Citation: 2011 TCC 383
Date: 20110907
Docket: 2008-2482(IT)G
BETWEEN:
1207192 ONTARIO LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Paris J.
[1]
This
is a reassessment of the Appellant’s taxation year ending February 28, 2003.
The Minister of National Revenue applied the General Anti-Avoidance Rule (“GAAR”)
in subsection 245(1) of the Income Tax Act
to deny the capital loss of $2,999,900 realized by the Appellant on the
disposition of the common shares it held in 2022900 Ontario Inc. (“Newco”)
[2]
The loss on the common
shares was generated by the declaration of a stock dividend by Newco on the
common shares prior to the disposition by the Appellant. The payment of the
stock dividend had the effect of decreasing the value of the Appellant’s common
shares in Newco by an amount equal to the value of the stock dividend. The
stock dividend consisted of preferred shares with a low paid-up capital and a
high redemption amount. The transfer of value from the common shares to the
preferred shares was referred to by Respondent’s counsel as a “value shift.” After
the payment of the stock dividend, the Appellant’s loss on the common shares
was crystallized by a disposition of those shares to a family trust of which
the beneficiaries were family members of the sole shareholder of the Appellant,
Mr. Dan Cross.
[3]
The
capital loss was used by the
Appellant
to offset a capital gain of $2,974,386 it realized during its 2003 taxation
year.
Issues
[4]
In
order for the GAAR to apply: there must be:
-a tax benefit resulting
from a transaction or series of transactions of which the transaction forms a
part; (s. 245(1) and (2));
-the transaction must be an avoidance
transaction in the sense that it cannot be said to have been reasonably
undertaken or arranged primarily for a bona fide purpose other than to
obtain a tax benefit; and
-there must be
abusive tax avoidance in the sense that it cannot be reasonably concluded that
the tax benefit would be consistent with the object, spirit or purpose of the
provisions relied upon by the taxpayer.
[5]
In
this case, the Appellant concedes that it obtained a tax benefit as a result of
the series of transactions that gave rise to the capital loss. At issue is
whether there was an avoidance transaction, and if so, whether there was
abusive tax avoidance.
[6]
The
Appellant maintains that none of the transactions that resulted in the capital
loss were undertaken primarily to obtain the tax benefit. It says that the
primary purpose of those transactions was to creditor-proof Mr. Cross, who at
the time of the transaction was about to embark on a financially risky venture.
The Appellant also says that there was no abusive tax avoidance because the tax
benefit is consistent with the object, spirit and purpose of the provisions of
the Act relied upon by the Appellant.
Background
[7]
Mr.
Cross has worked in the life insurance industry for many years. He started out
as a salesman and later became a broker. In 1987, he and a partner started
Bridan Insurance, which operated as a managing general agent (“MGA”). An MGA
acts as a middleman between insurance companies and independent insurance
brokers and earns commissions from the insurance companies on insurance
products sold by the brokers. Bridan Insurance operated until some time around
1990, after which Mr. Cross and a different partner started another MGA
business called Brokerage Underwriting Services.
[8]
In
the early 1990’s, Mr. Cross was pursued by a creditor in relation to certain
personal guarantees he had given on behalf of his partner in Bridan. As a
result, he declared bankruptcy. In those proceedings, his creditor sought to
set aside Mr. Cross’ transfer of his interest in the family home to his spouse
that had taken place the year prior to his declaring bankruptcy. The trustee
determined that the conveyance was not done to defeat creditors and Mr. Cross’
spouse was able to keep the home. However, Mr. Cross said that the possibility
of losing the home had caused him and his spouse a great deal of stress. Mr.
Cross was discharged from bankruptcy in 1995.
[9]
Through
the late 1990’s, Brokerage Underwriting Services, which Mr. Cross and his
partner continued to operate, prospered.
[10]
In
1999, Mr. Cross and his partner sold their shares in Brokerage Underwriting
Services to an arm’s length purchaser, Hub Insurance Group (“Hub”), in exchange
for shares in Hub. Mr. Cross transferred his Hub shares to the Appellant using
the provisions of section 85 of the Act.
[11]
Mr.
Cross was given a 10-year employment contract by Hub, but he retired in 2002
due to back problems. The Appellant disposed of its Hub shares between July and
October 2002, realizing a capital gain of $2,974,386.
[12]
After
retiring from Hub, Mr. Cross, along with Mr. Robert Young and Mr. Shawn
Comiskey, decided to start up an MGA business called Success Strategies Inc. (SSI).
Their intention was to sell high-face value life insurance policies on behalf
of AIG Life of Canada (“AIG”) through a limited number of brokers to wealthy
individuals. The policies were expected to have high premiums and to generate
large commissions for the brokers and for SSI. These policies would be subject
to chargebacks if a client cancelled the policy or did not pay the required
premiums at any point in the first two years of the policy. If either event
occurred, the insurance company writing the policy could collect back some or
all of the commission that had been paid to the broker and to the MGA. The
amount of this chargeback would depend on how long the policy had been in force
and the amount of the premiums that had already been paid. In this case, AIG
required guarantees from SSI and from Mr. Cross, Mr. Young and Mr. Comiskey
personally for the payment of any chargebacks.
[13]
Mr.
Cross testified that Mr. Young and Mr. Comiskey had limited resources at the
time SSI was starting up. This meant that if any claims were made against SSI,
he would have to pay them himself because he was the only one with any money.
In addition guaranteeing the debts of SSI to AIG, Mr. Cross also guaranteed
SSI’s line of credit with the bank. Mr. Cross said that he and his wife were
very concerned about his exposure under these guarantees because his previous
bankruptcy had resulted from claims arising from personal guarantees he had
given.
