Citation: 2013 TCC 310
Date: 20140328
Docket: 2011-952(IT)G
BETWEEN:
PIÈCES AUTOMOBILES LECAVALIER INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH
TRANSLATION]
AMENDED REASONS FOR JUDGMENT
Bédard J.
[1]
This is a reassessment for
the appellant’s 2002, 2004 and 2005 taxation years. The Minister of National
Revenue (Minister) applied the general anti-avoidance rule (GAAR) found in section 245
of the Income Tax Act, R.S.C. 1985), c. 1 (5th Supp.) (ITA) to
a series of transactions involving the purchase of shares in Greenleaf Canada
Acquisitions Inc. (Greenleaf) by the appellant.
[2]
In December 2002,
3929761 Canada Inc. (which subsequently became the appellant) purchased from
Ford U.S. all of the shares of its subsidiary Greenleaf in consideration of $1 and
the assumption of a debt of $9,742,007 owed by Greenleaf to its parent company,
Ford U.S. The amount of the debt owed by Greenleaf to Ford U.S. had been
previously reduced from $24,369,439 to $9,465,163 by Ford U.S. as it
had injected funds into Greenleaf by subscribing for additional common shares
for a total of $14,843,596 and, on the same day, Greenleaf paid those funds to
Ford U.S. as payment of part of the principal and the interest owing on the debt.
In carrying out those transactions prior to the sale of its subsidiary’s shares,
3929761 Canada Inc. acquired the debt of Ford U.S. for an amount exceeding 80% of
the principal amount of the debt at the time of acquisition. If 3929761 Canada
Inc. had proceeded with the acquisition of the shares and the debt of Greenleaf
without previously reducing the debt, subparagraph 80.01(6)(a)(ii) would
have applied such that the debt would have been characterized as a “specified
obligation”. This specified obligation would then have been considered a parked
obligation under subsection 80.01(7) and the debt forgiveness scheme would have
applied to the transaction under subsection 80.01(8). This would have resulted
in the loss of the various tax consequences with respect to Greenleaf and in the
immediate inclusion of $5,700,000 in the appellant’s income.
[3]
In determining the tax consequences
that are reasonable in the circumstances in accordance with subsection 245(5)
of the ITA, the Minister considered that the appellant had realized a gain of $14,944,275 on
a forgiveness of debt and that this gain had to be subject to the rules under
section 80 of the ITA. The Minister has therefore adjusted the tax consequences
for the appellant for 2012 as follows:
|
Changes made
pursuant to section 80
|
2002 taxation
year
|
|
Reduction of balance of
non-capital losses (subs. 80(3))
|
$414,964
|
|
Reduction with respect to
UCC (subs. 80(5))
|
$2,462,028
|
|
Reduction of CEC (subs.
80(7): ¾ x $71,773 = $53,830)
|
$53,830
|
|
Half of the balance (subs.
80(13): ½ x $11,995,510 = $5,997,755)
|
$5,997,755
|
|
Less deduction allowed at
the appellant’s request: (s. 61.3)
|
($5,997,755)
|
[4]
After making the
changes to the tax consequences with respect to Greenleaf pursuant to section 80
of the ITA, the Minister made certain adjustments to the appellant’s taxable
income for the 2002, 2004 and 2005 taxation years.
Issues
[5]
In order for the GAAR to
apply, the following conditions must be met:
(i) there must be a tax benefit resulting from a transaction or
a series of transactions;
(ii) the transaction must be
an avoidance transaction in the sense that it cannot reasonably be said to have
been undertaken or arranged primarily for a bona fide purpose; and
(iii) the
avoidance transaction from which the tax benefit arises must be abusive in the
sense that it cannot reasonably be concluded that obtaining the tax benefit would be consistent with the object, spirit or purpose of
the provisions relied upon by the taxpayer.
[6]
In this
case, the appellant acknowledges that it obtained a tax benefit. The issue therefore is whether the tax
benefit results from an avoidance transaction or a series of avoidance
transactions, and if so, whether the avoidance transaction or series of
avoidance transactions directly or indirectly results in abuse.
[7]
The appellant submits
that the purchase of the shares of Greenleaf by 3929761 Canada Inc. is not part
of the same series of transactions as the avoidance transactions identified by
the respondent because the transactions in the series were imposed by Ford U.S. The appellant also submits that the avoidance transactions identified by the
respondent were entered into for bona fide purposes, that is to say, the
American tax and economic considerations of Ford U.S. The appellant submits
that the purchase transaction was one in which the vendor had created a structure
without any regard for the tax consequences for the Canadian purchaser. Moreover,
the appellant submits that there was no abusive tax avoidance because the transaction
was not contrary to the object, spirit and purpose of section 80 of the
ITA.
[8]
Pièces Automobiles
Lecavalier was originally a family-owned company of which Roger Fugère Senior
had been the shareholder and director since the early 1980s. His sons,
including Roger Fugère Junior (Mr. Fugère), all played an important role in the
company.
[9]
In 1993, following an
estate freeze, the four children of Roger Fugère Senior became shareholders in
the company. Mr. Fugère was acting at that time as director and chief executive
officer.
[10]
In 1999, Ford U.S., in conjunction with the implementation of a restructuring plan for its operations, purchased a
number of automobile parts recycling centres in North America. On November 1, 2000,
Ford U.S, through its subsidiary Greenleaf, purchased the shares of Gestion
Phirobec Inc., the parent company of Pièces Automobiles Lecavalier, for
approximately $18,600,000. Following the purchase, Mr. Fugère kept his position
of chief executive officer at Pièces Automobiles Lecavalier.
[11]
Over the course of the restructuring
of Ford U.S., Greenleaf acquired several companies operating in the same field.
From January 1 to May 1, 2001, the following companies were amalgamated with Greenleaf
or wound up into Greenleaf: Plazek Auto Recycler Ltd., Cumberland Motor Sales
Ltd., Cumberland Auto Parts Ltd. and Les entreprises Jules Harbec Inc.
[12]
On May 1, 2001,
Pièces Automobiles Lecavalier and Gestion Phirobec Inc. amalgamated and the
company resulting from the merger was thereupon wound up into Greenleaf and
dissolved. Ford U.S. then continued all of its automobile parts recycling
operations in Canada through Greenleaf.
[13]
In April 2002, following
a change of leadership, Ford U.S. took steps to cease its automobile recycling
activities. Mr. Fugère saw this as an opportunity to buy back from Ford U.S. the Quebec division of Greenleaf, which at the time included several amalgamated corporations, including
Pièces Automobiles Lecavalier.
[14]
In September 2002, Ford
U.S. held 13,050,001 common shares of Greenleaf. Greenleaf also owed Ford
U.S. $24,369,439, which amount Ford U.S. had granted as advances.
[15]
According to the testimony
of Mr. Fugère, a first meeting was held between him and the
representatives of Ford U.S. in April 2002. At that meeting, Mr. Fugère purportedly
stated that he only wished to purchase the assets related to the recycling
activities in Quebec. He also purportedly told the representatives of Ford U.S. that he did not wish to acquire the shares of Greenleaf as he was not interested in that
subsidiary’s Ontario assets. Also according to him, Ford U.S. indicated instead at that time its firm intention to divest itself of all its Canadian
activities in that field by selling the shares of Greenleaf. On July 25, 2002,
Mr. Fugère said, he sent Ford U.S. an offer to purchase all of the shares
of Greenleaf and the debt owed Ford U.S. by Greenleaf in consideration of
$7,750,000. The offer was apparently refused by Ford U.S.
[16]
On August 22, 2002,
Mr. Fugère sent Ford U.S. a second offer, again to purchase the shares of Greenleaf
and the debt owed by Greenleaf. The offer contemplated two payment scenarios. According
to Mr. Fugère, those offers were also rejected.
[17]
Around September 23, 2002,
following a number of negotiating sessions, Mr. Fugère and Ford U.S. allegedly agreed on the purchase price for the shares of Greenleaf. The parties reached
an agreement in principle whereby a company to be created, 3929761 Canada Inc.
(which would eventually become the appellant, Pièces Automobiles Lecavalier), would
acquire all of the shares of Greenleaf and the debt of $24,369,439 for $9,742,008.
[18]
Following the agreement
in principle, the following transactions occurred. The transactions were
characterized by the parties as being [Translation] “debt clean-up”:
On October 15, 2002, there was a subscription
by Ford U.S. for 1,000,000 additional common shares of Greenleaf for a paid consideration
of $14,843,596. Ford U.S. now held a total of 14,050,001 shares in Greenleaf.
