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Citation: 2007TCC481
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Date: 20070828
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Docket: 2002-1316(IT)G
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BETWEEN:
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COPTHORNE HOLDINGS LTD.,
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Appellant,
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And
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Campbell J.
[1] The assessment in this appeal arose when
the Minister of National Revenue (the “Minister”) applied the General Anti-Avoidance Rule (the “GAAR”), section 245 of the Income Tax Act (the “Act”),
to transactions that facilitated the preservation of paid-up capital (“PUC”) in
respect to certain shares.
[2] The Minister assessed Copthorne Holding
Ltd. (a predecessor of the Appellant) on account of tax payable by a
non-resident, L.F. Investments. This tax arose in respect to a purported
failure to withhold and remit that tax on an amount deemed to be a dividend
paid to a non‑resident shareholder. Penalties were also assessed pursuant
to subsection 227(8) of the Act.
[3] The parties entered into a Joint Statement
of Facts and Law (“JSF”), which I have attached as Appendix “A” to these reasons.
In addition to the Schedule “B” diagrams attached to the parties’ joint
statement, I have included my own detailed series of diagrams of transactions
as Appendix “B” to my reasons. I intend to reference my own series of diagrams
in my analysis of the transactions by diagram number.
[4] The facts and transactions involved in this
appeal are lengthy and complex but the parties have largely agreed upon the
essential facts by way of their JSF. As a result, a brief overview of the
transactions, relevant to this appeal, will be sufficient.
The Facts
Events prior to the 1993 Share Sale
[5] Copthorne Holdings Ltd. (“Copthorne I”) was
incorporated in Ontario in 1981 in order to acquire the Harbour Castle
Hotel in Toronto. The one common share was issued to Big
City Project Corporation (“Big City”), a Netherlands
Corporation indirectly controlled by Li Ka-Shing. Both corporations are members
of a group of companies controlled directly or indirectly by the Li family.
In 1981, Copthorne I had PUC of $1. Copthorne I sold the Harbour Castle Hotel
(the “Hotel Sale”) in 1989 for a substantial capital gain.
[6] Following the Hotel Sale, Copthorne I incorporated
a wholly owned subsidiary under the laws of Barbados called Copthorne Overseas Investment Ltd. (“Coil”). Coil carried on a
successful bond-trading business through its Singapore branch.
[7] In 1987, VHHC Investments Inc. (“VHHC
Investments”) was incorporated in Ontario. Victor Li,
son of Li Ka-Shing, owned all of the Class A voting common shares of VHHC
Investments with PUC of $100, together with 18.75% of the Class B
non-voting common shares. The remaining Class B shares were owned by Asfield
B.V. (“Asfield”), a Netherlands corporation that was indirectly owned by a
trust whose principal beneficiary was Victor Li.
[8] Between 1987 and 1991, Victor Li, Asfield
and L.F. Holdings, a Barbados corporation controlled by Li Ka-Shing,
invested capital in VHHC Investments. At the end of 1991, VHHC Investments had
PUC of $96,736,845.
[9] During this period, VHHC Investments used
$67,401,279 of the invested capital, received from Victor Li, Asfield and L.F.
Holdings, to invest in shares of VHHC Holdings Ltd. (“VHHC Holdings”), a lower
tiered subsidiary of VHHC Investments. As a result, at the end of 1991, VHHC
Holdings had PUC of $67,401,279.
[10] Also by the end of 1991, VHHC Holdings owned
100% of another lower tiered subsidiary, VHSUB Holdings (“VHSUB”). VHSUB had a
substantial and accrued capital loss, resulting from its investment in another Canadian
corporation Husky Oil Ltd. (“HOL”). [JSF paras 3, 4(i) to 4(v)]
[11] In summary, following these December 1991 transactions, VHHC Investments
had used $67,401,279 of the capital invested by Victor Li, Asfield and L.F.
Holdings Investments to purchase 67,401,279 common shares of VHHC Holdings with
a PUC of $67,401,279. VHHC Holdings then used these share subscription funds to
invest, directly or indirectly, through its subsidiary VHSUB, in HOL. As a
result of declining oil and gas prices by the end of 1991, the value of HOL’s
shares had fallen dramatically. As a result, VHHC Holdings now owned shares of
VHSUB which had a substantial capital loss.
[12] In 1992, VHHC Investments sold its 67,401,279 common shares of VHHC
Holdings to Copthorne I for $1,000. The sole purpose of this transaction was to
shift the inherent capital loss of the shares of VHHC Holdings in VHSUB to Copthorne
I. A portion of the capital loss could then be used by Copthorne I to shelter
the capital gain it had realized on the Hotel Sale in 1989. The PUC of the
shares of VHHC Holdings remained at $67,401,279 and was passed on to the purchaser,
Copthorne I. [Diagrams 5(i) to 5(v)]
The 1993 Share Sale
[13] In 1993, the Li family decided to amalgamate Copthorne I, VHHC
Holdings and two other Canadian corporations so that:
(1) the losses
incurred by one or more corporations could be used to shelter income earned by
others, and
(2) the corporate
structure of the Li Family Canadian Holdings would be simplified.
[14] It is likely that prior consideration was given to amalgamation but it
did not occur until 1993 because the focus was on the loss transfer utilization
transactions that occurred in 1992. If VHHC Holdings and Copthorne I had amalgamated
prior to the 1992 transactions, the loss, triggered by the amalgamation could
not have been carried back to offset the capital gain realized by Copthorne I
on the Hotel Sale in 1989. It therefore became necessary to shift the capital
loss to the Appellant prior to an amalgamation.
[15] Because VHHC Holdings became a subsidiary of Copthorne I, after the
sale by VHHC Investments, the PUC in VHHC Holdings would be eliminated, under
corporate law, upon a vertical amalgamation of VHHC Holdings with Copthorne I.
