Date: 20070316
Docket: A-231-06
A-230-06
Citation: 2007 FCA 113
CORAM: DÉCARY
J.A.
NOËL J.A.
SEXTON J.A.
A-231-06
BETWEEN:
EARL LIPSON
Appellant
and
HER MAJESTY THE QUEEN
Respondent
A-230-06
BETWEEN:
JORDAN B. LIPSON
Appellant
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
NOËL J.A.
[1]
These are
appeals from a decision by Bowman C.J. (2006 TCC 148) denying the appeals brought by
the appellants with respect to reassessments issued for their 1994, 1995 and
1996 taxation years.
[2]
The
appeals were heard by the Tax Court on the basis of common evidence. Although
separate Statements of Agreed Facts were filed, the argument was presented by
reference to the Statement of Agreed Facts filed in the Earl Lipson appeal
only, and counsel agreed that the decision with respect to the Earl Lipson
appeal would also be determinative of the appeal brought by Jordan B. Lipson.
[3]
At the
beginning of the hearing before this Court, Counsel for the appellants sought
leave to make separate submissions in support of the Jordan B. Lipson appeal.
Given that the judgment under appeal was rendered by reference to the Statement
of Agreed Facts in the Earl Lipson appeal only, and that the parties agreed
that the decision with respect to Earl Lipson would apply to Jordan B. Lipson,
we denied this request.
[4]
Accordingly,
these reasons dispose of the appeal brought by Earl Lipson in docket
A-231-06, and a copy will be filed in docket A-230-06 as reasons for judgment
disposing of the appeal brought by Jordan B. Lipson.
BACKGROUND
[5]
The sole
issue is whether the transactions involved in this case, which are admitted to
be avoidance transactions within the meaning of subsection 245(3) of the Income
Tax Act (“the Act”), constitute an abuse or a misuse as contemplated by
subsection 245(4), thereby justifying the reassessments in issue. Bowman C.J.
held that such abuse and misuse had been established. The appellants contend
that he erred in reaching this conclusion.
[6]
No
evidence was adduced at trial other than the Statement of Agreed Facts which is
reproduced as Schedule A to the decision under appeal. According to this
Statement, Earl Lipson (“the appellant”) and Jordanna Lipson (“Jordanna”) are
husband and wife. They wanted to buy a home in Toronto and finance the cost of acquisition. At
the relevant time, the appellant also owned shares of Lipson Family Investments
Limited (“the family corporation”).
[7]
They
entered into an agreement to purchase the property with a closing date of
September 1, 1994. The purchase price was $750,000 with a $50,000 deposit being
paid.
[8]
On August
31, 1994, Jordanna borrowed $562,500 from the Bank and gave the Bank an
interest bearing demand promissory note. The appellant concedes that the Bank
would not have lent $562,500 to Jordanna on an unsecured basis without his
covenant to repay Jordanna’s loan from the mortgage funds to be advanced the
next day.
[9]
On the
same day, the appellant sold 20 and 5/6th of the shares he held in
the family corporation to Jordanna for $562,500. The number of shares
transferred was determined so that in the aggregate their fair market value
would be equal to Jordanna’s Bank loan.
[10]
Still on
the same day, Jordanna using the borrowed funds gave the appellant a cheque for
$562,500 as payment for the shares. The appellant forwarded that amount to the
trust account of the solicitor retained for the purchase of their new home who
was under irrevocable instructions to retire Jordanna’s loan with the proceeds
of the Bank’s mortgage loan.
[11]
The next
day (September 1, 1994), the appellant’s solicitor paid the $562,500 to
the vendor towards the purchase price of their new personal residence; the
Transfer/Deed of Land, showing the appellant and Jordanna as joint tenants, was
registered on the land as was the Charge/Mortgage; the Bank advanced $562,500
to the appellant’s solicitor in trust as proceeds from the mortgage on the
personal residence and; the solicitor, as instructed, directed the $562,500
mortgage proceeds back to the Bank to repay Jordanna’s loan.
