Citation: 2011 TCC 259
Date: 20110712
Docket: 2008-1667(IT)G
BETWEEN:
TRIAD GESTCO LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Favreau J.
[1]
These are appeals from
reassessments made under the Income Tax Act, R.S.C. 1985, c. 1
(5th Supp.), as amended (the “Act”), and dated March 8, 2006
for the taxation years ended August 31, 2001 and August 31, 2003, and
June 8, 2006 for the taxation year ended August 31, 2002.
[2]
By virtue of the
reassessments dated March 8, 2006, the Minister of National Revenue (the
“Minister”) disallowed:
(a)
the deduction of a net
capital loss of $143,063 in the appellant’s 2001 taxation year as a result of
the denial of the capital loss claimed by the appellant for its 2002 taxation
year;
(b)
the deduction of a non-capital
loss of $17,742 carried back from the appellant’s 2003 taxation year to its
2001 taxation year;
(c)
the deduction of
$17,742 relating to professional fees (not in dispute in this appeal) claimed
by the appellant for its 2003 taxation year.
[3]
By the reassessment
dated June 8, 2006, the Minister disallowed the deduction of a capital
loss in the amount of $7,999,935 claimed by the appellant for its 2002 taxation
year. The Minister took the position that it was a tax benefit that resulted
from a series of avoidance transactions within the meaning of section 245
of the Act (the "general anti-avoidance rule", referred to hereinafter
as the "GAAR").
[4]
In determining the appellant’s
tax liability for the 2001, 2002 and 2003 taxation years, the Minister made the
following assumptions of fact that are set out in paragraph 13 of the
Amended Reply:
a)
the Appellant is a taxable Canadian corporation
incorporated under the Canada Business Corporations Act and controlled
by Peter Cohen;
b)
Peter Cohen is a resident of Canada;
c)
the Appellant’s fiscal year end is
August 31;
d)
Peter Cohen is the sole director of the
Appellant;
e)
on December 6, 2001, the Appellant disposed
of a property and realized a capital gain of $7,799,545;
Rcongold Systems Inc.
f)
on July 25, 2002, Rcongold Systems Inc.
(“Rcongold”) was incorporated under the Canada Business Corporations Act;
g)
Rcongold was at all material times controlled by
the Appellant;
h)
Peter Cohen was at all material times the
director of Rcongold;
i)
on August 27, 2002, the Appellant
subscribed for 8,000 voting common shares of Rcongold for a total consideration
of $8,000,000;
j)
on August 28, 2002, Rcongold declared a
dividend of $1 payable to the common shareholders by the issuance of 80,000
Class “E” non-voting preferred shares with a redemption price of $100 each;
k)
the redemption price of the Class “E” non-voting
preferred shares was identical to the fair market value (“FMV”) of the common
shares;
l)
Rcongold has never filed income tax returns;
The Peter Cohen Trust
m)
on August 20, 2002, the Peter Cohen Trust
(the “Trust”) was settled by the transfer of $100 US from Mr. Guy Carbonneau, a
person not related to Peter Cohen;
n)
the Trust was created for the benefit of Peter
Cohen and the trustee is Sheldon Merling, a person not related to Peter Cohen;
o)
the Trust has never filed income tax returns and
has no business number;
p)
on August 29, 2002, the Appellant sold to
the Trust the 8,000 common shares in the capital stock of Rcongold for an
amount of $65, which resulted in the Appellant reporting a capital loss in the
amount of $7,999,935;
q)
the allowable capital loss of $3,932,998 claimed
by the Appellant in 2002 resulted in a net capital loss of $143,063 that the
Appellant applied to reduce its tax liability for the 2001 taxation year;
r)
although the Appellant claimed a capital loss of
$7,999,935 in its 2002 taxation year from the disposition of the Rcongold
common shares, it did not suffer any real loss;
s)
the following are avoidance transactions that
form part of a series that resulted in a tax benefit to the Appellant:
®
the incorporation of Rcongold;
®
the subscription by the appellant for 8,000
voting common shares in the capital stock of Rcongold for $8,000,000;
®
the creation of the Trust;
®
the payment by Rcongold of a stock dividend on
the common shares by issuing 80,000 high FMV/low paid-up capital (“PUC”) Class
E non‑voting preferred shares to the Appellant; and
®
the sale by the Appellant of the common shares
of Rcongold to the Trust;
t)
the transactions referred to above were not
undertaken or arranged primarily for bona fide purposes other than to
obtain a tax benefit for the Appellant; and
u)
the Appellant received a tax benefit as a result
of the creation of a loss of $7,999,935 on the disposition of Rcongold common
shares during its 2002 taxation year.
[5]
The issue to be decided
is whether the appellant’s loss on its disposition of the Rcongold common
shares in its 2002 taxation year was nil by operation of section 245 of
the Act such that the deduction of the loss in 2002 and the carry‑back
of a net capital loss in 2001 were properly denied.
Position of the Appellant
[6]
The appellant submits
that the following five transactions constitute the series of transactions to
be considered in the context of determining whether an “avoidance transaction”
exists:
a)
the incorporation of
Rcongold on July 25, 2002;
b)
the subscription by the
appellant on August 27, 2002 for 8,000 common shares of Rcongold for a
total consideration of $8,000,000, the payment of which was made by the
transfer of the assets listed at Tab 41 of the Joint Book of Documents;
c)
the declaration by
Rcongold on August 28, 2002 of a dividend of $1 payable to the appellant,
as the shareholder holding all issued and outstanding common shares, by the
issuance of 80,000 Class “E” non‑voting preferred shares having a
redemption price of $100 each;
d)
the creation on
August 20, 2002 of the Peter Cohen Trust (“PCT”) and the transfer to it of
$100 US from Guy Carbonneau, an unrelated person; the beneficiary of the
PCT is Peter Cohen during his lifetime;
e)
the sale by the appellant
on August 29, 2002 of the 8,000 common shares of Rcongold to the PCT
for an amount of $65, which represented the fair market value of the common
shares at that time.
[7]
The transactions
described above are part of the “Reverse Freeze” put in place to ensure that
any future growth of the assets of Rcongold would accrue to Peter Cohen through
the PCT.
