Canada Trustco Mortgage Company v. The Queen, 2003 TCC 215

Docket: 2002-1155(IT)G

BETWEEN:

CANADA TRUSTCO MORTGAGE COMPANY,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

____________________________________________________________________

Appeals heard on February 17, 18, 26 and 27, 2003, at Toronto, Ontario,

By: The Honourable Judge Campbell J. Miller
Appearances:
Counsel for the Appellant:	Al Meghji and Monica Bringer
Counsel for the Respondent:	Alexandra Brown and Michelle Farrell

____________________________________________________________________

JUDGMENT

The appeals from assessments of tax made under the Act for the 1996 and 1997 taxation year are allowed, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that (i) with respect to the 1996 taxation year the reassessment was conceded by the Respondent to be statute barred; and (ii) with respect to the 1997 taxation year section 245 does not apply to disallow the capital cost allowance claimed by the Appellant.

The Appellant is entitled to its costs.

Signed at Ottawa, Canada, this 7th day of May, 2003.

"Campbell J. Miller"

J.T.C.C.

Citation: 2003TCC215

Date: 20030507

Docket: 2002-1155(IT)G

BETWEEN:

CANADA TRUSTCO MORTGAGE COMPANY,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

REASONS FOR JUDGMENT

Miller J.

[1]      This is a general anti-avoidance rule (GAAR) case, in which I must determine whether a complex arrangement entered into by the Canada Trustco Mortgage Company ("Canada Trust") in 1996 crosses the line from good business planning to GAARable tax planning. There is no question this was a good deal from the Appellant's perspective - the question is: Was it an abusive deal from a Canadian tax perspective? Was it a legitimate commercial financing transaction planned to obtain the most effective tax treatment, or was it a contrived purchase of a tax benefit wrapped up in commercial trappings?

[2]      With the help of the Royal Bank of Canada ("RBC"), Canada Trust bought $120 million worth of trailers from Transamerica Leasing Inc. ("TLI"). The trailers were circuitously leased back to TLI. Canada Trust claimed approximately $31 million of capital cost allowance ("CCA"). The Minister of National Revenue ("the Minister") applied the GAAR to deny the tax benefit arising from this CCA. I find the transaction does not run afoul of GAAR because there has been no misuse of the provisions of the Act or an abuse having regard to the provisions of the Act read as a whole.

[3]      In analyzing this transaction, I will follow the process set forth in section 245 itself and the approach favoured by the Federal Court of Appeal.[1]

          1.        Does the deferral of tax constitute a tax benefit?

           2.       Can the arrangement which resulted in the deferral reasonably be considered to have been entered primarily for bona fide purposes, other than to obtain the tax benefit?

           3.       Was there a misuse of provisions of the Income Tax Act (the Act) or abuse of the Act as a whole? This can be broken down into the following questions:

         (i)        Does the GAAR legislation capture a misuse or abuse of regulations under the Act?

(ii)       What is the clear and unambiguous policy underlying the capital cost allowance (CCA) treatment in the sale-leaseback arrangements of exempt property?

          (iii)      Has there been a misuse or abuse due to:

(a)       there being no real cost against which there can be a claim for CCA; or

(b)      the transaction not being in the context of a financing arrangement.

4.        What are the reasonable tax consequences to the Appellant in the circumstances to deny the tax benefit?

Facts

[4]      The parties provided an Agreed Statement of Facts (Partial) and an Agreed Statements of Facts Supplementary (Partial), along with supporting documents to those agreed facts. The Appellant called one witness, Mr. Michael Lough, the officer of the Appellant who recommended this transaction to the Appellant's Board. The Respondent called no witnesses but submitted, pursuant to section 30 of the Canada Evidence Act, a business records affidavit of John Tanter, a Vice-President of Royal Bank of Canada Europe Limited (RBCEL). I will describe the relevant agreed facts before dealing with the other evidence.

A.         Introduction

1.         The Appellant was at all material times a large diversified financial institution carrying on business in Canada and a large corporation within the meaning of the Income Tax Act (Canada) (the "Act").

2.         The Appellant was at all material times a company subject to the Trusts and Loan Companies Act and regulated in Canada by the Office of the Superintendent of Financial Institutions ("OSFI").

3.         At all material times, the Appellant carried on business in Canada under the name Canada Trust in combination with its subsidiaries, including The Canada Trust Company. In an extract from the annual report of the Appellant's parent corporation CT Financial Services the operations and business of the Appellant are described as follows:

... Canada Trust also holds a portfolio of loans and leases to government agencies and large companies. Canada Trust does not intend to make any significant increase in this class of investment and since 1995, it has gradually reduced the size of the existing portfolio. ...

B.       Approval to enter into said transactions

4.         The transactions that are the subject matter of this appeal resulted from negotiations that were carried out by the Appellant and the other parties over a period of several months leading to the execution of a Term Sheet (the "Final Term Sheet") by the Appellant and other parties.

5.         The transactions that are the subject matter of this appeal were entered into by the Appellant after approval was granted first by the Appellant's "Senior Credit Committee" ("SCC") and then by the Executive Committee of the Appellant's Board of Directors ("Executive Committee").

6.         Appendix 1 is an authentic copy of a schedule produced by the Appellant setting out its investment in the lease, the return on that investment and the tax and accounting consequences of the transactions that are the subject matter of this appeal.

C.        The Purchase and Sale of the Equipment

          

7.         The Appellant entered into an equipment purchase agreement (the "Equipment Purchase Agreement") dated December 17, 1996, in respect of the purchase of certain equipment (the "Equipment") from Transamerica Leasing Inc. ("TLI"), a corporation resident in the United States of America, for a price of $120 million (CDN).

8.         The parties are agreed that the fair market value of the said Equipment was $120 million (CDN) at the material time.

9.         The terms of the Equipment Purchase Agreement provide, inter alia, that TLI agrees to sell, transfer and assign to the Appellant, the Appellant agrees to purchase of the Equipment absolutely (subject to the Operating Leases as defined therein), and at closing (December 17, 1996), a certificate of delivery, title to, ownership of and risk of loss in and to the Equipment shall pass from TLI to the Appellant.

D.        TLI to hold title documentation in trust for the Appellant

10.       The Appellant entered into a trust agreement (The "Trust Agreement") dated December 17, 1996 with TLI.

11.       The terms of the Trust Agreement provide, inter alia, that solely for administrative convenience the Appellant appoints TLI as trustee and agent of the Appellant to hold in TLI's name, for and on behalf of the Appellant each Certificate of Title, Certificate of Ownership, registration and like documentation in respect of the Equipment.

E.         Loan to the Appellant

          

12.       The total purchase price of the Equipment was $120 million (CDN). In addition, the Appellant incurred $2.34 (CDN) in related transaction costs.

13.       Approximately $24.98 million (CDN) of the Appellant's own funds were used to purchase the Equipment.

14.       The balance of the required funds, approximately $97.35 million (CDN), was borrowed by the Appellant from the Royal Bank of Canada ("RBC") pursuant to the terms of a loan agreement (the "Loan Agreement"), dated December 17, 1996 between the Appellant and RBC (the "Loan").

15.       The terms of the Loan Agreement provide, inter alia, that:

           (a)          the interest rate on the Loan was 7.5%; and

           (b)          the Appellant is required to make semi-annual instalment payments of principal and interest on the Loan to RBC as set out in "Schedule 2" to the Loan Agreement (the "Loan Instalment Payments").

           (c)          The terms of the Loan Agreement also provide that the Bank's recourse against the Appellant is limited as described in Article 4.2.

F.         Leasing of the Equipment to MAIL

16.       The Appellant entered into a lease agreement (the "Lease"), dated December 17, 1996, to lease the Equipment to Maple Assets Investments Limited ('MAIL"), a limited liability company incorporated under the laws of England.