[14]
Mr.
Cross said that these concerns led him to contact Mr. Doug Marshman at Deloitte
and Touche to obtain advice on possible creditor-proofing strategies.
[15]
Mr.
Marshman testified that at their first meeting in the fall of 2002, he and Mr.
Cross discussed the latter’s concerns about his exposure under the SSI
guarantees. They also discussed Mr. Cross estate planning in general. He said
that they “really didn’t discuss any tax issues”.
[16]
Mr.
Marshman said that later on he recalled a partner having discussed a particular
creditor-proofing plan at a partner’s meeting, and so he obtained a copy of the
plan along with the legal opinion relating to the plan. The plan outlined a
series of transactions that were substantially the same as those that were
carried out by Mr. Cross and the Appellant, and discussed the tax outcomes of
the transactions. One of the tax outcomes mentioned was the creation of “a
substantial capital loss.”
[17]
Both
Mr. Cross and Mr. Marshman testified that the plan was selected for its
creditor-proofing aspect and not because it resulted in a capital loss.
Mr. Cross also said that if he had to choose between a plan that provided
creditor-proofing and one that resulted in a capital loss, he would have chosen
the former. Mr. Marshman testified that he only realized that this
creditor-proofing plan would generate a capital loss to the Appellant at the
time that a particular Deloitte in-house technical memorandum on the file was
produced on January 28, 2003. He said he was pleasantly surprised by this
result. The technical memorandum refers to the “creditor-proofing reorganization
that is currently in progress” for Mr. Cross. Therefore, according to Mr.
Marshman’s testimony, he only realized that a capital loss would be produced
for the Appellant after the decision to use the plan had been made.
[18]
The
parties filed a Statement of Agreed Facts at the hearing, and the specific
transactions that were carried out are described in paragraphs 7 to 15 thereof,
which are reproduced here;
7. On February 20, 2003, 2022900 Ontario Inc. (“Newco”) was
incorporated. Mr. Cross was the sole director of Newco at all material times.
8.
The authorized capital of Newco is unlimited numbers of Class A
special shares, Class B special shares and common shares, with the following
attributes:
(a)
the Class A special shares had no dividend entitlement but had a
voting entitlement of 10 votes per share. These shares were redeemable at the
amount of their stated capital. In the event of a wind-up or liquidation of
the corporation, the Class A special shares ranked ahead of the common shares
for payment but payment was limited to the amount of the stated capital;
(b)
the Class B special shares while owned by the initial owner were
entitled to non-cumulative dividends at the discretion of the directors.
Otherwise their dividend entitlement was 6% of stated capital. They had paid
up capital (“PUC”) of $100 and were redeemable from the initial owner for $100
per share. Other than for the initial owner the redemption amount was the
stated capital of the shares plus any unpaid dividends. They were retractable
for the amount of their stated capital. In the event of wind-up or liquidation
of the corporation, the Class B special shares ranked ahead of all other shares
for payment but payment was limited to the amount of their stated capital.
These shares were non-voting; and
(c)
the common shares were entitled to dividends at the discretion of
the directors, even in preference to other classes of shares. Each common
share bore one vote.
9. On
February 25, 2003, the Cross Family Trust was founded:
(a) Ruth
Cross (Mr. Cross’ mother) was the settlor;
(b) the object settled was a gold coin;
(c) the
Cross Family Trust was established as a discretionary trust; and
(d) Marylee Cross (Mr. Cross’ wife), Robert Lesperance (Mr.
Cross’ brother-in-law) and Paula Adams (Mr. Cross’ lawyer) were the trustees.
The trustees made decisions for the trust according to majority rule. The
income and capital beneficiaries of the Cross Family Trust were Marylee Cross
and the couple’s children, Laura and Amy.
10. On
February 25, 2003, the Cross Voting Trust was founded:
(a) Ruth Cross was the settlor;
(b) The object settled was a $100 bill;
(c) The Cross Voting Trust was established as a discretionary
trust; and
(d) Mr. Cross, David Cross (Mr. Cross’ brother) and
Daniel Skellett (Mr. Cross’ friend) were the trustees. The appointment of the
trustees had to be approved by the director of the Appellant, being Mr. Cross.
The trustees made decisions for the Cross Voting Trust according to majority
rule. Marylee Cross, Laura Cross and Amy Cross were both income and capital
beneficiaries of the Cross Voting Trust. Mr. Cross was an income beneficiary.
11. On or about February 26, 2003, the Appellant purchased
marketable securities worth $2,847,505. It also retained $152,495 in cash to
establish a block of assets with a total fair market value (“FMV”) of
$3,000,000.
12. On February 27, 2003, the Appellant transferred its cash and
securities with a FMV of $3,000,000 to Newco and was issued from treasury
30,000 common shares in Newco with a stated capital of $2,999,900.
13. On February 27, 2003, Newco declared a stock dividend of 1
Class B special share per common share. The Appellant received 30,000 Class B
special shares with a redemption value, to the initial investor, of $3,000,000
and PUC/ACB of $100.
14. On February 27, 2003, the Cross Voting Trust subscribed for
10,000 Class A special shares in Newco and paid $100 for these shares. This
purchase gave the Cross Voting Trust 100,000 votes with respect to Newco and,
thus, control of Newco.
15. On February 28, 2003, the Appellant sold its 30,000 common
shares in Newco to the Cross Family Trust for $100.
[19]
The
creditor-proofing of Mr. Cross’ assets was accomplished through the restriction
on the redemption value of the Class B special shares for anyone other than the
initial owner. The Appellant was entitled to have those shares redeemed by
Newco for $100 per share, but for any subsequent owner of the shares, the
redemption amount was restricted to the paid up capital, which was only $.10
per share.
