Citation: 2013 TCC 327
Date: 20131017
Docket: 2010-1860(IT)G
BETWEEN:
THE BRENT KERN FAMILY TRUST,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Bocock J.
I.
Background and
Issues
[1]
At the core of this
Appeal is the engagement and applicability of the attribution rule within
subsection 75(2) of the Income Tax Act (“Act”). Once applicable,
subsection 75(2) effectively prohibits a person from transferring property to a
trust and having the income, loss, capital gain or capital loss (“benefit”)
flow to a different entity, where the transferor may have a future opportunity
to again receive the benefit. Instead, the rule under subsection 75(2) confers
the benefit back to the transferor immediately and thereby precludes the
diversion of the benefit through the use of a trust.
[2]
Until recently it
mattered not whether the property was transferred by gift or sale; however, in Canada
v Sommerer, 2012 FCA 207, 2012 DTC 5126 (FCA), the Federal Court of Appeal
pronounced that a transfer by genuine sale will not invoke subsection 75(2),
unlike in situations where the property is gifted. In this appeal, the property
in the form of shares was sold for valuable consideration by the transferor in
the persona of the Appellant. Therefore, this Court must determine if that sale
falls within the ambit of Sommerer. If it does, sub-section 75(2) will
not apply, the benefit from the dividend income will remain with the Appellant
and the Appellant cannot succeed in this appeal.
[3]
If Sommerer does
not apply and sub-section 75(2) applies, the sole issue remaining is whether
the use of this specific attribution rule to reduce tax, where the initial
owner acknowledges the benefit and primary purpose of avoiding tax, constitutes
a misuse or abuse of the subsection so as to attract the General Anti-Avoidance
Rule (“GAAR”) under subsections 245(1) and (3) of the Act.
[4]
Timing and sequence did
not assist the hearing of this matter. The initial hearing was concluded on
June 19, 2012. During the Court’s deliberations, the Federal Court of Appeal
released Sommerer some 23 days later on July 13, 2012.
[5]
Upon release of Sommerer,
counsel for the Respondent requested additional submissions on the issue
asserting the law had changed. Counsel for the Appellant opposed this request
on the basis that: relevant discoveries were not held in the context of such a
legal presumption (the non-applicability of subsection 75(2)), prejudice had
been suffered and Sommerer was not applicable in any event.
[6]
An Order of the Court
was issued on October 15, 2012 (2012 TCC 358) granting the request to hear
further legal submissions and affording the Appellant further discovery rights
and awarding costs. After those examinations for discovery were completed, further
oral and written submissions were heard and received respectively in early July
of 2013.
II.
Factual Background
[7]
Counsel greatly
shortened the proceedings through two Statements of Agreed Facts applicable to each
phase of the hearing. The material facts relevant to this appeal concerning the
transaction structure are:
1.
From 1997 to July 2004
Mr. Kern was originally the sole shareholder and controlling mind of Wilf’s
Oilfield Services (1997) Ltd. (“OPCO”);
2.
An Alberta limited
company, 905558 Alberta Ltd., was created in November of 2000 (“Holdco”);
3.
Two trusts were created
on July 30, 2004: the Appellant, the Brent Kern Family Trust (the “Brent
Trust”), and the Kern Family Trust (“the Kern Trust”);
4.
Mr. Kern ordered his
affairs such that he became a preferred shareholder in OPCO and Holdco. Mr.
Kern and OPCO were beneficiaries, along with other family members in the Brent
Trust, whereas Holdco, Mr. Kern and family members were beneficiaries in the
Kern Trust;
5.
Through share
exchanges, the common shares previously held by Mr. Kern in OPCO and Holdco,
were exchanged for preferred shares; and
6.
For valuable
consideration, OPCO common shares were sold to Kern Trust and similarly Holdco’s
shares of OPCO were sold to the Appellant, Brent Trust.
[8]
The material facts
concerning the reassessed transactions, which occurred after the creation of
the structure, described in paragraph 7 above are essentially the same in each
of the two reassessed taxation years, namely:
2005
1.
OPCO declared a
dividend in favour of Kern Trust for $245,000.00;
2.