[8]
The freeze of the
investment of Peter Cohen in the appellant was put in place in 2000 because he
had been diagnosed in 1999 with serious liver disease and a liver transplant
was recommended. Mr. Cohen was placed on a liver transplant list in the
fall of 1999, but was removed from the list in the spring of 2000 because of
additional risk factors.
[9]
The appellant is a
corporation created under the Canada Business Corporations Act (“CBCA”)
to own and manage real estate. Peter Cohen was the sole shareholder of the appellant,
holding 10 Class “A” shares and 30 Class “F” shares. The fiscal year-end
of the appellant is August 31 of each year.
[10]
Peter Cohen’s interest
in the appellant was frozen at fair market value - which was estimated to be $4
million as at June 22, 2000 - in favour of Peter Cohen’s children
(the “Freeze”). The Freeze was realized by the execution of the following
transactions:
a)
A family trust was
created by a trust deed dated June 21, 2000, the beneficiaries of which trust
were Peter Cohen’s children.
b)
By a resolution dated
June 22, 2000, 10 Class “A” shares of the appellant were converted into
10 Class “F2” shares of the appellant; the Class “F2” shares carried a non‑cumulative
dividend of 0.4% per month and were non‑participating, non‑voting
and redeemable, at the option of the holder or the company, at the fair market
value of the consideration received in exchange therefor, as determined by the
express resolution of the directors ($400,000 per share for a total of $4,000,000).
c)
On June 22, 2000, Peter
Cohen subscribed for 1,000 Class “C” shares of the appellant at the price
of $100 in the aggregate. The Class “C” shares carried a non‑cumulative
dividend of 0.5% per month and were non‑participating, voting, and
redeemable, at the option of the company, at the issue price.
d)
On June 22, 2000,
Peter Cohen, as trustee of the Peter Cohen Family Trust, subscribed for 30 Class
“B” shares of the appellant at the price of $1 per share. The Class “B” shares
were participating but non‑voting.
[11]
As a result of the
Freeze, Peter Cohen was holding 1,000 Class “C” shares, 10 Class “F2”
shares and 30 Class “F” Shares of the appellant, and the Peter Cohen
Family Trust was holding 30 Class “B” shares. The Class “F” shares carried
a non‑cumulative dividend of 0.5% per month and were non‑participating,
non‑voting, and redeemable, at the option of the holder or the company,
at the issue price.
[12]
During the period
between the Freeze and the Reverse Freeze, the following transactions were
executed:
a)
On December 6,
2001, a property located at 8 500 Decarie
Blvd., in the town of Mont‑Royal, was sold by the appellant to Cominar Real Estate
Investment Trust, a party not related to the appellant, for a selling price of
$32,650,000, which transaction gave rise to a capital gain of $7,799,545.
b)
On January 9,
2002, the appellant redeemed 30 Class “F” shares and 10 Class “F2”
shares of its capital stock registered in the name of Peter Cohen. The
30 Class “F” shares had an aggregate redemption value of $540,597 and a
paid‑up capital of $30. The 10 Class “F2” shares had an aggregate
redemption value of $4,000,000 and a paid‑up capital of $10. The
redemption of the 30 Class “F” shares and the 10 Class “F2” shares
gave rise to a deemed dividend of $4,540,557, which was treated by the appellant
as being a dividend paid out of its capital dividend account, and consequently the
deemed dividend was a tax‑free dividend in the hands of Peter Cohen.
c)
On January 18,
2002, Peter Cohen subscribed for 3,000,000 Class “E” shares of the appellant
at a price of $1 per share. The Class “E” shares carried a non‑cumulative
dividend of 6% yearly, were redeemable and retractable at the price paid for
them, and were voting preferred shares.
[13]
As a result of the
transactions described in the immediately preceding paragraph, Peter Cohen was
holding 1,000 Class “C” shares and 3,000,000 Class “E” shares of the
appellant and the Peter Cohen Family Trust was holding 30 Class “B” shares
of the appellant. Peter Cohen’s interest in the appellant was limited to
$180,000 generated annually (6% on 3,000,000 Class “E” shares), which he
considered to be insufficient to maintain his standard of living and to pay the
cost of medical treatment that could become available in the United States if
he was to survive longer than anticipated.
[14]
The appellant submits
that section 245 of the Act does not apply to the Reverse Freeze as
there is no avoidance transaction or misuse or abuse of any provision of the Act,
or of the Act read as a whole. None of the transactions which resulted
in the future growth of Rcongold being available to Peter Cohen are avoidance
transactions and those transactions were undertaken primarily for non‑tax
purposes.
[15]
The appellant refers to
the following extracts from Canada Trustco Mortgage Co. v. Canada,
[2005] 2 S.C.R. 601 ("Canada Trustco"), at paragraphs 13
and 17, to explain the intent of the GAAR provision and the requirements that
must be met in order for the GAAR to apply:
[…] This is a broadly drafted provision, intended to negate
arrangements that would be permissible under a literal interpretation of other
provisions of the Income Tax Act, on the basis that they amount to
abusive tax avoidance. […]
[…]
The application of the GAAR involves three steps. The first step is
to determine whether there is a "tax benefit" arising from a
"transaction" under s. 245(1) and (2). The second step is to
determine whether the transaction is an avoidance transaction under s. 245(3),
in the sense of not being "arranged primarily for bona fide
purposes other than to obtain the tax benefit". The third step is to determine
whether the avoidance transaction is abusive under s. 245(4). All three
requirements must be fulfilled before the GAAR can be applied to deny a tax
benefit.
[16]
The appellant submitted
an analysis of each of the requirements of the Canada Trustco decision
in the context of the facts pertaining to the Reverse Freeze.
Tax Benefit
[17]
The appellant referred
to the following extract from the Canada Trustco decision dealing with
“tax benefit”:
19 "Tax benefit" is defined in s. 245(1) as "a
reduction, avoidance or deferral of tax" or "an increase in a refund
of tax or other amount" paid under the Act. Whether a tax benefit exists
is a factual determination, initially by the Minister and on review by the
courts, usually the Tax Court. The magnitude of the tax benefit is not relevant
at this stage of the analysis.
