Mathew v. Canada, 2005 DTC 5538, 2005 SCC 55, [2005] 2 SCR 643

                                                 SUPREME COURT OF CANADA

Between:

Eugene Kaulius, Steven M. Cook, Charles E. Beil,

Craig C. Sturrock, Amalio De Cotiis, John N. Gregory,

347059 B.C. Ltd., Frank Mayer, John R. Owen,

Verlaan Investments Inc., William John Millar, NSFC

Holdings Ltd., TFTI Holdings Limited, Douglas H. Mathew,

Ian H. Pitfield, Estate of the late Lorne A. Green and

Innocenzo De Cotiis

Appellants

v.

Her Majesty the Queen

Respondent

Coram: McLachlin C.J. and Major, Bastarache, Binnie, LeBel, Deschamps, Fish, Abella and Charron JJ.

______________________________

Mathew v. Canada, [2005] 2 S.C.R. 643, 2005 SCC 55

Eugene Kaulius, Steven M. Cook, Charles E. Beil,

Craig C. Sturrock, Amalio De Cotiis, John N. Gregory,

347059 B.C. Ltd., Frank Mayer, John R. Owen,

Verlaan Investments Inc., William John Millar, NSFC

Holdings Ltd., TFTI Holdings Limited, Douglas H. Mathew,

Ian H. Pitfield, Estate of the late Lorne A. Green and

Innocenzo De Cotiis                                                                                        Appellants

v.

Her Majesty The Queen                                                                               Respondent

Indexed as:  Mathew v. Canada

Neutral citation:  2005 SCC 55.

File No.:  30067.

2005:  March 8; 2005: October 19.

Present:  McLachlin C.J. and Major, Bastarache, Binnie, LeBel, Deschamps, Fish, Abella and Charron JJ.

on appeal from the federal court of appeal

Income tax — Tax avoidance — Interpretation and application of general anti‑avoidance rule — Company transferring unrealized losses to arm’s length taxpayers through series of transactions involving partnerships — Taxpayers deducting those losses against their own income — Whether general anti‑avoidance rule applicable to deny tax benefit — Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .), ss. 18(13) , 96(1) , 245(4) .

STC carried on a business which included the lending of money on the security of mortgages on real property.  STC became insolvent and a liquidator was appointed.  At that time, STC owned a portfolio of 17 non‑performing loans with 9 underlying real estate properties having a fair market value of approximately $33 million.  The cost to STC of these “Portfolio Assets” was approximately $85 million.  Since STC was being liquidated, it could not use the approximately $52 million in  unrealized losses from the Portfolio Assets.  The liquidator devised and oversaw the execution of a series of transactions to realize maximum returns on the disposal of the Portfolio Assets.  The overall arrangement involved three stages.  At the first stage, STC transferred a portfolio of mortgages with unrealized losses to a non‑arm’s length partnership, Partnership A, thereby acquiring a 99 percent interest in it.  At the second stage, STC relied on s. 18(13)  of the Income Tax Act  to transfer the unrealized losses to Partnership A and then sold its 99 percent interest in it to an arm’s length party.  At the third stage, Partnership B was formed to acquire the 99 percent interest in Partnership A.  The appellant taxpayers joined Partnership B and claimed their proportionate shares of the losses from the eventual sale or write‑down of the mortgaged properties.  Relying on a combination of s. 18(13)  and the partnership provisions of the Act, they deducted over $10 million of STC’s losses against their own incomes.  The Minister of National Revenue reassessed the taxpayers, applied the general anti‑avoidance rule (“GAAR”) of the Income Tax Act  and disallowed the deduction.  Both the Tax Court of Canada and the Federal Court of Appeal upheld the Minister’s decision.

Held: The appeal should be dismissed.

Three requirements must be met to permit application of the GAAR.  The first two requirements, that there be a tax benefit and an avoidance transaction, were conceded.  The only issue in this case is whether the transactions result in abusive tax avoidance under s. 245(4)  of the Income Tax Act . [31‑32] [35]