[20]
The
Class B special shares issued to the Appellant by way of stock dividend had a
value of $3 million, equal to their redemption value. As stated earlier in
these reasons, the declaration of the stock dividend caused the common shares
to decrease in value by an amount equal to the value of the stock dividend.
This loss in value was crystallized into a capital loss by the disposition of
the common shares to the Family Trust for $100. It is not disputed that the
adjusted cost base of the common shares to the Appellant was $3 million, that
it received proceeds of disposition of $100 from the sale of the shares, and
that the Appellant thereby incurred a capital loss of $2,999,900 according to
the provisions of the Act read without the GAAR.
Was
there an Avoidance Transaction?
[21]
The
definition of “avoidance transaction” is found in subsection 245(3) of the Act:
245(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.
[22]
The
parties agree that the series of transactions that gave rise to the tax benefit
in this case consisted of the following transactions:
(a) the incorporation of Newco;
(b) subscription for 30,000 common
shares of Newco;
(c) Newco declaring
a stock dividend of 30,000 Class B special shares, which had a high FMV and low
PUC;
(d) the
establishment of the Cross Family Trust and the Cross Voting Trust; and
(e) the sale of the Newco common
shares to the Cross Family Trust.
[23]
Under
paragraph 245(3)(b) of the Act, it is necessary to determine
whether the primary purpose of any of these transactions was to obtain the tax
benefit. If so, the tax benefit from the series may be denied.
[24]
The
Respondent argued that while Mr. Cross may have wanted to protect himself
from potential creditors, the Appellant had no need for creditor-proofing. The
Appellant was not liable on any of the guarantees given by Mr. Cross, and there
was no evidence that it has any potential creditors. Therefore the only intent
of the plan must have been to generate a capital loss for the Appellant.
[25]
Furthermore,
counsel suggested that there was evidence that the plan was unsuitable for
creditor-proofing Mr. Cross. One of the assumptions made in the legal opinion
regarding the plan was that:
. . . no existing or impending creditors
of [the person seeking the creditor
protection] would go
unpaid as a result of his disposing of the portfolio of investments and that
he does not contemplate entering into some activity that carries an appreciable
risk of exposing him to unmanageable debts in future.
(Emphasis added)
[26]
This
was clearly not the case for Mr. Cross because he considered that the
guarantees he had given for SSI exposed him to a high risk of significant
future liability.
[27]
In
light of this evidence, the Respondent’s counsel submitted that the Appellant
had not shown that the purpose of the series of transactions was
credit-proofing Mr. Cross rather than creating a capital loss for the
Appellant.
[28]
The
Respondent’s counsel also submitted that the Appellant had failed to refute the
Minister’s assumption in reassessing that each of the transactions within the
series was not undertaken primarily for bona fide purposes other than to
obtain a tax benefit.
[29]
Turning
to the specific transactions, Respondent’s counsel argued that the primary
purpose of at least three of the transactions in the series was to obtain a tax
benefit, and therefore, that the tax benefit that existed from the entire
series – the capital loss – may be denied under GAAR.
[30]
Counsel
said that the only purpose for the payment by Newco of a stock dividend on the
common shares held by the Appellant and issuing 30,000 Class B non‑voting
preferred shares to the Appellant was to shift the value of the common shares
to the preferred shares (the “value-shift”) and thus create a latent capital
loss which the Appellant would then realize on the disposition of the common
shares to the Trust.
[31]
Counsel
also said that the only purpose for the creation of the Trust was to allow for
the recognition of the capital loss of $2,999,900 on the disposition of the
common shares of Newco to it. The disposition of the common shares of Newco to
the Trust rather than to Mr. Cross personally, or to a company controlled by
Mr. Cross, was undertaken to circumvent the application of the stop-loss rules
found in subparagraph 40(2)(g)(i), a specific anti-avoidance provision
within the Act.
[32]
Counsel
also argued that the creditor-proofing desired by Mr. Cross could have been
accomplished under the provisions of the Act without the creation of a
capital loss by having the Appellant subscribe directly for the Class B special
shares, rather than subscribe for common shares and obtain the Class B special
shares via a stock dividend. Therefore, the Respondent says that there was no
need to cause the value shift between the common and the Class B special
shares.
[33]
Counsel
for the Appellant submitted that it was clear from the uncontradicted testimony
of Mr. Cross and Mr. Marshman that the driving force behind the series of
transactions was Mr. Cross’ need for creditor-proofing. Mr. Cross had good
reason to be concerned about potential creditors given his previous history
with bankruptcy, the risky venture he was about to begin and his financial
situation compared to his new partners in SSI. The evidence showed that Mr.
Cross contacted Mr. Marshman for advice regarding creditor-proofing, and that
this remained Mr. Cross’ goal throughout.
[34]
Counsel
also submitted that each of the transactions in the series was integral to, and
carried out primarily for the purpose of, implementing the creditor‑proofing
plan. He described the relationship of each transaction to the overall goal of
creditor-proofing as follows:
·
The
incorporation of Newco. The creditor-proofing plan required that the portfolio of
assets be held by a corporation with a specific share structure: voting shares,
growth shares and credit-proofing shares. Newco was incorporated to be that
corporation.
·
Subscription
for 30,000 common shares of Newco. As mentioned above, the plan
required Newco to hold the portfolio of assets. In this transaction, the
Appellant transferred the portfolio of assets to Newco and took back common
shares of Newco as consideration. The transfer of assets to Newco was a
necessary part of the creditor-proofing plan.
·
Newco
declaring a stock dividend of high FMV-low PUC Class B special shares. Under the plan, the
Class B special shares were the creditor-proof shares. The issuance of these
shares effectively isolated the value of Newco in the new Class B special
shares and allowed this new class of shares (which held all existing value of
the portfolio) to be structured so that it would be difficult for a creditor to
realize that value.