[18]
The appellant argues
that no tax benefit as contemplated by section 245 of the Act resulted
from the Reverse Freeze because the capital loss of $7,999,935 triggered by the
disposition of common shares of Rcongold by the appellant to the PCT in 2002
gives rise neither to a reduction nor to a deferral of “tax or other amount
payable” as no amount was payable in respect of capital gains at the time of
the transaction. The capital loss does not, in and of itself, give rise to an
“increase in a refund of tax”. If a refund of tax was granted to the appellant
on the basis of the capital loss, such a refund would be the result of the
application of the loss carry‑back (or carry-forward) provision, which
application is not a transaction and cannot therefore result in a “tax benefit”
as contemplated by section 245 of the Act.
Avoidance Transaction
[19]
The appellant argues
that, for the GAAR to apply, at least one transaction in a series of
transactions must be an “avoidance transaction”, and in that case the tax
benefit that results from a series of transactions may be denied under the GAAR.
Conversely, if each transaction in a series was carried out primarily for bona
fide non‑tax purposes, the GAAR cannot be applied to deny a tax
benefit. To determine whether an “avoidance transaction” exists, each
transaction must be examined, without regard to its tax implications, to
determine whether its economic substance was what it purported to be.
[20]
According to the appellant,
the purpose of the series of transactions was clearly a non‑tax purpose, namely
to allow any future increase in the value of Rcongold to accrue to Peter Cohen.
It was a transfer from Peter Cohen’s children to him. Consequently, the result
of the series cannot be questioned. All of the steps taken in furtherance of
the Reverse Freeze had the economic substance they purported to have, were
legally effective, and were necessary to achieve the non‑tax purpose.
[21]
The incorporation of
Rcongold and the issuance of common shares of that corporation were not
avoidance transactions. The real economic effect was that assets were
transferred to Rcongold in exchange for shares issued from treasury.
[22]
The declaration and
payment of a stock dividend was an effective legal transaction carrying with it
economic substance. This is a normal feature of any freeze allowing the
transfer of values between family members. The amount of the dividend, which
determines the paid‑up capital, was set precisely so that the Reverse Freeze
could be achieved without tax being immediately payable.
[23]
According to the appellant,
each transaction in the series would have been undertaken even in the absence
of any “tax benefit”. In the absence of a capital loss for the appellant, the Reverse
Freeze would have been an effective solution to the problem perceived by Peter
Cohen and his children. It allowed the appellant to maintain its business
assets while allowing Peter Cohen to obtain the benefits of future growth on
the unanticipated gains realized by the appellant.
Abuse
[24]
The third requirement
for the application of the GAAR is that the avoidance transaction or series
must be abusive. An abuse analysis is only relevant where an avoidance
transaction and a “tax benefit” are present, and their presence is expressly
denied by the appellant. Abuse can only be found where the avoidance
transaction frustrates a clear legislative policy the existence of which must
be anchored in the wording of the Act. The Canada Trustco
decision explicitly rejected an economic substance test with respect to abuse.
[25]
The appellant states
that the GAAR is applicable only if it can be shown that Parliament intended to
deal with the matters and attempted to do so, but its efforts fell short. The
repeal of subsection 55(1) of the Act and the existence of
subsection 15(1.1) tend to indicate the contrary: Parliament was clearly
aware of the problem, but made no effort to deal with it.
[26]
The appellant refers to
the following statements made by the Supreme Court of Canada in the Canada
Trustco decision, at paragraphs 43 and 55:
43. […] Section 245(4) requires a single, unified approach to
the textual, contextual and purposive interpretation of the specific provisions
of the Income Tax Act that are relied upon by the taxpayer in order to
determine whether there was abusive tax avoidance.
[…]
55. In summary, s. 245(4) imposes a two-part inquiry. The
first step is to determine the object, spirit or purpose of the provisions of
the Income Tax Act that are relied on for the tax benefit, having regard
to the scheme of the Act, the relevant provisions and permissible extrinsic
aids. The second step is to examine the factual context of a case in order to
determine whether the avoidance transaction defeated or frustrated the object,
spirit or purpose of the provisions in issue.
[27]
The appellant further
states that:
The burden is on the Minister to establish abuse and to state which
provision of the Act could have been abused.
GAAR must be applied in a manner which ensures consistency, predictability
and fairness in tax law.
Where the existence of abusive tax avoidance is unclear, the benefit
of the doubt must favour the Taxpayer.
No economic substance or business purpose analysis is appropriate in
the context of the abuse analysis.
Specific provisions
[28]
The appellant further
argues that the transactions have not resulted, directly or indirectly, in a
misuse or an abuse of paragraphs 40(1)(b), 38(b) and 39(1)(b)
and subparagraph 3(b)(ii) of the Act.
[29]
The capital loss realized
by the appellant resulted from the application of the Act in determining
the adjusted cost base of the common shares of Rcongold without regard to the
stock dividend. The CBCA allows the taxpayer to pay such a dividend. The
reduction in value of the common shares arising from the stock dividend results
only from the mechanism provided for by the CBCA.
[30]
The appellant relied on
the net capital loss carry‑back provision in paragraph 111(1)(b)
of the Act, and on the definition of net capital loss in subsection 111(8).
The text and context of subsections 111(1) and 111(8) of the Act reveal
that Parliament’s purpose and intent was to permit taxpayers to carry a net
capital loss backward for three years and forward indefinitely. The appellant
cannot have abused paragraph 111(1)(b) of the Act or frustrated
Parliament’s intent with respect thereto by behaving in exactly the way which
Parliament intended.
Other Points
[31]
The Reverse Freeze
should not be considered as an abuse of the provisions of the Act. The
purpose of the transactions was not to create a loss but to effect a freeze.
The appellant’s transactions had real economic substance: the common shares of
Rcongold were transferred to the PCT for a real consideration after a dividend
was in fact paid by the issuance of preferred shares. Accordingly, there is
nothing “artificial” or “abusive” about the transactions.