To preserve the PUC of $67,401,279 in the shares of VHHC Holdings, Copthorne I
sold those shares for $1,000 to Big City in 1993 (the “1993 Share Sale”) prior to
the amalgamation. The Minister’s position is that this 1993 Share Sale is an
avoidance transaction.
[16] On January 1, 1994, Copthorne I, VHHC Holdings and two other Canadian
Corporations, owned by the Li family, were amalgamated (the “First
Amalgamation”) to form Copthorne Holdings Ltd. (Copthorne II). Prior to
amalgamation, Big City owned one common share in Copthorne I,
together with 67,401,279 common shares in VHHC Holdings, acquired pursuant to the
1993 Share Sale. After amalgamation these shares were converted to
20,001,000 common shares of Copthorne II with an aggregate paid up capital of
67,401,280 (i.e. $67,401,279 plus $1). [Diagrams 6(i) to 6(iii)]
The Redemption
[17] In 1994, the Department of Finance released revised amendments to the
foreign accrual property income (“FAPI”), including the proposed introduction
of what is now paragraph 95(2)(1) of the Act. The proposed changes would
have adversely affected Coil by making all of Coil’s income FAPI.
[18] As a result, the Li family decided to dispose of its investment in Coil
and repatriate the proceeds of such disposition for investment outside of Canada. The Li family decided to further simplify their
Canadian corporate structure and consolidate their principal Canadian
investments (Copthorne II and HOL) under a single offshore company.
[19] As part of this plan, L.F. Investments was incorporated in Barbados in November 1994. In December 1994, Victor Li and
Asfield sold their common shares, and L.F. Holdings sold its preferred shares,
in VHHC Investments, to L.F. Investments. [Diagrams 8(i) and 8(ii)]
[20] In addition, Big City sold its common shares in Copthorne II to L.F. Investments.
Consequently, L.F. Investments owned the common shares of Copthorne II with its
PUC of $67,401,280 and the common and preferred shares of VHHC Investments with
its PUC of $96,736,845 for an aggregate PUC of $164,138,125. [Diagrams 8(iii) to 8(iv)]
[21] In January 1995, Copthorne II, VHHC Investments and two other Canadian
corporations, owned by Li Ka-Shing, were amalgamated (the “Second Amalgamation”)
to form Copthorne Holdings Ltd. (“Copthorne III”) [Diagrams 9(i) to
9(iii)]. Immediately following, Copthorne III redeemed 142,035,895 of the Class
D preference shares (the “Redemption”) held by L.F. Investments. No amount
was withheld by Copthorne III in respect of this Redemption because Copthorne
III had an aggregate PUC of $164,138,025 after the Second Amalgamation. [Diagram
11] Therefore Copthorne III did not withhold and remit any tax on behalf of the
non-resident, L.F. Investments, pursuant to subsection 215(1) of the Act.
[22] On January 1, 2002 Copthorne III amalgamated with five other companies
and continued as Copthorne Holdings Ltd., the Appellant in this appeal.
The Minister’s Assessment
[23] The Minister applied GAAR and issued an assessment for unremitted
withholding tax, a penalty and interest, in respect to the Appellant’s failure
to withhold and remit Part XIII tax on the basis that:
(a) L.F. Investments received a “tax
benefit” within the meaning of subsection 245(1) of the Act;
(b) The tax benefit was the avoidance
of the withholding tax payable by L.F. Investments;
(c) The tax benefit arose from the
“inappropriate increase” in the PUC of the Class D preference shares of
Copthorne III which resulted from a series of transactions that included an
“avoidance transaction” within the meaning of subsection 245(3) of the Act;
(d) The avoidance transaction was the
1993 Share Sale;
(e) The avoidance transaction
resulted in an abuse of the Act read as a whole within the meaning of
subsection 245(4);
(f) The tax consequences, reasonable
in the circumstances to deny the tax benefit, would be to reduce the PUC of all
of the Class D preference shares by $67,401,280 so that a taxable dividend in
the amount of $58,325,223, calculated with reference to the revised PUC of each
of the shares, would be deemed to have been paid by Copthorne III to L.F. Investments
pursuant to subsection 84(3) of the Act;
(g) Copthorne III was therefore
required to deduct or withhold the amount of $8,748,783.40 (i.e. 15% of the
taxable dividend deemed to have been paid, which was the applicable rate under
the Canada-Barbados Income Tax Convention); and
(h) Having failed to deduct or withhold,
Copthorne III was liable to a penalty of 10% of the amount that should have
been deducted or withheld, or $874,878.34.
The Issues
[24] The central issue in the present appeal is whether
section 245 applied to the Redemption. In deciding whether section 245 applies,
there are four important sub‑issues:
(a) Whether a tax benefit was
received within the meaning of subsection 245(1) of the Act;
(b) Whether such a tax benefit
resulted, directly or indirectly, from a series of transactions that included
the sales of shares of VHHC Holdings by Copthorne I to Big City on July 7, 1993
(the 1993 Share Sale);
(c) Whether the 1993 Share Sale was an
avoidance transaction within the meaning of subsection 245(3); and
(d) Whether it may reasonably be considered that
the 1993 Share Sale, or series of transactions resulted, directly or
indirectly, in a misuse of the provisions of the Act or an abuse having
regard to the provisions of the Act, other than section 245, read as a
whole, within the meaning of subsection 245(4) of the Act.
Analysis
[25] The transactions in this appeal are numerous and at first glance lengthy
and complex. If one looks at these transactions in conjunction with the
governing provisions contained in the Act, it is not immediately
apparent why any of the corporate undertakings should have attracted the
application of GAAR. However, as the saying goes “that would not be seeing the
forest for the trees”. When I step back and look at the big picture of what
occurred here, the calculation of PUC resulted in the very blatant advantage of
a “double counting” in the amount of $67,401,279. None of the provisions in the
Act ever intended that an artificial inflation of PUC be preserved for a
subsequent return of such an increase to shareholders on a tax-free basis. I am
dealing with a total PUC of $164,138,025 belonging to Copthorne III, and
associated with Class D preference shares. The origin of this amount is made up
of $96,736,745 PUC originally belonging to VHHC Investments and $67,401,279 PUC
belonging to Copthorne II. However the $67,401,279 is easily traced to the
initial investment made by VHHC Investments in VHHC Holdings. This PUC was
preserved by the 1993 Share Sale and maintained throughout the First and Second
Amalgamations. This means that the $67,401,279 PUC is part and parcel of or is
derived from the $96,736,845 PUC. To permit transactions that produce an
aggregate of these two amounts creates a double counting of PUC in the amount
of $67,401,279. This simply produces an incorrect result and permits
shareholders an unfair advantage, something that was never intended in the
application of these provisions.