17.       The terms of the Lease include the following:

           (a)          the term of the Lease is for an initial period ending December 1, 2014;

           (b)          the Rent Payments under the Lease are based upon an effective rate of 8.5%;

           (c)          MAIL, as lessee, is required to make semi-annual payments to the Appellant as lessor in the amounts set out in "Schedule C" attached to the Lease (the "Rent Payments"); and

           (d)          MAIL is provided with an option to purchase the Equipment (the "Option Price") CDN $84 million being the First Option Value on December 1, 2005 and another option exercisable at the fair market value on December 1, 2014.

G.        Sub-Lease of the Equipment to TLI

18.       MAIL entered into a sub-lease agreement (the "Sub-Lease") dated December 17, 1996, to sub-lease the Equipment to TLI.

19.       Most of the terms of the Sub-Lease are similar to those found in the Lease. The Sub-Lease provided TLI, as sub-lessee, purchase options similar to those provided to MAIL under the Lease. One term in the Sub-Lease which differs from the terms of the Lease is that the Sub-Lessee was required to pre-pay to MAIL on the date of closing all amounts that are or may become due under the Sub-Lease.

H.        Co-ordination Agreement

20.       The Appellant entered into a co-ordination agreement (the "Co-ordination Agreement") dated December 17, 1996 with TLI and MAIL.

I.          Non-Disturbance Undertaking

21.       The Appellant gave a non-disturbance undertaking, dated 17 December, 1996, relating to the Lease, the Sub-Lease and the Co-ordination Agreement (the "Non-Disturbance Undertaking").

J.         Security for the Lease and Loan

22.       On or about December 17, 1996, TLI pre-paid its payment obligations under the Sub-Lease to MAIL, in the approximate amount of $116.4 million (CDN) (the "Pre-payment").

23.       On or about December 17, 1996 MAIL applied the Pre-payment funds as follows:

           (a)          MAIL placed on deposit with the RBC an amount equal to the Loan (approximately $97.35 million (CDN) (the "Defeasance Payment"); and

           (b)          MAIL paid the balance of the Pre-payment (approximately $19 million) to Royal Bank of Canada Trust Company (Jersey) as trustee of the Maple Assets Charitable Trust ("RBC Jersey") on the condition that RBC Jersey use these funds to purchase a Government of Ontario bond (the "Bond"), maturing on the December 1, 2005.

24.       The Appellant, MAIL and RBC Jersey entered into a support agreement (the "Support Agreement"), dated December 17, 1996. RBC Jersey, entered into the Support Agreement in its capacity as trustee of the Maple Assets Charitable Trust (the "Trust"). RBC Jersey is a wholly owned subsidiary of RBC. Pursuant to the terms of the Support Agreement, the Trust agreed to purchase the Bond and agreed to pledge it as security in support of MAIL's obligation to pay the Purchase Option Payments or the Termination Values.

25.       The Appellant, and RBC Jersey, in its capacity as trustee of the Trust, entered into a pledge agreement (the "RBC Pledge Agreement") dated December 17, 1996. Pursuant to the terms of the RBC Pledge Agreement, the Bond was pledged to the Appellant as security for MAIL's obligations under the Lease.

26.       The Appellant entered into a security assignment (the "Security Assignment"), dated December 17, 1996 with RBC.

27.       Pursuant to the terms of the Security Assignment, the Appellant provided RBC with an assignment of the Rent Payments owed from MAIL, provided MAIL with an irrevocable instruction to pay the assigned Rent Payments to RBC and agreed that Rent Payments be applied by RBC to the Loan Instalment Payments.

K.        Other Agreements

28.       The Appellant entered into a pledge agreement (the "MAIL Pledge Agreement") dated December 17, 1996 with MAIL.

29.       The Appellant entered into a custodial agreement (the "Custodial Agreement") dated December 17, 1996, with RBC Jersey, in its capacity as trustee of the Trust, and Scotia McLeod Inc. as Custodian. Under the terms of this agreement, the Custodian agrees to hold the Bond or Replacement Bonds until the Bonds mature or are disposed of.

30.       A management agreement dated December 17, 1996 was entered into between MAIL, RBC Jersey and Royal Bank of Canada Trust Corporation Limited, a company incorporated under the laws of England (the "Management Agreement"). Under the terms of the Agreement, RBCTC undertook to manage and fulfil the affairs and obligations of MAIL under the Transaction Documents and to provide the directors and officers of MAIL.

31.       A Guarantee dated December 18, 1996 was entered into between Transamerica Finance Corporation (TFC) the parent corporation of TLI and MAIL (the "TFC/MAIL Guarantee"), whereby Transamerica unconditionally and irrevocably guarantees to MAIL the performance of all of TLI's obligations under the Co-ordination Agreement and the Sub-Lease Agreement.

32.       A Guarantee dated December 18, 1996 was entered into between TFC and the Appellant (the "TFC/Appellant Guarantee"). By the terms of this Guarantee, TFC unconditionally and irrevocably guarantees all the obligations owed by TLI to the Appellant under the Equipment Purchase Agreement, the Co-ordination Agreement and the Trust Agreement.

L.         Tax Reporting and assessments

33.       In computing its income for the 1996 and 1997 taxation years the Appellant reported leasing income in the amounts of $48,920,847 and $51,787,114, respectively.

34.       In computing its income for the 1996 and 1997 taxation years the Appellant deducted capital cost allowance ("CCA") in respect of its leasing assets in the amount of $36,214,174 and $46,365,889, respectively. Pursuant to Regulation 1100(15) these capital cost allowance claims were made only against the leasing income realized by the Appellant in the particular years.

35.       By way of a reassessment dated October 18, 2002 the Minister reassessed the Appellant in respect of its 1997 taxation year by denying it the class 10 CCA claim of $31,196,700. The Minister reassessed on the basis that the Appellant had failed to acquire title to the equipment and, in the alternative, that section 245 of the Income Tax Act ("the GAAR") applied to deny the Appellant a deduction for the said CCA. The Attorney General has since abandoned the argument that the Appellant failed to obtain title to the equipment and the sole ground on which Attorney General seeks to sustain the reassessment is the GAAR. In reassessing, the Minister did not assume as a fact, and the Attorney General does not assert that:

·         any of the transactions in issue were a sham or were legally ineffective;

·         that the fair market value of the equipment at the time of the purchase by the Appellant was not $120 million;

·         that, with respect to the lease between the Appellant and MAIL, the rental rate on the equipment was not a market rate; or

·         that, with respect to the loan from the Royal Bank, the rate of interest on the loan was not a market rate.

Mr. Lough's evidence

[5]      Mr. Lough was actively involved in the negotiation and finalization of these transactions on behalf of the Appellant. He testified that he had given the arranger, Macquarie Corporate Finance (USA) Inc. ("Macquarie"), the idea that the Appellant wanted a leasing transaction for $100 million. He stated that he had specified the type of equipment (long-term assets easy to value, such as tractors or trailers), the length of the term and the strength of the counterparty sought. He did not stipulate that the Appellant had any need for financing. The structure of the deal was left to the arranger. Mr. Lough acknowledged the Appellant had engaged previously in a similar structure to the one ultimately implemented. He further acknowledged the type of assets sought was due to their good after-tax return.

[6]      Macquarie eventually found the Transamerica Leasing Inc. deal, which did involve the financing piece for the Appellant. Mr. Lough described the benefit of the financial arrangement as improving the economics of the transaction, by allowing the netting of the non-recourse loan against the total value of the lease for purposes of financial reporting on the balance sheet, which reduced the amount of capital the Appellant was required by regulatory authorities to hold, and also by relying on leveraged lease accounting to draw income to the early part of the lease.

[7]      Mr. Lough agreed that the non-recourse financing modestly reduced the risk, although the Appellant was comfortable with the financial strength of TLI's parent. He testified that the non-recourse financing had no effect on the equipment purchase or the lease.