Position of the Respondent
[32]
The respondent argues
that:
a)
The appellant entered
into a series of avoidance transactions the main purpose of which was the
creation of an artificial capital loss to offset a capital gain which had been made
in the same taxation year.
b)
The Appellant’s
assertion that the transactions in issue were designed to effect the reversal
of an earlier estate freeze is not supported by the evidence and fails to
explain how the creation of an artificial capital loss achieved the stated
estate planning objectives of its controlling shareholder, Peter Cohen.
c)
The tax benefit that
resulted from the series of transactions, namely, the creation of a capital
loss in the amount of $7,999,935 which was applied to offset a capital gain of
a similar amount, goes beyond the ambit of permissible estate planning. The
transactions in issue were specifically undertaken to avoid the payment of tax
on a capital gain, and the series as a whole results in a misuse and abuse of
the Act read as a whole and of the provisions dealing with the creation
of capital gains and losses.
[33]
The respondent states
that the GAAR denies the tax benefit sought by a taxpayer where:
a)
a tax benefit arises
from a transaction or a series of transactions (subsections 245(1) and
(2));
b)
the transaction, alone
or as part of a series, is an avoidance transaction, as defined in subsection 245(3);
and
c)
the avoidance
transaction results in a misuse or abuse within the meaning of subsection 245(4).
[34]
According to the respondent,
the taxpayer bears the burden of demonstrating that the first two criteria are
not met, while the burden is on the Minister to prove, on the balance of
probabilities, that the avoidance transaction results in a misuse or abuse
within the meaning of subsection 245(4).
Tax Benefit
[35]
The expression “tax
benefit” is defined in subsection 245(1) as “a reduction, avoidance or
deferral of tax” or “an increase in a refund of tax or other amount” paid under
the Act. The determination whether a tax benefit exists is a factual
determination. As stated by the Supreme Court of Canada in the Canada
Trustco decision at paragraph 20:
If a deduction against taxable income is claimed, the existence of a
tax benefit is clear, since a deduction results in a reduction of tax. […]
[36]
According to the respondent,
the tax benefit in this case arose from the offsetting of the capital gain of
$7,799,545 and the reduction to nil of the tax that would otherwise have been
payable on that gain.
[37]
In order for subsection 245(2)
to apply to a transaction, it is sufficient that the reduction, avoidance or
deferral of tax result directly or indirectly, from an avoidance transaction or
from a series of transactions of which the avoidance transaction is a part.
Avoidance Transaction
[38]
The respondent states
that to determine whether a transaction or any transaction in a series of
transactions is an “avoidance transaction” under subsection 245(3) in the
sense of not being "arranged primarily for bona fide purposes other
than to obtain the tax benefit", it is necessary to examine the primary
purpose of each transaction. The entire series need not be an avoidance
transaction as long as one transaction in the series was not undertaken
primarily for bona fide purposes other than to obtain the tax benefit.
[39]
Even where a bona
fide non‑tax purpose to the series of transactions is found to exist,
if the primary purpose of at least one transaction in the series is to obtain a
tax benefit, the tax benefit that results from the entire series may be denied
under the GAAR.
[40]
The respondent argues
that there are at least three clearly identifiable avoidance transactions in
the series of transactions entered into by the appellant:
–
the payment by Rcongold
of a stock dividend;
–
the creation of the
PCT;
–
the disposition of the
common shares of Rcongold to the PCT.
[41]
The only purpose of the
payment by Rcongold of a stock dividend in the amount of $1 on the common
shares held by the appellant through the issuance of 80,000 high fair
market value/low paid‑up capital Class “E” non‑voting preferred
shares to the appellant was to shift the value of the common shares to the
preferred shares (the “value/shift”) and to create a latent capital loss which
the appellant could then realize on the disposition of the common shares to the
PCT.
[42]
The only purpose of the
creation of the PCT was to allow the recognition and realization of the capital
loss of $7,999,935 on the disposition of the common shares of Rcongold to the
PCT. This is evident because the loss could not have been realized had the
shares been sold directly to Peter Cohen, his spouse or a company controlled by
Peter Cohen or his spouse. That is because subsection 251.1(1) of the Act
did not include, in 2002, the reference to a trust in the definition of
“affiliated persons”. Paragraphs 251.1(1)(g) and (h) were
added by S.C. 2005, c. 19, s. 54(1) applicable in determining
whether persons are, at any time after March 22, 2004, affiliated.
[43]
The disposition of the
common shares of Rcongold to the PCT rather than to Mr. Cohen personally,
or to a company controlled by him, was undertaken to avoid the application of
the stop‑loss rules in subparagraph 40(2)(g)(i) and to permit
the recognition of the capital loss under the technical provisions of the Act.
[44]
According to the respondent,
it is reasonable to conclude that the value/shift, the creation of the PCT and the
disposition of the common shares to the PCT were not undertaken or arranged
primarily for bona fide purposes other than to obtain a tax benefit. These
were accordingly avoidance transactions within the meaning of subsection 245(3)
of the Act.
[45]
The respondent further
submits that the primary purpose of the entire series of transactions was to
obtain the tax benefit and that the entire series is an avoidance transaction.
The facts of this case suggest that the entire series of transactions was
undertaken primarily to obtain the tax benefit rather than to allow Mr. Cohen
to access the future growth on $8 million. None of the transactions were
primarily undertaken to allow Peter Cohen to access funds which he had
relinquished in the course of the estate freeze that occurred in 2000, as there
is no evidence that Mr. Cohen actually took steps to access those funds.
[46]
The respondent also
argues that a reversal of the estate freeze could have been accomplished in many
other ways under the provisions of the Act without adverse tax
consequences and without the creation of a capital loss.
[47]
The respondent states
that the manner in which the appellant and Mr. Cohen undertook the series
of transactions discloses that it was carried out for the sole purpose of
obtaining the tax benefit. To realize a capital loss equal to the amount of the
gain realized weeks before, it was essential that the transactions unfold the
way they did. The transactions were, however, not required in order to allow
Mr. Cohen to access the future growth of the appellant.
[48]
According to the respondent,
it is possible and reasonable in this case to conclude that the tax benefit is
the only reason the transactions were arranged in the manner chosen by
Mr. Cohen and his tax advisors. For the appellant to be successful, the
evidence must show that the non‑tax business objectives of the appellant
required each specific step in the series to be taken.
[49]
Even if a bona fide
non‑tax purpose was found to exist for the series of transactions as a
whole, the creation of the loss and the presence of at least three clear
avoidance transactions trigger the application of subsection 245(2) of the
Act.