[26] The approach to be taken and the principles to be applied to cases where
an assessment has been made under section 245 were recently established in two
unanimous decisions of the Supreme Court of Canada, Canada Trustco Mortgage
Co. v. Canada, [2005] 2 S.C.R. 601, 2005 DTC 5523 and Mathew v. Canada,
[2005] 2 S.C.R. 643, 2005 DTC 5538 (“Kaulius”). In Canada Trustco, supra, at paragraph 66 the Supreme Court summarized the
requirements that must be met in order for the GAAR to apply:
The approach to s. 245 of the Income Tax Act may be summarized
as follows:
1. Three requirements must be established
to permit application of the GAAR:
(1) A tax benefit resulting from a
transaction or part of a series of transactions (s. 245(1) and (2));
(2) that the transaction is an avoidance
transaction in the sense that it cannot be said to have been reasonably
undertaken or arranged primarily for a bona fide purpose other than to
obtain a tax benefit; and
(3) that there was abusive tax
avoidance in the sense that it cannot be reasonably concluded that a tax
benefit would be consistent with the object, spirit or purpose of the
provisions relied upon by the taxpayer.
2. The burden is on the taxpayer to
refute (1) and (2), and on the Minister to establish (3).
3. If the existence of abusive tax
avoidance is unclear, the benefit of the doubt goes to the taxpayer.
4. The courts proceed by conducting a
unified textual, contextual and purposive analysis of the provisions giving
rise to the tax benefit in order to determine why they were put in place and
why the benefit was conferred. The goal is to arrive at a purposive
interpretation that is harmonious with the provisions of the Act that confer
the tax benefit, read in the context of the whole Act.
5. Whether the transactions were
motivated by any economic, commercial, family or other non-tax purpose may form
part of the factual context that the courts may consider in the analysis of
abusive tax avoidance allegations under s. 245(4). However, any finding in this
respect would form only one part of the underlying facts of a case, and would
be insufficient by itself to establish abusive tax avoidance. The central issue
is the proper interpretation of the relevant provisions in light of their
context and purpose.
[27] In the present appeal, the impugned tax benefit results from the
Redemption, which forms part of the “Second Series of Transactions” (JSF,
paragraph 62). The alleged avoidance transaction, the 1993 Share Sale, is
contained in the First Series of Transactions (JSF, paragraph 61). Because it
is clear from the facts in this appeal and because the parties have
acknowledged in their JSF that there are clearly two series of transactions, before
addressing any of the other issues in this appeal it will be first necessary to
determine whether the impugned tax benefit is part of a series of transactions
that included the alleged avoidance transaction.
[28] Subsections 245(2) and 245(3) of the Act use the expression
“series of transactions”. In determining the meaning of this expression, the
Supreme Court in Canada Trustco adopted the majority’s comments in OSFC
Holdings Ltd. v. The Queen, 2001 DTC 5471, and, at paragraph 25 stated:
The meaning of the expression “series of transactions
under s.245(2) and (3) is not clear on its face. We agree with the majority of
the Federal Court of Appeal in OSFC and endorse the test for a series of
transactions as adopted by the House of Lords that a series of transactions
involves a number of transactions that are “pre-ordained in order to
produce a given result” with “no practical likelihood that the pre-planned events
would not take place in the order ordained”: Craven v. White,
[1989] A.C. 398, at p. 514, per Lord Oliver; see also W.T. Ramsay
Ltd. v. Inland Revenue Commissioners, [1981] 1 All E.R. 865. [emphasis
added]
[29] In OSFC Holdings, supra, Rothstein, J.A. (as he was
then), at paragraph 24, concluded the following in respect to the common
law test or pre‑ordination test:
…Pre-ordination means that when the first transaction
of the series is implemented, all essential features of the subsequent
transaction or transactions are determined by persons who have the firm
intention and ability to implement them. That is, there must be no practical
likelihood that the subsequent transaction or transactions will not take place.
[30] The decision in OSFC Holdings was confirmed by the Federal
Court of Appeal in The Queen v. Canadian Utilities Limited et al., 2004
DTC 6475 (“Canutilities”), at p. 6483:
In Canada, a common law series only requires that,
when the initial transaction is completed, the subsequent transaction or
transactions needed to avoid tax have been determined by those persons who have
the firm intention and ability to implement them and that all of those
transactions do in fact occur.
[31] The Respondent did not argue that the First Series of Transactions and
the Second Series of Transactions were connected by application of the common
law test. At the time of the 1993 Share Sale, the essential features of the
Redemption had not been determined and Copthorne I had not formed the intention
to implement the Redemption. The evidence only indicates that PUC was preserved
because it was viewed as an attribute that held some value (Transcript pages 33‑35,
37-39). Therefore, when the 1993 Share Sale occurred, the Redemption was not
pre-ordained within the meaning of the OSFC Holdings common law test and
as such the Redemption, under that test alone, does not form part of the series
of transactions that includes the 1993 Share Sale. However, this alone is not
conclusive because it is necessary to consider whether the Redemption is
included in the First Series of Transactions pursuant to subsection 248(10),
which extends the meaning of the common law series.
[32] Subsection 248(10) states:
(10) For the purposes of this Act, where there is a
reference to a series of transactions or events, the series shall be deemed to include
any related transactions or events completed in contemplation of the series.