On October 15, 2002, there was a bank transfer
of $14,944,302 to Ford U.S. as repayment of the advances, which amount consisted
of $12,250,000 in principal and $2,694,301 in interest. At that time,
the total debt balance was reduced from $24,369,439 to $9,465,163.
[19]
On December 2, 2002,
Ford U.S. sold all of the shares of Greenleaf to 3929761 Canada Inc. in consideration
of $1. At the same time, Ford U.S. sold to 3929761 Canada Inc. for a
consideration of $9,742,007 the Greenleaf debt of $9,750,000 that it
held. The total consideration paid for all the shares and the debt was
$9,742,008, being the amount negotiated on or about September 23, 2002.
General anti-avoidance rule (GAAR)
[20]
The analytical
framework that applies to the general anti-avoidance rule found in section 245
of the ITA was set out by the Supreme Court of Canada in Canada Trustco
Mortgage Co. v. Canada and
confirmed in Lipson v. Canada and Copthorne
Holdings v. Canada. Subject to the possible application of the GAAR, taxpayers
are entitled to choose to conduct business or plan their affairs in such a way
as to minimize their tax liability, this being in accordance with the principle
stated in Commissioners of Inland Revenue v. Duke of Westminster.
[21]
The GAAR is a legal mechanism whereby Parliament has
given the courts the unusual task of going behind the words of the legislation
to determine the object, spirit or purpose of the provision or provisions
relied upon by the taxpayer.
It must be remembered, however, that the GAAR is a “provision of last resort”
that may be invoked by the Minister if he believes that the taxpayer’s transactions are
not in accord with the object, spirit, rationale or purpose of the provisions relied
upon and thus thwart them or constitute an abuse thereof.
The existence of a tax benefit
[22]
The first requirement for
the application of the GAAR is that of the existence of a tax benefit. The burden
is usually on the taxpayer to refute the Minister’s assumption of the existence
of such a benefit.
As mentioned earlier, the appellant acknowledges that it obtained a tax benefit,
namely, the retention of tax consequences that would have otherwise been
reduced pursuant to section 80 of the ITA. We must therefore go on to the
second requirement for the application of the GAAR.
Avoidance transaction: legal framework
[23]
The second requirement
for the application of the GAAR, as stated in Trustco, is that
the transaction giving rise to the tax benefit be an avoidance transaction within
the meaning of subsection 245(3) of the ITA:
(3) An avoidance
transaction means any transaction
(a) that, but for this section, would result, directly or indirectly, in
a tax benefit, unless the transaction may reasonably be considered to have been
undertaken or arranged primarily for bona fide
purposes other than to obtain the tax benefit; or
(b) that is part of a series of transactions, which series, but
for this section, would result, directly or indirectly, in a tax benefit,
unless the transaction may reasonably be considered to have been undertaken or
arranged primarily for bona fide purposes other than to obtain the tax
benefit.
[24]
The
function of this requirement is to remove from the ambit of the GAAR
transactions or series of transactions that may reasonably be considered to
have been undertaken or arranged primarily for one or more non-tax purposes. It is up to the taxpayer to refute the
Minister’s claim or challenge the Minister’s factual assumption by showing that
a bona fide non-tax purpose primarily drove the
transaction.
Since the determination of the existence of an avoidance transaction involves a
decision as to the facts, the burden of proof is the
same as in any tax proceeding where the taxpayer disputes the Minister’s
assessment: proof on the balance of probabilities.
[25]
Where, as here, the Minister
assumes that the tax benefit resulted from a series
of transactions rather than a single transaction, it is necessary to (1)
determine if there is a series, which transactions
make up the series, and whether the tax benefit resulted from the series, and (2)
determine if any transaction in the alleged series
constitutes an avoidance transaction. A series
of transactions that results directly or indirectly in a tax benefit will be
characterized as an avoidance transaction, unless each transaction in the series may reasonably be
considered to have been undertaken or arranged primarily for bona fide purposes
other than to obtain the tax benefit. Finally, the
person who undertakes or arranges the avoidance transaction need not be the one
who obtains the tax benefit.
Avoidance transaction: analysis
[26]
The Minister argues that
the two debt clean-up transactions undertaken on October 15, 2002, namely,
the share subscription by Ford U.S. and the use by Greenleaf of the amount of
the subscription to repay part of the debt, are avoidance transactions as they
had no bona
fide purpose and had
only been executed in order to obtain a tax benefit, i.e., the retention
of tax consequences. Together with the sale of the shares, these transactions constitute,
according to the Minister, the series of transactions that resulted in that tax
benefit.
[27]
For its part, the appellant
submits that the purchase of the shares of Greenleaf by 3929761 Canada Inc. was
not part of the same series of transactions as the two debt clean-up transactions
because those two transactions were imposed by Ford U.S., without regard to the
appellant’s motives.
[28]
With respect to the bona fide purpose of the
transactions alleged to have been avoidance transactions, the appellant
submits that they were entered into for reasons specific to Ford U.S. as well
as for U.S. tax reasons. The appellant submits that these were bona fide purposes.
[29]
In Copthorne,
the Supreme Court of Canada confirmed the position taken in Trustco with
respect to the series of transactions concept. That position was itself based
on the majority opinion of the Federal Court of Appeal judges in OSFC. In
the determination of the existence of a series of transactions, the starting point
is to be found in the English common law, under whose definition of a series “each transaction in the series [is] pre-ordained to produce a final result”. Subsection 248(10)
of the ITA broadens this definition by providing that “related transactions” completed
“in contemplation of” or because of the series shall be deemed to form part
of the series:
Series
of transactions
248(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.
[30]
The appellant submits
that the debt clean-up transactions did not form part of the same series of
transactions as the purchase of the shares because they were transactions that had
been unilaterally imposed by Ford U.S. The appellant asserted that the two debt
clean-up transactions, namely, the subscription for shares of the capital stock
and the repayment of the loan, had been imposed by Ford U.S. once the sale price was determined and hence constituted a series that was distinct
from the purchase of the shares of Greenleaf by 3929761 Canada Inc.
[31]
There were, according
to the appellant, two separate series of transactions, each having been
undertaken by different parties. I believe that this is the first time that this
Court has considered the existence of a series of transactions from this
perspective. It is therefore necessary to determine whether the two debt
clean-up transactions, which resulted in the tax benefit, may be viewed as
“related transactions” undertaken because of the purchase of the shares and
thus as constituting a series of transactions.
[32]
The appellant’s
evidence in that regard was essentially based on the testimony of Mr. Fugère
and Mr. Lacombe. Mr. Lacombe is a tax accountant and has been working
for the Fugère family since the early 1990s. The appellant also filed, as Exhibit A‑2, a
two-page document indicating the different stages of the debt clean-up transactions
that had to be completed prior to the purchase of the shares. According to Mr. Fugère’s
testimony, the various transactions shown in that document had been imposed by
Ford U.S., without any possibility of compromise. The document was apparently
sent by fax a few days after the agreement in principle, that is, between September
23 and September 30, 2002. Also, according to those witnesses, the aforementioned
stages of the transactions were never discussed or negotiated between the parties.
[33]
At the outset, I must
admit that the appellant has not satisfied me that Ford U.S. had imposed the debt
clean-up transactions. Even though Messrs. Fugère and Lacombe testified to that
effect, it would have been desirable, even necessary in this case, that a
representative of Ford U.S. testify that Ford U.S had indeed unilaterally structured
the transaction. When asked to comment on the absence of a representative of Ford
U.S. on the stand, counsel for the appellant explained this absence by a lack
of co-operation on the part of Ford U.S.
[34]
Moreover, the document
filed as Exhibit A‑2 is the only documentary evidence that Ford U.S.
had imposed the debt clean-up transactions. While the document may have come
from Ford U.S. and although its introduction in evidence was not challenged, I
consider, for the following reasons, that the probative value of that document is
relatively low. It is an undated, unsigned two-page document allegedly sent by
fax. The document shows a series of transactions and stages presented in a [Translation] “bare-bones” format. I would be surprised
if a company of the reputation and size of Ford U.S. had undertaken a transaction
of more than 9 million dollars and dictated its various stages by faxing to
its future purchaser a two-page document that I would call a [Translation] “draft”. Such a suggestion strikes me as
lacking credibility, especially since the documentary evidence shows that
American and Canadian tax specialists were called upon to work on this complex transaction. Thus, in
light of the evidence submitted at the hearing and having regard to the absence
of certain evidence that should have been produced, I am not satisfied that the
transactions in question were imposed by Ford U.S. as contended by the appellant.