[12]
Because
the appellant did not elect out of the attribution rules (subsection 73(1)) the
shares were deemed to have been sold to the appellant and acquired by Jordanna
for proceeds equal to their adjusted cost base (“ACB”) (thereby deferring any
taxable gain or loss until a subsequent sale). A further consequence is that
any income or loss from the shares computed in the hands of Jordanna would be
attributed back to the appellant under subsection 74.1(1) of the Act.
[13]
In
addition, since the mortgage on the home provided financing in substitution for
the demand loan used to acquire the shares, Jordanna was able to deduct the
mortgage interest against income derived from the shares by virtue of paragraph
20(3) of the Act.
REPORTING BASIS
[14]
In
reporting his income from the three years in issue, the appellant complied with
the attribution rules and declared as his, the income and losses derived by
Jordanna in respect of the shares.
[15]
Accordingly,
in the return filed for his 1994 taxation year, the appellant claimed a loss in
the amount of $12,948, representing interest expenses paid under the mortgage for
that year.
[16]
For his
1995 taxation year, the appellant reported income consisting of a taxable
dividend paid in respect of the shares in the amount of $53,546 less interest
expenses of $47,371 paid under the mortgage for that year.
[17]
For his
1996 taxation year, the appellant claimed a loss resulting from the difference
between the interest expenses paid under the mortgage for that year in the
amount of $44,572 and a taxable dividend paid in respect of the shares in the
amount of $12,895.
BASIS OF REASSESSMENTS
[18]
The
initial reassessments were issued on the basis that “the true economic purpose
for which the borrowed money was used was to purchase a principal residence for
the taxpayer and his wife”. The letter announcing the reassessments indicates
the Minister’s decision, relying on the decision of Bowman A.C.J. (as he then
was) in Singleton v. The Queen, 96 DTC 1850, to deny the interest
expenses claimed by the appellant for the three years in issue while leaving
the attribution of the income from the shares untouched (see Notice of Appeal, at
para. 13, as quoted in para. 10 of the Reasons). The results were additions to
the appellant’s income in the amounts of $12,948; $47,371; and $44,572 for the
1994, 1995 and 1996 taxation years respectively.
[19]
At the confirmation
stage, which took place after the Supreme Court released its decision in Singleton
v. Canada, [2001] 2 S.C.R. 1046, the Minister modified the basis of the
reassessment as follows:
[…] [T]he transaction
between the appellant and the appellant’s spouse “was an avoidance transaction
under subsection 245(3). The tax consequences have been determined according to
subsections 245(2) and 245(5) of the Act. The deductions you claimed, amounting
to $12,948 in 1994, $47,371 in 1995 and $44,572 in 1996 have been disallowed
according to subsection 245(5)” (see Notice of Confirmation as quoted in the
Notice of Appeal and reproduced at para. 10 of the Reasons).
DECISION OF THE TAX COURT
[20]
Bowman
C.J. began his analysis by asking whether the Minister should have persisted
and relied upon the true economic purpose of the transactions:
[15] I asked counsel
for the respondent, Mr. Gill, if the Crown was abandoning the original basis of
assessment, i.e. the principle quoted by the assessor from Singleton.
His answer was not quite as clear cut as it might have been, as I believe he
was endeavouring to keep the concept of "true economic purpose" alive
within the context of the GAAR.
[21]
Addressing
this concept in the context of the GAAR, Bowman C.J. first referred to his decision
in Evans v. The Queen, 2005 DTC 1762, in which he summarized the
decisions of the Supreme Court in both Canada Trustco Mortgage Co. v. Canada,
[2005] 2 S.C.R. 601 and Mathew v. Canada, [2005] 2 S.C.R. 643 (“Kaulius”).