·
The
establishment of the Cross Family Trust and the Cross Voting Trust. The Cross Voting Trust
was established to hold the voting shares of Newco so that no one person,
including any potential creditor who acquired the shares of the Appellant,
could control Newco. Keeping control of Newco out of the hands of a creditor
was critical because the Class B special shares were valuable only if they were
redeemed by Newco. The Cross Family Trust was established to acquire the common
shares of Newco. This was essential for two reasons: (i) any future growth in
the value of Newco would accrue to the common shares in the hands of the Cross
Family Trust and out of the reach of potential creditors; and (ii) the
creditor-proofing plan would not work if the Appellant held both the common
shares and the Class B special shares – ownership of these classes of shares
needed to be separated. Accordingly, the establishment of the trusts was
essential to the creditor-proofing objective.
·
The
sale of the Newco common shares to the Cross Family Trust. For the reasons
explained above, the acquisition of the common shares of Newco by the Cross
Family Trust was critical to the creditor-proofing plan. The step ensured that
the future growth of Newco would accrue to the Cross Family Trust and
separated the ownership of the common shares and the Class B special shares.
Without this step, the plan would not have been an effective creditor-proofing
plan.
Analysis:
Avoidance Transaction
[35]
As
indicated by the Federal Court of Appeal in MacKay v. R., the primary purpose of the series of
transactions is always a relevant factor. If the primary purpose of the series
is to obtain the tax benefit, the series will be an avoidance transaction. Furthermore,
a taxpayer must show that his or her non-tax objective required that each
specific step in the series be taken.
[36]
In
this case, the Respondent says that the only intent of the series of
transactions as a whole was to provide the Appellant with an artificial loss.
However, in my view, the evidence does not support this conclusion. The
uncontradicted testimony of both Mr. Cross and Mr. Marshman was that Mr. Cross
approached Mr. Marshman to assist him with creditor-proofing and that the
plan that was chosen was selected because it met Mr. Cross’ needs in this
regard. The reasons given by Mr. Cross for wanting to creditor-proof his assets
at that time are also plausible and there is ample evidence to show that he was
about to embark upon a new business venture that carried a high degree of risk.
Given Mr. Cross’ previous bankruptcy and the extent of his potential liability,
I accept that he wished to take steps to protect his assets and this motivated
him to seek professional advice from Mr. Marshman.
[37]
While
I agree with counsel for the Respondent that the Appellant itself did not need
creditor-proofing, the series of transactions was intended to creditor‑proof
Mr. Cross, and the creditor-proofing of the Appellant had the effect of
creditor-proofing both it and Mr. Cross at the same time.
[38]
Finally,
to the extent that the legal opinion assumed that there was no contemplation of
entering into an activity that carried and appreciable risk of exposing the
subject of the creditor-proofing plan to unmanageable debts, this would have
been true of the Appellant, because it was not a shareholder in SSI and had not
guaranteed its debts.
[39]
I
turn now to a consideration of the primary purpose for which each transaction
in the series was undertaken.
[40]
In
my view, the Appellant has not shown that the issuance of the common shares to
the Appellant was done primarily for the non-tax creditor-proofing purpose. It
appears that this step in the series did not accomplish anything that was
integral to the creditor-proofing. The protection of the Appellant’s assets was
achieved through the issuance of the Class B special shares to the Appellant,
but it has not been shown that it was necessary for the Appellant to first
subscribe for common shares and then receive the Class B shares by means of a
stock dividend that was paid on the common shares.
[41]
The
Appellant’s counsel submitted that the Appellant had to subscribe for the
common shares because it was necessary for the Appellant to transfer its assets
to Newco, the common shares being what it received back in exchange. However, I
see no reason why the Appellant could not have received shares with the same
restrictions on redemption value as the Class B special shares in exchange for
the assets it transferred to Newco. If the shares that the Appellant took back
from Newco in exchange for the transfer of the Appellant’s assets carried the
same restrictions on redemption value as the Class B special shares, this would
have achieved the creditor-proofing purpose sought by the Appellant.
[42]
Similarly,
while it was necessary for the Family Trust to have common shares in Newco,
there does not appear to be any reason why the shares could not have been
issued to the Family Trust directly.
[43]
The
only reason I can see that the Appellant acquired the common shares was to
permit the value of those shares to be shifted to the Class B shares prior to
their disposition to the Family Trust. This purpose had nothing to do with
creditor-proofing and was designed to generate a capital loss for the
Appellant.
[44]
Mr.
Marshman was asked by counsel for the Appellant about the purpose of the common
shares in the plan. His answer was that the common shares allowed the future
growth in Newco to go to the Family Trust. As I have said already, this purpose
could just as easily have been achieved by having the Trust acquire the common
shares directly.
[45]
Mr.
Marshman also said that none of the transactions in the series could have been
skipped because “we were trying to tailor this to meet the legal opinion we had
on creditor-proofing.” That legal opinion consisted of an opinion on a
hypothetical series of transactions for all intents and purposes identical to
those undertaken in this case. The opinion letter states that the law firm was
asked “to comment on certain corporate law and debtor law aspects of the
proposed financial structure described herein and the steps necessary to
achieve that structure.” The opinion letter, however, does not analyze the
purpose of each of those proposed steps, or state that each of those steps is
necessary to achieve the creditor-proofing objective. The opinion letter simply
states, in the last paragraph, that:
From a corporate law perspective, we have
considered whether there are alternative approaches to the structure that would
accomplish the desired objectives in a more effective manner. The alternative
approaches that we have considered are no more advantageous than this structure
in meeting the [client’s] objectives.