In light of the principles set out in the companion case Canada Trustco Mortgage Co. v. Canada, [2005] 2 S.C.R. 601, 2005 SCC 54, the Minister properly disallowed the taxpayers’ deductions under the GAAR.  To allow the taxpayers to claim the losses in this case would defeat the purposes of s. 18(13)  and the partnership provisions.  Interpreted textually, contextually and purposively, s. 18(13)  and s. 96  of the Income Tax Act  do not permit arm’s length parties to purchase the tax losses preserved by s. 18(13)  and claim them as their own.  The purpose of s. 18(13)  is to transfer a loss to a non‑arm’s length party in order to prevent a taxpayer who carries on a business of lending money from realizing a superficial loss.  The purpose of the broad treatment of loss sharing between partners is to promote an organizational structure that allows partners to carry on a business in common, in a non‑arm’s length relationship.  Section 18(13)  preserves and transfers a loss under the assumption that it will be realized by a taxpayer who does not deal at arm’s length with the transferor.  Parliament could not have intended that the combined effect of the partnership rules and s. 18(13)  would preserve and transfer a loss to be realized by a taxpayer who deals at arm’s length with the transferor.  To use, as here, these provisions to preserve and sell an unrealized loss to an arm’s length party results in abusive tax avoidance under s. 245(4) .  [58]

Cases Cited

Followed: Canada Trustco Mortgage Co. v. Canada, [2005] 2 S.C.R. 601, 2005 SCC 54; not followed: OSFC Holdings Ltd. v. Canada, [2002] 2 F.C. 288, 2001 FCA 260.

Statutes and Regulations Cited

Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .), ss. 18(13) , 96 , 245(1)  to (4) , 248(10) .

APPEAL from a judgment of the Federal Court of Appeal (Linden, Rothstein and Sexton JJ.A.), [2004] 1 C.T.C. 115, 311 N.R. 172 (sub nom. Kaulius v. Minister of National Revenue), 2003 D.T.C. 5644 (sub nom. Kaulius v. The Queen), [2003] F.C.J. No. 1470 (QL), 2003 FCA 371, affirming a decision of Dussault J.T.C.C., [2003] 1 C.T.C. 2045, 2002 D.T.C. 1637, [2002] T.C.J. No. 222 (QL).  Appeal dismissed.

Kim Hansen, for the appellants.

Graham Garton, Q.C., Anne‑Marie Lévesque and Alexandra K. Brown, for the respondent.

The judgment of the Court was delivered by

The Chief Justice and Major J. —

1.      Introduction

1                                   This appeal, like its companion case Canada Trustco Mortgage Co. v. Canada, [2005] 2 S.C.R. 601, 2005 SCC 54 (“Canada Trustco”) (released concurrently), raises the issue of the interplay between the general anti-avoidance rule (“GAAR”) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .), and specific provisions of the Act conferring tax benefits.

2                                   As discussed more fully in Canada Trustco, a tax benefit may be denied under the GAAR if allowing the tax benefit would frustrate or defeat the object, spirit or purpose of the provisions that are relied upon for the tax benefit.  The central issue in this appeal is the proper interpretation of  s. 18(13)  and the provision that allows for loss sharing among partners under s. 96(1).  For the reasons that follow, the appeal is dismissed with costs.

2.      Facts

3                                   As a result of a series of transactions, the appellants lowered their  incomes by deducting losses from the sale of mortgaged properties originally belonging to Standard Trust Company (“STC”). The overall arrangement  involved three stages. At the first stage, STC transferred a portfolio of mortgages with unrealized losses to a non-arm’s length partnership, Partnership A, thereby acquiring a 99 percent interest in it. At the second stage, STC relied on s. 18(13)  to transfer the unrealized losses to Partnership A and then sold its 99 percent interest in it  to an arm’s length party.  At the third stage, Partnership B was formed to acquire the 99 percent interest in Partnership A.  The appellants joined Partnership B and were thus able to claim their proportionate shares of the losses from the eventual sale or write-down of the mortgaged properties.  In this way, STC’s losses were transferred through s. 18(13)  and the partnership vehicle to arm’s length taxpayers who offset them against their own incomes, while STC recovered a portion of the losses associated with the defaulted mortgages.

4                                   STC carried on a business which included the lending of money on the security of mortgages on real property.  By May 1991, STC was insolvent and Ernst & Young was appointed as its liquidator.  At that time, STC owned a portfolio of 17 non-performing loans with 9 underlying real estate properties having a fair market value of approximately $33 million, the “Portfolio Assets”.  The cost to STC of the Portfolio Assets was approximately $85 million.  Since STC was being liquidated, it could not use the approximately $52 million in unrealized losses from the Portfolio Assets.