[8]      Mr. Lough was made aware of the prepayment aspect of the transaction when Macquarie first made the TLI proposal to the Appellant. He viewed this element as more TLI's business than the Appellant's, as he stated it had no impact on the economics of the deal to the Appellant. Mr. Lough ran the deal through the Appellant's usual credit approval process, including having the trailers appraised. This led to the submission of a credit application to the Internal Credit Committee, which in turn led to the production of the Final Term Sheet. It was clear all steps in the transaction were contemplated to be concluded and were concluded on one day in December 1996.

[9]      From a review of the Final Term Sheet, Mr. Lough confirmed that:

(i)       there were no ongoing lease obligations from TLI after the prepayment, though there were obligations with respect to indemnities, early terminations and that sort of thing;

(ii)       the deal could be unwound if there were adverse changes affecting the Appellant;

(iii)      the RBC recourse for the loan payments was from the stream of lease payments due to the Appellant and that those loan payments were equal to the lease payments; and

(iv)      the difference between the price received by TLI for the trailers from the Appellant and the prepayment of rent paid to Maple Assets Investments Limited (MAIL) was 3.35 per cent of the trailer cost, which Mr. Lough referred to as the net present value benefit.

[10]     From a review of the credit application, Mr. Lough confirmed that:

(i)       subject to indemnities there was no ongoing financial obligation of TLI;

(ii)       risk of the inability of MAIL to make the first option payment was mitigated by MAIL's acquisition of a province of Ontario bond and the provision to the Appellant of a security interest in the bond;

(iii)      the net investment was initially intended to be $24,985,541 which reduced over the first 2½ years and then went into a negative position; the projected $8.5 million income was accounted for over the initial 2½ year-period based on the leverage of the lease accounting approach;

(iv)      the lease payments and a portion of the first option price would go to pay off the RBC loan;[2] the remainder of the purchase option price would be covered by the bond and would yield the $8.5 million before tax return on the Appellant's approximate $25 million investment;[3]

(v)      there were no ongoing schedule payment obligations of TLI due to the prepayment it made and therefore there were no credit risk to the lessee;

(vi)      ownership of the trailers would provide CCA of 30 per cent on a declining balance basis on the purchase of the $120 million worth of equipment to shelter lease income;

(vii)     the transaction provided a shareholder value added to tax capacity ratio of 25 per cent, which Mr. Lough explained to mean the economic value added; basically it was an effective transaction;

(viii)    the Appellant would obtain an opinion that it would be entitled to the CCA and that the lease investment met all current Canadian tax regulations; and

(ix)      the transaction should be recommended as tax effective in utilizing the tax benefits to offset unsheltered taxable lease income.

Mr. Lough's recommendation went to the Board of the Appellant on similar terms.

[11]     Mr. Lough briefly went over the financial projection of the deal which is attached as Appendix "A". In addressing the purpose of the transaction Mr. Lough's evidence was as follows:

Q.         Mr. Lough, why did Canada Trust, or why did the appellant do the transactions that are the subject matter of this litigation?

A.         We did these transactions as an investment to earn income for the Canada Trust. It was, you know, we, as I had mentioned earlier, we had, you know, a number of alternatives that my department looked at. The lease portfolio had run off in recent years so we were looking to do a lease in order to, you know, to maintain the diversification between the various portfolios.

Q.         Mr. Lough, how did - did tax considerations enter into the decision to do this transaction? And if they did, how?

A.         You know, certainly we looked at the after tax returns on this transaction as we would on any sort of transaction.

[Transcript page 66 line 10 to page 67 line 1]

Other evidence

[12]     Apart from the documentation of the transaction itself introduced as evidence, the Appellant also entered several follow-up correspondences between Alan Wheable, Vice-President, Taxation, TD Bank Financial Group and the CCRA representative Guy Alden. The gist of these communications is that Canada Trust clarified with CCRA the role played by regulatory capital requirements.[4] What is apparent from this evidence is that the way the financing was structured, that is by the use of non-recourse debt, significantly improved Canada Trust's management of these requirements, though was of no economic import to Canada Trust. This advantage to Canada Trust was as a result of the net investment balance actively going negative (see Appendix A, Column 11) - this was triggered by the substantial CCA claimed.

[13]     Finally, the Respondent produced a Business Records Affidavit from John Tanter,[5] which attached the Transaction Request - Structured Finance, created in the Structured Finance Division of RBC London. This document refers to the facility sought by the Appellant as a "Limited Recourse Cash Backed Term Loan Facility as part of a Canadian Cross-Border Leveraged Tax Lease". It was diagrammed as set out in Appendix "B".[6] The Transaction Request described the purpose of the facility as follows:[7]

Purpose

TL is currently leasing Trailers to several End Users (location not relevant since we are not taking risk on them) through operating leases. To lower the financing costs TL will sell the Trailers to CTM who depreciate the assets and claim the Capital Allowances. CTM will finance the purchase using a combination of debt and equity, with the interest on the debt being tax deductible. CTM will lease the Trailers to a UK SPC, who will on-lease it to TL. The benefit arising from the allowances and deductibility of interest will be shared with TL via the lease rentals. Since TL is the Seller as well as the Sublessee, it can enhance the benefit even further by using the money received from the sale of the Trailers to prepay its lease rentals (ie it pays the present Value of the lease rentals). Part of the prepayment of the lease rentals will be used as cash collateral for the loan to CTM, thus eliminating the risk for the lending bank but CTM will still be able to deduct the interest costs.

[14]     Later, in detailing the structure of the transaction the Transaction Request states:[8]

To reduce the cost of funds for TL, TL wish to defease their debt and to hedge its "equity" obligations to CTM by way of buying a gov't of Ontario bond. In order to do this, TL prepays its obligations to MAIL under the sub-lease, which on day one is C$120MM less lease benefit of approx. C$3.5 MM. MAIL, in turn, upon receiving the TL prepayment, makes payment to RBC London of C$97.4MM to cover the debt defeasance - and that obligation is then taken on by RBC - and it also makes payment of C$19MM to MAIL for the equity hedging.

Appellant's Position

(1)      Tax Benefit

[15]     The Appellant contends the concept of tax benefit is comparative; that is, tax benefit compared to what? In the Appellant's view, compared to a standard sale-leaseback, which would have yielded the identical CCA treatment. Therefore, there is no tax benefit.

(2)      Purpose other than to obtain a tax benefit

[16]     Mr. Meghji's starting point in this argument is that an ordinary sale-leaseback is not an avoidance transaction. The differences between the ordinary sale-leaseback and this transaction are the elements of the TLI prepayment, the defeasance by MAIL and the RBC Limited recourse financing. None of which, according to the Appellant, impact on the tax treatment of this transaction versus the ordinary sale-leaseback.

[17]     The Appellant was in the business of providing financing through lease transactions. This is evident from the significant leasing income against which the Appellant could use the CCA. The investment was analyzed as any other investment, and was entered into for the purpose of earning income. Indeed, the 8.5 per cent rate of return compared favourably to returns on other types of investments. The limited recourse feature of the debt had commercial benefits, which were acknowledged by CCRA's representative. This was clear from the communications between Mr. Alden, the CCRA representative and Mr. Wheable, Vice-President. These communications do not prove the tax motive, as the Respondent suggests, but a commercial purpose derived in part from the tax treatment.

(3)      Misuse or Abuse

(i)       Applicability of GAAR to Regulations

[18]     As subsection 245(4) refers specifically to a misuse of "the provisions of this Act" it should not be interpreted to capture Regulations. This view is supported by both the Fredette v. The Queen[9] and Rousseau-Houle v. The Queen[10] decisions. The alleged misuse in this case is of the Regulations, not the legislation.

(ii)       What is the clear and unambiguous policy?

[19]     The policy behind the leasing property rules clearly sanctions the application of a loss generated by claiming CCA in respect of one leased property against rental income from another leased property. The specified leasing property rules limit the amount of CCA available to a lessor of property other than "exempt property". The policy behind the "exempt property" list is that it applies to certain types of property based on the attributes of the property itself. By their very nature of being trailers, the equipment qualifies as exempt property in the context of a leasing arrangement. The leasing property and specified leasing property rules provide a clear framework limiting a lessor's claim to CCA.