[emphasis added]
[33] The question is whether, pursuant to subsection 248(10), the
Redemption in January 1995 is connected to this First Series of Transactions
occurring in 1993. A determination of this question requires a consideration of
the phrase “related transactions or events completed in contemplation of the
series”.
[34] The Federal Court in OSFC Holdings did not indicate that
subsection 248(10) requires that the related transactions be pre-ordained
or that the related transactions should be completed at a particular point in
time. At paragraph 36, the Court stated:
…As long as the transaction has some connection with
the common law series, it will, if it was completed in contemplation of the
common law series, be included in the series by reason of the deeming effect of
subsection 248(10). Whether the related transaction is completed in
contemplation of the common law series requires an assessment of whether the
parties to the transaction knew of the common law series, such that it
could be said that they took it into account when deciding to complete the
transaction. If so, the transaction can be said to be completed in
contemplation of the common law series. [emphasis added]
[35] In Canada Trustco, the Supreme Court commented on the
application of subsection 248(10) at paragraph 26:
Section 248(10) extends the meaning of “series of transactions” to
include “related transactions or events completed in contemplation of the
series”. The Federal Court of Appeal held, at para. 36 of OSFC, that
this occurs where the parties to the transaction “knew of the ... series, such
that it could be said that they took it into account when deciding to complete
the transaction”. We would elaborate that “in contemplation” is read not
in the sense of actual knowledge but in the broader sense of “because of” or
“in relation to” the series. The phrase can be applied to events either
before or after the basic avoidance transaction found under s. 245(3). As has
been noted:
It is highly unlikely that Parliament could have intended to include in
the statutory definition of “series of transactions” related transactions
completed in contemplation of a subsequent series of transactions, but not
related transactions in the contemplation of which taxpayers completed a prior
series of transactions.
(D. G. Duff, “Judicial Application of the General Anti-Avoidance Rule
in Canada: OSFC Holdings Ltd. v. The Queen”,
57 I.B.F.D. Bulletin 278, at p. 287) [emphasis added]
[36] Since the Supreme Court in Canada Trustco confirmed that the
time line is inconsequential in connecting the transaction to the common law
series, it therefore does not matter whether the related transaction occurred
before or after the series. It is also clear from the quoted passages that the
Supreme Court has broadened the meaning of the word “contemplation”. The Court
clarified that actual knowledge of the common law series is not required but
instead the phrase “in contemplation of” is to be given the broader meaning of
“because of” or “in relation to” the series.
[37] The Respondent’s position is that the First Series of Transactions,
which included the 1993 Share Sale, constitutes the common law series and that
the Second Series of Transactions, which included the Redemption, are related
transactions completed in contemplation of the common law series. The Appellant
argued that “applying a low threshold of causality would expand the scope of
the provision so as to catch virtually every transaction which is done after
the common law series”. (Appellant’s Notes of Argument, paragraph 34). The
Appellant’s position is that a low threshold standard between transactions would
lead to an anomalous and inappropriate result.
[38] The Appellant asserts that “a transaction should only be considered to
be “in contemplation” of a common law series if the fact, that the common law
series had been undertaken (or is expected to be undertaken), is a significant
factor in deciding to undertake the transactions” (Appellant’s Notes of
Argument, paragraph 43). The Appellant points to the introduction of new FAPI
rules in February 1994, together with the proposed amendments released in June
1994, that would result in Coil’s income being considered FAPI, as being the
basis for the argument that the Redemption in 1995 was an independent event,
distinct from the 1993 Share Sale.
[39] While I agree that the Supreme Court never intended to catch transactions
that are only remotely connected to the common law series, I conclude that
there is a strong nexus between the transactions in this appeal.
[40] Unlike the situation in MIL (Investments) S.A. v. The Queen, 2006 DTC 3307 (“MIL”), where
there was evidence that the Appellant took steps to try to prevent the sale of
shares, being the transaction sought to be related to the series, the
Redemption, in the present appeal, was exactly the type of transaction
necessary to make a tax benefit a reality based on the preservation of the PUC.
Although there is no evidence that the Redemption was planned at the time of
the First Series of Transactions, when the Redemption occurred in January 1995,
it was clearly done in contemplation of the First Series of Transactions.
[41] Certainly one of the reasons for the Redemption was to extract the
surplus from Coil because of the changes in the FAPI provisions. However this
alone is not determinative. In Canutilities, supra, the fact, that a
transaction had an independent purpose and existence, quite apart from the
series, did not mean that it was excluded if it had been pre-ordained to
achieve a composite result. At paragraph 65, the Federal Court of Appeal
stated:
[42] Although this passage deals with connecting a transaction under the
common law test, the reasoning is equally applicable under a subsection 248(10)
analysis. In the present appeal, although changes to FAPI were the impetus for
engaging in the Redemption, this does not alter the fact that the Redemption
was done with the actual knowledge of and in contemplation of the 1993 Share
Sale. The evidence was that the Appellant preserved the PUC because it was
viewed as an attribute of value. Without the Redemption or some other similar
transaction, there would be no way of tapping into the value created by its
preservation. The Redemption became the mechanism for returning this preserved
PUC to one of the Li group of companies. The fact that the Li group had no
precise knowledge in 1993 of the mechanism, which would eventually be used to
access the preserved PUC, is not determinative. The First Series of Transactions
is related to the Second Series of Transactions because the Second Series is
completed in contemplation of the First Series, within the meaning of
subsection 248(10), in the sense that the Appellant had knowledge of the prior
preservation of PUC and took this into account when completing the Redemption.
I believe that, when the Supreme Court in Canada Trustco broadened the
meaning of “in contemplation of”, it was precisely this sort of factual
situation which it intended to address.