Abusive tax avoidance
[50]
The third step in the
GAAR analysis is the determination whether the avoidance transactions giving
rise to a tax benefit are abusive. The focus of the analysis must be on the
overall result of the series as opposed to the overall purpose.
[51]
The analysis under subsection 245(4)
requires a determination whether the transactions frustrate the object, spirit and
purpose of the relevant provisions of the Act, which in turn requires an
examination of the factual context of the transactions, their legitimacy and
the result that those provisions sought to achieve. The analysis under subsection 245(4)
is a two‑step analysis.
[52]
The first step requires,
in order to determine their object, spirit and purpose, a textual, contextual
and purposive approach to interpreting the provisions of the Act relied
upon by the appellant in seeking to obtain the tax benefit. The respondent
refers to the introduction of a tax on capital gains as part of the 1972 tax reform,
which was accompanied by the fiscal recognition of capital losses upon their being
incurred and by the enactment of specific anti‑avoidance provisions
relating to capital losses (sections 54 and 55 and paragraph 40(2)(g)).
[53]
Section 55 was enacted
to prevent capital losses from being artificially created to offset capital
gains. Any capital loss realized on a disposition in circumstances that could
reasonably be considered to have artificially or unduly created that loss was
deemed to be non‑existent. In 1980, the Act was amended to, inter
alia, broaden the scope of the anti‑avoidance rule in section 55
by the enactment of subsection 55(2).
[54]
Subparagraph 40(2)(g)(i)
and section 54 deem superficial losses to be nil. Those rules along with section 251.1,
which was added to the Act, continue to remain in effect and were in
effect under the Act as it read in 2002.
[55]
A contextual and
purposive interpretation of the provisions relied on by the appellant in
seeking to obtain the tax benefit discloses that their object, spirit and
purpose was to allow only the recognition of true capital losses incurred
outside the same economic unit.
[56]
A contextual and
purposive reading of sections 3, 38 (more specifically paragraph 38(b)),
39 and 40 must take into consideration their legislative history and context
and their interplay with subparagraph 40(2)(g)(i), section 54,
former subsection 55(1) and section 251.1. Such a reading leads to the
conclusion that the recognition of artificial losses realized within the same
economic unit is contrary to the object, spirit and purpose of those
provisions.
[57]
The second step in the
analysis under subsection 245(4) is to examine the factual context of this
case in order to determine whether the avoidance transactions undertaken by the
appellant defeat or frustrate the object, spirit or purpose of the provisions
in issue. Where a taxpayer has relied on a series of transactions to obtain a
tax benefit, the entire factual context of the series must be examined.
[58]
The transactions
undertaken by the appellant amount to abusive tax avoidance for the following
reasons:
a)
They defeat the
underlying rationale of the capital loss treatment provided for in paragraph 38(b),
which is only to allow the recognition of a true capital loss. The appellant
transferred artificially devalued shares of Rcongold that had been held by the appellant
for a mere 24 hours to a person within the same economic unit in order to
create a capital loss without incurring any economic loss. The recognition of a
capital loss resulting from the series of transactions is inconsistent with the
underlying object, purpose and spirit of the tax benefit provision found in paragraph
38(b), which was enacted concurrently with anti‑avoidance
provisions aimed at preventing a taxpayer from deducting artificially created
capital losses or capital losses realized within the same economic unit.
b)
They achieve an outcome
that the stop‑loss rules and other specific anti‑avoidance
provisions, found notably in subparagraph 40(2)(g)(i), seek to
prevent, that is, the deduction of a loss created within the same economic unit
in a manner that frustrates or defeats the object, spirit or purpose of those
provisions.
[59]
The respondent further
states that the artificiality and vacuity of the “loss” manufactured in this
case is an important factor in the examination of the factual context of the
case to determine whether the avoidance transaction defeats or frustrates the
object, spirit or purpose of the provisions in issue and results in a misuse
and abuse of the provisions of the Act, read as a whole. The respondent
refers to several cases in which the courts have considered the artificiality
of transactions undertaken by taxpayers in order to obtain a tax benefit or circumvent
specific provisions of the Act, in particular the Supreme Court of
Canada’s decision in Mathew v. Canada, [2005] 2 S.C.R. 643, 2005 SCC 55,
in which the abusive nature of the transactions was confirmed "by the vacuity
and artificiality of the non‑arm’s length aspect of the initial
relationship".
[60]
The respondent further
submits that the continued intention of Parliament with respect to deductible
capital losses is that this tax benefit should only apply in circumstances
where the loss is not created artificially. The respondent’s reasoning is based
on former section 55, renumbered subsection 55(1) in 1980, which was an anti‑avoidance
provision directed against transactions that could reasonably be considered to
result in the artificial or undue reduction of a capital gain or creation of a
capital loss. The result of the application of subsection 55(1) was that
the taxpayer’s gain or loss from the disposition of the property was computed
as if the artificial or undue reduction of the taxpayer’s gain, or creation or
increase of the taxpayer’s loss, had not occurred.
[61]
Former
subsection 55(1) was repealed upon the enactment of the general anti‑avoidance
rule in section 245.
[62]
The repeal of former subsection
247(1) and its replacement with section 245 did not signal that the strictures
against surplus stripping were being relaxed. The same conclusion should be
drawn with respect to the repeal of subsection 55(1) and its replacement
with section 245.
[63]
The respondent also
argues, on the basis of the decisions of the Supreme Court of Canada in Lipson
v. Canada, [2009] 1 S.C.R. 3, 2009 SCC 1, and Canada Trustco, cited
above, that an abuse may result from an arrangement that circumvents the
application of certain provisions, such as specific anti-avoidance rules, in a
manner that frustrates or defeats the object, spirit or purpose of those provisions.
In this case, the anti‑avoidance provisions that the appellant seeks to circumvent
are the stop‑loss provisions. These stop‑loss rules deem a capital
loss to be nil and aim at denying or limiting the deductibility of losses
arising from the disposition of capital property in circumstances where the
disposition occurred within a group of certain non‑arm’s length parties.