[20]     The Appellant provided a history of the leasing property rules to assist with the identification of the clear policy. In 1976, the leasing property rules (Regulation 1100) were introduced to restrict CCA on leasing property to be applied against leasing income. This legislation was introduced in the following manner by the 1976 Budget Papers:[11]

While there is much leasing which is entered into for bona fide commercial reasons, nevertheless there is need for a tax rule to prevent unwarranted use of capital cost allowances. The most direct approach would be to look through the form of leases and distinguish between those which are in substance financing arrangements designed to transfer the deductibility of capital cost allowances, and those which are true leases in a more conventional sense. However, past experience and further study indicates that this approach is highly impractical, and that there is need for a more general rule of a workable nature.

It is therefore proposed that with respect to all leases of moveable property, the capital cost allowances thereon cannot be used to create a loss to shelter non-leasing income. This rule would apply to individuals and corporations. It would not affect those taxpayers such as equipment dealers or manufacturers who are allowed for tax purposes to treat moveable property held for both sale or lease as inventory.

[21]     The application of CCA from one leasing property against rental income of another leasing property is clearly sanctioned by the Regulations. This is exactly what the Appellant did.

[22]     The specified leasing property rules were introduced in 1989, further restricting the amount of CCA available in respect of "specified leasing property". Leases of such property were recharacterized as a loan. Certain properties were exempt from the specified leasing property rules. Trailers designed for hauling freight were on the exempt list. The 1989 Budget Supplementary Information stated:[12]

The new regime will not apply to assets which are commonly leased for operational purposes and for which CCA reasonably approximates actual depreciation. Based upon these considerations, leases of computers, office equipment and furniture having a value of up to $1 million each, residential furniture and appliances, buildings, automobiles and light trucks will be exempt from these rules. The rules will not, of course, apply in respect of the licensing of films, video tapes, patents, and other intangible properties.

The trailers in issue have the necessary attributes of "exempt property".

[23]     In 1991, the Government of Canada added railway cars to the exempt list. Once added, it is implicit that the Minister of Finance is of the view that the CCA rate approximates economic depreciation.

[24]     While the clear and unambiguous policy behind the specified leasing property rules is to restrict the CCA which a lessor may claim, the clear and unambiguous policy is also that specified leasing property rules not apply to exempt property. The policy behind the exempt property list is that it applies to certain types of property based on the attributes of the property itself.

(iii)      Has the policy been misused or abused?

(a)       On the basis there is a zero cost

[25]     The Appellant rejects the Respondent's position that there is a misuse or abuse because the transaction resulted in the Appellant having no "real cost" in respect of the trailers. The Appellant did have a "real cost" of approximately $120 million. It is not open to the Respondent to recharacterize a transaction and then allege misuse or abuse based on the recharacterized transactions. The question of misuse or abuse applies to the legal rights and obligations that exist, not to a recharacterization of such rights. Only after a misuse has been found can the transaction then be recharacterized to determine the appropriate tax consequences. The Appellant cites The Queen v. Canadian Pacific Limited[13] in support of this proposition.

[26]     In Canadian Pacific and in Consumers' Gas Company Ltd. v. The Queen,[14] it is established that cost in property, "real" or otherwise, does not turn on economic burden, but upon what outlay was made for the property. The Appellant also relies also on the comments of Le Dain J. in Gelber v. The Queen:[15]

... In my opinion, the fact that a purchaser of property provides, as a condition of the purchase, for a leaseback under which he is assured of a revenue that will cover the amount of his investment and some return on it does not make the purchase price any less the true capital cost of the property. The degree to which an investment is at risk is not, in the absence of a provision in the Act or the regulations to that effect, a valid criterion as to what is capital cost.

Similarly in Signum Communications Inc. v. The Queen[16] the Court applied the decisions in Reed (H.M. Inspector of Taxes) v. Young[17] and Gelber to hold that a limited partner could claim a loss beyond his at-risk amount where no statutory at-risk rules were applicable.

[27]     The Appellant argues that Parliament reacted to the case law, rejecting the premise that cost is determined by extent of economic burden by introducing a number of specific provisions to override the case law: limited partnership-at-risk rules, tax shelter rules, limited recourse debt rules, and computer software tax shelter rules. These do not apply here.

(b)      On the basis there is no financing provided to the lessee

[28]     The Appellant rejects the Respondent's no-financing argument on the basis that the policy identified by the Appellant is not couched in terms of financing being an essential requirement of such a policy. Even if financing were necessary to be in compliance with the policy, financing was in this case provided to TLI. The Respondent's position ignores the Appellant's perspective. What TLI proceeds to do is just not relevant to the finding of whether financing was provided. No policy requires that the vendor under a sale-leaseback arrangement must use the proceeds in any particular manner.

[29]     The alleged misuse is directed at, in this case, the lessor, so surely it is the lessor's perspective which must be considered. But, even in considering the lessee's viewpoint, the Appellant's position is that the Appellant obtained financing. The factors that might suggest no financing was provided, do not involve the lessor (for example, the prepayment by the lessee), and consequently cannot affect the CCA claim.

(4)      Reasonable consequences

[30]     There is no dispute that the reassessment in issue arose because of the fact of the prepayment, defeasance and the limited-recourse financing. The Respondent has admitted that the purchase of the equipment and the lease with MAIL are not objectionable per se. The Appellant says that in order for the tax consequences to be considered reasonable in the circumstances, there should be some reasonable nexus between the abusive transactions and the resulting tax consequences. The entitlement to the CCA claim arose from the purchase of the equipment and the lease with MAIL and not the purportedly abusive transactions. As such the Appellant says that even if one were to accept the Minister's theory of the misuse and/or abuse, the denial of the CCA or the cost is not reasonable in the circumstances.

Respondent's Position

(1)      Tax benefit

[31]     The Respondent suggests that no comparable is required to find that there is a tax benefit, in this case, the benefit being the deferral of tax that arises by nature of the deduction of CCA in the amount of $31,196,700 for 1997. And even if a comparable were required to determine the tax benefit, the only comparable in this case would be no investment at all; that is, the Appellant would not have bought trailers without concurrently entering into the whole arrangement, which provided the tax benefit without any ongoing risk.

(2)      Purpose other than to obtain a tax benefit

[32]     Firstly, the Respondent maintains that the whole arrangement, not just the acquisition of the trailers, is an avoidance transaction. It is not appropriate to parse out the separate elements of the arrangement. Neither the acquisition nor the arrangement as a whole was undertaken primarily for a bona fide reason other than to obtain the tax benefit. There was nothing to this deal except the tax benefit. Relying on an objective determination, by examining contemporaneous events, this pre-ordained series of transactions was entered into primarily for the purpose of obtaining the tax benefit and sheltering other income.

[33]     The Respondent relies on Mr. Lough's report to the Credit Committee in which he refers to the tax benefits generated by the transaction. This was further supported by the summary for presentation to the Board, which talked in terms of the sheltering of other taxable lease income. This, the Respondent suggests, was in the context of a company winding down its leasing operations, as stated in the company's 1996 annual return. The Respondent also relies on the RBC analysis which refers to a "tax lease".

[34]     As the transaction presents no risk to the Appellant, the Respondent maintains it lacks commerciality. Also, the Respondent suggests a further lack of commerciality due to the ability for the deal to be unwound if tax laws change to adversely affect the Appellant.

[35]     Further, the fact TLI could, after closing the transaction, claim depreciation for accounting and US tax purposes is significant.