5                                   The liquidator devised and oversaw the execution of a series of transactions to realize maximum returns on the disposal of the Portfolio Assets.  The transactions are described in greater detail in a statement of admitted facts, which is reproduced at para. 5 of the decision of the Tax Court of Canada ([2003] 1 C.T.C. 2045).  In sum, the appellants who are partners in a relatively passive partnership that dealt with STC at arm’s length deducted over $10 million of STC’s losses against their own incomes.

6                                   On October 21, 1992, STC incorporated a wholly owned subsidiary, 1004568 (the “subsidiary”).  On October 23, 1992, STC and its subsidiary entered into a partnership agreement to create the STIL II Partnership (“Partnership A”).  On that date, STC contributed the Portfolio Assets as capital for a 99 percent interest in Partnership A and the subsidiary borrowed $417,318 from STC to make its capital contribution for a 1 percent interest.  At its inception, Partnership A did not deal with STC at arm’s length.

7                                   Section 18(13)  of the Income Tax Act  prohibits a taxpayer whose ordinary business includes the lending of money from deducting a loss on the disposition of a mortgage if at the end of a specified period, the mortgage is owned by a partnership that does not deal at arm’s length with the transferor.  Under such circumstances, the loss is added to the cost of the mortgage to the partnership.

8                                   STC relied on s. 18(13)  to transfer the Portfolio Assets into Partnership A at their historical cost of $85 million.  From the outset, it was STC’s goal to use this transaction to preserve the unrealized losses of the Portfolio Assets of $52 million and to transfer them into Partnership A so that STC could eventually sell its 99 percent interest in Partnership A to an arm’s length party. 

9                                   The partnership rules under s. 96 of the Act provide that a partnership’s income or losses flow through to its partners at the end of the taxation year. Partners are entitled to claim their proportionate shares of partnership losses, provided they are partners at the end of the taxation year, regardless of when they joined the partnership. 

10                               It was STC’s plan to sell its 99 percent interest in Partnership A to an arm’s length party so that Partnership A would dispose of the Portfolio Assets and realize losses of up to $52 million, and the new partner would rely on s. 96 of the Act to claim 99 percent of the losses.  Between August 1992 and January 1993, STC contacted 38 prospective purchasers for its 99 percent interest in Partnership A.

11                               In January 1993, STC began negotiations with OSFC Holdings Ltd. (“OSFC”), an arm’s length corporation.  On May 31, 1993, STC and OSFC agreed on the purchase and sale of the 99 percent interest in Partnership A.  One of the terms of the purchase agreement was that OSFC would pay to STC an adjustable “Additional Payment” of up to $5 million if Partnership A realized losses from the disposition of the Portfolio Assets for income tax purposes.  The result of this term was to convert STC’s $52 million in unrealized losses into up to $5 million in cash for STC.

12                               OSFC had planned from the outset to syndicate its interest in Partnership A.  Before describing the remaining transactions, it is useful to describe the 4 corporate and 13 individual appellants.

13                               TFTI Holdings Ltd. (“TFTI”) and NSFC Holdings Ltd. (“NSFC”), are controlled by Peter Thomas, who also controlled OSFC.  Mr. Thomas, who is not a party to this appeal, is very experienced in real estate, having founded the Century 21 real estate firm in Canada.

14                               Mr. Kaulius is a chartered accountant by training and was, from 1992 until 1998, president of OSFC, NSFC and TFTI.

15                               Verlaan Investments Inc. and 347059 B.C. Ltd. are real estate development companies.

16                               Messrs. Amalio and Innocenzo De Cotiis are brothers who are heavily involved in the real estate business.

17                               Mr. Mayer is an investment analyst who has been specializing in real estate for over 28 years.

18                               Mr. Gregory, Mr. Cook, and the seven remaining appellants were all lawyers with the firm of Thorsteinssons.  Mr. Gregory testified that he was fairly experienced in the real estate business and Mr. Cook testified that he was familiar with real estate through his training.

19                               On July 5, 1993, OSFC and TFTI formed the SRMP Realty & Mortgage Partnership (“Partnership B”), to acquire and manage OSFC’s 99 percent interest in Partnership A.  The capital of Partnership B was divided into 35 class A units and 15 class B units.  The class B units were allocated as follows:

Class B unitholder          No. of class B units

OSFC                                                                                                12.0

TFTI                                                                                                     2.0

NSFC                                                                                                  0.5

Eugene Kaulius                                                                        0.5

20                               TFTI, NSFC and Eugene Kaulius were issued their class B units for $1 per class B unit.  OSFC was issued 12 class B units as part of its consideration for transferring its 99 percent interest in Partnership A to Partnership B.  OSFC was managing partner for Partnership B and was authorized to raise capital for Partnership B in order to purchase OSFC’s 99 percent interest in Partnership A by offering and selling class A units.  OSFC approached a number of potential investors to participate as partners in Partnership B, including the appellants.