That said, even if the transactions had been imposed by Ford U.S., I believe that the debt clean-up and the purchase of the shares formed part of the same series
of transactions for the reasons that follow. Mr. Fugère testified that 3929761
Canada Inc. had wished, at the beginning of the negotiation process, to acquire
the assets of Greenleaf. However, Ford U.S. allegedly indicated at that point its
firm intention to sell its shares in order to realize its latent capital loss with
respect to the shares. Furthermore, to realize that loss, Mr. Lacombe testified,
Ford U.S. absolutely had to undertake the debt clean-up transactions. This
entire portion of the testimony constitutes hearsay. However, even if I were to
accept this portion of the testimony, I would arrive at the conclusion that
Ford U.S. undertook the debt clean-up transactions in order to be able to
realize its capital loss by selling the shares of Greenleaf to 3929761 Canada
Inc. Ford U.S. wanted to sell its shares in order to realize its latent capital
loss, which would only have been available if the debt clean-up had been
carried out. Thus, had Ford U.S. not performed the debt clean-up, it would not
have been able to benefit from its capital loss. In such a situation, it would
have been a matter of indifference to Ford U.S. whether it was the shares or the
assets of its subsidiary that were sold. Can it therefore be said that the debt
clean-up transactions, which resulted in the tax benefit, may be considered
“related transactions” undertaken because of the purchase by 3929761 Canada
Inc. of the shares of Greenleaf? It seems to me that the answer is obvious.
[35]
To conclude on this point,
I am of the view that the debt clean-up transactions and the sale of the shares
of Greenleaf formed part of the same series of transactions, on the one hand because
the debt clean-up had been carried out because of the purchase of the shares
and on the other hand because I am not satisfied that the clean-up transactions
were imposed by Ford U.S.
Whether any transaction
in the alleged series constitutes an avoidance transaction
[36]
The
determination of whether a transaction is undertaken primarily for a non‑tax
purpose must
be made objectively on the basis of all of the evidence available to the court. At this stage, the burden of proof is still on the taxpayer, who must
prove the existence of a bona
fide non-tax purpose.
[37]
As the Supreme Court stated
in Trustco, the Tax Court of Canada judge must weigh
the evidence to determine whether it is reasonable to conclude that the
transaction was not undertaken or arranged primarily for a non-tax purpose.
Thus the possibility of different interpretations of
the events must be objectively considered.
[38]
If at least one of the transactions
forming part of the series of transactions constitutes an avoidance transaction,
then the tax
benefit that results from the series may be denied under the GAAR. Conversely, if each transaction in the series was undertaken primarily for bona
fide non-tax purposes, the GAAR cannot be applied to deny the
resulting tax benefit. Finally, I note that there may be a tax motive behind a
transaction without it necessarily being inferred that the tax motive is the primary reason for the transaction.
[39]
The appellant submits
that the debt clean-up transactions were entered into for reasons specific to Ford
U.S. as well as for U.S. tax reasons. The appellant submits that those are bona fide purposes.
[40]
The respondent submits
that the subscription for additional shares by Ford U.S. and the use by Greenleaf
of the subscription amount to repay part of the debt owed to Ford U.S. constitute
avoidance transactions as they had no bona fide purpose.
Also according to the respondent, the sole purpose of these transactions was to
preserve the tax consequences with respect to Greenleaf by preventing the application
of the debt forgiveness rules of sections 80 and 80.01 of the ITA.
[41]
From a reading of paragraph 245(3)(b)
and the definition of “tax benefit” in subsection 245(1), I note that [Translation] “purely American” tax motivations are in
themselves bona fide purposes. Indeed, although obtaining a tax benefit is
not considered a bona fide purpose, the definition of tax benefit refers to
the “reduction, avoidance or deferral of tax . . . payable under this Act”, which
is a specific reference to the ITA:
245(1)
“tax
benefit” means a reduction, avoidance or deferral of tax or other amount
payable under this Act or an increase in a refund of tax or other amount
under this Act, and includes a reduction, avoidance or deferral of tax or other
amount that would be payable under this Act but for a tax treaty or an increase
in a refund of tax or other amount under this Act as a result of a tax treaty.
245
(3) An avoidance transaction means any transaction
.
. .
(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.
(Emphasis added.)
[42]
Thus, if it is reasonable
to consider that the transaction was undertaken
primarily for bona fide purposes, being in this case American tax
motivations and reasons specific to Ford U.S., the debt clean-up transactions cannot
be characterized as avoidance transactions.
[43]
The evidence submitted
by the appellant on this issue consisted essentially of the testimony of Mr. Lacombe
and Brian Nerney. Mr. Lacombe testified that the debt clean-up
transactions had been imposed by Ford U.S. for U.S. accounting and tax reasons and
so that Ford U.S. could benefit from its capital loss when it disposed of the Greenleaf
shares. Mr. Lacombe is a Canadian tax accountant. He was not designated by
the Court as an expert on Canadian tax, much less as an expert on U.S. tax. Furthermore, having him so recognized does not appear to have been contemplated
by counsel for the appellant. With respect, I cannot accept that part of his
testimony pertaining to the U.S. tax consequences for Ford U.S. The appellant could have and should have called as a witness an expert on American tax in order
to present the various impacts of the debt clean-up transactions. Moreover, Mr. Lacombe
admitted to turning to a Canadian tax professional specializing in U.S. taxation to provide him with information in that regard. However, the appellant did
not think it useful to call that person as a witness, stating that it was a
matter of cost. The Court has no judicial knowledge of the law of the United States and is not required to make findings with respect to its application to certain
transactions in a Canadian context. Accordingly, I cannot accept this aspect of
Mr. Lacombe’s testimony.
[44]
Brian Nerney was subpoenaed
by the appellant to testify about his role in similar transactions which had occurred
in the United States. More specifically, he had apparently been a director and
shareholder of Greenleaf U.S., an automobile recycling company purchased by
Ford U.S. during the restructuring of its operations.
[45]
Essentially, his
testimony was that Ford U.S. had imposed on him a transaction similar to that
which is in question here. According to him, the transaction was so structured
for the sole purpose of enabling Ford U.S. to benefit from a latent capital
loss on the sale of the shares, as the extinguishing of a debt between parties not
at arm’s length prevented the loss from being realized.
[46]
It is important to note
that Mr. Nerney was not qualified as an expert witness. His testimony is
hearsay and, while it is interesting, its probative value is still very limited.
[47]
The appellant did not
think it useful or was unable to have a representative of Ford U.S. testify concerning
the internal reasons that would have led Ford U.S. to structure the debt clean-up
transactions as it did. Nor did the appellant deem it useful to call an expert in
U.S. law to inform the Court regarding the U.S. tax consequences of those
transactions. The respondent is asking me to draw a negative inference from this,
which I am willing to do for the reasons set out hereunder.
[48]
In civil matters, the
general rule respecting adverse inferences from the failure to call a witness
goes back to Blatch v. Archer,
a decision in which, at page 65, Lord Mansfield stated the following:
It
is certainly a maxim that all evidence is to be weighed according to the proof
which it was in the power of the one side to have produced, and in the power of
the other to have contradicted.
[49]
And in The Law of
Evidence in Civil Cases (John Sopinka and Sidney N. Lederman, Toronto.
Butterworths, 1974), the authors explain at pages 535-36:
The application of this maxim has led to a well-recognized
rule that the failure of a party or a witness to give evidence, which it was
in the power of the party or witness to give and by which the facts might have
been elucidated, justifies the court in drawing the inference that the evidence
of the party or witness would have been unfavourable to the party to whom
the failure was attributed.
(Emphasis added.)
[50]
This principle was reiterated
by the Supreme Court of Canada in 1970 in Lévesque v. Comeau:
This is not all. Appellant Lola Levesque's expert examined
her for the first time more than a year after the accident, and after she had
consulted several doctors and undergone different examinations in the meantime.
She alone could bring before the Court the evidence of those facts and she
failed to do it. In my opinion, the rule to be applied in such circumstances is
that a Court must presume that such evidence would adversely affect her case.
The fact that those witnesses all live in Montreal does not make the rule any
less applicable. Appellant Lola Levesque should, if necessary, have applied for
a rogatory commission. Under the circumstances, her testimony and that of her
husband respecting her good state of health before the accident could properly
be considered insufficient evidence for the purpose of excluding the other
possible causes of the deafness.
(Emphasis added.)