[46]
In
my view, the legal opinion offers no support for the proposition that all of
the transactions in the series were necessary to accomplish the creditor‑proofing
objective. All that can be said is that none of the undisclosed alternatives
that were considered would have been more effective in their result or more
advantageous to the client.
[47]
Although
it is not necessary for me to consider the purpose of the remaining
transactions in the series, I agree with the Appellant, for the reasons given
by its counsel, that they were necessary to achieve the creditor-proofing
objective.
Was
there abusive tax avoidance?
[48]
I
turn now to subsection 245(4) of the Act and the determination of
whether there has been abusive tax avoidance in this case. Subsection 245(4)
reads 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.
[49]
In the
Canada Trustco case, the Supreme Court of Canada set out the approach to
be followed in making this determination.
At paragraphs 44 and 45 of that decision, the Court said:
44 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.
45 This analysis will lead to a finding of abusive
tax avoidance when a taxpayer relies on specific provisions of the Income
Tax Act in order to achieve an outcome that those provisions seek to
prevent. As well, abusive tax avoidance will occur when a transaction defeats
the underlying rationale of the provisions that are relied upon. An abuse may
also 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. By contrast,
abuse is not established where it is reasonable to conclude that an avoidance
transaction under s. 245(3) was within the object, spirit or purpose of the
provisions that confer the tax benefit.
[50]
The
Respondent has the burden of establishing abusive tax avoidance.
[51]
The
Respondent maintains that the underlying rationale of the provisions of the Act
that deal with the computation and deduction of capital losses is to allow a deduction
where a taxpayer has suffered a real economic loss on a disposition of
property. The Act further limits the deduction of losses to situations
where the property has been disposed of to a person outside the economic unit
of which the taxpayer forms a part. It is therefore maintained that the
result of the series of transactions undertaken by the Appellant defeats this
policy of the Act.
[52]
Counsel
said that a consideration of the legislative history of the capital regime
reveals that from the outset and up to the time of the transactions in issue,
the deduction of capital losses under the Act has been limited by
anti-avoidance rules that deny the recognition of artificial, superficial or
undue losses. The specific capital loss anti-avoidance provisions referred to
above were enacted concurrently with the adoption of the new capital gains
regime under the 1972 Income Tax Act, and this showed that Parliament
consistently intended to deny the recognition of artificial, superficial or
undue losses and losses that do not result from a true disposition of property.
[53]
Former
subsection 55(1) provided that any undue reduction of the amount of a capital
gain or the undue creation of, or increase in the amount of, a capital loss on
the disposition of property would be disregarded in determining the taxpayer’s
gain or loss and the disposition.
[54]
While
subsection 55(1) was repealed in 1988, counsel submitted that the Technical
Notes accompanying its repeal clearly indicate that Parliament still intended
that only real capital losses should be deductible, and that the losses
previously covered by former subsection 55(1) would be denied under the
GAAR. The Technical Notes read 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.
[55]
Similarly,
counsel said that subparagraph 40(2)(g)(i) in conjunction with the
definition of “superficial loss” in paragraph 54(g) showed that
Parliament intended that only losses resulting from a true disposition of
property would be deductible.
[56]
Counsel for the
Respondent argued that the transactions undertaken by the Appellant defeated or
frustrated the underlying rationale of paragraph 38(b), the provision
relied upon by the Appellant because those transactions did not result in a
true economic loss. The loss was fabricated by manipulating the fiscal “amount
or value” of the Newco shares held by the Appellant for only 24 hours, and
ultimately the Appellant did not suffer any loss. Counsel said that the
economic substance of the transactions was a relevant consideration to the
extent that they established that the transactions frustrate the purpose of the
relevant statutory provisions.
[57]
Counsel also
argued that the transactions circumvented the stop-loss rule in subparagraph
40(2)(g)(i), which deems a loss from dispositions of capital property to
an affiliated person to be nil. It is the Respondent’s position that the
transactions achieve an outcome that this stop-loss rule seeks to prevent: the
creation of a loss between parties with the same economic affiliations.
[58]
Counsel for the
Respondent asserted that the Cross Family Trust was used to acquire the
Newco common shares in order to avoid the application of
subparagraph 40(2)(g)(i). In 2003, when these transactions were
carried out, trusts and beneficiaries of trusts were not included in the
definition of “affiliated persons” in section 251.1.
[59]
Counsel also
submitted that the amendment in 2005 to the definition of “affiliated persons”
in section 251.1 to include trusts and majority-interest beneficiaries was
aimed at disallowing losses such as those in this case. If the amended
definition had been in effect in the 2003 taxation year, the loss on the
disposition of the common shares to the Cross Family Trust would have been
deemed to be nil. Counsel argued that by closing the loophole in the stop-loss
rules relied upon by the Appellant, Parliament was demonstrating that the loss
obtained by the Appellant was unintended.
[60]
The Appellant
counsel asserted that the Respondent has not met the burden of demonstrating
abusive tax avoidance. The provision relied upon by the Appellant to calculate
its capital loss and allowable capital loss operate in a mechanical fashion and
provide that a loss will result where there has been a decrease in value of a
capital asset. Since it is conceded that the adjusted cost base of the Newco
common shares to the Appellant was $3 million, and the proceeds of disposition
received for those shares was $100, a capital loss of $2,999,900 resulted, all
in accordance with the underlying rationale of the sections that were used.
