The following transactions occurred under a KPMG-advised plan in order to avoid 90% of the B.C. income tax that otherwise would have been payable on the taxable capital gain on a sale of the shares of a corporation (“ALI”) which closed on July 8, 2002:
- Shareholders of ALI transferred their shares on a rollover basis under ITA s. 85(1) to a newly-incorporated B.C. corporation (the taxpayer, and “Veracity”), which had selected a June 30 fiscal year-end for federal and B.C. income tax purposes.
- Shortly after the closing, Veracity paid $2,000 in directors’ fees to two B.C. directors and lent the net sales proceeds of approximately $23.5 million on a non-interest-bearing basis to one of its shareholders (a corporation).
- In late July 2002, Veracity purchased 15,000 units (with a cost $266,337) of a publicly-traded limited partnership (“Gaz Metro”) carrying on regulated natural gas utility business in Quebec, having a permanent establishment there and having a September 30 fiscal year end (so that a proportionate part of its gross revenues and payroll would be allocable to the purchased units at that year end on the basis inter alia that Veracity as a partner also had a Quebec establishment).
- Veracity selected an August 31, fiscal year end for Quebec income tax purposes.
- In September 2002, Veracity acquired a further 30,000 Gaz Metro units.
The payment of the directors’ fees before August 31, 2002 (together with allocations on the Gaz Metro units not occurring until after August 31, 2002) ensured that when the taxable capital gain was reported for the August 31, 2002 Quebec taxation year, the Quebec allocation formula allocated 100% of that income to B.C. On the other hand, in the federal/B.C. return for the year ended June 30, 2003, the allocation of gross revenues and payroll on the Gaz Metro units in that year resulted in 90% of the income (mostly the taxable capital gain from the sale) being allocated to Quebec for B.C. allocation purposes.
Before affirming CRA’s assessment to apply the B.C. GAAR to allocate 100% of the taxable capital gain to B.C., Macintosh J found (at paras. 23, 27) that although the LP units purchased were “a reasonable, stand-alone investment,” the targeted tax savings were five-times the investment return on the LP units and the units were purchased primarily for the purposes of these “Quebec Year-end shuffle” transactions.
Before finding that the transactions were “abusive of the inter-provincial income allocation provisions” (para. 56), Macintosh J stated (at para. 50) that the
legislative scheme intends that capital gains earned in Canada by corporations be taxable as income by the provinces based on an allocation formula designed to prevent both the over-taxation and the under-taxation of income earned by a corporation which is active in more than one province.
Other abuses also were identified, including the use of s. 85(1) as “using a tax deferral provision in that way, resulting in the tax being avoided completely” (para. 54).