[64]
Pursuant to subparagraph 40(2)(g)(i)
and the definition of “superficial loss” in section 54, a taxpayer’s loss
on the disposition of property to an affiliated person, as defined in subsection 251.1(1),
is deemed to be nil. Subparagraph 40(2)(g)(i) did not apply to deny
the loss on the disposition of the common shares of Rcongold to the PCT in 2002
because, at the time that the transaction occurred, the PCT and the appellant
were not included within the ambit of the definition of “affiliated persons” in
subsection 251.1(1), as it read at the time.
[65]
The definition of
“affiliated persons” in section 251.1 was amended in 2005 to include trusts.
The amendments were aimed primarily at disallowing losses on transactions
carried out between related persons through the use of a trust, which
transactions previously circumvented the anti‑capital gain stripping tax
policy considerations underlying, inter alia, subparagraph 40(2)(g)(i).
Subsection 251.1(1) now ensures that transactions between a trust and a
person with whom it is “affiliated” will be subject to the “stop‑loss”
rules contained in the Act. The loss on the disposition of the shares to
the PCT for the benefit of Mr. Cohen would now be deemed to be nil. The
amendment of section 251.1 is an indication that the results achieved by
the appellant were contrary to the object, spirit and purpose of the Act,
read as a whole.
Analysis
[66]
The Minister's
reassessment dated June 8, 2006 was based on section 245 of the Act which
provides as follows:
245. [General Anti-Avoidance Rule - GAAR] — (1) Definitions — In this section,
"tax benefit" means a reduction, avoidance or deferral
of tax or other amount payable under this Act or an increase in a refund of tax
or other amount under this Act, 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;
"tax consequences" to a person
means the amount of income, taxable income, or taxable income earned in
Canada of, tax or other amount payable by or refundable to the person under
this Act, or any other amount that is relevant for the purposes of computing
that amount;
"transaction"
includes an arrangement or event.
(2) General anti-avoidance provision [GAAR] —
Where a transaction is an avoidance transaction, the tax consequences
to a person shall be determined as is reasonable in the circumstances in order
to deny a tax benefit that, but for this section, would result, directly or
indirectly, from that transaction or from a series of transactions that
includes that transaction.
(3) Avoidance transaction — An avoidance transaction means any
transaction
(a) that, but for this
section, would result, directly or indirectly, in a tax benefit, unless the
transaction may reasonably be considered to have been undertaken or arranged
primarily for bona fide purposes other than to obtain the tax benefit;
or
(b) that is part of a series of transactions, which
series, but for this section, would result, directly or indirectly, in a tax
benefit, unless the transaction may reasonably be considered to have been
undertaken or arranged primarily for bona fide purposes other than to
obtain the tax benefit.
(4)
Application of subsec. (2) — 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 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.
(5)
Determination of tax consequences — Without restricting the generality of
subsection (2), and notwithstanding any other enactment,
(a) any deduction,
exemption or exclusion in computing income, taxable income, taxable income
earned in Canada or tax payable or any part thereof may be allowed or
disallowed in whole or in part,
(b) any such deduction, exemption
or exclusion, any income, loss or other amount or part thereof may be allocated
to any person,
(c) the
nature of any payment or other amount may be recharacterized, and
(d) the tax effects that would otherwise result from
the application of other provisions of this Act may be ignored,
in determining
the tax consequences to a person as is reasonable in the circumstances in order
to deny a tax benefit that would, but for this section, result, directly or
indirectly, from an avoidance transaction.
Tax benefit
[67]
In applying the approach
suggested by the Supreme Court in Canada Trustco, the first question to be
determined is whether the appellant obtained a tax benefit from a transaction
or part of a series of transactions. In determining what constitutes a series
of transactions, consideration should be given to subsection 248(10) of
the Act, which states that:
(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.
[68]
In this instance, there
is no dispute between the parties that the series of transactions to be
considered consists of the five transactions forming part of the Reverse Freeze
namely: the incorporation of Rcongold, the subscription for shares of Rcongold
by the appellant, the declaration of a stock dividend by Rcongold, the creation
of the PCT, and the sale by the appellant of shares of Rcongold to the PCT.
[69]
In order for a “tax
benefit” to exist, a reduction, avoidance or deferral of tax is required. The
Supreme Court of Canada clearly stated in Canada Trustco that, where a
deduction against taxable income is claimed, the existence of a tax benefit is
clear since a deduction results in a reduction of tax. In the absence of the
transactions forming part of the Reverse Freeze, the appellant would have had
to pay tax on a capital gain of $7,799,545. Instead, a capital loss of
$7,999,935 was created and made available to the appellant to apply against its
capital gain. The tax benefit arose from the offsetting of the capital gain
against the capital loss and the reduction to nil of the tax that would
otherwise have been payable on that gain.
Avoidance transaction
[70]
The next step in the
GAAR analysis is to determine whether a transaction or any transaction in a series
of transactions is an “avoidance transaction” under subsection 245(3), in
the sense of not having been “arranged primarily for bona fide purposes
other than to obtain the tax benefit”. The determination that must be made is
the primary purpose of each transaction in the series and not the primary
purpose of the entire series.
[71]
The incorporation of
Rcongold and the issuance of common shares of Rcongold were not avoidance
transactions in and of themselves. They were legally effective transactions
having the economic substance they purported to have. However, they were
necessary steps taken in furtherance of the Reverse Freeze and, for that reason,
they were part of the series of transactions.
[72]
The declaration by
Rcongold, the day after the common shares were subscribed for, of a dividend of
$1 on the common shares held by the appellant and the payment of the dividend
on the same day by issuing 80,000 high FMV/low PUC Class “E” non‑voting
preferred shares of the appellant was an avoidance transaction aimed at shifting
the value of the common shares to the preferred shares and creating a latent
capital loss which the appellant could then realize on the disposition of the
common shares to the PCT. The real economic effect of these transactions was the
payment of a $1 dividend by means of 80,000 preferred shares having a
redemption price and a fair market value of $8,000,000.
[73]
The creation of the PCT
was also an avoidance transaction since the only purpose of the PCT was to
allow the recognition and realization of the capital loss of $7,999,935 on the
disposition of the common shares of Rcongold.
[74]
The sale of the common
shares of Rcongold to the PCT was an avoidance transaction undertaken
primarily to realize a capital loss on the common shares while avoiding the
application of the stop‑loss rules found in subparagraph 40(2)(g)(i)
and to permit the recognition of the capital loss under the technical
provisions of the Act.