He said with respect to these decisions:
[18] I think that what
the Supreme Court of Canada directs is a unified textual, contextual and
purposive analysis not only of the sections giving rise to the tax benefit but
of the very section which the Minister says denies the benefit, i.e. section
245. It is a general principle of statutory interpretation of broad application
and I can think of no reason for not applying it to section 245 as well as to
any other section of the ITA. It would be a mistake to fail to give to
section 245 the same type of textual, contextual and purposive interpretation
as the Supreme Court of Canada requires be given to all of the other provisions
of the ITA.
[22]
After
reviewing the provisions relied upon by the appellant and the transactions in
light of the tax benefit sought, Bowman C.J. held, at para. 23, that:
The overall purpose as
well as the use to which each individual provision was put was to make interest
on money used to buy a personal residence deductible.
Earlier on, at para. 16, he had put the matter this way:
… The purpose of the
series of transactions was to make the interest deductible that would not be
deductible if the money was simply used to buy the house.
[23]
Given this
purpose (i.e., borrowing money in such a way as to make the interest deductible),
Bowman C.J. found that the transactions resulted in a misuse and abuse of the
provisions of the Act, specifically paragraph 20(1)(c) and subsection 20(3).
Subsection 73(1) and 74.1 were also misused to the extent that they were used
to execute the scheme as a whole (Reasons, at paras. 25 and 26). This
conclusion was reached in light of Bowman C.J.’s assessment of the object,
spirit and purpose of each of these provisions.
[24]
Bowman
C.J. went on to state:
[31] This case is, in
my view, an obvious example of abusive tax avoidance. Whatever commercial or
other non-tax purpose, if any, is served by transferring Earl's shares to
Jordanna, it is subservient to the objective of making the interest on the
purchase of the house deductible by Earl.
[32] In this case I am
not looking to any "overarching policy" that supersedes the specific
provisions of the ITA. I am simply looking at the obvious purpose of the
various provisions that are relied on and have concluded that those purposes
have been subverted and those sections turned on their heads. I mentioned above
that section 245 must itself be subjected to a textual, contextual and
purposive analysis. If there ever was a case at which section 245 was aimed, it
is this one. …
ANALYSIS AND DECISION
[25]
In support
of the appeal, the appellant contends that Bowman C.J. erred by improperly
importing into the GAAR analysis the concepts of economic purpose and reality
and by recharacterizing the transactions in issue. He conducted the abuse and
misuse analysis on the basis that the borrowings were used to buy the home
rather than by reference to the transactions as they actually took place and
the legal relationships which were created. In so doing, Bowman C.J. strayed
from the “principled approach” set out in Canada Trustco and Kaulius.
[26]
The appellant
first relies on a line of cases, notably Singleton and Shell Canada
Ltd v. Canada, [1999] S.C.R. 622, which have held in a non-GAAR context
that avoidance transactions should be assessed in light of what actually took
place, and not by recharacterizing the transactions on the basis of a Judge’s
perception of their economic reality or overall purpose (Singleton, at paras.
30-35; Shell Canada, at paras. 38 and 39).
[27]
According
to the appellant, this approach has subsisted under the GAAR. In Canadian
Pacific v. The Queen, 99 DTC 5132 (FCA), a decision of this Court involving
complex and allegedly circuitous transactions (the transactions were virtually
identical to those scrutinized by the Supreme Court in Shell Canada),
the Court rebuked the Crown’s attempt to recharacterize the transactions.
Sexton J.A., writing for the Court, quoted with approval the following passage
of the reasons of the Tax Court Judge at para. 31:
In my view the Minister
put the cart before the horse when, as already explained, he attempted to
recharacterize events by asserting that issuing the debt in A$ was an abuse of
the Act as a whole because it converted non-deductible Canadian principal
repayments to a deductible expense. That, I repeat, is not what happened.
[28]
Sexton
J.A. added at para. 33:
This does not mean a
recharacterization cannot occur. A recharacterization of a transaction is
expressly permitted under section 245, but only after it has been established
that there has been an avoidance transaction and that there would otherwise be
a misuse or abuse. A transaction cannot be portrayed as something which it is
not, nor can it be recharacterized in order to make it an avoidance
transaction.
