in order to achieve “economies of scale”. He
said the restructuring was necessary “in order to really make a difference” and
“to bring everything under one management group so there would be no
duplication of efforts by anyone.” He said that there would be a “tremendous
savings of costs plus there wouldn’t be the same fight for the rental revenue.”
Mr. Jacobs said that Allied made
the recommendation to bring the two partnerships together after Allied was
approached by investors from Roseland I who were aware that Allied had taken
over the management of Roseland II, although he did not give any specific date
when this happened.
Mr. Froio said that rumours began
circulating among the partners of Roseland I in late 1993 or early 1994 that
Allied had some idea of putting the partnerships together to save some costs,
and the topic was discussed at a meeting of the Roseland I partners in April
1994. The Appellant said that he first became aware of the restructuring
proposal after reading the quarterly reporting letter sent out by Allied to the
limited partners in June 1994.
The documents in evidence show
that the matter of the restructuring was discussed at the annual meetings of
both limited partnerships in the spring of 1994.
Also, according to a report to Roseland II partners dated June 1, 1994 the restructuring proposal
had the support of both limited partnerships at that time.
Mr. Jacobs said that after
obtaining the support of the limited partners for the proposal, Allied retained
the services of Ralph Neville, senior tax partner at BDO Dunwoody Ward Malette,
as well as the law firm Aird & Berlis, in order to confirm the viability of
the transaction. He said that Allied wanted to try and understand if the
restructuring was possible and what the implications of it would be. He said
that Allied did not want the restructuring to have a negative impact on the
partners so it “approached BDO to try and understand what were the implications
of bringing two different partnerships together as a single partnership.”
Allied also obtained an
appraisal of the assets of Roseland I and Roseland II. The appraisal
report was dated August 31, 1994. On the basis of these appraisal values,
an estimate of each partner’s terminal loss was calculated.
Allied set up two meetings for
September 8, 1994, one for the partners of Roseland I and the other for the
partners of Roseland II, to discuss and vote on the proposal. The
partners were provided in advance of the meetings with an information circular
including the estimate of the potential terminal loss for each partner and a
copy of an opinion letter from Mr. Neville. The proposal was described in the
following terms in the information circular:
The proposed restructuring involves the sale of each Limited
Partnership's property in its entirety to a new limited partnership, which will
be owned directly or indirectly by the current limited partners of the Limited
Partnerships. Each limited partnership interest will continue to be referenced
to its current individual condominium unit and each limited partner of the new
limited partnership will have the same rights and obligations as in their
respective previous limited partnership.
Allied also sent a letter dated
August 26, 1994 to the Roseland I partners setting out the following advantages
of its proposal:
Benefit: Average terminal loss per limited partnership interest of
approximately $19,000, permitting reduction in income taxes payable in 1994 by
approximately $10,106 (assuming top marginal rates of income tax).
Potential to benefit from evident recovery in real estate market by selling at
a future date into an improved market.
Highly flexible, in that it does not preclude any course of action in the
future, including outright liquidation.
Highly effective, in that it liberates a loss for income tax purposes in 1994
without crystallizing an economic loss.
Management: Allied Canadian has comprehensive asset management capability
that can be brought to bear on the combined properties of both limited
partnerships, resulting in diversification of risk and the achievement of
economies of scale.
Cost of Holding: The after-tax cost to limited partners of holding the
investment throughout 1995 and 1996, taking account of the terminal loss, will
The Appellant attended the special
meeting of the partners of Roseland II on September 8, 1994 where presentations
were made by representatives of Allied, BDO and Aird & Berlis. The
Appellant said that the limited partners were told that the
restructuring would create a larger rental pool and create efficiencies in
operations such as common management, and only one management residence on site
rather than two. The tax consequences of the proposal were also
discussed, and were estimated to have taken up about half the time of the meetings.
At his examination for discovery, the Appellant had said that the bulk of the
discussion at the meeting was related to the tax aspect of the transaction.
The limited partners of
Roseland II then approved the proposal and the necessary special
resolution was passed on or about September 8, 1994.
The Appellant stated that he voted
for the proposal because he felt that a larger unit with more effective rental
policies would stop or decrease the “rush to the door selling” and that there
would be “a larger pool on which to develop the investment.” He also thought
that the restructuring would eliminate competition between the two buildings.
He said that he was skeptical about the tax benefit because in other limited
partnerships in which he had been involved, cash flow and tax projections had
not always proved reliable.
In cross-examination he agreed that
at the time he was desperate to get something out of his investment, although
he still wanted to continue with it.
The Appellant said that from his
point of view the primary purpose of the reorganization was “to salvage our
investments, to have a larger rental pool with proper management to be a more
effective sufficient rental organization.”
A special meeting of the partners
Roseland I was also held on September 8, 1994 to vote on the proposal. Mr.
Froio said that he understood before the meeting that “there was going to be a
good cost potential savings to put it together” and a better payout to the
partners. He voted in favour of the restructuring “mainly for the business
purposes and a possibility of the tax thing”, although he thought the tax benefit
was too good to be true. He also added that, from his perspective, the
transaction was undertaken for cost savings and to create synergies with regard
to getting the tenants that both buildings were competing for.