Kern Trust allocated
$245,000.00 to Holdco;
3.
Holdco declared a
dividend on the common shares owned by the Brent Trust in the amount of
$245,000.00;
4.
The Appellant contends
that subsection 75(2) applies and deems the dividend of Brent Trust to be
received by OPCO (the “Attributed Dividend”), because OPCO is the person which
transferred the property to Brent Trust while OPCO was an enduring potential
beneficiary;
5.
On that basis, the
Brent Trust reported no income from the declared dividend on its T-3 trust
income return;
6.
This Attributed
Dividend in OPCO’s hands was a dividend received by a corporation pursuant to
section 112 of the Act which section affords the non-taxable payment of
inter-corporate dividends; and
7.
The amount of the
dividend, $245,000.00 (“Dividend Amount”) was allocated and paid to Mr. Kern,
who in turn lent the Dividend Amount to OPCO.
2006
Similar transactions and income tax
reporting occurred in 2006, save and except that the amount of the 2006
dividend declared was $155,000.00 and through incremental reduction, the amount
ultimately lent to OPCO by Mr. Kern was $151,591.99.
[9]
As a result of the 2005
and 2006 transactions in respect of which neither OPCO nor the Appellant
declared income nor paid tax, the Minister reassessed the Appellant on the
basis of the non-reporting of taxable dividends of $306,250.00 and $190,368.00 purportedly
received by the Appellant in each of taxation years 2005 and 2006,
respectively. The Minister asserts that subsection 75(2) does not apply firstly
because of Sommerer or, in the alternative, because of GAAR and the
alleged abuse of the subsection.
III. The Effect of Sommerer on the
Application of Subsection 75(2)
a) The Wording of Subsection 75(2)
[10]
As described above,
subsection 75(2), as a specific anti-avoidance section of the Act,
directs that the transfer of property to a trust by an enduring potential
beneficiary will attribute income, loss and capital gains, or capital losses
back to that beneficiary.
[11]
In its entirety (with
emphasis of relevant portions added), the sub-section provides:
75(2)
Where, by a trust created in any manner whatever since 1934, property
is held on condition
(a)
that it or property substituted therefor may
(i) revert to the person from whom the property or property
for which it was substituted was directly or indirectly received
(in this subsection referred to as “the person”), or
(ii) pass to persons to be determined by the person at a time
subsequent to the creation of the trust, or
(b) that, during the existence of the person, the property
shall not be disposed of except with the person’s consent or in accordance with
the person’s direction,
any
income or loss from the property or from
property substituted for the property, and any taxable capital gain or
allowable capital loss from the disposition of the property or of property
substituted for the property, shall, during the existence of the person
while the person is resident in Canada, be deemed to be income or a
loss, as the case may be, or a taxable capital gain or allowable capital loss,
as the case may be, of the person.
[12]
As contained within the
Agreed Facts, the following requisite facts which would otherwise engage
subsection 75(2) existed: a trust, a transferor with an enduring potential
beneficial interest, a transfer of property and a possibility that the property
transferred may revert in future to the beneficiary/transferor.
b) The Sommerer Decision
[13]
Prior to the Sommerer
decision, counsel jointly agreed that subsection 75(2) applied to the facts of
the case before the Court. The question remains: did Sommerer change
that application? To answer this, the Court must review Sommerer and its
findings.
i)
At Trial
[14]
It must be borne in
mind that the decision of the Federal Court of Appeal in Sommerer upheld
unanimously the trial decision of Justice C. Miller of this Court (2011 TCC
212) on all of his factual findings and most importantly to the issue before
this Court, the legal determination that property sold for valuable
consideration to a trust by an enduring potential beneficiary will not engage
the attribution rule in subsection 75(2).
[15]
At trial, Justice
Miller found that:
1.
a trust existed
(paragraphs 67 and 81);
2.
the Appellant was an
enduring potential beneficiary under the trust (paragraph 81); and
3.
subsection 75(2) does
not apply to a beneficiary vendor of property at value (paragraph 131).