Tax Benefit
[43] For the purposes of GAAR, tax benefit is defined in subsection 245(1)
as:
…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;
[44] The Respondent’s position is that the tax benefit derives from the
application of subsection 215(6) of the Act in respect to the
Appellant’s failure to withhold and remit Part XIII tax on a dividend, deemed
to have been paid to L.F. Investments, for which L.F. Investments is
liable under subsection 212(2). Although the redemption amount is equal to the
PUC of the shares, the tax benefit arises from the preservation of PUC at the
time of the First Series of Transactions and its subsequent distribution to a
non-resident shareholder.
[45] The Supreme Court in Canada Trustco, indicated that, in some
instances, in order to establish the existence of a tax benefit, it will be
necessary to compare the resulting consequences of an alternative arrangement.
In this appeal, the Li group of companies could have completed the First
Series of Transactions, which included the First Amalgamation, without selling
and transferring the shares of VHHC Holdings to Big City. If this 1993
Share Sale had not occurred, the $67,401,279 of PUC in VHHC Holdings would have
been eliminated and it would have been unavailable to be distributed tax-free
at the time of the 1995 Redemption.
[46] Subsection 245(2) addresses a tax benefit that results from a “series
of transactions”. In order for subsection 245(2) to apply to a transaction, it
is sufficient that the reduction, avoidance or deferral of tax, results,
directly or indirectly, from a series of transactions of which the avoidance
transaction is a part. The fact that neither the 1993 Share Sale, nor the preservation
of PUC, resulted in a direct reduction, avoidance or deferral of tax in 1993 is
not ultimately the determinative factor. In this appeal, the tax benefit
resulted from a series of transactions, within the meaning of subsection
245(10), which commenced with the preservation of PUC and ended with the
Redemption of the Copthorne III Class D preferred shares. If the 1993 Share
Sale had not occurred, $96,736,845 of PUC only would have been available to be
distributed tax-free as a return of capital to the shareholders of Copthorne
III. Instead, total PUC of $164,138,025 was available of which $142,035,895 was
actually distributed. Therefore the tax benefit, within the meaning of section
245, is this additional amount which was available for distribution because of
the preservation of PUC within that First Series of Transactions. However the
real core of the problem here is that the PUC of $67,401,279 is actually only
an artificial increment which resulted in a double counting of a portion of the
$96,736,845. The tax benefit occurred when the artificial increase was returned
to shareholders on a tax-free basis.
Avoidance Transaction
[47] The second requirement which must be addressed in a GAAR analysis is
whether the series of transactions, or any transaction within the series, was
an avoidance transaction. This is essentially a factual determination. A tax
benefit must result as part of a series of transactions that includes an
avoidance transaction. The question then becomes whether the transaction(s) may
reasonably be considered to have been undertaken or arranged primarily for a bona
fide purpose other than to obtain a tax benefit.
[48] Subsection 245(3) defines avoidance transaction as:
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.
[49] The alleged avoidance transaction in this appeal is the July 7, 1993 Sale
of Shares of VHHC Holdings by Copthorne I to Big City (the 1993 Share Sale). The common shares of VHHC Holdings were sold for
$1,000, which was the estimated fair market value of these shares (JSF,
paragraph 37). The 1993 Share Sale is the only avoidance transaction upon which
the Respondent relies in supporting the GAAR assessment (Respondent’s Written
Argument, paragraph 34).
[50] The Respondent argues that the 1993 Share Sale was not arranged
primarily for bona fide purposes other than to obtain this tax benefit
because the only purpose for the Share Sale was to preserve approximately $67
million PUC which would facilitate a future tax-free distribution. This PUC
would otherwise have disappeared on the First Amalgamation.
[51] The Appellant’s position is that the primary purpose of the First
Amalgamation and the 1993 Share Sale was the reorganization of the Li family’s
corporate holdings. The Appellant submits that such a reorganization is akin to
an investment objective and, as such, a bona fide non-tax purpose. The
Appellant also argued that the Redemption is irrelevant to a determination of
whether the 1993 Share Sale and First Amalgamation have bona fide non-tax
purposes because the First Series of Transactions have to be considered alone
in ascertaining whether the primary purpose was to achieve a tax benefit.
[52] Guidance in the determination of whether a transaction is an avoidance
transaction, within the meaning of subsection 245(3), was provided by the
Supreme Court in Canada Trustco at paragraphs 27 to 35. I have reviewed
at length the principles to be distilled from Canada Trustco in MacKay
et al. v. The Queen, 2007 DTC 425, 2007 TCC 94. Generally the test under
subsection 245(3) requires an objective assessment of the relative importance
of the driving forces of the transaction (Canada Trustco, paragraph 28).
In conducting this inquiry the courts must examine the relationships between
the parties and the actual transactions that were executed between them. The
facts surrounding the transactions will be central in determining whether there
was an avoidance transaction (Canada Trustco, paragraph 30).
[53] In applying the Canada Trustco test and conducting an objective
assessment of the driving forces of the transaction, evidence regarding the
purpose for the 1993 Share Sale, the First Amalgamation and the Redemption will
be relevant. Subsection 245(3) requires that the primary purpose of the impugned
transaction, the 1993 Share Sale, be determined. Relevant, although not
determinative, to this inquiry will be the overall purpose of the First Series
of Transactions.
[54] The Appellant argues that even if one transaction is arranged
primarily to obtain a tax benefit “it remains that each and every transaction
in a series could be viewed as being an integral part of a series of
transactions that has a bona fide purpose which is more important than
the tax purpose of a transaction taken individually” (Appellant’s Notes of
Argument, paragraph 68). While the overall purpose of the First Series of
Transactions, including the First Amalgamation, could be viewed as having a
legitimate non-tax purpose, the 1993 Share Sale was not an integral component
to achieving the commercial purpose of simplifying the Li family corporate
holdings. In fact, when the First Series of Transactions are viewed in their
entirety with the subsequent Redemption, the inescapable conclusion is that the
1993 Share Sale was implemented to preserve approximately $67 million in PUC
for the ultimate purpose of facilitating a tax‑free distribution within
the Li corporate group, in the event of a transfer of the relevant shares or a
further corporate reorganization or amalgamation. If this had not been done,
the PUC would have disappeared on the First Amalgamation. Therefore, I conclude
that the 1993 Share Sale was undertaken primarily to preserve what amounted to
a double counting of PUC in VHHC Holdings which resulted in a tax benefit. As such
it is an avoidance transaction within the meaning of subsection 245(3).