The special resolution approving
the sale of the assets of the partnership to a new limited partnership was
subsequently passed by the Roseland I limited partners on September 22, 1994.
The sale of the assets of
Roseland II to RPM took place as follows:
- RPM was formed and registered on December 21,
- on December 23, 1994, Roseland II
subscribed for 4,448 interests in RPM. The subscription price of $4,448,000,
being equal to the fair market value of the net assets of Roseland II net
assets (as determined by the appraisal referred to above), was
paid by promissory note.
- on December 23, 1994, Roseland II directed
RPM to issue the limited partnership interests subscribed for in RPM, to the
limited partners of Roseland II in proportion to their existing interests
in Roseland II. The Appellant received a 1.002% interest in RPM.
- on December 28, 1994, Roseland II sold all
of its assets to RPM for fair market value consideration paid by cancellation
of the promissory note given by Roseland II for the subscription price of the
partnership interests in RPM.
The sale of the assets of
Roseland I to RPM was done in a similar manner, except that an additional
step was added to ensure that Ontario land transfer tax would not have to be paid.
The sale of the assets by
Roseland I and Roseland II resulted in terminal losses of $1,709,454
and $2,916,612 respectively, which were allocated to the limited partners.
Roseland I and
Roseland II were dissolved on June 3, 1998.
The Appellant said that after the
reorganization of the partnerships, he recalled that there was some increase in
cash flow. Wayne Jacobs said that the two properties had better operating
results but gave no details in this regard.
No reference was made by any of
the witnesses to a document
included in the joint book of documents which set out the income and expenses
for Roseland I and II for 1993 and 1994, and for RPM for 1995, which on its
face does not appear to show any significant change in income or expenses after
1994 when the partnerships were combined.
The Appellant withdrew from RPM in
2000, and exercised his option to take title to Unit 1005A. He then sold that
unit to an unrelated party for $63,500. He reported the difference between the
sale price and his share of the cost at which RPM purchased the Roseland II
assets in 1994 on income account. At the time of the hearing, Mr. Froio was
still a member of RPM.
Mr. Ralph Neville gave evidence
concerning the accounting advice he provided on Allied’s proposal to combine
the two limited partnerships. He stated that the “traditional” way of effecting
a merger of two partnerships was to dissolve the existing partnerships and
distribute the assets of the partnerships into the hands of the existing
partners, and then have the existing partners contribute those assets into a
new partnership in return for a partnership interest.
In this case, he felt that there
were certain business reasons for not using this method to merge the
partnerships. The first related to the fact that, upon distribution of
partnership property to the limited partners, each limited partner would hold
an undivided interest in the entire property. In order to transfer that
property into the new limited partnership, it would be necessary for all of
them to agree to the transfer. Without the unanimous agreement of the limited
partners, the transfer could not proceed, thus giving each limited partner the
power to block the transfer of the property to the new limited partnership by
withholding his or her agreement. Mr. Neville said that it was not certain in
this case whether all of the limited partners in Roseland I and II would have
consented to such a transfer. The second reason for not using the traditional
method was that the transfer of the partnership property would have attracted Ontario land transfer
He therefore recommended the
method that was used here, which involved the sale of the partnership property
to RPM, and the issuance of partnership interests in RPM that were subsequently
distributed to the limited partners of Roseland I and II.
Mr. Neville also gave evidence
that he understood that using the traditional method would have enabled the
limited partners in Roseland I and II to claim terminal losses to the same
extent as using the method he recommended. He explained that upon dissolution
of a partnership the distribution of the partnership assets to the partners is
done at the fair market value of the assets (in the absence of any election by
the partners under subsection 98(3)). This would have triggered a terminal loss
in the same way that the disposition of the assets at fair market value to RPM
The Minister assessed the limited
partners of Roseland I and II and denied the deduction of the terminal losses. The
Minister initially took the position that there was no change in beneficial
ownership of the Roseland I and II assets upon the sale to RPM, that the “stop‑loss”
provisions of section 85(5.1) of the Act applied to deny to the
terminal losses resulting from the transfer of the property, and, finally, in the
alternative, that the GAAR applied to deny the terminal losses.
Subsequent to the Appellant’s
notice of objection, the Minister confirmed the reassessment, relying only on
Section 245 reads as follows for
the year in issue:
245. (1) In this section,
"tax benefit" means a reduction, avoidance or
deferral of tax or other amount payable under this Act or an increase in a
refund of tax or other amount under this Act, and includes a reduction,
avoidance or deferral of tax or other amount that would be payable under this
Act but for a tax treaty or an increase in a refund of tax or other amount
under this Act as a result of a tax treaty;
"tax consequences" to a person means the amount of
income, taxable income, or taxable income earned in Canada of, tax or other
amount payable by or refundable to the person under this Act, or any other
amount that is relevant for the purposes of computing that amount;
"transaction" includes an arrangement or event.
(2) Where a transaction is an avoidance transaction,
the tax consequences to a person shall be determined as is reasonable in the
circumstances in order to deny a tax benefit that, but for this section, would
result, directly or indirectly, from that transaction or from a series of
transactions that includes that transaction.