21                               On July 7, 1993, OSFC sold its 99 percent interest in Partnership A to Partnership B for cash, 12 class B units in Partnership B, and other consideration.  Partnership B also assumed the obligation to pay the “Additional Payment” for realized losses to STC.

22                               On or about July 9, 1993, the class A unit holders described in Appendix A (see para. 5 of the Tax Court decision) subscribed for the stated number of class A units, for $110,000 per class A unit plus additional subscription proceeds to Partnership B to fund their proportionate shares of the “Additional Payment”.

23                               The appellants are class A and class B unit holders in Partnership B and their shares are set out in the following table:

24                               During the relevant period, neither Partnerships A nor B ever acquired or sold any property other than the Portfolio Assets.

25                               By September 30, 1993, as a result of the sale of some of the Portfolio Assets and the write-down of the remaining assets to fair market value, Partnership A realized losses in excess of $52 million. Partnership A allocated 99 percent of its losses to Partnership B which then allocated these losses to its partners, including the appellants.

26                               The appellants together deducted over $10 million of the Partnership B losses against their own incomes in 1993 or 1994.  Some of the appellants, in addition to reducing their taxable incomes for the relevant year to NIL, also computed non-capital losses to be carried forward or back.

27                               The Minister of National Revenue reassessed the appellants, applied the GAAR, and disallowed the deduction of their share of the Partnership B losses.

3.      Legislative Provisions

28                               Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .)

18. . . .

(13) [Superficial loss] Subject to subsection 138(5.2) and notwithstanding any other provision of this Act, where a taxpayer

(a)  who was a resident of Canada at any time in a taxation year and whose ordinary business during that year included the lending of money, or

(b)  who at any time in the year carried on a business of lending money in Canada

has sustained a loss on a disposition of property used or held in that business that is a share, or a loan, bond, debenture, mortgage, note, agreement of sale or any other indebtedness, other than a property that is a capital property of the taxpayer, no amount shall be deducted in computing the income of the taxpayer from that business for the year in respect of the loss where

(c)   during the period commencing 30 days before and ending 30 days after the disposition, the taxpayer or a person or partnership that does not deal at arm’s length with the taxpayer acquired or agreed to acquire the same or identical property (in this subsection referred to as the “substituted property”), and

(d)  at the end of the period described in paragraph (c), the taxpayer, person or partnership, as the case may be, owned or had a right to acquire the substituted property,

and any such loss shall be added in computing the cost to the taxpayer, person or partnership, as the case may be, of the substituted property.

96. (1) [General Rules] Where a taxpayer is a member of a partnership, the taxpayer’s income, non-capital loss, net capital loss, restricted farm loss and farm loss, if any, for a taxation year, or the taxpayer’s taxable income earned in Canada for a taxation year, as the case may be, shall be computed as if

                                                                   . . .

(g)  the amount, if any, by which

(i)  the loss of the partnership for a taxation year from any source or sources in a particular place,

exceeds

(ii) in the case of a specified member (within the meaning of the definition “specified member” in subsection 248(1) if that definition were read without reference to paragraph (b) thereof) of the partnership in the year, the amount, if any, deducted by the partnership by virtue of section 37 in calculating its income for the taxation year from that source or sources in the particular place, as the case may be, and

(iii)    in any other case, nil

were the loss of the taxpayer from that source or from sources in that particular place, as the case may be, for the taxation year of the taxpayer in which the partnership’s taxation year ends, to the extent of the taxpayer’s share thereof.

245. (1) [Definitions] 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;

                                                                   . . .

“transaction” includes an arrangement or event.

(2) [General anti‑avoidance provision] 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) [Avoidance transaction] 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) [Where s. 2 does not apply] For greater certainty, subsection (2) does not apply to a transaction where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of this Act or an abuse having regard to the provisions of this Act, other than this section, read as a whole.