[75]
In my opinion, it is
reasonable to conclude that the value/shift, the creation of the PCT and the
disposition of the common shares to the PCT were not undertaken or arranged
primarily for bona fide purposes other than to obtain a tax benefit, and
that the primary purpose of the entire series of transactions was to obtain the
tax benefit. Consequently, the entire series of transactions is an avoidance
transaction.
[76]
The facts of this case
suggest that the entire series of transactions was undertaken primarily to
obtain the tax benefit rather than to allow Mr. Cohen to access the future
growth on $8 million worth of assets. None of the transactions were primarily
undertaken to allow Mr. Cohen to access funds which he had relinquished in the
course of the estate freeze that occurred in 2000, and there is no evidence
that Mr. Cohen actually took steps to access those funds.
[77]
At the time the series
of transactions was entered into, Mr. Cohen had access, on a tax-free basis, to
$3 million upon redemption of the Class "E" preferred shares of the appellant.
The Class "E" preferred shares had a paid-up capital, a redemption
price and an adjusted cost base of $3,000,000. They were voting shares,
redeemable, at the option of the holder or the company, at the issue price, and
they were non-participating except for a non-cumulative 0.5% per month
dividend. They were subscribed and paid for by Mr. Cohen on January 18, 2002.
The $3,000,000 subscription price paid for the said preferred shares came
partly or entirely from the redemption on January 9, 2002 of the 30 Class
"F" shares and 10 Class "F2" shares of the appellant held
by Mr. Cohen for $540,597 and $4,000,000, respectively. The said share redemptions
triggered two deemed capital dividends (and thus tax-free in the hands of Mr.
Cohen) pursuant to elections made under subsection 83(2) of the Act. For
tax purposes, the two deemed dividends were considered to have been paid out of
the appellant's capital dividend account that was created as a result of the
sale of the real property on December 6, 2001. As suggested by the appellant's
tax advisors, the capital dividend account of the appellant had to be
distributed prior to the creation of the capital loss in order to avoid the
reduction of the account balance.
[78]
As described above, Mr.
Cohen received from the appellant a total of $4,540,597 during the month of
January 2002 and reinvested only $3,000,000 in Class "E" shares
of the appellant generating a monthly dividend of $15,000. In the
circumstances, I have some difficulty accepting that Mr. Cohen absolutely needed
to have access to the future growth on $8,000,000.
[79]
The facts concerning
the growth of the assets transferred to Rcongold show that the growth was
uncertain and that the assets transferred were not a reliable source of income.
Approximately 10% of the assets transferred were not generating any income at
all and had an uncertain value. Those assets were interest-free loans to
related companies or to members of Mr. Cohen's family. From the tax returns
filed by Rcongold on August 23, 2006 for its 2002, 2003, 2004 and 2005 taxation
years, the after-tax net income (loss), the retained earnings, the share
redemptions and the taxable dividends paid in those years were as follows:
|
Year-end
(August 31)
|
Net income
or loss
$
|
Retained earnings
$
|
Share
redemptions
|
Taxable dividends paid
|
|
2002
|
(220)
|
(220)
|
Nil
|
Nil
|
|
2003
|
44,004
|
24,784
|
Nil
|
Nil
|
|
2004
|
184,878
|
203,662
|
Nil
|
Nil
|
|
2005
|
31,360
|
230,022
|
Nil
|
Nil
|
[80]
The information
contained in the tax returns of Rcongold clearly shows that the $8,000,000 in assets
generated very little income and that in fact Mr. Cohen took no steps to access
those funds.
[81]
A reversal of the
earlier estate freeze could have been accomplished in many other ways under the
provisions of the Act and without the creation of a capital loss. For
example, a new freeze could have been carried out by having the appellant roll
over to a new corporation (Newco), all (complete freeze) or part (partial
freeze) of its assets in exchange for preferred shares of Newco having a
redemption price equal to the fair market value of the assets transferred to
Newco. Mr. Cohen could then have subscribed for common shares of Newco for a
nominal amount. Alternatively, the Peter Cohen Family Trust could have
exchanged its common shares of the appellant for preferred shares by using the
rollover provisions of sections 51, 85 or 86 of the Act. Mr. Cohen could
then have subscribed for common shares in the appellant for a nominal amount.
This would have allowed Mr. Cohen to participate in the future growth of the appellant
as of the date of those transactions.
[82]
The manner in which the
appellant and Mr. Cohen undertook the series of transactions reveals that the
transactions were carried out in that way for the sole purpose of obtaining the
tax benefit. In order to realize a capital loss equal to the amount of the gain
previously realized, it was essential that the transactions unfold the way they
did. The transactions were not required in order to allow Mr. Cohen to access
the future growth of the assets of the appellant.
[83]
In the circumstances,
it is reasonable to conclude that the realization of the tax benefit was the
only reason the transactions were arranged in the manner chosen by Mr. Cohen
and his tax advisors.
Misuse or abuse
[84]
The third requirement
for the application of the GAAR is that the avoidance transaction or series of
transactions be abusive. The burden is on the Minister to establish the abuse
and to state which provisions of the Act have been abused.
[85]
With the inclusion, as
of 1972, of taxable capital gains in the calculation of income and with the
existence of the ability to have those gains offset by deductible capital
losses incurred in the year, specific anti-avoidance provisions relating to
capital losses were enacted. These provisions included former section 55,
paragraph 40(2)(g) and section 54 of the Act.
[86]
Former section 55 of
the Act was enacted to prevent capital losses from being artificially
created in order to offset capital gains. Any capital loss realized on a
disposition in circumstances that could reasonably be considered to have
artificially or unduly created that loss was deemed to be non-existent.
[87]
Former section 55, renumbered
55(1) in 1980, provided as follows:
For the purposes of this subdivision, where the result of one or
more sales, exchanges, declarations of trust, or other transactions of any kind
whatever is that a taxpayer has disposed of property under circumstances such
that he may reasonably be considered to have artificially or unduly
(a) reduced the amount of his gain from the disposition,
(b) created a loss from the disposition, or
(c) increased the amount of his loss from the
disposition,
the taxpayer's gain or loss, as the case may be, from the
disposition of the property shall be computed as if such reduction, creation or
increase, as the case may be, had not occurred.