(3) An avoidance transaction means any transaction
(a) that, but for this section, would
result, directly or indirectly, in a tax benefit, unless the transaction may
reasonably be considered to have been undertaken or arranged primarily for bona
fide purposes other than to obtain the tax benefit; or
(b) that is part of a series of
transactions, which series, but for this section, would result, directly or
indirectly, in a tax benefit, unless the transaction may reasonably be
considered to have been undertaken or arranged primarily for bona fide
purposes other than to obtain the tax benefit.
(4) Subsection (2) applies to a transaction only if
it may reasonably be considered that the transaction
(a) would, if this Act were read without
reference to this section, result directly or indirectly in a misuse of the
provisions of any one or more of
(i) this Act,
(ii) the Income
(iii) the Income
Tax Application Rules,
(iv) a tax
(v) any other enactment that is relevant in
computing tax or any other amount payable by or refundable to a person under
this Act or in determining any amount that is relevant for the purposes of that
(b) would result directly or indirectly
in an abuse having regard to those provisions, other than this section, read as
(5) Without restricting the generality of subsection
(2), and notwithstanding any other enactment,
(a) any deduction, exemption or exclusion
in computing income, taxable income, taxable income earned in Canada or tax
payable or any part thereof may be allowed or disallowed in whole or in part,
(b) any such deduction, exemption or
exclusion, any income, loss or other amount or part thereof may be allocated to
(c) the nature of any payment or other
amount may be recharacterized, and
(d) the tax effects that would otherwise
result from the application of other provisions of this Act may be ignored,
in determining the tax consequences to a person
as is reasonable in the circumstances in order to deny a tax benefit that
would, but for this section, result, directly or indirectly, from an avoidance
The terminal loss provision,
subsection 20(16) read as follows for the year in issue:
paragraphs 18(1)(a), 18(1)(b) and 18(1)(h), where at the
end of a taxation year,
(a) the total of
all amounts used to determine A to D in the definition “undepreciated capital
cost” in subsection 13(21) in respect of a taxpayer’s depreciable property of a
particular class exceeds the total of all amounts used to determine E to J in
that definition in respect of that property, and
(b) the taxpayer no longer
owns any property of that class,
in computing the
taxpayer’s income for the year
(c) there shall be deducted
the amount of the excess determined under paragraph 20(16)(a), and
(d) no amount shall be deducted for the year under
paragraph 20(1)(a) in respect of property of that class.
The Appellant concedes that the
terminal loss allocated to him by Roseland II is a tax benefit within the
meaning of subsection 245(1). However, he takes issue with the Minister’s
conclusions that the transaction giving rise to the terminal losses, i.e. the
disposition of the property by Roseland II to RPM, was not done for bona
fide purposes other than to obtain the tax benefit, and that the
transactions result in a misuse of the provisions of the Act or an abuse
of the Act read as a whole.
The Appellant argued that there
was no avoidance transaction in this case because the primary purpose of the
transactions was to bring two competing buildings into a common pool,
streamlining costs and management.
The Appellant submitted that the
fact that information was received on the tax savings resulting from the
reorganization must be considered in the context of all the evidence and does
not prove the sale was tax motivated. Mr. Jacobs indicated that the business
purpose was identified before tax advice was sought and that lawyers and
accountants were only contacted in order to determine the best way to effect
the sale and ensure that there were no adverse consequences to the partners.
The Appellant also referred to his
testimony that his decision to vote for the reorganization had nothing to do with
the proposed tax benefits.
Based on the foregoing the
Appellant concluded that the sale of the building was done primarily for
business reasons other than to obtain the terminal losses.
The Appellant further submitted
that the disposition of the partnership assets to RPM did not involve any
misuse of the terminal loss provision, subsection 20(16), or any abuse of
the Act as a whole.
The Appellant submits that there
is nothing in the object, spirit or purpose of subsection 20(16) that would
prevent partners from claiming a terminal loss on the disposition of
depreciable property by the partnership such as was done in this case.
The Appellant referred to the
understanding expressed by Mr. Neville that terminal losses are generally
available in a traditional merger of partnerships where the conditions of
subsection 20(16) are otherwise met: see Interpretation Bulletin IT‑ 471R
dealing with the merger of partnership.
The Appellant also referred to an opinion
letter written by the Rulings Directorate of Revenue Canada in 1994 that states
that if there is a dissolution of a limited partnership and a distribution of
the partnership assets to the partners, the partnership will be deemed to have
disposed of the assets and any terminal loss arising from that disposition can
be allocated to the partners and claimed by them.
In the Appellant’s view, this
shows that the Canada Revenue Agency (“CRA”) accepts that the object, spirit
and purpose of subsection 20(16) is not offended by these transactions.
The Appellant underlined the fact
that this case does not involve a scheme whereby the Appellant is trying to
claim a loss incurred by some other taxpayer. The Appellant in this case
suffered a real economic loss on his investment in Roseland II when the property
was sold for fair market value in 1994 because the property was worth less than
when it was purchased in 1989. The fair market value of the property was
therefore substantially less than its undepreciated capital cost and this
resulted in a terminal loss under subsection 20(16) of the Act.
The Appellant said that none of
the stop‑loss rules to which the Respondent referred in argument were
applicable in this case and that the object spirit and purpose of the stop-loss
rules is therefore irrelevant to the issue to be decided. The only issue is the
object, spirit and purpose of subsection 20(16).