[51]
This excerpt from Lévesque
v. Comeau has often been accompanied, in recent case law, by the
following comments of James H. Chadbourn, ed., Wigmore on Evidence, vol. 2
(Boston: Little, Brown & Company, 1979), at page 192:
. . . The failure to bring before the tribunal some
circumstance, document, or witness, when either the party himself or his
opponent claims that the facts would thereby be elucidated, serves to indicate,
as the most natural inference, that the party fears to do so; and this fear is
some evidence that the circumstance or document or witness, if brought, would
have exposed facts unfavorable to the party. These
inferences, to be sure, cannot fairly be made except upon certain conditions;
and they are also open always to explanation by circumstances which make some
other hypothesis a more natural one than the party’s fear of exposure. But the
propriety of such an inference in general is not doubted.
(Emphasis added.)
[52]
The Supreme Court recently
reminded us of this principle in R. v. Jolivet.
Although this is a criminal law judgment, the Court made some interesting remarks
regarding the application of this principle in civil matters. For instance, the
party against whom the adverse inference is sought may provide a satisfactory
explanation of the reasons for the failure to call the
witness.
The Court further noted that one must be precise
about the exact nature of the adverse inference sought to be drawn. Quoting
Sopinka,
the Court points out that the failure to call
evidence may, depending on the circumstances, amount “to an implied admission that the evidence of the absent
witness would be contrary to the party’s case, or at least would not support it.”
[53]
Again in Jolivet, the
Supreme Court also states that the circumstances in
which trial counsel decides not to call a particular witness may restrict the
nature of the appropriate adverse inference. For example, one may decide
against calling a witness because the point has been
adequately covered by another witness, or because an honest witness may have a
poor demeanour, or on account of other factors unrelated to the truth of the
testimony.
[54]
In Downey
v. Canada,
the appellant was party to a sale between persons not at arm’s length and had
to show that unrelated parties would have concluded the transaction at a
similar price. The Tax Court Judge determined that the appellant had failed to
provide sufficient evidence to refute the Minister’s assumptions: he did not call
the co-contractor as a witness to provide evidence on the circumstances of the transaction
and the determination of the price. That decision was affirmed by the Federal Court
of Appeal.
[55]
In Teelucksingh
v. Canada,
at paragraph 81, Justice Miller stated that, for a negative inference to be drawn,
there must be a vacuum in the evidence.
[56]
In order to
draw a negative inference with respect to the absence of a witness, the trial judge
must first be dissatisfied with the evidence before the court or, at least, have
a real doubt as to its content. Where the trial judge has misgivings or
expresses some doubt regarding the evidence and where the only person able to provide
additional evidence or to corroborate that already submitted does not testify, a
negative inference may be drawn from that absence
unless it can be explained by plausible and credible circumstances. In that regard,
the judge must consider whether the circumstances that led trial counsel not to call a particular witness may restrict the nature of the
appropriate adverse inference.
[57]
In the present appeal, the
appellant is attempting to show that the debt clean-up transactions were
imposed by Ford U.S. for its own U.S. tax and U.S. financial purposes. The appellant’s
evidence to that end is based on the testimony of Mr. Fugère and Mr. Lacombe.
Their testimony is self-serving and constitutes to a great extent hearsay. Some
aspects of it are also dubious or implausible in light of the facts. In
addition, the appellant submitted inadequate documentary evidence to which no great
probative value can be given. Thus, there was clearly a vacuum in the evidence.
[58]
Only a representative
of Ford U.S. would have been able to corroborate the testimony of Mr. Fugère
and Mr. Lacombe. The appellant submits that, owing to the lack of cooperation
by Ford U.S., the Court was unable to have the benefit of the testimony of such
a representative. As stated by Justice Archambault in Morley, the Act
and rules of practice provide for various means to ensure the attendance of a
witness at the hearing.
[59]
In addition, the appellant
did not find it necessary to call an expert who could have enlightened the
Court as to the U.S. tax consequences the debt clean-up transactions would have
had, which consequences could have constituted bona fide purposes. Counsel
for the appellant stated that the cost involved was what led to the decision
not to call such a witness. I note, however, that the appellant had Mr. Nerney
come from Texas to testify for about five minutes in total on subjects that
were on their very face hearsay and which were of no assistance to the Court.
[60]
Evidence of the terms
and conditions of the sale was essential if the appellant wished to meet its
burden with respect to the existence of avoidance transactions. Considering as
well that it was the appellant that had the burden of disproving the existence
of such a transaction, I have no hesitation in drawing a negative inference from
the absence of testimony by a representative of Ford U.S. The importance of such testimony and the absence of explanations and justifications
that would have been credible in the circumstances support that inference.
Finding on
the series of
avoidance transactions
[61]
In conclusion, since the
determination whether a transaction was undertaken
primarily for a non-tax purpose is to be made objectively in light of all of
the evidence presented to the Court, I am of the view that the appellant
has failed to establish on a balance of probabilities
that the debt clean-up
transactions had been undertaken primarily for
non-tax purposes.
[62]
It is clear that the transactions
had tax purposes. The appellant, however, had the burden of proving that there
were non-tax purposes, and that the transactions
had been undertaken primarily for those purposes. That was not done. U.S. tax considerations and internal considerations, whether accounting, economic or
otherwise, can in some cases constitute bona fide non-tax purposes. Here, the evidence does not
enable me to draw that conclusion. Accordingly, I find that both debt clean-up
transactions constituted avoidance transactions which resulted in a tax benefit,
namely, the preservation of tax consequences.
[63]
Before moving on to the
third stage of the analysis, I would like to make the following comments. The appellant
repeatedly claimed that the tax aspects of the transaction were never considered
until Ford U.S. sent the document describing the transactions to be undertaken.
Mr. Fugère and Mr. Lacombe both testified that it was only when the
transactions were imposed by Ford U.S., around September 30, 2002, that
they asked themselves about the tax consequences of the purchase of the shares
and the debt. It is unclear from the evidence submitted whether that argument was
in relation to the existence of a series of transactions or whether it related
to the avoidance transactions per se. In light of the analysis conducted in the
preceding paragraphs, it is not necessary for me to entertain such an argument.
I have already found that there was a series of transactions that included two
avoidance transactions. Nevertheless, since the appellant has stressed this aspect,
I believe it is important to address this part of its argument.
[64]
Mr. Fugère and Mr. Lacombe
testified that the negotiations pertaining to the purchase of the shares of Greenleaf
by 3929761 Canada Inc. had begun in March 2002. According to their testimony, it
was not until the end of September 2002, when Ford U.S. sent the document imposing
the various transactions, that they considered the tax consequences of the
purchase. I understand from their testimony that a period of approximately six months
had elapsed between the start of the negotiations and the implementation of the
transaction structure and that, prior to that, the tax aspects of the transaction
had never been considered. While the testimony of Mr. Fugère and Mr. Lacombe
were consistent, they failed to persuade me.
[65]
Mr. Lacombe is an
experienced tax accountant. He is a consultant and has been a close advisor to the
Fugère family since the early 1990s. He explained at length his various coaching
roles in the estate freeze relating to Pièces Automobiles Lecavalier, in the
sale to Ford in 1999 and in the purchase at issue here. At all stages of the
transaction that led to the purchase of the shares of Greenleaf, he was Mr.
Fugère’s advisor.
[66]
Mr. Lacombe was
aware of the existence of the $24,000,000 debt owed by Greenleaf to Ford U.S., as he had had access to the internal financial statements of Greenleaf. Although he
claimed he was unaware of the nature of the debt, it seems unlikely to me that
an experienced tax specialist would not automatically have thought to seek further
information when he knew that 3929761 Canada Inc. was going to acquire the
shares and debt of Greenleaf for $9,750,000. It seems to me that such a situation
would have raised the alarm with any tax specialist with regard to the
application of the debt forgiveness rules in sections 80 and 80.01 of the ITA.
[67]
In conclusion, the appellant
did not persuade me that the tax consequences were never considered prior to
receiving the fax indicating the transactions that were to follow. It seems to me
that the tax consequences were too significant and contemporary for no one to
be concerned about them. If the transaction had been undertaken in the manner
suggested in the final letter of offer, there would have been an inclusion in
the appellant’s income of $5,700,000 in addition to the loss of the tax
consequences. By proceeding with the debt clean-up, that possibility was avoided.
From a purely Canadian perspective, neither way of proceeding had any impact on
Ford U.S. However, for the appellant, there was a very real and immediate
problem. Although this analysis is not essential to the determination at the
second stage, I believe that it confirms my findings as to the existence of a
series of transactions and the absence of bona fide purposes with
respect to the debt clean-up transactions.
