The following transactions occurred under a KPMG-advised “Q-Yes” plan for the avoidance of 90% of the B.C. income tax that otherwise would have been payable on the taxable capital gain realized on the July 8, 2002 closing of the arm’s-length sale of the shares of a corporation (“ALI”):
- On June 14, 2002, shareholders of ALI transferred their shares on a rollover basis under ITA s. 85(1) to a newly-incorporated B.C. corporation (“Veracity,” which was the taxpayer), 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.
The Minister assessed Veracity under the B.C. GAAR provision (s. 68.1 of the Income Tax Act (B.C.)) on the basis that 100% of the taxable capital gain was taxable in B.C.
After noting that s. 68.1(1)(d) (the B.C. equivalent of ITA s. 245(4)) referenced a misuse or abuse of the provisions of the B.C. Act, MacKenzie JA rejected the Crown’s submission that the transactions constituted an abuse of the ITA s. 85 rollover rule, stating (at paras. 68-69):
[S]. 68.1(1)(d)… does not apply to provisions in the federal Act that are not expressly incorporated into the BC Act. …
Had the Legislature intended the BC GAAR to cover misuse or abuse of provisions beyond the BC Act and its regulations, such as the federal Act, it could easily have adopted the explicit language in subsection (c) [the equivalent of ITA s. 245(3), which referred to the reduction, avoidance or deferral of tax under the B.C. Act or “under any other federal or provincial Act.”]
(Similarly, Veracity exploited the ability to choose a different year end under the Quebec Act “but the provisions of the Quebec Act are clearly not within the scope of s. 68.1(1)(d)…” (para. 123).)
She went on to note that, in any event, although “s. 85’s purpose encompasses both deferral and preservation of a taxable capital gain such that upon the transferee’s ultimate disposition, the taxable capital gain, if any, will be realized and included in the transferee’s taxable income” (para. 85), its purpose was not “ensuring that the gain will give rise to an actual tax liability” (para. 86, emphasis in original), so that here “s. 85…operated as intended” even though “100% tax did not result” (para. 90). To reach a finding of a general abuse of the capital gains provisions of which s. 85(1) was a part would require an impermissibly “broad reading of the GAAR whereby any transaction that leads to lower taxes payable would trigger an abuse of general provisions such as s. 3” (para. 92).
In contrast to ITA s. 85(1), the inter-provincial “Allocation Rules” in Part IV of the ITA Regulations were specifically referenced in s. 13.3 of the B.C. Act. However (paras. 102-103, emphasis in original):
The purpose of the Allocation Rules is to allocate the income to the provinces. How the provinces tax that income, if at all, is beyond the purpose, object and spirit of the Allocation Rules. … I note the… comment in Copthorne…that:
… in some cases the underlying rationale of a provision would be no broader than the text itself. …
[T]he underlying rationale of providing a mechanism of allocation is fully explained by the formula it provides, choosing, as it did, to use gross revenues and salaries and wages as the factors.
S. 68.1(1)(d) should not have been applied.