[61]
The Appellant
also maintains that the Respondent has not identified any specific provisions
of the Act that demonstrate a general policy of denying artificial
losses. Counsel relied upon paragraphs 41 and 42 of the Supreme Court of Canada
decision in Canada Trustco where the Court said:
41 The courts cannot search for an overriding
policy of the Act that is not based on a unified, textual, contextual and
purposive interpretation of the specific provisions in issue. First, such a
search is incompatible with the roles of reviewing judges. The Income Tax
Act is a compendium of highly detailed and often complex provisions. To
send the courts on the search for some overarching policy and then to use such
a policy to override the wording of the provisions of the Income Tax Act
would inappropriately place the formulation of taxation policy in the hands of
the judiciary, requiring judges to perform a task to which they are
unaccustomed and for which they are not equipped. Did Parliament intend judges
to formulate taxation policies that are not grounded in the provisions of the
Act and to apply them to override the specific provisions of the Act?
Notwithstanding the interpretative challenges that the GAAR presents, we cannot
find a basis for concluding that such a marked departure from judicial and
interpretative norms was Parliament's intent.
42 Second, to search for an overriding policy of
the Income Tax Act that is not anchored in a textual, contextual and
purposive interpretation of the specific provisions that are relied upon for
the tax benefit would run counter to the overall policy of Parliament that tax
law be certain, predictable and fair, so that taxpayers can intelligently order
their affairs. Although Parliament's general purpose in enacting the GAAR was
to preserve legitimate tax minimization schemes while prohibiting abusive tax
avoidance, Parliament must also be taken to seek consistency, predictability
and fairness in tax law. These three latter purposes would be frustrated if the
Minister and/or the courts overrode the provisions of the Income Tax Act
without any basis in a textual, contextual and purposive interpretation of
those provisions.
[62]
Counsel
submitted that the Respondent is seeking to apply GAAR based on what its view
of the law ought to be, rather than on the basis of policy as expressed in the
words of the Act. This approach, he said, has the effect of turning the
GAAR into a smell test and defeats the requirement for certainty, fairness and
predictability in tax law.
Textual Contextual
and Purposive Analysis
[63]
The provisions
that give rise to the capital loss in issue form part of the capital gains tax
regime introduced in the 1972 Act. Capital gains and losses and taxable
capital gains and allowable capital losses are calculated in accordance with
the rules found in Subdivision c of Division B of Part I of the Act.
[64]
Paragraph
39(1)(b) provides that a taxpayer’s capital loss from the disposition of
any property is his or her loss calculated according to the rules in Subdivision
c, and paragraph 38(b) determines the portion of the capital loss,
referred to as an “allowable capital loss” that is relevant in computing a
taxpayer’s income under section 3 as an offset to capital gains made by
the taxpayer:
38. For the purposes of this
Act,
…
(b) a taxpayer’s allowable
capital loss for a taxation year from the disposition of any property is 1/2 of
the taxpayer’s capital loss for the year from the disposition of that property;
39. (1) For the
purposes of this Act,
…
(b) a
taxpayer’s capital loss for a taxation year from the disposition of any
property is the taxpayer’s loss for the year determined under this subdivision
. . . from the disposition of any property of the taxpayer other than
(i) depreciable property, or
(ii) property described in any of subparagraphs 39(1)(a)(i), (ii) to (iii) and (v);
[65]
The general
rules for calculating a loss from the disposition of property are found in subparagraph
40(1)(b)(i) which reads:
40. (1) Except as otherwise expressly provided in
this Part
…
(b) a taxpayer's loss for a taxation year from the
disposition of any property is,
(i) if the property was disposed of in the year, the
amount, if any, by which the total of the adjusted cost base to the taxpayer of
the property immediately before the disposition and any outlays and expenses to
the extent that they were made or incurred by the taxpayer for the purpose of
making the disposition, exceeds the taxpayer's proceeds of disposition of the
property, . . .
[66]
In the case of
property other than depreciable capital property, “adjusted cost base” is
defined in paragraph 54(a) of the Act as the cost of the property
to the taxpayer adjusted in accordance with section 53. The starting point for
that determination is the taxpayer’s cost of the property. The relevant portion
of the definition of “adjusted cost base” reads as follows:
"adjusted cost base" to a taxpayer of any property at any
time means, except as otherwise provided,
(a)
where the property is depreciable property of the taxpayer, the capital cost to
the taxpayer of the property as of that time, and
(b)
in any other case, the cost to the taxpayer of the property adjusted, as of
that time, in accordance with section 53,
[67]
“Disposition”
is defined in subsection 248(1) to include “any transaction or event entitling
a taxpayer to proceeds of disposition of property”. Finally, “proceeds of
disposition” is defined in section 54 to include “the sale price of property
that has been sold”.
[68]
Through the
various provisions set out above, it can be seen that, generally speaking, a
capital loss is allowed where a taxpayer has disposed of property and received
proceeds from the disposition that are less than the taxpayer’s cost of the
property plus outlays and expenses incurred for the purpose of the
disposition.
[69]
As noted by the
Respondent, subparagraph 40(2)(g)(i) denies a loss to the extent that it
is a “superficial loss”. A “superficial loss” is defined in section 54 as a
loss occurring on a disposition of property by a taxpayer and a reacquisition
of the same or an identical property by a taxpayer within 30 days before or
after the disposition, or an acquisition of the same property or an identical
property by a person affiliated with the taxpayer within 30 days before or
after the disposition.
[70]
The parties
agree that the Appellant and the Cross Family Trust were not “affiliated
persons” as that term was defined in section 251.1 of the Act for
the year in issue.