Abusive tax avoidance
[68]
The GAAR can only be applied to deny a tax benefit where the Court
finds that the abusive nature of the transaction is clear. Subsection
245(4) of the ITA states as follows:
245(4)
Subsection (2) applies to a transaction only if it may
reasonably be considered that the transaction
(a)
would, if this Act were read without reference to this section, result directly
or indirectly in a misuse of the provisions of any one or more of
(i)
this Act,
(ii)
the Income Tax Regulations,
(iii)
the Income Tax Application Rules,
(iv)
a tax treaty, or
(v)
any other enactment that is relevant in computing
tax or any other amount payable by or refundable to a person under this Act or
in determining any amount that is relevant for the purposes of that
computation; or
(b) would result directly or indirectly in an abuse
having regard to those provisions, other than this section, read as a whole.
[69]
In order to
determine whether a transaction is an abuse or misuse of the Act, a court must
first determine “the object, spirit or purpose of the provisions [of the ITA] that are
relied on for the tax benefit, having regard to the scheme of the Act, the
relevant provisions and permissible extrinsic aids.” The object, spirit or purpose can be identified by taking a
unified textual, contextual and purposive approach to statutory interpretation.
[70]
Second, a
court must consider whether the transaction falls within or frustrates the
identified purpose. As
stated by Justice LeBel in Lipson, at paragraph 34, the abusive nature of a transaction that is part of a
series will only become apparent in the context of that series and of the
overall result that is achieved. Thus, where it
is part of a series, the transaction must be
considered in the context of the series in order for a determination to be made
as to whether abusive tax avoidance has occurred.
[71]
The Court must find abusive tax avoidance in one of the following three circumstances:
(1) where the transaction achieves an outcome
the statutory provision was intended to prevent; (2) where the transaction defeats the underlying rationale of
the provision; or (3) where the
transaction circumvents the provision in a manner that frustrates or defeats
its object, spirit or purpose.
It is possible that these considerations may overlap as they are not independent of one another. The Minister must clearly demonstrate that the avoidance transaction is an
abuse of the Act, and the benefit of the doubt is given to the taxpayer.
[72]
The respondent submits
that the avoidance transactions frustrated and circumvented the object, spirit and purpose of section 80 of the
ITA in general. The respondent contends that, when a debtor benefits from a
forgiveness of debt, it is the equivalent of income as there is an increase in the
debtor’s net worth. In other words, the debtor’s economic power is increased by
the amount of the forgiven debt. Moreover, where its debt is extinguished and
the debtor has deducted expenses from its income, the expenses so deducted did
not, in theory, cost the debtor anything.
[73]
The respondent submits
that, if the debt had not been forgiven in part through the injection of capital
and the subsequent repayment just before the sale, the debt parking rules would
have applied. In other words, had the shares been sold for $9,750,000 when
Greenleaf’s debt was more than $24,000,000, section 80.01 of the ITA with
respect to debt parking would have applied and a forgiveness of debt would have
been deemed to have taken place.
[74]
Finally, the respondent
submits that paragraph 80(2)(g) of the ITA sets out the scheme that
is applicable when shares of the capital stock of a corporation are issued as consideration
for the settlement of a debt. According to the respondent, that is a provision which
establishes an automatically applicable mechanism whereby the amount paid in satisfaction
of the debt is deemed to be equal to the fair market value (FMV) of the shares.
According to the respondent, the object of paragraph 80(2)(g) of the
ITA is to have section 80 of the ITA apply where a debt is converted to
equity and the shares thus issued have a fair market value that is less than
the principal amount of the debt. Thus, in the case of an exchange of a debt
for shares that are worth nothing or that have a lower fair market value, the
debt forgiveness rules must be applied.
[75]
For its part, the appellant
submits that sections 80 et seq. of the ITA are series of very clear rules,
and that, since these rules are detailed and comprehensive, it is difficult to demonstrate
the existence of an underlying policy that would go beyond what the legislation
already provides.
[76]
The appellant also submits
that there are two aspects to the tax policy underlying the section 80 scheme in
the ITA. On the one hand, there is the increase in the debtor’s economic power
which results from the debt forgiveness, and on the other hand, there is the deduction
by the creditor of the loss on the bad debt. Thus, according to the appellant,
since there was no deduction of the bad debt loss of Ford U.S. following the debt forgiveness, there was no abuse of the spirit, object
and purpose of the ITA.
[77]
Finally, the appellant states
that by undertaking the debt clean-up transactions, Ford U.S. simply put itself in the same situation it would have been in had it decided to capitalize its
interest in Greenleaf rather than resorting to a combination of loans and shares.
In that sense, there could not have been any abuse.
[78]
It should be noted that
the appellant did not make any submissions on the object,
spirit and purpose of paragraph 80(2)(g) of the ITA or
section 80.01 of the ITA.
Textual, contextual and purposive analysis
[79]
The three provisions of
the ITA which were abused or misused according
to the respondent are sections 80 and 80.01 in general and paragraph 80(2)(g).
The object,
spirit and purpose of the section 80 scheme
The wording of the section 80 scheme
[80]
Where an assessment is
issued on the basis of the GAAR, the text of the provision that generates the tax
benefit will not specifically preclude that benefit.
If the tax benefit was prohibited by the text, on
reassessing the taxpayer, the Minister would only have to rely on the
text and the GAAR would become superfluous. However, this does not mean that
the text is irrelevant. In a GAAR assessment the text
is considered to see if it sheds light on what the provision was intended to
do.
[81]
Sections 80 to 80.04 of
the ITA set out a complex scheme of rules that apply where a commercial
obligation
is settled or extinguished for an amount less than the lesser of the amount of
the principal or the amount for which the obligation was issued.
Essentially, this scheme provides that the amount that the debtor will not have
to repay (the forgiven amount) will reduce some of that debtor’s balances and tax
consequences.
[82]
Rather than reproduce those
provisions in detail (they take up about twenty pages in the ITA), I will first
set out their structure. I will then analyze in more detail the relevant provisions
referred to by the parties.
I.
Subsection
80(1) provides definitions that apply to section 80. The fundamental concepts
are those of “forgiven amount” and “commercial obligation”.
II.
Subsection
80(2) states the set of rules that apply where there is debt forgiveness. It
addresses, for instance, obligations that are settled or extinguished otherwise
than by way of a bequest or inheritance,
or debts extinguished as consideration for shares. It also deals with the order
in which the subsequent subsections apply,
and the order in which obligations settled at the same time are treated as
having been settled.
III.
Subsections
80(3) to (18) form the substance of the rules that apply when there is debt
forgiveness. Essentially, those subsections specify to what extent and in what
order the “forgiven amount” will apply to reduce the debtor’s various tax
consequences and balances. As for subsection 80(13), it provides for the inclusion
of the balance when the forgiven amount is greater than the reduced tax
accounts.
IV.
Section
80.01 sets out, among other things, the rules that apply to debt parking and
the circumstances in which they apply.
V.
Section
80.02 sets out special rules that apply when a debtor issues distress preferred
shares.
VI.
Section
80.03 states the circumstances under which a capital gain may be realized
following the application of subsections 80(9), (10) or (11).
VII.
Section
80.04 sets out the terms and conditions under which a debtor may transfer the
unused fraction of a forgiven amount to an eligible corporation or eligible
partnership.
[83]
As noted above, section
80 sets out the tax consequences for a debtor whose commercial obligation has
been forgiven. Subsection 80(1) of the ITA provides the following definitions
of “commercial obligation”, “commercial debt obligation” and
“forgiven amount”:
S. 80(1) “commercial obligation” issued by a debtor means
(a)
a commercial debt obligation issued by the debtor, or
(b)
a distress preferred share issued by the debtor;
S. 80(1) “commercial debt obligation” issued
by a debtor means a debt obligation issued by the debtor
(a) where interest was paid or
payable by the debtor in respect of it pursuant to a legal obligation, or
(b) if interest had been paid
or payable by the debtor in respect of it pursuant to a legal obligation,
an amount
in respect of the interest was or would have been deductible in computing the
debtor’s income, taxable income or taxable income earned in Canada, as the case
may be, if this Act were read without reference to subsections 15.1(2) and
15.2(2), paragraph 18(1)(g),
subsections 18(2), (3.1) and (4) and section 21;
S. 80(1) “forgiven amount” at any time in respect of a
commercial obligation issued by a debtor is the amount determined by the
formula
A – B
where
A
is the lesser of the amount for which the
obligation was issued and the principal amount of the obligation, and
B
is the total of
(a) the amount, if any, paid at
that time in satisfaction of the principal amount of the obligation,
(b) the
amount, if any, included under paragraph 6(1)(a) or subsection 15(1) in computing the income
of any person because of the settlement of the obligation at that time,
(c) the amount, if any,
deducted at that time under paragraph 18(9.3)(f) in computing the forgiven amount in respect
of the obligation,
(d) the capital gain, if any,
of the debtor resulting from the application of subsection 39(3) to the
purchase at that time of the obligation by the debtor,
(e) such portion of the
principal amount of the obligation as relates to an amount renounced under
subsection 66(10), (10.1), (10.2) or (10.3) by the debtor,
(f) any portion of the
principal amount of the obligation that is included in the amount determined
for A, B, C or D in subsection 79(3) in respect of the debtor for the taxation
year of the debtor that includes that time or for a preceding taxation year,
(g) the total of all amounts
each of which is a forgiven amount at a previous time that the obligation was deemed
by subsection 80.01(8) or (9) to have been settled,
(h) such portion of the
principal amount of the obligation as can reasonably be considered to have been
included under section 80.4 in computing the debtor’s income for a taxation
year that includes that time or for a preceding taxation year,
(i) where the debtor is a
bankrupt at that time, the principal amount of the obligation,
(j) such portion of the
principal amount of the obligation as represents the principal amount of an
excluded obligation,
(k) where the debtor is a
partnership and the obligation was, since the later of the creation of the
partnership or the issue of the obligation, always payable to a member of the
partnership actively engaged, on a regular, continuous and substantial basis,
in those activities of the partnership that are other than the financing of the
partnership business, the principal amount of the obligation, and
(l) the amount, if any, given
at or before that time by the debtor to another person as consideration for the
assumption by the other person of the obligation.