[88]
Former subsection 55(1)
was repealed upon the enactment of the general anti-avoidance rule in section
245. The Department of Finance Technical Notes for 1988 with respect to former
subsection 55(1) reads as follows:
Subsection 55(1) of the Act is an anti-avoidance provision aimed at
transactions designed to artificially or unduly reduce a capital gain or
increase or create a capital loss on a disposition of property.
Subsection 55(1) is repealed as a consequence of the introduction of
new section 245 of the Act, which constitutes a general anti-avoidance
rule. Because the scope of that general anti-avoidance rule is broad enough to
cover the transactions to which subsection 55(1) was intended to apply, that
subsection is no longer necessary. Subsection 55(1) is repealed.
[89]
The repeal of
subsection 55(1) and its replacement with section 245 did not signal a policy
shift. On the contrary, it confirmed the continued intention of Parliament with
respect to deductible capital losses that this tax benefit should only apply in
circumstances where the loss is not created artificially.
[90]
The other specific
anti-avoidance provisions relating to capital losses that were enacted by
Parliament are subparagraph 40(2)(g)(i) and section 54 (generally
referred to as the stop-loss provision). The concept of "affiliated
persons" was introduced into the Act in 1995 primarily in support
of a number of new and amended anti-avoidance provisions, most of which are stop-loss
provisions.
[91]
In 2002, subparagraph
40(2)(g)(i) read as follows:
Notwithstanding subsection (1)
. . .
(g) a taxpayer's loss, if any, from the
disposition of a property, to the extent that it is
(i)
a superficial loss,
. . .
is nil.
[92]
In 2002, the expression
"superficial loss" was defined in section 54 as follows:
"superficial loss" of a taxpayer means the taxpayer's loss
from the disposition of a particular property where
(a) during the period that begins 30 days
before and ends 30 days after the disposition, the taxpayer or a person
affiliated with the taxpayer acquires a property (in this definition referred
to as the "substituted property") that is, or is identical to, the
particular property, and
(b) at the end of that period, the
taxpayer or a person affiliated with the taxpayer owns or had a right to
acquire the substituted property.
[93]
Pursuant to subparagraph
40(2)(g)(i) and the definition of "superficial loss" in
section 54, a taxpayer's loss on the disposition of property to any affiliated
person is deemed to be nil.
[94]
Subparagraph 40(2)(g)(i)
did not apply to deny the loss on the disposition of the common shares of
Rcongold to the PCT in 2002 because, at the time the transaction occurred, the PCT
and the appellant were not included within the ambit of the definition of
"affiliated persons" in section 251.1 as it then read.
[95]
The definition of
"affiliated persons" in section 251.1 was amended in 2005 to include
paragraphs (g) and (h), which resulted in the inclusion of trusts
within that definition. Paragraph (g) is relevant in this case and reads
as follows:
(1) Definition of "affiliated persons". For the purposes
of this Act, "affiliated persons", or persons affiliated with
each other, are
. . .
(g) a person and a trust, if the person
(i)
is a majority-interest beneficiary of the trust,
or
(ii)
would, if this subsection were read without
reference to this paragraph, be affiliated with a majority-interest beneficiary
of the trust, . . .
[96]
Subsection 251.1(1) now
ensures that transactions between a trust and a person with whom it is
"affiliated" will be subject to the stop-loss rules contained in the Act.
[97]
In my opinion, the 2005
amendment to section 251.1 is a clear indication that the results achieved by
the appellant were contrary to the object, spirit and purpose of the Act
when read as a whole.
[98]
The legislative history
of sections 3, 38, 39 and 40 reveals that, from the inception of these
provisions, the deduction of capital losses under paragraph 38(b) has
been limited by anti-avoidance rules that refuse the recognition of artificial,
superficial or undue losses. The interplay of these provisions with
subparagraph 40(2)(g)(i), section 54, former subsection 55(1) and
section 251.1 leads to the conclusion that the recognition of artificial
capital losses realized within the same economic unit is contrary to the
object, spirit and purpose of these provisions.
[99]
A contextual and
purposive interpretation of the provisions relied on by the appellant in
seeking to obtain the tax benefit discloses that their object, spirit and
purpose was to allow only the recognition of "true" capital losses sustained
outside the economic unit.
[100]
The transactions
undertaken by the appellant amount to abusive tax avoidance because they defeat
the underlying rationale of the capital loss provisions in the Act. Through
the manipulation of the fiscal "amount" of the Rcongold common
shares, the appellant created artificially devalued property that was
transferred to a person within the same economic unit to create an artificial
capital loss without incurring any real economic loss. On August 27, 2002, the appellant
owned shares of Rcongold which had a fair market value of $8 million (the
common shares). On August 28, 2002, the appellant continued to own shares of
Rcongold which had a fair market value of $8 million (the Class "E"
shares) and after the disposition of the common shares of Rcongold to the PCT,
the appellant continued to own shares in Rcongold having a fair market value of
$8 million.
[101]
In The Queen v. Landrus,
2009 DTC 5085, 2009 FCA 113, the Federal Court of Appeal determined that the GAAR
did not apply because a real economic loss resulted from the transactions under
review and the underlying scheme of the Act allowed for the deduction of
that real loss.
[102]
The transactions undertaken
by the appellant, however, clearly circumvent the application of specific
anti-avoidance rules, which are, in this case, the stop-loss provisions.
Subparagraph 40(2)(g)(i) and subsection 251.1(1) as it then read were
circumvented by the appellant in 2002 in a manner that achieved an outcome that
the provisions sought to prevent, namely, the creation of an artificial capital
loss between parties with the same economic affiliations. The loss on the
disposition of the common shares of Rcongold to the PCT established for the
benefit of Mr. Cohen would now be deemed to be nil.
[103]
In my opinion, the
transactions forming part of the Reverse Freeze resulted in an abuse of the Act
to which the GAAR should apply.
[104]
For the foregoing
reasons, I would dismiss this appeal with costs.
Signed at Ottawa, Canada, this 12th day of July 2011.
"Réal Favreau"
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