4.      Judicial Decisions

4.1    Tax Court of Canada, [2003] 1 C.T.C. 2045

29                               The appeal before the Tax Court of Canada proceeded solely on the issue of whether the GAAR could be applied to deny the tax benefit.  The Tax Court judge found (at para. 233) that the transactions at issue were “basically the same” as those that were considered in OSFC Holdings Ltd. v. Canada,  [2002] 2 F.C. 288, 2001 FCA 260 (“OSFC”).  The Tax Court judge followed the decision of the majority in OSFC and dismissed the appeal.

4.2    Federal Court of Appeal, [2004] 1 C.T.C. 115, 2003 FCA 371

30                               The Federal Court of Appeal agreed that the facts in this case were essentially the same as those in OSFC; it followed the decision of the majority in OSFC and dismissed the appeal.  In OSFC, the Federal Court of Appeal applied a two-step approach to the GAAR: it held at the first step that s. 18(13)  and s. 96  allowed the appellants to claim the losses at issue, but held at the second step that the appellants should be denied those losses because allowing the tax benefit would contravene the overriding policy of the Income Tax Act  against the trading of losses between taxpayers.

5.      Analysis

5.1    The Interpretation and Application of the GAAR

31                               Our conclusions on the interpretation and application of the GAAR are summarized at para. 66 of the Canada Trustco appeal, released concurrently.

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.

6.                                 Abusive tax avoidance may be found where the relationships and transactions as expressed in the relevant documentation lack a proper basis relative to the object, spirit or purpose of the provisions that are purported to confer the tax benefit, or where they are wholly dissimilar to the relationships or transactions that are contemplated by the provisions.

7.                                 Where the Tax Court judge has proceeded on a proper construction of the provisions of the Income Tax Act  and on findings supported by the evidence, appellate tribunals should not interfere, absent a palpable and overriding error.

(Emphasis in original.)

32                               As in the Canada Trustco appeal, the first two requirements, that there be a tax benefit and an avoidance transaction, were conceded. The tax benefits are the losses, in excess of $10 million, that were deducted by the appellants, who are unitholders in Partnership B (the “tax benefit”). 

33                               A “series of transactions” is explained at paras. 25 and 26 of Canada Trustco.  The GAAR may apply to a tax benefit that is the result of a “series of transactions” which includes events “completed in contemplation of the series” (s. 248(10)  of the Income Tax Act ).  In the instant appeal, the series of transactions includes all the transactions, as described earlier, from the transfer of losses by STC into Partnership A to the losses claimed by the  unitholders in Partnership B.  The Tax Court judge found that the primary purpose of each transaction in the series was to obtain a tax benefit.

5.2    The Issue

34                               As stated, the primary purpose of each transaction in the series was to transfer STC’s losses into Partnership A so that Partnership A could serve as a vehicle to sell the losses to arm’s length taxpayers.  Ultimately, the appellants, who dealt with STC at arm’s length, purchased the tax losses through the use of Partnership B. The appellants deducted those losses against other income and some also computed non-capital losses to be carried forward or back.  In return they provided funds which found their way back to STC, which thus recovered a portion of its loss on the non-performing mortgages.  The appellants relied on a combination of s. 18(13)  and the partnership provisions of the Income Tax Act  to claim the losses.  This was essentially a series of transactions aimed at transferring unrealized losses from one arm’s length taxpayer to another.  The tax consequences of the transactions are the issue, not the status of the partnerships.

35                               The question is whether these transactions, which it is agreed are avoidance transactions giving rise to a tax benefit, result in abusive tax avoidance within s. 245(4) .  More specifically, in the context of this series of transactions, would allowing the appellants to deduct these losses frustrate the object, spirit or purpose of s. 18(13)  and the partnership provisions of the Act?  As stated at para. 44 of Canada Trustco,  “[t]he heart of the analysis . . . 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.”

36                               Section 18(13) will apply to a partnership if the following conditions are met: (1) a taxpayer in the money-lending business disposes of a mortgage (or similar non-capital property); (2) a partnership owns or has a right to acquire the property at the end of the prescribed period; and (3) the partnership does not deal at arm’s length with the taxpayer.

37                               When s. 18(13) applies, it produces two tax consequences. First, the transferor cannot deduct the loss from the disposition.  Second, the loss is added to the cost of the property to the transferee.

38                               The effect of the first result is to prevent the transferor from claiming the loss that would ordinarily result from the transfer.  This result is not at issue in this case, since STC did not claim the losses on this transaction.  The second result, however, is at issue.