[84]
Under the section 80 scheme
in the ITA, a debtor realizes a gain on the settlement of a debt when an amount
has been forgiven by the debtor’s creditor. The forgiven amount then reduces, pursuant
to subsections 80(3) to 80(7) of the ITA, the following tax consequences:
•
Non-capital
losses;
•
Capital
losses;
•
Balance
of the various UCCs;
•
Balance
of the CEC.
[85]
Then, pursuant to
subsections 80(8) to 80(12) of the ITA, the remaining unapplied portion of the
forgiven amount reduces, in the following order:
•
Certain
resource expenditures;
•
The adjusted
cost bases of certain capital properties;
•
The
adjusted cost bases of certain shares and debts;
•
The adjusted cost bases of
certain shares, debts and partnership interests;
•
Current
year capital losses.
[86]
If there is still a
balance, the amount referred to in subsection 80(13) of the ITA must be included
in the debtor’s income, subject to a possible balance transfer to a corporation
related to the debtor under section 80.04 of the ITA.
Context of the section 80 scheme
[87]
The
consideration of the context of
sections 80 et seq. involves an examination of other
sections of the ITA, as well as of permissible extrinsic aids. The
appellant submits that the provisions allowing a creditor to avail itself of a
deduction for bad debt must be read as being part of the context of section 80 of the ITA.
Thus, according to the appellant, the object, spirit and purpose of section 80 of the ITA would be twofold in the sense
that they would include both the enrichment of the debtor and the deduction by
the creditor of the forgiven debt.
[88]
For the debtor, a gain on
the settlement of a debt would be “current” or “capital” in nature depending on
whether the debt is of a “capital” nature or is related to the taxpayer’s
day-to-day transactions. When the forgiven debt is “current” in nature and the basic
rules for computing profits require that an amount be included in computing income for the taxation year under section 9
of the ITA, section 80 of the ITA will not apply. Only
when the debt is of a “capital” nature will its forgiveness result in the application
of section 80 of the ITA for the debtor.
[89]
Similarly, the tax treatment
of a bad debt for the creditor will follow the same logic. If the debt is of a
current nature, the creditor will, in certain very specific circumstances, be
able to deduct it from income pursuant to paragraph 20(1)(p) of the
ITA. However, if the debt is of a capital nature, the creditor will also, under
certain terms and conditions, be able to deduct it from income under section 39
or section 50 of the ITA, subject to subparagraph 40(2)(g)(ii) of
the ITA.
[90]
The sections allowing a
creditor to deduct his or her loss on a debt are found either in Subdivision b
(Income or Loss from a Business or Property) or in Subdivision c (Taxable Capital
Gains and Allowable Capital Losses). As for section 80 of the ITA, it is
found in Subdivision f (Rules Relating to Computation of Income).
[91]
The sections allowing a
creditor to deduct a bad debt apply in very specific situations; they apply
independently and in a much broader context than that in which section 80 of
the ITA applies. Furthermore, the scheme presented by section 80 of the
ITA sets out, independently, the consequences for a debtor of the forgiveness
of a commercial obligation. In my view, there is no symmetry between the two
schemes. Paragraph 20(1)(p), section 50 and subsection 39(1) of the ITA specify
how creditors can deduct a bad debt in certain instances (including cases in
which there is debt forgiveness). Thus, it is possible that a given legal situation
will result in the simultaneous application of both schemes. I do not believe,
however, that the aforementioned provisions and the principles flowing
therefrom are part of the context, spirit and purpose of section 80 of the ITA.
Purpose of the section 80 scheme
[92]
This last step of the
analysis advocated by the Supreme Court seeks to
ascertain what outcome Parliament intended a provision or provisions to achieve,
amidst the myriad of purposes promoted by the Act. Prior
to tax reform in 1972, gains on debt forgiveness were not taxed because they
were considered as gains of a capital nature. It is in the Report of the Royal
Commission on Taxation (Carter Report) that the recommendations which formed
the basis of the introduction of the debt forgiveness rules in section 80
of the ITA can be found.
[93]
At pages 528-29 of
volume 3 of the Report, the Commission wrote as follows:
We believe that when a debt
is cancelled the debtor has, in effect, received income. For, as the
cancellation of liabilities increases a person's net assets, his economic power
is increased by the amount of the debt cancelled. Where a debtor who is in
business has one or more of his debts cancelled, he has claimed expenses or has
recorded assets which in fact will have cost him nothing. Income in prior years
has, therefore, been understated, and it appears only reasonable to require an
offsetting adjustment in the current year. Because such an adjustment will
usually only arise when there is a loss, it will serve to reduce the loss
rather than to create taxable income.
[94]
In terms of the symmetry
between the scheme applicable to a debtor and that applicable to a creditor, the
Commission wrote as follows at page 529:
We are not recommending that
the borrower should necessarily be considered to have received income at the
time the lender merely writes off all or some portion of the debt. Although to
regard income as arising to one party at the time the expense was recorded by
the other party has the virtue of consistency, such treatment would not be
practical in this case, and in fact may not be theoretically correct, because
the borrower might still regard his obligation as a liability that he intended
to meet.
[95]
Following the
establishment of the debt forgiveness scheme, substantial changes were
introduced in sections 80 et seq. of the ITA. According to the Supplementary
Information and Notices of Ways and Means Motions on the Budget of February
22, 1994,
the budget proposed a number of changes to the debt settlement rules. Those
changes pertained, for instance, to the inclusion in income of the undeducted parked
amount balance, to the debt parking rules or to distress preferred shares.
[96]
It is only in the
preamble to the “Debt Forgiveness and Foreclosures” section of that document,
at page 36, that reference is made to the creditor:
The rationale for section 80 is that debt enables a debtor
to acquire property or make expenditures that give rise to deductions in
computing income. To the extent that debt is forgiven, the cost of the
expenditures has not been borne by the debtor and should therefore not be
recognized for tax purposes. Moreover, given that creditors are generally
able for income tax purposes to recognize losses arising from lending funds
that are not repaid, it is reasonable that corresponding gains to debtors be
recognized for income tax purposes.
(Emphasis added.)
[97]
In the Explanatory
Notes to Draft Legislation on Debt Forgiveness and Foreclosures, there
is no reference to symmetry of the schemes. The Explanatory Notes of February
1995
that followed the passage of the bill are also silent on this issue.
[98]
The Explanatory Notes
of 2012 relating to sections 80-80.04
read as follows:
Sections 80 to 80.04 of the Act set out the rules that
apply when an obligation is settled or extinguished for less than its principal
amount or the amount for which it was issued. When such a commercial debt
obligation is settled or extinguished, it gives rise to a “forgiven amount” as
defined in subsection 80(1). A forgiven amount in respect of a commercial debt
obligation issued by a debtor is required to be applied against certain tax
pools of the debtor, in a specified order, as provided in subsections 80(3) to
(12). In general, subsection 80(13) requires that one half of any
remaining unapplied portion of the forgiven amount be included in computing the
debtor’s income, unless it can be transferred to another taxpayer under section
80.04.