The Appellant also contended that
the Respondent is attempting to characterize the transaction in suggesting that
there was no disposition of an economic interest. There was a real change of
ownership of the assets from Roseland Park II to RPM which resulted in the
receipt of proceeds of disposition.
In the event that the GAAR is
found to apply, the Appellant does not challenge the Minister’s determination
of the appropriate tax consequences pursuant to subsection 245(5) of the Act.
The Respondent takes the position
that the primary purpose of the dispositions of the assets by Roseland I and II
was to obtain a tax benefit for the limited partners by crystallizing
the terminal losses on the properties, without disposing of their investment in
the underlying assets, and that the dispositions would result in a misuse of
the provisions of the Act or an abuse having regard to the provisions of
the Act as a whole.
The Respondent acknowledged that,
once it has been established that an avoidance transaction occurred, GAAR will
apply only if the Respondent is able to show that the transaction was abusive
within the meaning of subsection 245(4) of the Act. This involves a two
step process. The provision that gave rise to the tax benefit must be
interpreted to ascertain its object, spirit or purpose and then the Respondent
must demonstrate that the avoidance transaction frustrates the object spirit or
purpose of that provision.
The Respondent identified the
provisions which gave rise to the tax benefit to the Appellant in this case, as
subsection 20(16) and section 96 of the Act. He said that “the scheme of
the Act within which these provisions operate seeks to prevent
deductions in respect of the disposition of capital property in circumstances
in which there is not a true economic disposition of the property between
parties within the same economic unit such that the taxpayer either directly or
indirectly continues to participate with the same or an identical property even
after the disposition.”
The Respondent explained that
subsection 20(16) is part of the Capital Cost Allowance (“CCA”) system in the Act
which allows the taxpayer to deduct the actual cost of depreciable assets over
a period of time at a rate prescribed by the Act. Citing the Federal
Court of Appeal decision in Water’s Edge Village
Estates (Phase II) v. Canada,
he stated that the object and spirit of the CCA provisions in the Act
was to provide for the recognition of money spent to acquire qualifying assets
to the extent that they are consumed in income earning processes under the Act.
The Respondent said that the
terminal loss under subsection 20(16) is premised on the taxpayer no longer
owning any property of a prescribed class at the end of a taxation year, and
there being “unused” UCC in respect of that prescribed class. Therefore, the
terminal loss provision acts as a final adjustment to CCA “when an arm’s length
sale demonstrates the property has been under-depreciated” under the CCA
According to the Respondent, the
policy of the Act is to recognize a disposition only in situations in
which there has been a “real economic disposition” of a taxpayer’s interest in
The Respondent argued that further
evidence of this policy is found in the following provisions in the Act
(as it read for the year in issue), commonly referred to as “stop-loss”
40(2)(g)(i), which provided that a superficial loss from the
disposition of a capital property is nil. “Superficial loss” is defined in
subsection 54(1) as the loss arising from a disposition of property by a
taxpayer where the same or identical property was acquired by the taxpayer, the
taxpayer’s spouse or a corporation controlled by the taxpayer directly or
indirectly in any manner whatever within a period beginning 30 days before the
disposition and ending 30 days after the disposition.
40(2)(e), which denied a corporation’s loss from the disposition of any
capital property by it to a person by whom it was controlled or to a
corporation that was controlled by a person who controlled the corporation;
85(4), which denied a loss that would otherwise arise on the disposition of
capital property (except depreciable capital property) or eligible capital
property by a taxpayer to a corporation controlled, directly or indirectly in
any matter what ever, by the taxpayer, by the spouse of the taxpayer or by a
person or group of persons by whom the taxpayer is controlled, directly or
indirectly in any matter what ever; or where an amount would otherwise be
deductible under paragraph 24(1)(a),
85(5.1) which denied or reduced a terminal loss which would otherwise have
resulted from the disposition of depreciable property by a person or
- a corporation that was
controlled, directly or indirectly in any manner whatever immediately after the
disposition by the transferor, the transferor's spouse, or a person, group of
persons or partnership by whom the transferor was so controlled; or
- a person, spouse of a person,
member of a group of persons or partnership who controlled the transferor; or
- a partnership in which the
transferor’s interest, as a member, was as a majority interest partner as
described in paragraphs 97(3.1)(a) or (b) of the Act.
The stop-loss rule in subsection
85(5.1) was repealed and replaced in 1998 by subsection 13(21.2) which was made
applicable to transactions occurring after April 26, 1995. One of the
changes brought about by the enactment of subsection 13(21.2) was to expand the scope of former subsection 85(5.1)
to include a broader range of transferees, and to cover transfers made
indirectly to those transferees.
The definition of superficial loss
was also amended at the same time to apply to a reacquisition of the subject
property (or acquisitions of identical property) by a wider group of persons
related to the taxpayer.
The Respondent submitted that the
Court could look to the policy behind subsection 13(21.2) and the
amendments to the superficial loss definition even though those provisions were
not yet in effect in the year in issue in this appeal. He said that in Water’s
Edge Village Estates (Phase II) v. Canada, the Federal Court of Appeal accepted that subsequent
amendments to the Act could be taken as demonstrating a desire by
Parliament to close loopholes that previously existed in the Act in
which permitted an anomalous result having regard to the object and spirit of
the relevant provisions of the Act.