[71]
In 2005 the
definition of “affiliated persons” was amended to include a trust and
majority-interest beneficiaries of the trust. A “majority-interest beneficiary”
is defined in subsection 251.1(3) as a beneficiary of a trust who, either alone
or together with certain other affiliated persons, is entitled to more than
half of the trust’s income or capital. Pursuant to paragraph 251.1(4)(d),
in determining whether a person is affiliated with a trust, if the amount of
income or capital the person is entitled to receive from the trust depends on
the exercise of a discretionary power by any person, that person will be deemed
to have exercised the discretionary power. These provisions read as follows:
251.1(3) "majority-interest beneficiary", of a trust at any time,
means a person whose interest
as a beneficiary, if any,
at that time
(a) in the income of the trust has, together
with the interests as a beneficiary in the
income of the trust of all persons
with whom the person is affiliated, a fair
market value that is greater than 50% of the fair market value of all the
interests as a beneficiary in the
income of the trust; or
(b) in the capital of the trust has, together
with the interests as a beneficiary in the
capital of the trust of all persons
with whom the person is affiliated, a fair
market value that is greater than 50% of the fair market value of all the
interests as a beneficiary in the
capital of the trust.
251.4 (4) Interpretation
. . .
(d) in determining whether a person is affiliated with a trust,
(i) if the amount of income or
capital of the trust that a person may receive as
a beneficiary under the trust depends on the
exercise by any person of, or the
failure by any person to exercise, a
discretionary power, that person is deemed to
have fully exercised, or to have failed to exercise, the power, as the case may
be,
(ii) the interest of a person in a trust as a beneficiary is
disregarded in determining whether the person deals at arm's length with the trust if the person would, in the
absence of the interest as a beneficiary, be
considered to deal at arm's length with the trust,
(iii) a trust is not a
majority interest beneficiary of another
trust unless the trust has an interest
as a beneficiary in the
income or capital, as the case may be, of the other trust, and
(iv) in determining whether a contributor to one trust is affiliated with a contributor to another
trust, individuals
connected by blood, marriage, common-law partnership or adoption are deemed to
be affiliated with one
another.
[72]
In the case of
the Cross Family Trust, Mr. Cross’ spouse and his two children were entitled to
payments of income and capital at the complete discretion of the trustees. Had paragraph 251.1(4)(d)
been in effect at the relevant time, I find that Mr. Cross’ spouse would have
been a majority-interest beneficiary on the basis of the trustees’ discretion
to pay her up to 100% of the income and capital of the trust.
[73]
I will deal
firstly with the Respondent’s argument that the Act contains a general
policy against allowing losses on dispositions of property to persons with the
same economic affiliations as the transferor. The Respondent’s counsel also
referred to this as the transferee being part of the same economic unit as the
transferor.
[74]
This argument
is very similar to the one that the Respondent made before me in Landrus v
The Queen. There,
the taxpayer was a member of a limited partnership that had transferred all its
assets to a new limited partnership. The transfer resulted in a terminal loss
to the original partnership. The taxpayer’s claim for his share of the terminal
loss was denied by the Minister under section 245 of the Act. The Crown
argued in that case that the loss contravened the general policy in the Act
to disregard losses on dispositions of property to parties related to the
transferor. In support of its position, the Crown cited various stop-loss
rules, including paragraph 40(2)(e) and subparagraph 40(2)(g)(i).
However, I concluded that the stop-loss rules referred to did not evidence the
general policy contended by the Crown, but were intended to deny losses in the
limited and specific circumstances set out in those provisions. At paragraph
117 of my decision, I wrote:
. . . These rules are precisely drafted and set out
detailed conditions for the denial of a loss that would otherwise arise on the
disposition of a particular type of property. Those conditions vary from one
stop-loss rule to the other. An important variation, for the purposes of this
case, is in the degree of connection or relationship required between the
transferor and transferee.
[75]
This finding
was upheld by the Federal Court of Appeal, which wrote, at paragraph 47 of its
decision:
. . .However, where it can be shown that an
anti-avoidance provision has been carefully crafted to include some situations
and exclude others, it is reasonable to infer that Parliament chose to limit
their scope accordingly.
[76]
The definition
of “affiliated persons” in section 251.1 as it read for the year in issue sets
out a carefully crafted group of relationships, and I believe that it is
reasonable to infer that Parliament chose to limit the scope of the definition
accordingly.
[77]
In Landrus,
I also considered the effect of the amendments to the stop-loss rules
subsequent to the taxation year in which the loss in that case was claimed. Those
amendments would have disallowed the loss claimed by the taxpayer. This is
similar to what happened in this case, as a result of the amendment to the
definition of “affiliated persons” to include trusts and majority-interest
beneficiaries. If those amendments had been in effect in the year in issue, the
appellant and the Cross Family Trust would have been affiliated because Mr.
Cross’ spouse would have been a majority-interest beneficiary of the Trust on the
basis of the trustees’ discretion to pay her up to 100% of the income and
capital of the trust. (see paragraph 251.1(4)(d))
[78]
I held, though,
that the amendments in Landrus did not “alter the fact that the
stop-loss rules were exceptions that operate in well-defined circumstances” and
that even after the amendments they did not deny losses on all transfers
between all related parties. Therefore, the amendments were not material to the
determination of the policy underlying the stop-loss rules in effect for the
year under appeal.
[79]
The Respondent
has not shown that there is readily apparent commonality between the
relationship of trust and majority-interest beneficiary and the other
relationships specified in the pre-amendment definition of “affiliated persons”
such that one can say that Parliament intended the definition to cover that
type of relationship as well.
[80]
The difficulty
for the Respondent is that the related parties that Parliament treats as being
part of the same economic unit varies from one stop-loss rule to the next. There
is not one overall definition of an economic unit that is applicable for all of
the stop-loss rules. Therefore, it cannot be said that there was a clear and
unambiguous policy in the Act to treat parties such as the Appellant and
the Cross Family Trust as part of the same “economic unit” for the purposes of
subparagraph 40(2)(g)(i).