The judicial treatment of section 80
[99]
In Carma Developers
Ltd. v. Canada,
at paragraph 23, Judge Bowman, as he then was, stated with respect to
section 80 of the ITA:
. . . The effect of section 80 is to ascribe certain
specific tax consequences to a formal and binding forgiveness or reduction of
debt. . . . It is presumably based on the rather
sensible assumption that business indebtedness is incurred to pay expenses laid
out in the computation of losses or to pay for depreciable or other property
used in the business and when those debts are forgiven or reduced this fact
should be reflected in some manner in the computation of income or taxable
income by the reduction of such losses or the cost of capital properties. . . .
[100]
In Jabin Investments
Ltd v. Canada,
the Federal Court of Appeal confirmed the findings of the trial judge with
respect to the application of the GAAR in section 80 of the ITA in a
context where the debt was not legally extinguished. The Court states at
paragraph 4 that it is not satisfied that there
is a clear and unambiguous policy that debts that are not legally extinguished
are to be treated as if they were. The Court upholds, however, the trial
judge’s conclusion that the “the policy intended by
Parliament was to impose tax consequences [only] where a debt was legally extinguished”.
Although that judgment only deals with whether a debt was legally extinguished
or not, it is relevant insofar as there is recognition that the scheme set out
in section 80 of the ITA may have one or more underlying policies that extend
beyond that of taxing debtors on income each time a debt is forgiven them.
Conclusion on the object, spirit and
purpose of the section 80 scheme in the ITA
[101]
As stated above, the
appellant submits that the object, spirit and purpose of the scheme set out in
section 80 et seq. of the ITA is twofold. On the one hand, there is the
reduction in the tax consequences and the inclusion of the economic gain by the
debtor and, on the other hand, there is the deduction of the loss on the bad
debt by the creditor. With respect, the analysis does not allow me to arrive at
such a conclusion.
[102]
The textual, contextual
and purposive analysis shows a scheme which applies only to debtors of a
settled or extinguished debt whose amount is less than the lesser of the
principal amount and the amount for which the
obligation was issued. The appellant’s position on the duality of the
object, spirit and purpose is primarily based on the supplementary information
and notices of ways and means motions document of February 22, 1994, where it
is mentioned for the first time that creditors are generally able to recognize
losses arising from lending funds that are not repaid. However, this simple
statement alone does not support a conclusion that the object, spirit and
purpose of section 80 of the ITA have the scope that the appellant would give
them.
[103]
I find that the object,
spirit and purpose of this section are to ensure that the tax consequences for
debtors who benefited from a gain on the forgiveness of a debt, and who also
benefited from expenses or deductions, are adjusted accordingly.
Object, spirit and purpose of subsections 80.01(6), (7) and (8) of the
ITA
[104]
Subsections 80.01(6),
(7) and (8) of the ITA read as follows:
(6) For
the purpose of subsection (7), an obligation issued by a debtor is, at a
particular time, a specified obligation of the debtor where
(a) at any previous
time (other than a time before the last time, if any, the obligation became a
parked obligation before the particular time),
(i) a person who owned the
obligation
(A) dealt at arm’s length with the
debtor, and
(B) where the debtor is a corporation,
did not have a significant interest in the debtor, or
(ii) the obligation was
acquired by the holder of the obligation from another person who was, at the
time of that acquisition, not related to the holder or related to the holder
only because of paragraph 251(5)(b); or
(b)
the obligation is deemed by subsection 50(1) to be reacquired at the particular
time.
Parked obligation
(7) For
the purposes of this subsection and subsections (6), (8) and (10),
(a) an obligation
issued by a debtor is a “parked obligation” at any time where at that time
(i) the obligation is a
specified obligation of the debtor, and
(ii) the holder of the obligation
(A) does not deal at arm’s
length with the debtor, or
(B) where the debtor is a
corporation and the holder acquired the obligation after July 12, 1994
(otherwise than pursuant to an agreement in writing entered into on or before
July 12, 1994), has a significant interest in the debtor; and
(b) an obligation that is, at any time, acquired or reacquired in
circumstances to which subparagraph 6(a)(ii) or paragraph 6(b)
applies shall, if the obligation is a parked obligation immediately after that
time, be deemed to have become a parked obligation at that time.
(8) Where at any particular time after February
21, 1994 a commercial debt obligation that was issued by a debtor becomes a
parked obligation (otherwise than pursuant to an agreement in writing entered
into before February 22, 1994) and the specified cost at the particular time to
the holder of the obligation is less than 80% of the principal amount of the
obligation, for the purpose of applying the provisions of this Act to the
debtor
(a) the obligation shall be deemed to have been
settled at the particular time; and
(b) the forgiven amount at the particular time in
respect of the obligation shall be determined as if the debtor had paid an
amount at the particular time in satisfaction of the principal amount of the
obligation equal to that specified cost.
[105]
Subsections (6)
and (7) must be read together. Essentially, subsection (7) sets out the
necessary conditions for an obligation to be characterized as a parked
obligation. One of those conditions is that the obligation must be a specified
obligation under subsection (6). Under subparagraph 80.01(6)(a)(i),
a specified obligation is an obligation of a person who at a particular time
owned the obligation and dealt at arm’s length with the debtor or, where the
debtor is a corporation, did not have a significant interest in the debtor.
Also, under subparagraph 80.01(6)(a)(ii), a specified obligation
may be an obligation acquired by the holder of the obligation from a person who
was, at the time of that acquisition, not related to the holder.
[106]
Subsection (8)
creates a presumption whereby a parked obligation whose cost to its holder is
less than 80% of the principal amount of the obligation shall be deemed to have
been settled. The effect of that presumption is to trigger the application of
the debt parking rules found in section 80 of the ITA.
Context of
subsections 80.01(6), (7) and (8) of the ITA
[107]
The context of
section 80.01 is relatively simple. This section creates a set of
presumptions that, in certain specific circumstances, result in a debt
settlement and, accordingly, in the application of section 80. Thus, the
purpose of section 80.01 is to bring within the purview of section 80 certain
specific situations that would not otherwise be covered by section 80 itself.
[108]
For instance, with
respect to mergers and wind-ups, subsections 80.01 (3), (4) and (5) presume
that there will be a debt settlement upon the occurrence of certain events. As
regards dispositions of debts to unrelated third parties or between persons not
dealing with each other at arm’s length, it is subsections 80.01 (6), (7) and
(8) that provide for the application of the debt parking scheme.
Purpose of subsections 80.01(6), (7) and
(8) of the ITA
[109]
Extrinsic documents
show quite clearly Parliament’s intention in passing in 1995 the statutory amendments
relating to debt parking.
[110]
For instance, according
to the Supplementary Information and Notices of Ways and Means Motions on
the Budget tabled in the House of Commons on February 22, 1994, by the
Minister of Finance (at page 37):
Third,
an amendment is proposed to address “debt parking” transactions. These
transactions involve debt owed by a debtor to a financial institution or other
unrelated creditor. Instead of forgiving all or part of the debt, the unrelated
creditor typically sells the debt at a substantial discount to a person with
whom the debtor does not deal at arm’s length at the time of the sale (or
at a subsequent time after there has been a change of control of the debtor).
Once sold to the new creditor, there is an incentive for the new creditor to
leave the debt outstanding indefinitely because of the application of the rules
in section 80. It is proposed to treat such “parked” debt . . . as if it were
settled for an amount equal to the cost of the debt to the new creditor.
(Emphasis added.)
[111]
It is also apparent
from the Draft Legislation on Debt Forgiveness and Foreclosures,
at page 82, that
Subsection
80.01(8) contains a rule that is designed to counter the “parking” of a commercial
debt obligation. In general terms, it can apply where an obligation originally
issued by a debtor to one creditor is transferred, directly or indirectly, to
another creditor who is related to the debtor or is a specified shareholder of
the debtor. . . .
[112]
And it is apparent, at
page 83, that:
.
. . subsection 80.01(8) provides a de minimis rule which provides that
the above rules do not apply to an obligation issued by a debtor unless the
specified cost to the current creditor of the obligation is less than 80% of
its principal amount.
[113]
A review of these
documents shows that Parliament proposed certain changes in 1994 so that the
scheme applicable to debt forgiveness could no longer be circumvented by
carrying out certain transactions aimed at “parking” debts, primarily
between persons not dealing with each other at arm’s length. However,
Parliament did provide a de minimis exception according to which this
scheme would not apply where such debt was acquired for an amount greater than
80% of its principal amount.
Conclusion on the object, spirit and
purpose of subsections 80.01(6), (7) and (8) of the ITA
[114]
In passing these
statutory amendments in 1995, Parliament intended to prevent taxpayers from
disposing of an obligation in circumstances that could be assimilated to those
of debt forgiveness but which fell outside the purview of the section 80 scheme.