[29]
According
to the appellant, the framework of analysis proposed by the Supreme Court in Canada
Trustco and Kaulius is consistent with this approach. Reference is
made to the passage in Canada Trustco, at para. 24, where the Supreme
Court introduces the discussion with respect to the misuse and abuse analysis:
The heart of the analysis under s. 245(4) lies in a contextual and
purposive interpretation of the provisions of the Act that are relied on by the
taxpayer, and the application of the properly interpreted provisions to the
facts of a given case. The first task is to interpret the provisions giving
rise to the tax benefit to determine their object, spirit and purpose. The next
task is to determine whether the transaction falls within or frustrates that
purpose. The overall inquiry thus involves a mixed question of fact and law.
The textual, contextual and purposive interpretation of specific provisions of
the Income Tax Act is essentially a question of law but the application
of these provisions to the facts of a case is necessarily fact-intensive.
[30]
This dual
test for misuse under the GAAR is a key element in the framework of analysis.
According to the appellant, it bears little resemblance to the approach
concerning “artificial reductions” in income under former subsection 245(1): Fording
Coal Ltd. v. Canada, [1996] 1 F.C. 518 (F.C.A.); Novopharm Ltd. v Canada, 2003 D.T.C. 5195 (F.C.A.),
at paras. 24-34. Although economic substance remains relevant to the analysis
under subsection 245(4), it cannot be isolated from the factual context (Canada
Trustco, at paras. 51-60, 76). The appellant places particular reliance on
the following passage at para. 60:
We should reject any
analysis under s. 245(4) that depends entirely on “substance” viewed in
isolation from the proper interpretation of specific provisions of the Income
Tax Act or the relevant factual context of a case.
[31]
Based on
the foregoing, the appellant submits that the task in a misuse analysis is to
first construe the provisions giving rise to the tax benefit in order to
determine their object spirit and purpose and then to determine whether the
transactions, as they actually took place, fall within or frustrate this
purpose. The appellant concedes that Bowman C.J. properly performed the first
task. However, Bowman C.J. committed a reviewable error by performing the
second task by reference to the overall purpose of the transactions rather than
by reference to the actual transactions and the legal relationships which they
created. In any event, Bowman C.J. placed too much weight on this overall
purpose and not enough on the legal relationships actually created.
[32]
The issue
therefore is whether Bowman C.J. was entitled to take the overall purpose of
the transactions into account in his misuse and abuse analysis and attribute to
this purpose the weight that he did.
[33]
I agree
with the appellant that if the transactions are considered without regard to
the overall purpose identified by Bowman C.J., it is difficult to find that
there has been a misuse or abuse of any of the provisions relied upon. This is
the conclusion that one must reach when regard is had to Bowman C.J.’s
assessment of the object, spirit and purpose of the relevant provisions.
[34]
Beginning
with the attribution rules, Bowman C.J. analyzed the text, context and purpose
of subsection 73(1) at para. 21 of his reasons:
Subsection
73(1) has as its purpose the facilitation of inter-spousal transfers of
property without immediate tax consequences. Such transfers, in the case of
non-depreciable property, are deemed to take place at the transferor's acb
unless the transferor elects to have subsection 73(1) not apply. If the
operation of subsection 73(1) is excluded by an election, the transfer is
deemed to take place at fmv. In fact, the transfer did take place at fmv but
the deemed transfer price was Earl's acb. In other words Jordanna acquired the
property for tax purposes at Earl's acb. If the property is sold, the capital
gain is attributed back to Earl in any event.
[35]
Bowman
C.J. further explained (Reasons, at para. 22), that subsection 74.1(1) is part
of the rules (section 74.1 through 74.5) which are designed to prevent income
splitting. In the context of this appeal, it is useful to add that the income
which section 74.1 attributes is “net income” (i.e., income within the meaning
of paragraphs 3(a) and (d) and subsections 9(1) and (2) of the Act).