[81]
I find that the
Respondent in this case has not shown that there is a general policy in the Act
to disallow losses on any transfer of property to persons with the same degree
of connection as the Appellant and the Cross Family Trust. Therefore I find
that the triggering of the loss by transferring the common shares to the Cross
Family Trust is, in and of itself, not abusive tax avoidance.
[82]
I am aware that
in Triad Gestco Ltd v The Queen,
my colleague, Favreau J, recently held that even prior to the amendment of the
definition of “affiliated persons” in section 251.1, there was a general policy
in the Act to deny losses on transfers of property between a person and
a trust where the person was the sole 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.
[83]
For the reasons
set out above, I must respectfully disagree with this conclusion.
[84]
I will now
address the Respondent’s argument that the transactions defeated or frustrated
the underlying rationale of paragraph 38(b) because they did not result
in a true economic loss to the Appellant.
[85]
I agree with
the Respondent that the purpose of paragraph 38(b) is to give tax relief
(to the extent of an offset against capital gains) in circumstances where a
taxpayer has suffered an economic loss on the disposition of property. This is
apparent from the manner in which a loss is calculated, by determining the
excess of the cost of the property over the proceeds from the disposition of
the property. Furthermore, capital gains are recognized as income under the Act
because they represent an addition to a taxpayer’s economic power. The
Report of the Royal Commission on Taxation,
proposed that capital gains be taxed for the following reasons:
Rights to and interests in property can produce
increases in economic power, whether held or disposed of. These increases take
two basic forms: rents, dividends, royalties,interest, and other returns
derived from holdng property rights; and gains derived from increases in the
market value of property rights. The first form is already taxed as income in Canada,
while the second is normally exempt as a “capital gain”. While the changes we
propose in the taxation of returns from holding property are minor, we suggest
a major change in the tax treatment of gains on the disposal of property. We
have emphasized in this Report that the only equitable basis for
taxation is to include in the comprehensive tax base the value of all additions
to economic power, including so-called capital gains.
[86]
It is logical
to infer that capital losses are allowed under the Act as an offset to
capital gains because they represent a decrease to a taxpayer’s economic power.
[87]
In addition,
the Explanatory Notes to section 245 state that the provisions of the Income
Tax Act are intended to apply to transactions with real economic substance.
the Supreme Court of Canada discusses this point at paragraph 56 of the Canada
Trustco decision:
56 The Explanatory Notes elaborate that the
provisions of the Income Tax Act are intended to apply to transactions
with real economic substance. Although the expression "economic substance"
may be open to different interpretations, this statement recognizes that the
provisions of the Act were intended to apply to transactions that were executed
within the object, spirit and purpose of the provisions that are relied upon
for the tax benefit. The courts should not turn a blind eye to the underlying
facts of a case, and become fixated on compliance with the literal meaning of
the wording of the provisions of the Income Tax Act. Rather, the courts should
in all cases interpret the provisions in their proper context in light of the
purposes they intend to promote.
[88]
I also agree
with counsel for the Respondent that former subsection 55(1) of the Act
is relevant in determining the policy of the Act concerning capital
losses and forms part of the context for the interpretation of the capital loss
provisions of the Act. While subsection 55(1) has been repealed, the
reason for the repeal was not because of a change of policy, but because
Parliament believed the policy behind the repealed provision could be enforced
by means of the then newly introduced section 245. The Technical Note that
accompanied the repeal of subsection 55(1) is clear in this respect. Technical
Notes and Explanatory Notes are permissible extrinsic aids in the determination
of legislative policy in a GAAR case: see The Queen v. Imperial Oil Inc.
[89]
The former
subsection 55(1) was a tax avoidance provision aimed at the artificial
reduction of gains and the artificial creation or increase in the amount of
losses on the disposition of property. Since subsection 55(1) operated for the
purposes of subdivision c of the Act, its application was limited to
capital gains and losses.
[90]
I find that the
Respondent has shown that the purpose of paragraph 38(b) is to recognize
economic losses suffered by a taxpayer on the disposition of property. The
Respondent has also shown that despite the repeal of subsection 55(1), the
policy of the Act is still to disallow the artificial or undue creation
or increase of a capital loss, which underlines the intention to allow capital
losses only to the extent that they reflect an underlying economic loss.
[91]
The next step
in the analysis under subsection 245(4) is to examine the transactions
undertaken by the Appellant to determine whether they defeat or frustrate the
object, purpose or spirit of paragraph 38(b) of the Act.
[92]
In this case,
the Appellant acquired the common shares of Newco and disposed of them almost
immediately thereafter while retaining the full value of its interest in Newco
by means of the Class B special shares. From the way in which the transactions
were structured, it is clear that there was never any intention that the common
shares would represent the true value of the Appellant’s interest in Newco, but
rather, the Appellant would have access to the full amount of his investment in
Newco through the Class B special shares. The acquisition of the common shares
by the Appellant and the pre-ordained disposition of the common shares to the
Trust served no purpose other than to manufacture a capital loss for tax
purposes. These transactions did not reduce the Appellant’s economic power in
the manner contemplated by Parliament in allowing for the deduction of capital
losses. The transactions are artificial and lack substance with respect to
paragraph 38(b) as well as other capital loss provisions of the Act,
specifically, paragraphs 39(1)(b) and 40(1)(b) which are premised
on actual economic losses being incurred.
[93]
In summary, I
find that the transactions carried out in this case were not executed within
the object spirit and purpose of the capital loss provisions of the Act
and that they constitute abusive tax avoidance under subsection 245(4).
[94]
For all these
reasons, the appeal is dismissed, with costs.
Signed at Ottawa, Canada, this 7th day of September 2011.
“B.Paris”
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