Misuse or Abuse
[56] The relevant passages, which provide this direction, are contained
within paragraphs 44 and 45 of Canada Trustco:
44 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 fact-intensive.
45 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.
[57] The provisions that are in issue in this
appeal are subsection 89(1), which defines PUC, subsection 84(3), the dividend
deeming section and paragraph 87(3)(a), which involves the computation of
PUC on amalgamation. I believe that the series of transactions in this appeal
resulted in a misuse of these provisions in that they were used to artificially
increase the PUC on amalgamation with the subsequent return of this artificial
increase to shareholders on a tax‑free basis, the very result that these
provisions were intended to prevent.
The Text of the Provisions:
[58] Pursuant to subsection 89(1), although PUC is an income tax concept,
the initial calculation of the amount of the PUC of a class of shares is based
on relevant corporate law principles rather than tax law. It is referred to
generally as the “stated capital” of a class of shares, subject to adjustments
for tax purposes, calculated according to specific provisions of the Act.
One of these adjustments may occur on corporate amalgamations, resulting in PUC
being less than the reported stated capital.
[59] On a redemption of shares, subsection 84(3) provides for a deemed
dividend to the extent that the amount paid on redemption exceeds the PUC of
the shares. This ensures that the PUC can be returned to the shareholder on a tax‑free
basis but that any excess will be deemed to be and treated as a dividend.
[60] Paragraph 87(3)(a) provides the mechanism for the computation of PUC
on an amalgamation. It requires a PUC reduction when the PUC of the new
corporation exceeds the aggregate of the PUC of the predecessor corporations.
The Context of the Provisions
[61] The Supreme Court in Kaulius at paragraph 47 commented on the
proper approach to be taken in determining the context:
47 The basic
rules of statutory interpretation require that the larger legislative context
be considered in determining the meaning of statutory provisions. This is
confirmed by s. 245(4), which requires that the question of abusive tax
avoidance be determined having regard to the provisions of the Act, read as a
whole.
[62] The question is whether other provisions of the Act provide
guidance in determining if Parliament intended that PUC could be preserved in a
multi-level amalgamation.
[63] The initial starting position is that subsection 89(1) provides that
the PUC of a share will be equal to its stated capital, in accordance with
corporate legislative provisions, both federally and provincially. Since
adjustments must be made to PUC for tax purposes, when certain corporate
transactions would otherwise confer advantages upon shareholders, Parliament
enacted certain provisions and it is subsection 87(3) that specifically applies
to this appeal. The immediate context of subsection 87(3) is the preceding
subsection 87(2), which provides for the continuity of Canadian corporations,
from an income tax perspective, upon qualifying mergers. It is a detailed provision
dealing with the continuity of surplus accounts, reserves, costs and other
financial aspects of the predecessor corporations. Such a provision for
continuity is consistent with the intention for continuity of PUC, as
contemplated in subsection 87(3). In addition, paragraph 87(9)(b) contains
a similar rule to decrease PUC where, on a merger, it is increased by an amount
that exceeds the total PUC in respect to shares of the predecessor corporations
exchanged for parent shares. The scheme therefore of section 87 is to generally
preserve the continuity of PUC on amalgamations provided the PUC of the
corporations that are amalgamated is not higher than that of those corporations
that are being amalgamated.
[64] Subparagraph 178(2)(a)(iii) of the Ontario Business Corporations
Act supports my analysis concerning increases to PUC. It provides for the
cancellation of shares held by one amalgamating corporation in another, without
any repayment of capital. In order for an amalgamation to become legally
effective, section 178 requires that the articles of incorporation be submitted
in the prescribed form including a statement from the directors of the
corporation providing:
(a) there are reasonable
grounds for believing that,
(i) each
amalgamating corporation is and the amalgamated corporation will be able to pay
its liabilities as they become due, and
(ii) the
realizable value of the amalgamated corporation’s assets will not be less than
the aggregate of its liabilities and stated capital of all classes;
(Emphasis added)
This corporate law principle limits the effectiveness of transactions
where a corporation sells shares of its subsidiary corporation to the
corporations’ parent company. This principle limits the effectiveness of such
transactions that achieve an increase in the stated capital of the amalgamated
corporation, which increases the PUC.
[65] Like the other subsections within section 84, subsection 84(3) ensures
that PUC can be returned to a shareholder tax-free but any excess of PUC will
be treated as a deemed dividend.
The Purpose of the Provisions and Parliament’s
Intent
[66] Prior to the amendment to the definition of PUC in 1976, PUC was
computed according to corporate law without any reference to the provisions of
the Act. In corporate law, stated capital represents the money that a
shareholder has committed to the corporation and is akin to a corporation’s
permanent capital base. Even though the starting point for the calculation of
PUC is the stated capital, adjustments are made in keeping with the general
purpose of the Act to tax income and not capital. Such general purposes
are apparent in many provisions in the Act, notably section 84.
[67] The aim of subsection 84(3) is to tax corporate distributions to
shareholders as dividend income, unless those distributions represent a return of
capital. This purpose is especially apparent when subsection 84(3) is viewed in
the context of section 84 in its entirety.
[68] The history and policy reasons behind the enactment of section 84 were
described in 1979 by Gould and Laiken (Dividend vs. Capital Gains under Share
Redemptions, Canadian Tax Journal [March – April 1979], Vol. 27, No. 2, p. 162):
… Also introduced in 1950 was the
concept of a deemed dividend to prevent the conversion to capital of corporate
surplus which would otherwise be distributed as a dividend. This concept is now
contained in section 84 of the Income Tax Act (the “Act”). In
1963, a provision for the use of ministerial discretion was passed as the last
in a series of measures to prevent dividend stripping. This provision became
subsection 247(1) of the Act.