[36]
Considering
the transactions as they unfolded, the purposes of subsections 74.1(1) and
73(1) were fulfilled. The appellant (presumably in a higher tax bracket his
Counsel suggests) transferred the shares to his spouse with the result that
(pursuant to ss. 74.1(1)) any income or loss incurred by Jordanna with respect
to the shares was attributed back to the appellant.
[37]
Subsection
73(1) also operated as intended. The shares were transferred from the appellant
to Jordanna on a rollover basis (i.e., at the appellant’s ACB) and any future
gain or loss resulting from the disposition of the shares by Jordanna will be
attributed back to the appellant.
[38]
Turning to
paragraph 20(1)(c) of the Act, Bowman C.J. identified at para. 19 of his
reasons, its purpose as follows:
Generally speaking,
interest on borrowed money is deductible when the money is used for a
commercial purpose. It is not deductible when the money is used for an
ineligible (i.e. non commercial or personal) purpose. A purpose of paragraph
20(1)(c) is to "create an incentive to accumulate capital with the
potential to produce income by allowing taxpayers to deduct interest costs
associated with its acquisition". (Ludco Enterprises Ltd. v. Canada, [2001] 2
S.C.R. 1082, quoted in Novopharm Limited v. The Queen, 2003 DTC 5195, at
5204-5205; Tennant v. The Queen, 96 DTC 6121 at 6126-6127 (S.C.C)).
[39]
In this
case, Jordanna borrowed money to acquire shares which had the potential to
produce and did produce non-exempt income. The change in the respective
ownership positions of the appellant and his spouse is real from both a legal
and an economic perspective, and this is unaltered by the distinct treatment
which the attribution rules provide for the purposes of the Act. The shares no
longer belong to the appellant; they belong to Jordanna.
[40]
Jordanna
having acquired an income producing asset and having financed the cost of
acquisition, there is an obvious link between the borrowed money and a current
eligible use. As such, paragraph 20(1)(c) cannot be said to have been misused.
[41]
Lastly,
Bowman C.J. identified, at para. 27 of his reasons, the purpose of subsection
20(3) as follows:
…, imprinting on the
refinancing loan the tax incidents arising from the use of the money borrowed
by the initial loan.
[42]
In this
case, the mortgage loan was used to repay the money which had been previously
borrowed to purchase the shares. As such, the text, context and purpose of
subsection 20(3), is to attribute to the mortgage loan the same purpose as the
demand loan. Again, ignoring the overall purpose identified by Bowman C.J., I
see no basis for holding that there has been an abuse or a misuse of that
provision.
[43]
However, I
believe that Bowman C.J. was entitled to consider the transactions as a whole and
their overall purpose in the conduct of his misuse and abuse analysis and to
give this factor the weight that he did. In the course of his reasons, Bowman
C.J. found as a fact that these transactions formed part of a series, the
purpose of which was to make interest payable on the mortgage deductible
(Reasons, at paras. 16 and 23). Although, the appellant takes issue with this
finding, I am of the view that it reasonably flows from the Statement of Agreed
Facts.
[44]
This
finding impacts on the analysis to be conducted pursuant to section 245. Subsection
245(2) contemplates the denial of a tax benefit that would result from a
transaction that is an avoidance transaction “or from a series of
transactions that includes that transaction”. Paragraph 245(3)(a) describes
in turn an “avoidance transaction” as one which “would result, directly or
indirectly, in a tax benefit, …”. Notably, paragraph 245(3)(b) extends this
definition to a transaction “that is part of a series of transactions, which
series, but for this section, would result directly or indirectly, in a
tax benefit, …” [Emphasis added].
[45]
It follows
in my view that where a tax benefit results from a series of transactions, the
series becomes relevant in ascertaining whether any transaction within the
series gives rise to an abuse of the provisions relied upon to achieve the tax
benefit. Counsel for the appellant pointed out that no reference is made to a
series of transactions in subsection 245(4). That is so. However subsection
245(4) must also be read in context and where the tax benefit results from a
series of transactions under subsection 245(3), the series cannot be ignored in
conducting the abuse analysis.