The Respondent argued that in each
of these stop‑loss provisions, the Act specifically provides that
a legal disposition in and of itself is not sufficient to permit a deduction of
a loss where the taxpayer has simply transferred the interest to either a
related party or a member of an “economic unit” of which the taxpayer is a
part. Any recognition of the losses for tax purposes would be premature, since
the taxpayer has not truly disposed of his or her economic interest in the
property. In the Respondent’s words, there was no “disposition of economic
According to counsel this is
indicative of a policy under the Act to prevent recognition of losses
where no disposition of the taxpayer’s economic interest in the property has
occurred, or where the taxpayer continues to have a direct or indirect interest
in the property after the disposition.
The Respondent submitted,
therefore, that the transaction carried out by Roseland II in this case
frustrated the object, spirit or purpose of subsection 20(16) because it
was simply a transfer of property by a group of partners from one partnership
to another, and was not a true disposition of property as intended by
Parliament. He said that, in the end, the Appellant and the other investors
were able to access the terminal losses while at the same time continuing their
investment in the same property or a similar property through different
partnerships. There was no change to their investment after the transfer since
they continued to have the right to acquire the same referenced condominium
units after the restructuring as they did before. The realization of terminal
loss was premature because the investors had not stopped using the partnership
assets in the income earning process. It was therefore only a paper loss
occasioned by the decrease in the value of the partnerships’ assets by 1994. In
the Respondent’s view, accessing the terminal losses before the sale of the
partnership assets to third parties constituted abusive tax avoidance.
Purpose of the transaction
Subsection 245(3) provides
that the GAAR will not apply to a transaction that "may reasonably be
considered to have been undertaken or arranged primarily for bona fide
purposes other than to obtain the tax benefit." In determining purpose,
regard must be had to all of the circumstances surrounding the transaction. In
OSFC Holdings Ltd. v. R.,
Rothstein J. said:
"may reasonably be considered to have been undertaken or arranged" in
subsection 245(3) indicate that the primary purpose test is an objective one.
Therefore the focus will be on the relevant facts and circumstances and not on
statements of intention. It is also apparent that the primary purpose is to be
determined at the time the transactions in question were undertaken. It is not
a hindsight assessment, taking into account facts and circumstances that took
place after the transactions were undertaken
Firstly, I am unable to accept
that the proposal to merge the partnerships was initially developed and
promoted by Allied as a means of saving operating costs and eliminating
competition between the buildings for rentals. The first documented reference
to the restructuring proposal, found in the reporting letter sent out by Allied
to the Roseland II limited partners in the fourth quarter of 1993, refers only
to the potential “significant” income tax benefits of the restructuring:
formulating a restructuring proposal for the Limited Partnership. If
implemented, this restructuring could have significant income tax benefits for
limited partners in the 1994 taxation year. Management intends to call a
meeting within the next couple of months to introduce the proposed
restructuring to limited partners in a comprehensive way.
This is inconsistent with Mr.
Jacobs’ evidence that Allied was not in a position to discuss the tax
ramifications of the restructuring prior to obtaining legal and accounting
advice in the summer of 1994. Mr. Jacobs said that initially Allied did not discuss
any tax issues with the partners of Roseland II because it was a real estate
company and was not in a position to discuss tax strategies. However, I infer that the reference in the
reporting letter was to the restructuring proposal that was ultimately carried
out since Mr. Jacobs was not aware of any other proposal ever being developed
by Allied for Roseland I and II.
This first reference to
the restructuring makes no mention of any benefit to the limited partners other
than the tax benefit.
There is also evidence
that leads me to believe that Allied had previous experience with restructuring
limited partnerships that resulted in tax advantages to the limited partners. The minutes of the special meeting of the partners of
Roseland I, held on September 8, 1994, show that Mr. Mike Emory, the
president of Allied, addressed the meeting and referred to Allied’s previous
experience with “these types of transactions”.
the President of Allied Canadian Equities Corporation, presented his view that
there were significant benefits to the partners to be gained from the
transaction. Mr. Emory stated that the transaction would have a business
purpose which would comply with income tax laws and that the immediate income
tax deductions to partners would be approximately $19,000 per unit. Mr. Emory
also advised that Allied Canadian had not obtained an advance tax ruling from
Revenue Canada with respect to the transaction. In addition, Mr. Emory
reviewed his firm’s experience with these types of transactions and their
performance to date.
Given the apparent focus of Mr.
Emory’s comments at the meeting on the tax aspects of the restructuring, I
infer that the reference to “these types of transactions” was a reference to
restructuring limited partnerships, and that Allied was aware from the outset
of the potential tax benefits from these arrangements. Mr. Jacobs’ evidence
that Allied developed a niche in the market in the early 1990’s working with
limited partnerships whose property had fallen in value is consistent with this
I am also not satisfied that the
Appellant has proven that the primary goal of the restructuring was to save
costs and eliminate competition between the buildings. Although the Appellant,
Mr. Froio and Mr. Jacobs all stressed that they believed the restructuring
would result in such savings, it does not appear that any analysis was done by
any of the parties to determine what those savings would likely be. The
Appellant was unaware of any work done to determine whether the anticipated
savings in operating expenses would outweigh the costs of the restructuring,
and there is no evidence that any cost/benefit analysis or financial
projections relating to the restructuring were ever prepared for the partners
of Roseland I or II.