[16]
Justice Miller was
required to grapple with many issues present in Sommerer, which are
assumed facts in this appeal: was the foundation a trust arrangement, was the
appellant a beneficiary, was there a sale of transferred property by the
beneficiary and was the beneficiary seized of the transferred property when
sold?
[17]
In spite of the factual
complexity in Sommerer, Justice Miller nonetheless stated in a
conclusive matter at the end of paragraph 91 regarding subsection 75(2) as
follows;
[91]
[…] I recognize that this may take the reader several readings of what at first
might seem simple language. It is not. But once properly unravelled and viewed
grammatically and logically, the only interpretation is that only a settlor, or
a subsequent contributor who could be seen as a settlor, can be the “the person”
for purposes of subsection 75(2) of the Act.
ii) On Appeal
[18]
The factual
complexities existing at the trial level, not surprisingly, evaporated on
appeal. Although dealing at some length with the contentious factual finding of
a trust, Justice Sharlow, confirmed the issue was moot before the appeal court
since it was not challenged by the appellant on that ground at appeal.
[19]
Factually, the trust
used proceeds received from the settlor to purchase shares from the beneficiary
at fair market value. The trust then sold the shares and realized a capital
gain. In Sommerer, the Crown alleged subsection 75(2) applied and the
beneficiary received the gain.
[20]
Justice Sharlow, in
interpreting subsection 75(2) as to its textual, contextual and purposive
meaning, held that to interpret subsection 75(2) such that it would apply to a
beneficiary selling property in a bona fide sale transaction renders outcomes
which are absurd and could not have been intended by Parliament (paragraph 49).
In providing a series of examples, the ultimate example in the opinion of the
Court of Appeal was held up as the most absurd (paragraphs 54 and 55). The
absurdity identified is that the application of the attribution rule under subsection
75(2) becomes a permanent, repetitive allocative taxation measure potentially
attracting the same capital gain simultaneously to multiple taxpayers because
of its objective application.
[21]
At paragraph 57,
Justice Sharlow concludes that the premise that subsection 75(2) can apply to a
beneficiary of a trust who sells property for value is “wrong”. In doing so,
she referenced paragraph 91 of the trial decision and thereby upheld and
highlighted Justice Miller’s conclusive statements regarding his interpretation
of the subsection.
iii) Is Sommerer
applicable to or distinguishable from this Appeal?
[22]
In suggesting that Sommerer
does not apply, Appellant’s counsel submitted that:
1.
The complexity of the
facts in Sommerer make it an exceptional case where the settled property
was used to purchase the transferred property;
2.
The Federal Court of
Appeal was upholding a finding in Sommerer in order to avoid the
possibility of double taxation, which is not existent in the present appeal;
3.
The statements of the
Federal Court of Appeal that subsection 75(2) do not apply in all circumstances
where fair market value is paid for the property, even in the absence of
conversion of the settled trust property, are obiter dicta and not part
of the material facts in that decision; and
4.
In the present case,
the historical context and purpose of subsection 75(2) have been extensively
pleaded (unlike in Sommerer) and on that basis Parliament did intend that
subsection 75(2) apply where property was acquired by the trust for valuable
consideration. The historical legislative intention and evolution of the
subsection illustrate that attribution back to the person holding a
reversionary interest was paramount and therefore it is antithetical to provide
an exemption for property sold which might revert back to a beneficiary in due
course. In short, in Sommerer, the Courts (at trial and on appeal) were
denied their respective opportunity to view subsection 75(2) as to its textual,
contextual and purposive meaning because of deficient pleadings.
[23]
In totality, despite
this valiant effort to distinguish this appeal from the law established in Sommerer,
for the following reasons this Appellant cannot succeed in its appeal.
A. Complexity of Facts in Sommerer
[24]
Certainly at the trial
level, as acknowledged and outlined herein, Justice Miller weeded through many
issues. However such factual findings were not overturned on appeal. Before the
Federal Court of Appeal, the factual finding of a trust was not pleaded and the
applicability of subsection 75(2) was the sole determinative issue upon which
the Federal Court of Appeal deliberated. The facts in the present case are not
distinguishable from those in paragraph 57.