(3)      Misuse or Abuse

(i)       Applicability of GAAR to Regulations

[36]     The Rousseau-Houle decision upon which the Appellant relies is under appeal. The Respondent simply disagrees with that decision. Many of the details of the CCA scheme, while found in the Regulations are rooted in the Act. Specifically, paragraph 18(1)(b) provides no deduction shall be allowed for an amount on capital account "except as expressly permitted by this Part." Also, subsection 20(1) provides that:

20(1)     Notwithstanding paragraphs 18(1)(a), (b) ... there may be deducted ...

(a)         such part of the capital cost to the taxpayer of property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by regulation;

[37]     GAAR specifically refers to an analysis of the abuse "having regard to the provisions of this Act ... read as a whole". The Regulations are inextricably connected to the Act.

[38]     Finally, relying upon the Supreme Court of Canada decisions in Attorney General of Québec v. Blaikie[18] and Leaf v. Governor General in Council[19] the Respondent argues the Supreme Court of Canada, outside the criminal context, has endorsed the proposition that "Act" includes subordinate legislation such as Regulations.

(ii)       What is the clear and unambiguous policy?

[39]     The clear and unambiguous policy behind CCA is to recognize the capital cost of assets consumed in a taxpayer's business.

[40]     Recognizing that leasing arrangements afforded lower financing costs to lessees by transferring CCA entitlement to a lessor, the government introduced the leasing property rules to limit CCA to lessors to application against their leasing income. As these arrangements continued to proliferate the specified leasing property rules were introduced, with the effect of treating payments under a lease as if they were loan payments of principal and interest. Exceptions in the form of exempt property were identified: these were assets commonly leased for operational purposes and for which CCA reasonably approximated depreciation.

[41]     The Respondent cites the Department of Finance Technical Notes of March 14, 1991, quoting the Regulatory Impact Analysis Statement:[20]

In many cases, leasing constitutes a financing alternative to conventional purchasing and borrowing. For taxpayers who are not currently taxable, leasing may provide a form of after-tax financing ... the tax advantages of leasing arise because the capital cost allowance (CCA) for leased property may exceed actual depreciation. In this situation, leasing allows a non-taxpaying lessee to trade accelerated CCA which the lessee cannot use to a taxpaying lessor in return for reduced rental payments. For the lessor, the accelerated write-offs defer taxes payable on other income - a benefit that can extend indefinitely if the asset base of the lessor is expanding. While a lower cost of financing can be achieved by leasing in these circumstances, the savings are generated at the expense of government tax revenues.

[42]     Further, the April 27, 1989, Budget Papers state:[21]

The government has made a number of changes to the Income Tax Act over the last five years to curtail opportunities for after-tax financing ... Consistent with these changes, the budget proposes to alter the tax treatment of certain leases for the purposes of the CCA provisions. These changes reduce the tax advantages of leasing for taxpayers who are tax-exempt or who are currently not taxable. The changes do not, however, alter the relative treatment of leased assets and purchased assets where there is no benefit from transferring deductions. In particular, special rules are provided to ensure that the full benefit of capital cost allowance remains available to taxpayers using the leased property in the course of their businesses.

(iii)      Has the policy been misused or abused?

(a)       On the basis there is a zero cost

[43]     The Respondent's position is that the true economic substance in this case is that the Appellant incurred no cost, and Parliament did not intend that a taxpayer with no true cost be allowed to claim CCA. The prepayments in the context of the non-recourse loan insured the Appellant had no economic risk. Borrowed funds from RBC were returned the same day, not used to acquire capital assets in an income-earning process. Even the Appellant's equity funding was ultimately covered by a province of Ontario bond.

[44]     The Respondent relies on comments in the Tax Court of Canada decisions of McNichol v. The Queen[22] and RMM Canadian Enterprises Inc. et al v. The Queen[23] for the proposition that the Court must look at "the effect of the transaction viewed realistically".

(b)      On the basis there was no financing

[45]     The policy underlying the specified leasing property rules is to allow leasing to persist as an alternative method of financing while limiting tax advantages of doing so. The Respondent submits that the object and spirit of the specified leasing property rules is to reduce the tax advantage of leasing while continuing to allow lease financing to acquire assets for operational purposes. No such financing was provided in this case to bring the Appellant within this context.

(4)      Reasonable tax consequences

[46]     The Respondent proposes that the reasonable tax consequences are as follows: Where the misuse and abuse arise: (a) because the Appellant did not incur any real cost, the Appellant should be taxed as if its cost for CCA purposes is nil; or, alternatively, (b) because there was no financing provided, the Appellant should be taxed as if the specified leasing property rules apply with the result that no CCA is available.

Analysis

[47]     Section 245 of the Income Tax Act reads in part as follows:

245(1) 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;

"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)         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)         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)         For greater certainty, subsection (2) does not apply to a transaction where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of this Act or an abuse having regard to the provisions of this Act, other than this section, read as a whole.

(5)         Without restricting the generality of subsection (2),

(a)         any deduction 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, 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.

[48]     There has been ample written about this most unique piece of legislation that no explanatory preamble is required before heading down the analytical path recommended by the Federal Court of Appeal in OSFC and Water's Edge.

1.        Does the deferral of tax constitute a tax benefit?

[49]     The legislation defines a tax benefit as "a deferral of tax under the Act". It seems clear that on the simplest construction of these words the approximate $31 million CCA claimed by the Appellant in 1997 results in a tax deferral which would therefore be a tax benefit. Yet, in tax laws nothing is apparently as simple as it appears. One must read these words in a comparative sense argues Mr. Meghji, relying on Judge Bonner's comments in the McNichol and Canadian Pacific cases, and on editorial comment of Mr. Harry Erlichman.[24]

[50]     There may be cases which lend themselves to a comparative analysis for purposes of clearly identifying the tax benefit. But some transactions do not lend themselves to such an approach. This is one of them. This is not a case of a commercial venture whose very essence is readily separable from any tax implications, which can be compared to a like venture with tax implications then overlaid. The difficulty with this transaction is that the tax is integral to the very commerciality of the deal - there is no simple tax-untainted transaction to compare to.

[51]     I am not satisfied that the comparative requirement is even a necessary part of the analysis of tax benefit. In this case, it is acknowledged that the benefit, if any, is a tax deferral. When you read the term "tax deferral" (or even tax reduction) in the context in which it is used (being subsection 245(3) of the Act), that section then reads as follows: "An avoidance transaction means any transaction ... that, but for this section, would result, ...in a tax deferral".

[52]     I suggest the logical interpretation of this would be that the deferral (or reduction even) arises not in comparison to some hard-to-establish normative transaction, but in comparison to the taxpayer's position before the purported avoidance transaction. Indeed, many reductions, deferrals or avoidances will be tax benefits, but certainly not all are avoidance transactions. The definition of tax benefit should not be determined in a vacuum, but should be determined in the context of the question of whether there is an avoidance transaction. In this case, after the Appellant's transaction, there has been a deferral of tax compared to prior to the transaction. This leads to the question of the purpose behind the transaction to determine whether it is indeed an avoidance transaction.

2.        Can the arrangement which resulted in a deferral reasonably be considered to have been entered primarily for bona fide purposes other than to obtain the tax benefit?

[53]     The distinction between the sort of arrangement before me, and other arrangements that have been subjected to GAAR, is that in a form of sale-leaseback transaction, the CCA treatment is not extraneous to the commercial venture, but intrinsic to it. A financial institution which provides lease financing is aware of the specified leasing property rules, and the ability to continue to receive generous CCA treatment with respect to exempt property. This fact came through loud and clear in Mr. Lough's recommendations to the Credit Committee, and in the Final Term Sheet itself. This is not a situation of tax treatment being applied, after the fact, to a commercial transaction, but being inextricably caught up in the commercial venture. It becomes difficult therefore to disassociate the bona fide purpose of "other than to obtain the tax benefit" from the purpose of obtaining the tax benefit, in trying to determine which is the primary purpose.