This contrasts with the effort put
into obtaining legal and accounting advice on the restructuring and the
estimation of the terminal loss for each partner prior to the special meetings
of the partners.
Furthermore, no evidence was led
to show that cost savings were in fact achieved as a result of the
restructuring or to show that any attempt was ever made to monitor the
performance of the properties after the restructuring to determine whether the
anticipated benefits had been realized.
It does not appear that any less
costly alternative to restructuring was considered in order to achieve the
stated purposes, either. The Respondent queried Mr. Jacobs about the
possibility of combining the rental operations of Roseland I and II by having a
common general partner and sharing a property manager. This would have allowed
the two buildings to share services and achieve any economies of scale that
were made possible by the restructuring of the partnerships, but would have avoided
the costs of the restructuring itself. Mr. Jacobs said that he did not consider
this to be a feasible option because of the difficulties the general partner
and property manager would face in having to “serve two masters.” However, the
two buildings had been under common management up to 1991 and there was no
evidence to show that there was any conflict between the two groups of limited
partners that affected the management of the rental operations during that
Another stated purpose of the restructuring
was to eliminate competition for tenants between the Roseland I and II
buildings. However, the Appellant admitted in cross-examination that the
competition faced by Roseland II for tenants came from other rental properties
in the area and not from Roseland I and it was not shown that rents for units
in Roseland I or II were ever set to undercut each other. According to the
appraisal report prepared in August 1994, both Roseland I and II benefited from
high rents and low vacancy rates prior to the transfer. It cannot be said,
therefore, that competition between the buildings was affecting operating
results or that by combining the two operations there would have likely been
any meaningful increase to revenue. The Appellant himself admitted that he did
not anticipate any increase in rents as a result of the restructuring.
Finally, the magnitude of the
anticipated tax benefit dwarfed any costs to be saved from the rental
operations. The terminal loss for Roseland II was $2,916,612 million whereas the
total of all expenses of Roseland II exclusive of property taxes was
approximately $320,000 in 1994.
After considering all of the
circumstances surrounding the transaction, I conclude that the disposition of
the assets of Roseland II to RPM cannot reasonably be considered to have been
undertaken or arranged primarily for bona fide purposes other than to
obtain the tax benefit, and was therefore an avoidance transaction.
Second issue: Misuse or abuse
Having found that the disposition
of the partnership property by Roseland II to RPM was an avoidance transaction,
it is necessary to determine whether that transaction amounts to abusive tax
avoidance according to subsection 245(4) of the Act.
In Canada Trustco, the
Supreme Court of Canada set out the approach to be followed in making this
determination. At paragraphs 44 and 45 of that decision, the Court said that:
The heart of the analysis under s. 245(4) lies
in a contextual and purposive interpretation of the provisions of the Act that
are relied on by the taxpayer, and the application of the properly interpreted
provisions to the facts of a given case. The first task is to interpret the
provisions giving rise to the tax benefit to determine their object, spirit and
purpose. The next task is to determine whether the transaction falls within or
frustrates that purpose. The overall inquiry thus involves a mixed question of
fact and law. The textual, contextual and purposive interpretation of specific
provisions of the Income Tax Act is essentially a question of law but
the application of these provisions to the facts of a case is necessarily
This analysis will lead to a finding of abusive
tax avoidance when a taxpayer relies on specific provisions of the Income
Tax Act in order to achieve an outcome that those provisions seek to
prevent. As well, abusive tax avoidance will occur when a transaction defeats
the underlying rationale of the provisions that are relied upon. An abuse may
also result from an arrangement that circumvents the application of certain
provisions, such as specific anti-avoidance rules, in a manner that frustrates
or defeats the object, spirit or purpose of those provisions. By contrast,
abuse is not established where it is reasonable to conclude that an avoidance
transaction under s. 245(3) was within the object, spirit or purpose of the
provisions that confer the tax benefit.
The Appellant contends that
subsection 20(16) is the provision giving rise to the tax benefit in this case,
and is therefore the focus of the textual, contextual and purposive
interpretation mandated by the Supreme Court of Canada.
The Respondent referred the Court
to section 96 as well as subsection 20(16).
While section 96 is relevant
to the Appellant’s claim in the sense that the terminal loss was calculated at
the partnership level because the transaction involved the disposition of the
partnership assets, that section, in and of itself, gives rise to no benefit.
In this case its effect is limited to the flow through of the losses on the disposition
of the partnership property to the partners of the limited partnership. In Mathew
the Supreme Court said at paragraph 51 that:
The partnership rules under s. 96 are predicated
on the requirement that partners in a partnership pursue a common interest in
the business activities of the partnership, in a non-arm's length relationship.
It is not disputed that, at the
time of the transfer of the partnership property by Roseland II to RPM, the
partners of Roseland II were carrying on business in common in a non-arm’s
length relationship. The flowing of the terminal loss to the limited partners
accords with the underlying purpose of the partnership rules. It is not
necessary therefore to consider the context and purpose of the partnership
rules beyond this point.