39                               The appellants, who ultimately claimed the losses, seek to rely in part on the loss-preservation aspect of s. 18(13).  They argue that all the conditions under s. 18(13) were met and that in particular, since Partnership A did not deal at arm’s length with STC at the end of the period prescribed, the unrealized losses were properly transferred to Partnership A.  Further, once the losses were preserved for the benefit of Partnership A under s. 18(13), they were entitled to claim losses in proportion to their interest in Partnership B, under the partnership provisions. The Minister, on the other hand, argues that the series of transactions results in abusive tax avoidance and should be precluded under the GAAR.

5.3      Interpretation of Section 18(13)  and Section 96(1)  of the Income Tax Act 

5.3.1   The Proper Interpretive Approach

40                               To resolve the dispute arising from the combined operation of s. 18(13)  and s. 96  of the Income Tax Act , it is necessary to determine Parliament’s intention in enacting these provisions by interpreting them purposively, in light of their context.  

41                               The majority of the Federal Court of Appeal in the related case of OSFC interpreted s. 18(13) and s. 96 of the Act in a literal manner at the first stage of its two-part test. It concluded that since s. 18(13)  does not on its face restrict the losses once they are transferred, the losses may be subsequently transferred to an arm’s length taxpayer.  Similarly, it reasoned that the partnership rules in s. 96 of the Act would allow the appellants to claim the losses on the basis that they provide for a distribution of income and losses from the partnership to the partners at the end of the partnership’s fiscal year, without any further restriction.  The Federal Court of Appeal then went on to disallow the benefits under the GAAR at the second stage of its analysis, where it considered the policy of the Act as a whole.

42                               In effect, the majority conducted a narrow textual analysis of the specific provisions at issue, s. 18(13)  and s. 96  (stage 1), and supplemented this by a broad purposive analysis having regard to what it considered to be a policy of the Act as a whole (stage 2).  While it reached the correct result, we reject its two-stage method in favour of a unified textual, contextual and purposive approach to interpretation.  There is an abiding principle of interpretation: to determine the intention of the legislator by considering the text, context and purpose of the provisions at issue.  This applies to the Income Tax Act  and the GAAR as much as to any other legislation.

43                               We add this. While it is useful to consider the three elements of statutory interpretation  separately to ensure each has received its due, they inevitably intertwine.  For example, statutory context involves consideration of the purposes and policy of the provisions examined.  And while factors indicating legislative purpose are usefully examined individually, legislative purpose is at the same time the ultimate issue — what the legislator intended.

5.3.2   The Text of the Provisions

44                               As outlined above, the appellants submit that they are entitled to deduct the losses because of the wording of s. 18(13)  and s. 96 . It is clear that the preservation of the loss under s. 18(13)  is for the benefit of a person or partnership who does not deal  at arm’s length with the transferor.  Since the words of s. 18(13)  do not expressly restrict the ability to claim the loss to the immediate non-arm’s length transferee, the appellants argue that they may use the partnership provisions to claim it.  The Minister, on the other hand, argues that the section addresses a non-arm’s length relationship and an arm’s length taxpayer cannot use the partnership provisions to claim the loss preserved by that section.

45                               On their face, the partnership provisions found in s. 96 of the Act impose no restrictions on loss sharing between partners, except for foreign partnerships under s. 96(8).  Accumulated losses are available to all partners, provided they entered the partnership before the end of the taxation year.  It is agreed that the appellants claimed losses in proportion to their interests in Partnership B.  Nevertheless, a question arises as to whether these provisions can apply in conjunction with s. 18(13)  to allow the appellants to claim losses that originated with the original transferor, STC.

46                               The requirement that a partnership “not deal at arm’s length with the taxpayer” under s. 18(13)  and the partnership rules must be purposively construed in relation to each other and in the context of other provisions of the Income Tax Act  that address the transfer of losses. The task is to determine, in light of the series of transactions, whether to allow the appellants to claim the losses would frustrate or defeat the object, spirit or purpose of the treatment of losses under s. 18(13)  and the partnership rules, notwithstanding that the tax benefit might arise from the application of a literal interpretation of these provisions.

5.3.3   The Context of the Provisions

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.

48                               The question is whether other provisions of the Income Tax Act  shed light on whether Parliament intended s. 18(13)  and s. 96  to be used to preserve an unrealized loss for future sale to an arm’s length party.  The government argues that other provisions of the Act show that the transfer of losses to arm’s length parties is generally against the policy of the Act.  It is allowed only exceptionally in specific circumstances for specific purposes.  The appellants counter that where Parliament wished to prevent the transfer of losses to arm’s length parties, it did so explicitly, and that the absence of explicit prohibitions in s. 18(13)  and s. 96  permits the inference that Parliament intended to allow such transfers.