[54]     The Respondent argues that this is not difficult at all, because there are no competing purposes - there is only one purpose - to obtain the tax benefit. Obviously it will therefore be the primary purpose. The Appellant takes the position that, while there may be a tax-motivated purpose, it was incidental to the commercial purpose of engaging in the Appellant's profitable business of lease financing, and more specifically, to maintain some sort of diversification amongst its investments. While I do not accept the Respondent's contention that there was only one purpose, the tax purpose, I do find that, on balance, these transactions cannot be viewed as having been undertaken primarily for bona fide purposes other than to obtain the tax benefit.

[55]     In arguing this aspect of the case, Mr. Meghji makes much of the contention that, had this been an ordinary sale-leaseback, it would not have been offside. That may be so, but not necessarily because it would not be viewed as an avoidance transaction, but more, I would suggest, because it would not be viewed as an abuse or misuse of provisions of the Act. I am prepared to deal with the comparison between the Appellant's transaction and an ordinary sale-leaseback, but I believe it is more appropriate to do so in the debate surrounding the object and spirit of the legislation. The emphasis should shift from the tax benefit and avoidance transaction argument, where the threshold is not particularly high, to the misuse and abuse argument, where I believe the GAAR emphasis should, in this particular case, be placed. In this light, GAAR can be viewed as an endorsement of avoidance transactions, an endorsement of the grand old Duke, except for those transactions that clear the considerably higher abuse and misuse hurdle.

[56]     I return to the issue of purpose, and why I find the Appellant's transaction is an avoidance transaction. This will be brief. Mr. Lough made it clear to the arranger from the outset that Canada Trust had approximately $100 million to be put out, and it sought exempt property investments. Why? Because it had $51 million of leasing income that it needed to shelter and only certain assets were still available to provide that CCA shelter. Mr. Lough told the arranger that trailers were on the list of the desirable assets, as they would yield a good after-tax return. Granted, Mr. Lough also testified that the investment was to earn income, maintain a diversification between portfolios and enhance regulatory capital requirements, but foremost was the ability to capture the CCA. Indeed, I am satisfied the enhancement of the regulatory capital requirements was achieved due to the effect of the CCA. [25] Mr. Lough's recommendation to his Credit Committee confirms the dominance of the tax benefit purpose:

          Recommendation: This proposed trailer lease is a three-rated, tax effective transaction involving hard assets which provides an exceptional return on investment. There are very limited number of transactions of this nature available in today's market. CT currently has sufficient unsheltered taxable lease income to fully utilise the tax benefits generated by this transaction.

And, further, in his recommendation to the Board:

The transaction provides very attractive returns, by generating CCA deductions which can be used to shelter other taxable lease income generated by Canada Trust.

Even the Appellant's own banker, RBC, referred to the transaction in their Transaction Outline as a Canadian Cross-Border Leveraged Tax Lease.

[57]     I conclude that this was a profitable investment in a commercial context, but such a finding does not outweigh the primary purpose of obtaining the tax benefit from the investment - the tax benefit drove the deal. Mr. Meghji suggests that this approach could lead to his RRSP contribution being considered an avoidance transaction - an absurd notion to Mr. Meghji. Yet, I have no difficulty in imagining for example, an RRSP contribution motivated solely by a one-year tax deferral. Such a contribution could be viewed as an avoidance transaction. Avoidance transaction is not a dirty word. The RRSP contribution would most likely be saved however by the application of subsection 245(4). Delving into the object and spirit of the RRSP scheme is best left to another day.[26]

(3)      Was there a misuse of provisions of the Act or abuse of the Act as a whole?

(i)       Does the GAAR legislation capture a misuse or abuse of Regulations under the Income Tax Act?

[58]     The Appellant relies on the position of Archambault J. in the Rousseau-Houle case, which he relied upon in the Fredette case, to the effect that, because subsection 245(4) does not refer to the Act and Regulations read as a whole, one cannot take account of Regulations in applying GAAR. The Rousseau-Houle case is under appeal to the Federal Court of Appeal. Given how I am ultimately deciding this case, it is unnecessary for me to engage in a lengthy analysis of this particular issue, which I am reluctant to do, given the status of the Rousseau-Houle case. Judge Archambault determined that firstly, it should only be Parliamentarians through legislative policy, not the executive through regulatory policy, that can yield as heavy a hammer as GAAR to deny a taxpayer a tax benefit, and, secondly, that had Parliament intended the legislation to apply to the Regulations, it would have specifically stated such, as it has done in other provisions of the Act. If I allow the appeal solely on the basis that GAAR is not applicable to Regulations, I run the risk that the Federal Court of Appeal overturns Rousseau-Houle and likewise effectively overrules my decision. I prefer proceeding on the basis that any policies surrounding the availability of CCA stems from the Act itself, as paragraph 20(1)(a) incorporates Regulations in the legislation, and therefore the misuse/abuse analysis is warranted in this case.

(ii)       What is the clear and unambiguous policy underlying the CCA treatment in the sale-leaseback arrangements of exempt property?

[59]     Both Justice Rothstein in OSFC and Justice Noël in Water's Edge emphasized the need for clarity in identifying the object and spirit of the relevant provisions. As Justice Noël stated at page 7180:

[52] In so holding, I am giving section 245 a similar application to that given by this Court in [OSFC] Holdings Ltd. v. Canada [2001 DTC 5471] [2001] F.C.J. No. 1381; (leave to appeal denied, June 20, 2002, [2001] S.C.C.A. No. 522). But I wish to place particular emphasis on a key aspect of that decision (paragraph 69) where Rothstein, J.A. states that:

... to deny a tax benefit where there has been strict compliance with the Act, on the grounds that the avoidance transaction constitutes a misuse or abuse, requires that the relevant policy be clear and unambiguous. The Court will proceed cautiously in carrying out the unusual duty imposed upon it under subsection 245(4). The Court must be confident that although the words used by Parliament allow the avoidance transaction, the policy of relevant provisions or the Act as a whole is sufficiently clear that the Court may safely conclude that the use made of the provision or provisions by the taxpayer constituted a misuse or abuse.

In my view, this very particular threshold has been met in this instance.

Framing the policy is critical. Both sides advised that the provisions in issue have a clear policy behind them, yet framing the policy has proven tricky. The Appellant states that the object and spirit of the leasing policy rules is to limit CCA on leasing property to profits from a leasing business. Further, with respect to the specified leasing property rules, the policy regarding trailers is that they are a type of property on a list which exempts them from the application of the rules because of the intrinsic nature of trailers. Because "legions of columnists and lawyers and tax policy analysts", as Mr. Meghji put it, drafted the exempt property list, the policy must be that if the property is on the list, it receives the generous CCA treatment.

[60]     The Respondent frames the relevant CCA policy in terms of providing for the recognition of money spent to acquire qualifying assets to the extent they are consumed in the income-earning process. The policy reason for the exemption of certain property from the specified leasing property rules is to exempt that property where CCA reasonably approximates depreciation, but only in the context of a lease financing arrangement.

[61]     What neither party has addressed in depth is the why behind their policy descriptions; or as Justice Noël put it in Water's Edge, the "reason for being" for these provisions. I know trailers are on an exempt property list and that list was negotiated by many people, but simply because it is on the list does not clarify what policy the government is promoting. Is it part of a fiscal policy to encourage growth by a form of borrowing? Is it part of a policy to assist businesses who cannot use the CCA to obtain cheap financing in exchange for transferring its CCA to an entity who can use it? What are these leasing property and specified leasing property rules really getting at? What indeed is the object and spirit?

[62]     There are two approaches to grappling with these questions. One is to limit the policy quest to an analytical review of the provisions alone. There may indeed be some cases where the object and spirit of the provisions are readily apparent on their face. Many however will not be. The second approach is to conduct the same review by considering, as well, any extrinsic evidence that sheds some light on the legislators' rationale in adopting the provisions. I believe following the latter approach has a greater likelihood of success, though must be approached with some caution. What text writers and tax commentators say is the government policy is obviously not as edifying as what the government itself says; what the government says after the fact is not as enlightening as what the government says at the time of introduction of the provisions. The object and spirit of the leasing property and specified leasing property rules in the context of the general CCA scheme are not crystal clear on their face.