The specific conditions to be met
in order to claim a terminal loss are found in subsection 20(16). The
issue before this Court is therefore whether allowing the Appellant to claim a
terminal loss would frustrate or defeat the object purpose or spirit of this
For ease of reference
subsection 20(16) is reproduced, for the year in issue:
paragraphs 18(1)(a), 18(1)(b) and 18(1)(h), where at the
end of a taxation year,
(a) the total of all amounts
used to determine A to D in the definition “undepreciated capital cost” in
subsection 13(21) in respect of a taxpayer’s depreciable property of a
particular class exceeds the total of all amounts used to determine E to J in
that definition in respect of that property, and
(b) the taxpayer no longer owns any property of
in computing the taxpayer’s income
for the year
(c) there shall be
deducted the amount of the excess determined under paragraph 20(16)(a),
(d) no amount
shall be deducted for the year under paragraph 20(1)(a) in respect of
property of that class.
The opening words simply indicate
that the deduction of the terminal loss is permitted notwithstanding paragraphs
18(1)(a), (b) and (h). Paragraphs 20(16)(a) and (b)
then set out two conditions that must be met at the end of the taxation year in
order to obtain the terminal loss. The first, in paragraph (a), is that
the undepreciated capital cost of the class of property be a positive amount.
The calculation in paragraph (a) mirrors the calculation of the
undepreciated capital cost of a class of property that is set out in the
definition of “undepreciated capital cost” in subsection 13(21). The
second condition, according to paragraph (b), is that the taxpayer no
longer owns any property of the particular class.
Where those two conditions are
met, the amount determined under paragraph (a) may be deducted
under paragraph (c). The deduction is known as a “terminal loss.”
It is conceded by the Respondent
that there is no ambiguity in the wording of subsection 20(16) and that on
a literal reading of paragraphs (a) and (b), the conditions set
out therein were met. In particular, Roseland II disposed of its legal and
beneficial interest in the condominium building to RPM on December 28, 1994 and
therefore did not own any property in that class at the end of the 1994
It is also conceded by the
Respondent that there is no express restriction in subsection 20(16) on
claiming a terminal loss where both the transferor and the transferee of the
depreciable capital property are partnerships and all of the members of the
transferor partnership are members of the transferee partnership after the
transfer. Also, there is nothing in subsection 20(16) itself from which to
infer any limitation on claiming a terminal loss where depreciable capital
property is disposed of to a related party.
Context and purpose
As set out by the parties,
subsection 20(16) is a part of the CCA system under the Act. This
system permits the deduction of an annual allowance in respect of assets that
are used to produce income from business or property. CCA takes the place of
any deduction for depreciation, which is prohibited by paragraph 18(1)(b)
of the Act.
The amount of the allowance is
based on the cost of the assets to the taxpayer and is intended to allocate the
cost of the assets over its economic life. In the words of Noël, J.A. in Duncan
“the clear and obvious purpose of the provisions is to provide for the
recognition of money spent to acquire qualifying assets to the extent that they
are consumed in the income-earning process."
The general scheme of the CCA
system can be described as follows:
CCA is allowed
as deduction under 20(1)(a) to the extent provided by the Income Tax
assets, referred to as “depreciable property”, are grouped into prescribed
classes in accordance with Schedule II of the Regulations.
Regulation 1100 prescribes the rates of CCA that
can be deducted each year for each class of depreciable property. This rate is
a percentage of the “undepreciated capital cost” of the property in the class.
“Undepreciated capital cost” is defined in
subsection 13(21) and, roughly speaking, is the cost to the taxpayer of all of
the property in that class minus the amount of any CCA taken on the property in
that class in previous years and minus the proceeds from the disposition of any
assets in the class before that time (up to the cost of the assets).
On disposal of assets, to the extent that the
proceeds of disposition exceed the “undepreciated capital cost” of the class,
capital cost allowance previously taken is “recaptured” (i.e. added back into
income) pursuant to subsection 13(1) of the Act.
Upon disposal of all the assets in a particular
class any remaining balance of “undepreciated capital cost” for the class is
deductible in the year as a terminal loss under subsection 20(16).
The purpose of the terminal loss
provision is to adjust the aggregate of the annual deductions of CCA taken by a
taxpayer on a class of depreciable property when subsequent events demonstrate
that the property in that class have been under-depreciated. The adjustment
occurs when a taxpayer no longer owns any property of that class at the end of
a given taxation year and is predicated on the fact that the taxpayer is no
longer able to use the property to earn income because that property is no
longer available to him or her. It is intended to match the total CCA deduction
under the Act in respect of property used to earn income by a taxpayer
to the actual cost of that property to the taxpayer.
The Respondent argues that despite
the disposition of the partnership assets to RPM the property was still
available to the Appellant to earn income, albeit through another partnership,
and that the transfer was done to precipitate the terminal loss before a
disposal of the Appellant’s economic interest in the property.