49                               The Federal Court of Appeal considered other provisions of the Income Tax Act  that address the transfer or sharing of losses between taxpayers.  It properly concluded that the general policy of the Income Tax Act  is to prohibit the transfer of losses between taxpayers, subject to specific exceptions.  It also correctly concluded that under such exceptions, Parliament intended to promote a  particular purpose concerning a distinct relationship between the transferor and the transferee under specifically described circumstances.  However, we note that it cannot be automatically inferred from the general policy against the transfer of losses between taxpayers that s. 18(13)  must be read as preventing the appellants from claiming the losses in this case.  This policy is but one consideration to be taken into account in determining Parliament’s intent with respect to s. 18(13)  and s. 96 .

50                               In summary, the legislative context surrounding s. 18(13)  and s. 96  of the Income Tax Act , while perhaps not in itself conclusive, suggests that Parliament would not likely have intended arm’s length parties to be able to buy losses generated by s. 18(13)  transfers.

5.3.4   The Purpose of Section 18(13)  and Section 96  of the Income Tax Act  and Parliament’s Intent

51                               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.  Although, on its face, s. 96(1)  imposes no restriction on the flow of losses to its partners, except for the treatment of foreign partnerships under s. 96(8), it is implicit that the rules are applied when partners in a partnership carry on a business in common, in a non-arm’s length relationship.

52                               The purpose for the broad treatment of loss sharing between partners is to promote an organizational structure that allows partners to carry on a business in common, in a non-arm’s length relationship.

53                               The purpose of s. 18(13) in particular is to prevent a taxpayer who is in the business of lending money from claiming a loss upon the superficial disposition of a mortgage or similar non-capital property.  This purpose is achieved by confining the loss that would ordinarily be claimed by the transferor to a non-arm’s length transferee.  Where s. 18(13) does not apply, only the transferor may claim the loss on the disposition, which would be consistent with the general policy of the Act against the transfer of losses. 

54                               Under s. 18(13), the loss is generally under the control of the transferor or traceable to the business of the transferor and is preserved because of its special relationship with the transferee partnership.  The section in effect denies the loss to the transferor because it originated and remains in the transferor’s control before and after the transfer.  To allow a new arm’s length partner to buy into the transferee partnership and thus to benefit from the loss would violate the fundamental premise underlying s. 18(13) that the loss is preserved because it essentially remains in the transferor’s control.  It would contradict the main purpose of s. 18(13) and the premise on which it operates.  Section 18(13) allows the preservation and transfer of a loss because of the non-arm’s length relationship between transferor and transferee.  Absent that relationship, there is no reason for the provision to apply.

5.3.5   Conclusion on Interpretation of Section 18(13) and Section 96 of the Act

55                               These observations suggest that the combined effect of s. 18(13) and the partnership provisions do not allow taxpayers to preserve and transfer unrealized losses to arm’s length parties. Section 18(13) relies on the premise that the partners in the transferee partnership pursue a business activity in common other than to transfer the loss and that the partnership and the transferor deal in a non-arm’s length relationship with respect to the property.

5.4    Application

56                               This brings us to the ultimate question of whether the only reasonable conclusion is that the series of transactions on which the appellants rely for the tax benefits they claim results in abusive tax avoidance when s. 18(13)  and s. 96(1)  are interpreted purposively, in the context of the Act as a whole.

57                               As stated at para. 59 of Canada Trustco, a determination of whether there was abusive tax avoidance under s. 245(4)  requires a close examination of the facts in order to determine whether allowing a tax benefit would be within the object, spirit or purpose of the provisions relied upon by the taxpayer.  Although no single factual element is in itself determinative of whether there was abusive tax avoidance, the GAAR may be applied to deny a tax benefit “where the relationships and transactions as expressed in the relevant documentation lack a proper basis relative to the object, spirit or purpose of the provisions that are purported to confer the tax benefit, or where they are wholly dissimilar to the relationships or transactions that are contemplated by the provisions” (Canada Trustco, at para. 60).