[63]     Justice Noël's review of the object and spirit of the CCA scheme generally in Water's Edge is a useful starting point for an understanding of the more specific leasing and specified leasing property regime. Of particular note are his following comments:

... There can be no doubt that the object and spirit of the relevant provisions is to provide for the recognition of money spent to acquire qualifying assets to the extent that they are consumed in the income earning process under the Act.

Counsel's review of the legislative history was also helpful, particularly in providing statements from the government at the time amendments were introduced. The following is an excerpt from the 1976 Budget Papers introducing the leasing property rules:[27]

As explained above, the capital cost allowance for tax purposes may often be larger in early years than the depreciation recorded in financial statements and this timing difference is generally useful in providing funds for capital investment. However, the government's intention is that these faster write-offs should be directed to the taxpayers most directly carrying out the intended activity.

In some instances there are leasing arrangements under which the use of capital cost allowances is effectively traded to another taxpayer in exchange for lower financing costs. At the individual level, high marginal rate taxpayers have thus been able at an increasing rate to shelter personal income with capital cost allowances on leasing of moveable property such as equipment and aircraft. At the corporate level, there has been an extremely rapid growth in recent years of transactions which in substance are of a financial nature and yet in form are drawn up as a lease in order to give the financing corporation the benefit of deducting capital cost allowances which the person using the property cannot utilize either because of tax exemption or lack of taxable income.

While there is much leasing which is entered into for bona fide commercial reasons, nevertheless there is need for a tax rule to prevent unwarranted use of capital cost allowances. The most direct approach would be to look through the form of leases and distinguish between those which are in substance financing arrangements designed to transfer the deductibility of capital cost allowances, and those which are true leases in a more conventional sense. However, past experience and further study indicates that this approach is highly impractical, and that there is need for a more general rule of a workable nature.

It is therefore proposed that with respect to all leases of moveable property, the capital cost allowances thereon cannot be used to create a loss to shelter non-leasing income. This rule would apply to individuals and corporations. It would not affect those taxpayers such as equipment dealers or manufacturers who are allowed for tax purposes to treat moveable property held for both sale or lease as inventory.

Transitionally, the limitation would apply to moveable property acquired for leasing after May 25, 1976, except where there is an existing contractual commitment. The capital cost allowances on such property would be limited to the income from leasing of all moveable property. The revenue effects of this proposal will be minimal in the balance of the fiscal year 1976-77 since the capital cost allowances on moveable property under existing lease contracts will not be affected.

[64]     It is apparent the government was interested in treating financing arrangements through the guise of leases for what they were - financing arrangements, but wanted some workable way of accomplishing this. The practical solution was to deny the sheltering of non-leasing income, or put another way, allow CCA in lease financing to a limited degree. Policy? This is gleaned from the last paragraph which refers to the revenue effect. The restriction on generous CCA entitlement is to reduce sheltering and raise revenue.

[65]     Leap ahead to 1989 and the following extract from the 1989 Budget Papers:[28]

Leasing

In many cases, leasing constitutes a financing alternative to conventional purchasing and borrowing. For taxpayers who are not currently taxable, leasing may provide a form of after-tax financing. The budget is proposing changes to leasing rules to eliminate these after-tax financing advantages, while at the same time not interfering with the availability of leasing for operational and other non-tax reasons. This will be accomplished by restricting the capital cost allowance deductible by a lessor with respect to leased property.

The tax advantages of leasing arise because the capital cost allowance (CCA) for leased property may exceed the actual depreciation, particularly in the early years of a lease. In this situation, leasing allows a non-taxpaying lessee to trade accelerated CCA which it cannot use to a taxpaying lessor in return for reduced rental payments. For the lessor, the accelerated write-offs defer taxes payable on other income - a benefit that can extend indefinitely if the asset base of the lessor is expanding. While a lower cost of financing can be achieved by leasing in these circumstances, the savings are generated at the expense of government tax revenues.

The government has made a number of changes to the Income Tax Act over the last five years to curtail opportunities for after-tax financing ... Consistent with these changes, the budget proposes to alter the tax treatment of certain leases for the purposes of the CCA provisions. These changes reduce the tax advantages of leasing for taxpayers who are tax-exempt or who are currently not taxable. The changes do not, however, alter the relative treatment of leased assets and purchased assets where there is no benefit from transferring deductions. In particular, special rules are provided to ensure that the full benefit of capital cost allowance remains available to taxpayers using the leased property in the course of their businesses.

Proposed Rules: Details

Under the proposed rules, a taxpayer who leases property, other than exempt property, to another person for more than one year will have the capital cost allowance on such property restricted. The amount of capital cost allowance that may be claimed in a year by a lessor in respect of leased property will be limited to the amount that would have been a repayment of principal had the lease been a loan and had the rental payments been blended payments of principal and interest.

[66]     Further, the government's Technical Notes with regards to these provisions read as follows:[29]

Alternatives Considered

These regulations, which result from the April 1989 budget proposals, are part of a series of proposals over the last six years to curtail opportunities for after-tax financing. For example, the rules with respect to limited partnerships, preferred shares and carve-outs have been amended to reduce the tax advantages associated with such arrangements. These regulations are consistent with the tax reform effort to reduce tax preferences and broaden the tax base.

Anticipated Impact

These regulations, will restrict the CCA deductible by lessors of specified leasing property in order to reduce the use of leasing as an after-tax financing mechanism. The changes do not, however, interfere with the availability of leasing for operational and other non-tax reasons or alter the relative treatment of leased assets and purchased assets where there is no benefit from transferring deductions. For a more detailed analysis, reference may be made to the budget documents presented in the House of Commons on April 27, 1989.

[67]     This suggests to me that the policy is to simply broaden the tax base by restricting the sheltering effect. Exempt property however is not captured. The reason cited is because these are properties "commonly leased for operational purposes or for which CCA reasonably approximates actual depreciation". So, the policy does not extend to these properties. Leases of such properties will continue to be viewed as acceptable means of providing lower cost financing. This seems not so much a matter of some greater economic policy promoting sale-leasebacks of exempt property, though that may be the effect, as the policy of broadening the base simply not extending to such properties. There is no discussion of encouraging the shipping sector; there is no discussion of restricting the favourable treatment of lease financing of exempt property to domestic borrowers. The explanatory government publications are issued in the context of raising revenue by restricting the sheltering of leasing income, except in those lease-financing arrangements involving certain types of property. And the rationale for the exception, from the materials provided to me, is that such properties are exempt due to their nature of being leased for operational purposes and for which CCA can reasonably approximate actual depreciation, or in Mr. Meghji's terms, because they are on the list. Frankly, this is not so much a theory of object and spirit, though it may be a policy. To attempt to delve more deeply to find some greater purpose can only lead down a path of conjecture and imagination - neither of which are appropriate pegs to hang the policy hat on.[30]

[68]     To summarize, I would adjust Justice Noël's policy statement with respect to CCA cited earlier to take into account the particularity of the leasing property rules as they pertain to exempt property. The object and spirit of the relevant provisions is to limit the generous CCA treatment in lease financing arrangements to a recognition of money invested to acquire property leased for operational purposes, and for which CCA reasonably approximates actual depreciation, to the extent that such property is consumed in an income-earning process, such consumption limited to deductions against leasing income. Unwieldy certainly, yet it captures the spirit of the provisions as being restrictive, along with the object of exempting certain types of property provided they are acquired in a lease-financing context.

(3)(iii) Has there been a misuse or abuse?

(a)       Due to there being no real cost against which there can be a claim for CCA

[69]     The Respondent's argument goes to the requirement in the policy that there must be money invested. The Respondent's position is simply there was no risk, there was only a shuffling of paper, and consequently there was no money spent or invested - no real economic cost. To accept the Respondent's position would be to recharacterize the legal form and substance of the transaction, for the purposes of then determining whether there has been a misuse or abuse. The GAAR provisions cannot be applied in that way.