More specifically, the textual, contextual and purposive analysis leads to me
conclude that the object, spirit and purpose of subsections 80.01(6), (7)
and (8) is to ensure that certain dispositions of debt which amount in substance
to debt forgiveness are treated in the same manner as “classic” debt
forgiveness under section 80.
Object, spirit and purpose of paragraph 80(2)(g) of the ITA
[115]
The appellant did not
make any submissions on the abuse of the object,
spirit and purpose of paragraph 80(2)(g). This is not, however,
crucial as at this stage the onus is on the respondent to demonstrate that
there has been an abuse of the object, spirit and
purpose of the provisions relied upon.
[116]
Paragraph 80(2)(g)
reads as follows:
80
(2) For the purposes of this section,
(g) where a corporation issues a share (other than an excluded
security) to a person as consideration for the settlement of a debt issued by
the corporation and payable to the person, the amount paid in satisfaction of
the debt because of the issue of the share is deemed to be equal to the fair
market value of the share at the time it was issued.
[117]
Paragraph 80(2)(g)
provides for a situation in which a debtor corporation issues new shares of its
capital stock as consideration for the settlement of the debt by the creditor.
In such a situation, the amount paid in satisfaction of the debt is deemed to
be equal to the FMV of the shares at the time they were issued. The amount paid
in satisfaction of the debt is the key element of “B” in the definition of
“forgiven amount”. Thus, the amount forgiven for the purposes of reducing tax
consequences would be equal to the principal amount of the debt less the FMV of
the shares at the time they were issued.
Context of paragraph 80(2)(g)
[118]
The contextual analysis
prompts us to look at the various provisions around which paragraph 80(2)(g)
revolves. The set of rules contained in the various paragraphs of subsection
80(2) are rules of automatic application that set out presumptions governing
debt forgiveness. Specifically, paragraph 80(2)(g) establishes a
presumption that, where a debt is settled as consideration for shares, the
amount paid for the debt forgiveness is equal to the FMV of the shares issued
as consideration.
Purpose of paragraph 80(2)(g)
[119]
As stated earlier, the
analysis of the purpose of the provisions relied upon seeks to ascertain the
outcome sought by Parliament at the time of their enactment. From
the wording of paragraph 80(2)(g) and from the context of
section 80, it is fairly easy to discern Parliament’s intention in
adopting this rule. A debtor whose debt has been forgiven for an amount less
than its principal receives an economic benefit. Parliament sought to restore
balance in this situation by introducing the section 80 scheme, which provides
for a reduction in certain tax balances and, ultimately, inclusion in income.
To prevent taxpayers from easily circumventing this general scheme through
“corporate manipulations”, Parliament introduced certain measures to address
specific situations,
one of these measures being paragraph 80(2)(g). That paragraph addresses
situations where the creditor and the debtor would have an interest in
transforming the debt into capital stock, for example for the purpose of writing
off a liability for the debtor. In such a situation, the debt forgiven as
consideration for the shares would be presumed to have been forgiven for an
amount equal to the FMV of the shares issued. Thus, if the shares issued as
consideration for the settlement have no value, the amount paid in satisfaction
of the debt will be nil. The smaller the amount paid and the higher the
forgiven amount to be applied to reduce the balances and tax consequences, the
more important it is to prevent taxpayers from circumventing the debt
forgiveness rules by issuing shares.
Conclusion on the object, spirit and
purpose of the ITA’s paragraph 80(2)(g) scheme
[120]
The textual, contextual
and purposive analysis leads me to conclude that the object, spirit and purpose
of paragraph 80(2)(g) is to ensure, where a debt is settled in exchange
for shares, that the debt forgiveness rules apply through the taking into
account of the value of the shares issued. Parliament did not intend that the
debt forgiveness rules could be circumvented by transforming a debt into shares
of lesser value. Parliament wanted the forgiven amount to reflect the FMV of
the underlying shares.
Was there a misuse or abuse of the
provisions of the ITA?
[121]
First of all, the
purpose of the scheme set out in section 80 is to ensure that the tax
consequences for debtors who have benefited from a gain on the forgiveness of a
debt, and who have also had the benefit of expenses or deductions, are adjusted
accordingly. Moreover, as stated earlier, in adopting section 80.01 of the ITA,
Parliament intended to prevent taxpayers from disposing of an obligation in
circumstances that can be assimilated to those of debt forgiveness while escaping
the application of the ITA’s section 80 scheme.
[122]
The appellant was running
a deficit and owed Ford U.S. over $24,000,000. If the series of avoidance
transactions had not occurred immediately before the sale, the shares and the debt
of approximately $24,000,000 would have been sold for $9,750,000. Under
paragraph 80.01(6)(b), at that time the debt would have become a
specified obligation. Under subsection 80.01(7), this specified obligation
would have been characterized as a parked obligation and, since it would have
been acquired for less than 80% of its principal amount, it would have been
considered under subsection 80.01(8) as a forgiveness of debt pursuant to
section 80. Consequently, all of the appellant’s tax balances would have
been reduced and the appellant would have had to include in its income for 2002
an amount of $5,000,700 pursuant to subsection 80(13).
[123]
By injecting
“temporary” capital, the appellant artificially reduced the debt in order to
benefit from the de minimis exception and thus avoid the application of
the debt parking rules. In addition, by proceeding in that fashion, the
appellant was able to benefit from a loan of over $24,000,000 and discharge
its obligation to pay approximately $14,000,000 while still being able to benefit
from expenses and deductions in relation to this loan.
[124]
Thus, by undertaking the
avoidance transactions, the appellant clearly circumvented the application of
sections 80 and 80.01 in a manner that
frustrated or defeated the object, spirit or purpose of those provisions.
Therefore, the debt clean-up transactions were clearly abusive avoidance
transactions and, in that respect, the application of the GAAR is justified.
[125]
If there was no misuse
or abuse of sections 80 and 80.01, the application of the GAAR would still be
justified as the avoidance transactions are also abusive with respect to
paragraph 80(2)(g). Although I mentioned it earlier, it is important to point
out that, for some unknown reason, the appellant did not make any submissions with
regard to that paragraph.
[126]
The object, spirit and
purpose of paragraph 80(2)(g) are to ensure that, where a debt is
settled in exchange for shares, the debt forgiveness rules apply through the
taking into account of the true value of the shares issued. If the newly issued
shares are of little value, the forgiven amount will be low and the tax
consequences will be reduced to a greater degree. By enacting that paragraph,
Parliament intended to prevent taxpayers from transforming a debt into shares
with little value and from thereby avoiding the application of the debt
forgiveness rules.
[127]
Here, since the
issuance of the shares was followed by the repayment of capital and interest,
the FMV of the shares was high at the time of their issuance but their real
value decreased immediately after the repayment. It is true that, without the
GAAR, paragraph 80(2)(g) would not trigger the application of the debt
forgiveness rules. By proceeding in two stages rather than directly converting
debt into shares, the appellant circumvented the application of paragraph
80(2)(g) and thus avoided a gain on debt forgiveness. It appears clear
to me that the two avoidance transactions that led to the tax benefit were
aimed at circumventing the application of the provision in a manner that
frustrated or defeated the object, spirit and purpose of that provision. From
the perspective of paragraph 80(2)(g), the debt clean-up transactions
were therefore abusive avoidance transactions.
[128]
The appellant stated
that ultimately there was no misuse or abuse because, by undertaking the debt
clean-up transactions, Ford U.S. simply put itself in the same position as it
would have been in had it decided to capitalize its interest in Greenleaf
rather than resorting to a combination of loans and shares. With respect, such
a proposition cannot be accepted. The funding vehicle chosen by the parent
company, whether it be capitalization or loans, comes with its own set of
advantages and drawbacks. It is a choice made, one would hope, with full
knowledge of the situation, and the taxpayer must live with the tax and financial
consequences of that choice.
[129]
In summary, I find that
the debt clean-up transactions were not carried out in conformity with the object, spirit and purpose of the debt forgiveness and debt
parking provisions and that, in that sense, they resulted in tax
avoidance that constituted an abuse with regard to sections 80 and 80.01, or in
the alternative, paragraph 80(2)(g).
[130]
For these reasons, I
dismiss the appeals with costs.
Signed at Ottawa, Canada, this 28th day of March 2014.
These amended reasons for judgment are being issued to
replace the reasons for judgment dated October 2, 2013.
“Paul Bédard”
Translation certified true
on this 23rd day of April 2014.
Erich Klein, Revisor
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