[69] Although subsection 247(1), referred to in the above passage, has now
been repealed, it is relevant in conducting a purposive analysis of section 84.
When this subsection was introduced in 1963, the Minister of Finance, in his
Budget Speech, stated:
Another type of tax avoidance about
which the government is particularly concerned is the proliferation of methods
of moving undistributed income from a corporation into the hands of its
shareholders without the payment of tax. This abuse, and it is an expensive
abuse to the public treasury, has become increasingly prevalent in recent
years.
[70] Prior to its repeal, subsection 247(1) was amended in 1985 in response
to the introduction of the capital gains exemption. In the Technical Notes
accompanying Bill C-84 (November 1985), the Department of Finance stated:
It is intended that subsection
247(1) apply in circumstances where, as part of a corporate reorganisation of a
public or private corporation, the paid up capital of shareholders is
increased inappropriately but in circumstances where no specific avoidance
provision of the Act applies. (emphasis added)
[71] Subsection 247(1) was repealed when GAAR was introduced in 1988. Although
subsection 247(1) has no application in the present appeal, it is noteworthy
that the purpose of this provision was complementary to section 84 in
situations where specific anti-avoidance rules did not apply. Subsection 87(3)
is an example of one such specific anti-avoidance rule. It was enacted in
respect to amalgamations occurring after March 31, 1977 and applies
where the PUC of the new corporation exceeds the total PUC of the predecessor
corporations. Before the enactment of this subsection, the same situation gave
rise to a paid up capital deficiency (“PUCD”) under paragraph 87(2) (s.1). With
the repeal of PUCD, it was necessary to prevent the inflation of distributable
capital on amalgamation by an artificial adjustment in PUC.
[72] Because PUC is paramount in determining tax consequences, it is
essential to have provisions in the Act relating to PUC in the context
of amalgamations. Subsection 87(3) insures that the PUC of a new corporation is
limited to the aggregate of the PUC of the predecessor corporations, which prevents
the artificial inflation of PUC on amalgamation. Implicit in subsection 87(3)
is that the shares, and therefore the PUC of the shares of a predecessor
corporation held in another predecessor corporation, are to be eliminated.
[73] The Supreme Court in Canada Trustco indicates that the second
step, in a subsection 245(4) analysis, requires a determination of whether the
transaction or transactions fall within or frustrate the object, spirit and
purpose of the relevant provisions. Since the Supreme Court decision, this
Court has addressed the question of surplus stripping and GAAR in a number of
cases. Both the provisions and the circumstances in the present appeal differ
from those in Desmarais v. Canada, [2006] 3 C.T.C. 2304, 2006 TCC 44 and Evans v. The Queen,
2005 DTC 1762, 2005 TCC 684. While the Act contains many
provisions which seek to prevent surplus stripping, the analysis under
subsection 245(4) must be firmly rooted in a unified textual, contextual
and purposive interpretation of the relevant provisions. As such, reliance on a
general policy against surplus stripping is inappropriate to establish abusive
tax avoidance. In Lipson v. Canada, 2007 DTC 5172, 2007 FCA 113, the
Federal Court of Appeal confirmed that the overall purpose of the series of
transactions must be considered in understanding an abuse analysis. Justice
Noël at paragraph 45 stated:
45. It follows in my view that where
a tax benefit results from a series of transactions, the series becomes
relevant in ascertaining whether any transaction within the series gives rise
to an abuse of the provisions relied upon to achieve the tax benefit. Counsel
for the appellant pointed out that no reference is made to a series of
transactions in subsection 245(4). That is so. However subsection 245(4) must
also be read in context and where the tax benefit results from a series of
transactions under subsection 245(3), the series cannot be ignored in
conducting the abuse analysis.
[74] At first glance in this appeal, it is not
immediately obvious that any of the transactions in this appeal constitute
abusive tax avoidance. The provisions of the Act appear to have operated
precisely as they were intended to, producing the results that would be
expected. After the 1993 Share Sale, the First Amalgamation was completed in
accordance with subsection 87(3), in that the PUC was preserved and the PUC of
the new corporation was equal to the aggregate PUC of the predecessor
corporations. The Redemption of the Class D Preference shares of Copthorne III
was later effected pursuant to subsection 84(3). Similarly, the Redemption
does not appear to offend the provisions or result in an abuse. However, when
the Redemption is viewed together with the 1993 Share Sale of VHHC Holdings to Big City, the abusive element becomes apparent.
When VHHC Investments is later amalgamated with Copthorne II, the underlying
principles respecting the calculation of PUC are offended because approximately
$67 million of PUC is essentially double counted in the PUC of the newly
amalgamated corporation. It is this double counting that circumvents the proper
application of the relevant provisions in a manner that frustrates and defeats
the object, spirit and purpose of those provisions, which individually, together
and when read in conjunction with other provisions in the Act, are meant
to operate to prevent the artificial increase of PUC on amalgamation and its
subsequent return to shareholders on a tax‑free basis. Of the total PUC
of $164,138,025 associated with Class D Preference shares, $96,736,845 belonged
to VHHC Investments and $67,401,280 belonged to Copthorne II. However, the
$67,401,279 can be traced back to the investment made by VHHC Investments in
the common shares of VHHC Holdings, a lower tiered subsidiary. The $67,401,279
amount originated with the $96,736,845 amount invested by Victor Li, Asfield
and L.F. Holdings. VHHC Holdings was sold to Copthorne I and the PUC of
$67,401,279 in VHHC Holdings was preserved through the 1993 Share Sale by
Copthorne I to Big City. This same PUC was maintained throughout
the First and Second Amalgamations. Therefore $67,401,279 of PUC associated
with the Class D preference Shares of Copthorne III is derived from the
same $96,736,845 of PUC associated with the shares of VHHC Investments. This is
the origin of the double counting of $67,401,279 of PUC and the aggregate of
$67,401,279 and 96,736,845 results in this artificial increase. Instead
$142,035,895 was distributed as a tax-free return of capital when only $96,736,845
of PUC was actually ever available for distribution. Consequently, the overall
result that the relevant provisions were meant to address has been
circumvented. In doing so, the purpose and underlying rationale of these
statutory provisions (as well as corporate principles) have been frustrated and
their object, spirit and purpose defeated. The resulting artificial
preservation and inflation in PUC allowed the stripping of surplus without
appropriate withholding tax. When the many transactions here are distilled down
to the essential core, it is clearly an abuse of the Act to which
section 245 should apply.