58                               We are of the view that to allow the appellants to claim the losses in the present appeal would defeat the purposes of s. 18(13) and the partnership provisions, and that the Minister properly denied the appellants the losses under the GAAR.  Interpreted textually, contextually and purposively, s. 18(13)  and s. 96  do not permit arm’s length parties to purchase the tax losses preserved by s. 18(13) and claim them as their own.  The purpose of s. 18(13) is to transfer a loss to a non-arm’s length party in order to prevent a taxpayer who carries on a business of lending money from realizing a superficial loss.  The purpose for the broad treatment of loss sharing between partners is to promote an organizational structure that allows partners to carry on a business in common, in a non-arm’s length relationship.  Section 18(13) preserves and transfers a loss under the assumption that it will be realized by a taxpayer who does not deal at arm’s length with the transferor.  Parliament could not have intended that the combined effect of the partnership rules and s. 18(13) would preserve and transfer a loss to be realized by a taxpayer who deals at arm’s length with the transferor.    To use these provisions to preserve and sell an unrealized loss to an arm’s length party results in abusive tax avoidance under s. 245(4) .  Such transactions do not fall within the spirit and purpose of s. 18(13)  and s. 96 , properly construed.

59                               The appellants’ submission that nothing in s. 18(13) limits subsequent dispositions of the property to arm’s length parties depends on a literal interpretation of the section and fails to address the main inquiry under the GAAR, which rests on a contextual and purposive interpretation of the provisions at issue.  As discussed above, the text of the provision is open to a competing interpretation offered by the Minister and does not itself resolve the dispute. To do so, we must refer to the purposive construction of the provisions.  The interplay of s. 18(13)  and s. 96  requires us to look at the entire factual context of the series of transactions to determine whether it frustrates the object and spirit of these provisions.

60                               The backdrop to the impugned transactions was the failure of STC, leaving non-performing mortgages in its wake. STC transferred $52 million in unrealized losses to Partnership A in a notionally non-arm’s length transaction.  Partnership A was to serve as a holding tank for the unrealized losses and STC planned from the outset to sell its interest in Partnership A after the application of s. 18(13) so that the losses preserved in Partnership A could be transferred to arm’s length parties through a substitution of partners in Partnership A.  The subsequent transactions involving Partnership B were executed “in contemplation of” the transactions between STC and Partnership A.

61                               By these subsequent transactions, the losses preserved in Partnership A were transferred to Partnership B which sold units to the appellants, who dealt with STC at arm’s length.  The new partnership, Partnership B, was relatively passive.  From its inception, the purpose of Partnership B was simply to realize and allocate the tax losses, without any other significant partnership activity.  Nor are these conclusions negated by the fact that (1) the underlying properties to the mortgages were appraised and sold or written off, (2) the appellants paid substantial amounts in order to acquire their interests in Partnership B, or (3) the appellants sought to minimize their exposure to risk, should the tax losses not be accepted by the authorities.

62                               The abusive nature of the transactions is confirmed by the vacuity and artificiality of the non-arm’s length aspect of the initial relationship between Partnership A and STC.  A purposive interpretation of the interplay between s. 18(13)  and s. 96(1)  indicates that they allow the preservation and sharing of losses on the basis of shared control of the assets in a common business activity.  In this case, the absence of such a basis leads to an inference of abuse.  Neither Partnership A nor Partnership B ever dealt with real property, apart from STC’s original mortgage portfolio.  Nor was STC ever in a partnership relation with either OSFC or any of the appellants, having sold its entire interest to OSFC.  The only reasonable conclusion is that the series of transactions frustrated Parliament’s purpose of confining the transfer of losses such as these to a non-arm’s length partnership.

63                               As discussed in the companion case of Canada Trustco, where the Tax Court  judge has applied the law correctly and made findings and inferences supported by the evidence, an appellate court should not interfere.   Here the Tax Court judge, Dussault J.T.C.C., was obliged to apply the two-step approach mandated by the Federal Court of Appeal in OSFC.  He was also obliged, at the first step, to accept the majority’s conclusion that the avoidance transactions at issue did not violate the spirit and purpose of  s. 18(13).  However,  he went on to state at para. 304 that he preferred the minority view in OSFC that Parliament could not have intended for s. 18(13) to permit the transfer of losses between arm’s length taxpayers.  In the result, had it been open to him, he would have applied the GAAR to disallow the losses on the basis of his interpretation of s. 18(13).  We agree with these conclusions and endorse them.

6.      Conclusion            

64                               We would dismiss the appeal with costs.

Appeal dismissed with costs.

Solicitor for the appellants:  Kim Hansen, Vancouver.

Solicitor for the respondent:  Deputy Attorney General of Canada, Ottawa.