[46]
Indeed,
this is how the Supreme Court approached the matter in Kaulius, at para.
46:
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.
The Court later added, at para 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, and in the context of the Act as a whole.
[47]
In Canada
Trustco, at para. 24, the Supreme Court confirmed that the expression
“series of transactions” in section 245 refers to transactions that are
“pre-ordained in order to produce a given result” with “no practical likelihood
that the planned events would not take place in the order ordained” (Craven
v. White, [1989] A.C. 398, at p. 514; W.T. Ramsey Ltd. v. Inland Revenue
Commissioners, [1981] 1 All E.R. 865). Subsection 248(10) extends the
meaning of this expression to include “related transactions or events completed
in contemplation of the series”.
[48]
Keeping
this in mind, the series of transaction in this case unfolded in two sequences.
First, on August 31, 1994 and September 1, 1994, Jordanna obtained a
demand loan from the Bank; she used the money to purchase the shares from the
appellant’s family corporation; the appellant used the proceeds to buy the
home; the appellant and Jordanna obtained permanent financing secured by a
mortgage on the new home, and used the proceeds to retire the demand loan.
[49]
The
following events were later completed in contemplation of the series: Jordanna deducted the
financing costs of the shares pursuant to paragraph 20(1)(c), which costs
extended to the mortgage loan by reasons of the deeming provision contained in
subsection 20(3); the appellant at filing time allowed the attribution rules to
apply (by not electing out) and therefore continued to treat the shares as his
own for income tax purposes.
[50]
At the end
of the first sequence, the appellant and Jordanna were the owners of a new
home; at the end of the second, the appellant had deducted the financing costs.
Bowman C.J. was unable to attribute any other purpose to the series. He considered
each transaction in light of the series and concluded, when regard is had to
the tax benefit claimed by the appellant, that these transactions result in an
abuse of paragraph 20(1)(c) (and the other provisions relied upon) when read
purposively in the context of the Act. Specifically, the use of these
provisions to make the interest payments to finance the purchase of the home
deductible results in abusive tax avoidance (compare Kaulius, at para.
58).
[51]
The appellant
contends that in coming to this conclusion Bowman C.J. gave the series too much
weight and did not pay enough attention to the legal relationships created.
Reference is made in particular to the legally binding sale of shares worth
$562,500. Bowman C.J. discounted the importance of this sale. He found that it
was part and parcel of the plan and subservient to its purpose. He also noted
that the effect of the sale was to a significant extent nullified since the
plan contemplated that the appellant would continue to be treated as the owner
of the shares for taxation purposes. In the end, he attributed little or no
importance to this sale.
[52]
Similarly,
Bowman C.J. attributed no importance to the fact that taxable dividends were
paid with respect to the shares in two of the three years in issue. Although he
did not say so much, it is apparent from the reasons that Bowman C.J. was of
the view that this was also part and parcel of the plan, and intended to give
it a degree of substance. I note in this respect that the appellant did not see
fit to adduce any evidence with respect to the circumstances which led to the
payment of the dividends.
[53]
Although
no single element is determinative of whether there has been abusive tax
avoidance, Bowman C.J. gave substantial weight to the series of transactions,
and its purpose, something which he was entitled to do. The Supreme Court has
made it clear in both Canada Trustco and Kaulius that where there
is no error in the construction of the relevant provisions or in the analytical
approach, the question whether the transactions give rise to abusive tax
avoidance belongs to the Tax Court Judge. Bowman C.J. concluded that the appellant
engaged in abusive tax avoidance, and I can see no basis for interfering with
this decision.
[54]
I would
dismiss the appeals with one set of costs in docket A-231-06.
“Marc
Noël”
“I
agree
Robert
Décary”
“I
agree
J.
Edgar Sexton”
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