Penalty
[75] The assessment in this appeal included a ten per cent penalty under
subsection 227(8) for the Appellants’ failure to deduct or withhold tax.
Paragraph 227(8)(a) reads:
(8) Penalty – Subject to subsection
(8.5), every person who in a calendar year has failed to deduct or withhold any
amount as required by subsection 153(1) or section 215 is liable to a penalty
of
(a) 10% of the amount
that should have been deducted or withheld; or […]
[76] The first
determination that must be addressed is whether subsection 227(8) is a
strict liability or absolute liability penalty provision. In Safety Boss Ltd
v. Canada, 2000 DTC 1767, [2000]
T.C.J. No. 18, Chief Justice Bowman addressed the issue of whether subsection
227(8) was an absolute liability provision. Although he found it unnecessary to
decide this issue, he was of the view that Canada (Attorney General) v.
Consolidated Canadian Contractors Inc. (C.A.), [1999] 1 F.C. 209 (F.C.A.)
(“Consolidated Canadian Contractors”) did not support the argument that
subsection 227(8) was an absolute liability provision and therefore the
application of the penalty could be subject to a defence of due diligence. In Ogden
Palladium Services (Canada) Inc. v. Canada, [2001] 2 C.T.C. 2404, affirmed
[2003] 1 C.T.C. 206 (F.C.A.), the Court also relied on Consolidated Canadian
Contractors and stated that a defence of due diligence was available under
subsection 227(8).
[77] It is only because of the
application of GAAR that the liability to pay the withholding tax arises. The
question therefore is whether the Appellant becomes liable to pay a penalty
under subsection 227(8) when it was not technically required to withhold tax
under the relevant provisions of the Act. I do not think that a GAAR
assessment can give rise to penalties for non-compliance with the technical
sections of the Act. First, the GAAR is not a penalty provision. If a
transaction, or series of transactions, runs afowl of GAAR, the remedy
specified in subsection 245(2) is that tax consequences will be determined that
are reasonable in the circumstances in order to deny a tax benefit that would
otherwise result from the transaction. Subsection 245(2) does not indicate that
a successful GAAR assessment will cure the deficiency in the scheme of the Act
but merely that the tax benefit resulting from the technical application of the
section will be denied.
[78] Second, there is nothing in the
GAAR provisions that would allow a taxpayer to self assess on the basis that
GAAR applies. Subsection 245(7) provides that:
Notwithstanding any other provision
of this Act, the tax consequences to any person, following the application of
this section, shall only be determined through a notice of assessment,
reassessment, additional assessment or determination pursuant to subsection
152(1.11) involving the application of this section.
This provision indicates that a taxpayer cannot
self-assess on the basis that GAAR applies. The Appellant argued that:
… Taxpayers self assess
on the basis of compliance with the technical provisions of the Act. The application
of GAAR can only be initiated by the CRA. Unless subsection 227(8) is an
absolute liability provision (which, as discussed below, it is not), a penalty
should not be imposed as a consequence of the successful application of GAAR by
the Minister, since a taxpayer can never file or pay anything on the basis that
GAAR applies, without the Minister first initiating the application of GAAR.
(Appellant’s Notes of Argument, paragraph 126).
I agree with the Appellant’s comments and conclude
that a successful GAAR assessment prevents the Minister from applying penalties
under subsection 227(8), where, according to the technical application of
subsection 215(1), there was no tax payable by a non-resident.
The Reasonable Tax Consequences
[79] The Appellant also objected to
the Minister’s calculation of the tax benefit and submits that it was not
reasonable in the circumstances (Notice of Appeal, paragraph 54). The revised
PUC of the redeemed shares was computed by the Minister as follows:
Number of shares
redeemed x Revised PUC = Revised PUC of Redeemed Shares
Number of shares issued
$142,035,895 x $96,736,845
= $83,710,672
$164,138,025
This method meant that the difference of $58,325,223, between $142,035,895
of PUC (for the Class D preference shares of Copthorne III that were redeemed)
and the $83,710,672 is a taxable dividend received by L.F. Investments, upon
which Part XIII tax would have been exigible. The end result under Article X of
the Canada-Barbados Tax Convention limits the tax on the dividend to 15% or
$8,748,783.
[80] The
Appellant did not provide an alternative basis for this calculation, nor did
the Appellant indicate why the Minister’s method was not acceptable. It is
reasonable to reduce the amount of PUC of the redeemed shares by the
proportionate amount that PUC was overstated for those redeemed shares. Had all
of the Class D preference shares been redeemed, with a revised PUC of $96,736,845,
the amount of the deemed dividend would have been $67,401,280. The Minister’s
calculation of the deemed dividend according to the proportion of shares
actually received, which is equal to the tax benefit, is therefore reasonable.
[81] The
appeal is therefore allowed to delete penalties that have been applied. In
respect to the GAAR assessment, a taxable dividend of $58,325,223 will be
deemed to have been paid by Copthorne III to L.F. Investments, pursuant to
subsection 84(3), resulting in the amount of $8,748,783 to be remitted by
Copthorne III as withholding tax on this deemed dividend. Because the
Respondent has been successful for the most part, there will be an award of two
sets of counsel fees in respect to costs.
Signed at Summerside,
Prince Edward Island, this 28th
day of August 2007.
Campbell J.
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