The Respondent stated that
the stop-loss provisions in paragraphs 40(2)(g)(i), subsection 85(4),
paragraph 40(2)(e) and subsection 85(5.1) of the Act, and
certain amendments to those provisions, are also part of the legislative
context of subsection 20(16) that is relevant for the purpose of the GAAR
analysis, and that they are evidence of a general policy in the Act to disregard
dispositions of property to persons within what he described as “the same
economic unit” as the taxpayer.
In my view, the stop-loss
provisions cited by the Respondent do not show a clear and unambiguous policy
in the Act to disregard dispositions and deny any loss where the
disposition giving rise to the loss was from the taxpayer to any related party.
I think that the Respondent overstates the extent and comprehensiveness of the
policy underlying these provisions.
In a paper presented at the 1995
Canadian Tax Foundation Conference entitled “New Rules, Old Chestnuts, and
Emerging Jurisprudence: The Stop-Loss Rules”, at p. 34:1, Edward Heakes
described the policy underlying those rules in the Act as follows:
legislators have long recognized that, in order to prevent undue erosion of the
tax base, special rules are needed to deal with the recognition, denial, or
deferral of losses for tax purposes that might otherwise be recognized on
transfers of property between persons having a degree of connection or
relationship with each other. The Income Tax Act is no exception and contains
numerous provisions, commonly referred to as “stop-loss rules”, that are intended
to deal with this concern. . .
Parliament has addressed the
problem by creating a series of provisions that deny losses that would
otherwise be allowed under the Act, in specific situations. These
rules are precisely drafted and set out detailed conditions for the denial of a
loss that would otherwise arise on the disposition of a particular type of
property. Those conditions vary from one stop-loss rule to the other. An
important variation, for the purposes of this case is in the degree of
connection or relationship required between the transferor and transferee.
This can be seen from the
following comparison of these sections. Paragraph 40(2)(e) applies
to dispositions by a corporation to a person by whom the corporation is
controlled or to a corporation that was controlled by such a person.
Subsection 85(4) applies to dispositions by all taxpayers, including
partnerships, to corporations controlled by the transferor, the spouse of the
transferor or by a person or group of persons who controlled the transferor.
Subsection 85(5.1) also applies to dispositions by all taxpayers, but is
limited to the disposition of depreciable capital property. The range of transferees
targeted in subsection 85(5.1) is broader than in either paragraph 40(2)(e)
or subsection 85(4). It covers dispositions to:
-a corporation that immediately after the disposition
was controlled by the transferor, by his spouse, or by a person, group of
persons, or partnership under the control the transferor;
-a person, the spouse of that person, a member of a
group of persons, or partnership immediately after the disposition controlled
the transferor; or
-a partnership in which the transferor is a majority
In each case, it is reasonable to
infer that Parliament intended to promote
a particular purpose concerning the distinct relationship or relationships described
in those provisions between the transferor and the transferee.
In my view, the particularity with
which Parliament has specified the relationship that must exist between the
transferor and transferee for the purpose of each stop-loss rule referred to by
the Respondent is more indicative that these rules are exceptions to a general
policy of allowing losses on all dispositions. In other words, where there is a
general provision in the Act allowing for the deduction of a loss,
subject to a restriction or exception in certain circumstances, the limited
nature of the exception can be seen as underscoring the general policy of the Act
to allow the loss. Furthermore, it is not accurate to say that these rules deny
losses on transfers between all related parties. As seen above, the distinct
relationship that Parliament sought to target in each case is clear.
The large-scale revision of the
stop-loss rules in 1998, effective with respect to transactions entered into
after April 26, 1995, is not material to the determination of the policy
underlying the stop‑loss rules cited by the Respondent that were in
effect for the year under appeal. The changes that were made do not alter the
fact that the stop-loss rules are exceptions that operate in well-defined
The Respondent has therefore not
satisfied me that there is a general or overall policy in the Act prohibiting
losses on any transfer between related parties, or parties described by counsel
as forming an economic unit.
I would also point out that Parliament
has chosen to define the circumstances in which the terminal loss will be
denied on transfers of depreciable property between partnerships in
subsection 85(5.1) (now subsection 13(21.2)) and in doing so would appear
to have chosen to allow taxpayers who are not within the circumstances set out
in that provision to claim their terminal losses. The Minister admits in this
case that Roseland II did not fall within subsection 85(5.1) because it was not
a majority interest partner in RPM.
The Minister is therefore using
the GAAR in this case to fill in the gaps left by Parliament in subsection
85(5.1). This is an inappropriate use of the GAAR, as noted by Bowman A.C.J. in
Geransky v. The Queen:
. . .The Income Tax Act is a statute that is
remarkable for its specificity and replete with anti-avoidance provisions
designed to counteract specific perceived abuses. Where a taxpayer applies
those provisions and manages to avoid the pitfalls the Minister cannot say
"Because you have avoided the shoals and traps of the Act and have
not carried out your commercial transaction in a manner that maximizes your
tax, I will use GAAR to fill in any gaps not covered by the multitude of
specific anti-avoidance provisions".
In light of my findings above, I
conclude that the transaction in issue did not result in a misuse of any
provision of the Act, or an abuse having regard to the provisions of the
Act read as a whole. Therefore, the GAAR is not applicable and the
appeal is allowed, with costs.
Signed at Ottawa, Canada, this 2nd day of May 2008.