B. Double Taxation made
the Federal Court of Appeal “do it”
[25]
It may be argued that
the possibility of double taxation was a collateral issue which caused the
Federal Court of Appeal and the trial judge to avidly pursue the matter, but such
issue was neither prominent nor particularly referable in the analysis,
interpretation and ultimate decision regarding subsection 75(2) as outlined at
paragraph 57 and paragraph 91 of the Sommerer appeal and trial
decisions, respectively.
C. Universal
Applicability of subsection 75(2) when property sold is obiter dicta
[26]
The absence of intent
and subjectivity is the hallmark of subsection 75(2). The Federal Court of
Appeal stated strongly that situational applicability of the subsection is
unacceptable because it applies to every situation it describes. While perhaps
unfair, this was the very submission of the Appellant prior to the decision in Sommerer
in the context of subsection 75(2)’s automatic and objective application.
Legally, the only difference now is that a genuine transfer for value to a
trust by a beneficiary, by virtue of Sommerer, no longer falls within
the ambit of the automatic attribution rule.
D. Sommerer does
not contain a relevant textual, contextual and purposive analysis of subsection
75(2)
[27]
While making reference to
the lack of historical legislative history pleaded in Sommerer, counsel
for the Appellant in this appeal made extensive submissions on such historical
context. A review of both the trial and appeal decisions in Sommerer
reveals that both the trial judge (paragraphs 87 through 110) and the appeal
court (paragraphs 44 through 59) spent considerable time in analysing the text,
context and purpose of the subsection, or at least sufficiently enough, in
order to establish the foundation and the definitive decision that subsection
75(2) does not include as a “person” a beneficiary who sells property to a
trust for valuable consideration.
IV. Conclusion
[28]
Appellant’s counsel
also raised reasons why he felt the decision in Sommerer is wrong as
opposed to inapplicable: insufficient contextual and purposive analysis, use of
faulty hypotheticals, unintended universal removal of a common type of
transaction from the ambit of subsection 75(2) and possibly absurd future
consequences as a result of the decision. This Court’s response is simple. The
Tax Court of Canada is not a review court for unequivocal decisions of the
Federal Court of Appeal. This Court is required to follow and apply the
statements of law handed down by the Federal Court of Appeal; stare decisis
is a hierarchal process. The ratio decidendi within Sommerer, as
outlined in paragraph 57 of the appeal decision, now comprises pronounced law;
challenges to such required deference by this Court are also part of a well
known hierarchical process.
[29]
To encapsulate, the
Appellant trust purchased 100 common shares of Holdco (905558 Alberta Ltd.) for
valuable consideration from OPCO (Wilf’s Oilfield). OPCO was also an enduring
beneficiary under the Appellant trust. As such, subsection 75(2) does not apply
to the dividend declared on the Holdco shares which comprised the property. The
dividend income is not attributable to OPCO, but instead remains to the benefit
and for the account of the Appellant.
a)
GAAR Issue
[30]
The sole remaining
legal issue before the Court was whether the GAAR would apply to the
transactions. The Appellant admitted that the first two requirements of GAAR,
namely, the conferral of the tax benefit and the existence of an avoidance
transaction were present and need not be proved by the Minister.
[31]
The final ground, the
presence of abuse or misuse of the subsection 75(2) would have remained the
sole issue for determination in respect of which the Respondent bore the onus
of establishing. For the reasons stated above, on the authority of Sommerer,
subsection 75(2) of the Act does not apply to a transaction where
property is sold for value by a person in whom an enduring beneficial interest
remains and therefore the issue of the applicability of GAAR is moot.
[32]
The sequence of events
in the appeal process and the various phases related to the bifurcated manner in
which the appeal was heard must inform any decision on costs. Therefore, costs
are awarded to the Respondent in the cause for those costs incurred in
responding to the appeal from and after October 15, 2012 which was the date
when the Court decided to hear additional arguments on the non-applicability of
subsection 75(2).
Signed at Ottawa, Ontario, this 17th
day of October 2013.
“R.S. Bocock”
Email this Content