[70]     The first step in this review is to determine what is the cost for tax purposes, GAAR aside. Is the cost to be determined based on the notion of real economic costs? Justice Le Dain stated in the Gelber case:[31]

... In my opinion, the fact that a purchaser of property provides, as a condition of the purchase, for a leaseback under which he is assured of a revenue that will cover the amount of his investment and some return on it does not make the purchase price any less the true capital cost of the property. The degree to which an investment is at risk is not, in the absence of a provision in the Act or the regulations to that effect, a valid criterion as to what is capital cost.

I was referred to no subsequent judicial pronouncement that overturns this finding. Indeed, though neither side raised the recent Supreme Court of Canada decision in Singleton v. R.,[32] it confirmed that a true economic purpose test, in the context of subparagraph 20(1)(c)(i) is not the correct legal test. In unequivocal terms the Supreme Court of Canada relied upon Justice McLachlin's statement in the Shell Canada Ltd. v. Canada[33] case that:

... this Court has never held that the economic realities of a situation can be used to recharacterize a taxpayer's bona fide legal relationships. To the contrary, we have held that, absent a specific provision of the Act to the contrary or a finding that they are a sham, the taxpayer's legal relationships must be respected in tax cases. ...

Second, it is well established in this Court's tax jurisprudence that a searching inquiry for either the "economic realities" of a particular transaction or the general object and spirit of the provision at issue can never supplant a court's duty to apply an unambiguous provision of the Act to a taxpayer's transaction. Where the provision at issue is clear and unambiguous, its terms must simply be applied.

[71]     It is noteworthy that the Supreme Court of Canada states: "absent a specific provision ... to the contrary ... legal relationships must be respected". There are several specific provisions in the Act which do require an investigation of the economics of the situation: the limited partnership at risk rules, tax shelter rules, limited recourse debt rules and computer software tax shelter rules. There is no specific legislative provision requiring cost be determined on any economic reality test for purposes of the application of the Act's CCA regime in the context of sale-leaseback-like arrangements.

[72]     There is no uncertainty as to the legal relationship arising on the acquisition by the Appellant of the equipment. There was a payment of $120 million for the equipment to TLI, partly with borrowed funds and partly with the Appellant's own money. There is no evidence to suggest the money was not paid. Likewise, the evidence is that the Appellant became the owner of the equipment. It then leased the equipment to MAIL. The documents reflecting these transactions are excruciatingly meticulous.

[73]     It is the legal cost which is determinative, not the real economic cost. It is unnecessary for me therefore to consider whether the Respondent is even correct in its assessment that the real economic cost in this case is zero. I will say though that in making the finding I have, it is not to be implied that I accept the Respondent's assessment on that point. I determine the cost is $120 million.

[74]     The second step is to determine whether GAAR can be applied to recharacterize the cost for purposes of determining whether there has been a misuse or abuse. As I have previously indicated, that would be a misapplication of GAAR.

[75]     The Respondent relies on Judge Bonner's statement in McNichol[34] as follows:

... It is evident from section 245 as a whole and paragraph 245(5)(c) in particular that the section is intended inter alia to counteract transactions which do violence to the Act by taking advantage of a divergence between the effect of the transaction, viewed realistically, and what, having regard only to the legal form appears to be the effect. For purposes of section 245, the characterization of a transaction cannot be taken to rest on form alone. I must therefore conclude that section 245 of the Act applies to this transaction.

and its endorsement from Associate Chief Judge Bowman in the RMM decision:[35]

To what Bonner, J. has said I would add only this: the Income Tax Act, read as a whole, envisages that a distribution of corporate surplus to shareholders is to be taxed as a payment of dividends. A form of transaction that is otherwise devoid of any commercial objective, and that has as its real purpose the extraction of corporate surplus and the avoidance of the ordinary consequences of such a distribution, is an abuse of the Act as a whole.

[76]     The Respondent's interpretation of these statements to the effect they lead to the proposition that GAAR permits a recharacterization for purposes of determining a misuse or abuse, is an overly enthusiastic reading. Judge Bonner refers specifically to paragraph 245(5)(c) and also to the effect of the transaction. It is worth repeating paragraph 245(5)(c) here as follows:

(5)         Without restricting the generality of subsection (2),

            ...

(c)         the nature of any payment or other amount may be recharacterized, and

...

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.

So, yes, a recharacterization is permitted, but only at the stage of determining the tax consequences, not at the stage of determining the misuse or abuse. The effect of the transaction must be related to the tax consequences, not to the determination of an abuse.

[77]     GAAR is not to be imposed lightly. It should not permit a recharacterization of a transaction to find the transaction is abusive in its recharacterized form. The transaction must be viewed in its legal context and if found abusive, only then recharacterized to determine the reasonable tax consequences. That is how the GAAR provisions are set out: is there a tax benefit, is there a primary purpose other than obtaining that benefit, and does that avoidance transaction result in an abuse or misuse? All those questions require a review of the transaction, which is otherwise acceptable under all other provisions of the Act; that is, the legal transaction.

[78]     Support for this conclusion is found in the Canadian Pacific decision where Justice Sexton stated:[36]

This does not mean a recharacterization cannot occur. A recharacterization of a transaction is expressly permitted under section 245, but only after it has been established that there has been an avoidance transaction and that there would otherwise be a misuse or abuse. A transaction cannot be portrayed as something which it is not, nor can it be recharacterized in order to make it an avoidance transaction.

[79]     I reject the Respondent's zero-cost argument. There was money invested of $120 million, resulting in a cost of $120 million. No abuse or misuse has arisen by claiming CCA on such cost.

(3)(iii)(b)       Due to the transaction not being in the context of a financing arrangement

[80]     Recalling the policy, it was cast in terms of an underlying requirement that the transaction be a form of financing. The Respondent's position is simply that the transaction was not a means of providing financing to TLI, because of how the money ultimately flowed. The Appellant's position is that what TLI does with the money should not impact on the finding that it received financing.

[81]     This is unlike the zero-cost argument as it is not a matter of recharacterizing the legalities of a situation, but more a matter of characterizing the nature of the transaction to begin with. There was some debate as to whose perspective should be considered in addressing this issue - the Appellant's or TLI's? I suggest the scrutiny should extend to both and beyond. So, for example, how did other players in the overall transaction view the deal?

[82]     It is in this context that it is appropriate to examine the normative comparable, which is the ordinary sale-leaseback of exempt property. A sale-leaseback of exempt property converts the seller's capital asset into cash, while enabling the seller to retain operational control over the asset, thanks to the lease. This is a method of affording businesses the possibility of financing at potentially more favourable rates than traditional lenders. This form of financing falls within the scope of the policy. It is why such sale-leasebacks are not subjected to GAAR.

[83]     Is the transaction at issue before me so significantly different? It is not. Looking at it first from the Appellant's perspective, what was the deal? The Appellant was in the business of putting money out. It was at the time the largest operation of CT Financial Services Inc. It was registered under and carried on business subject to the provisions of the Insurance and Loan Companies Act. In its 1996 annual return, under the heading "Loans", the following description is given:[37]

Canada Trust holds a diversified portfolio of residential mortgages and offers a wide range of consumer and small business credit facilities, including MasterCard. Canada Trust also holds a portfolio of loans and leases to government agencies and large companies. Canada Trust does not intend to make any significant increase in this class of investment and since 1995, it has gradually reduced the size of the existing portfolio. Money market operations invest funds in short term investments, manage liquidity and maintain clearing balances with the Bank of Canada.

[84]     The Respondent emphasized the trend to reduce lease investments, yet for purposes of identifying the business the Appellant carried on, I do not conclude it was out of the lease finance business altogether. Indeed, I find that the Appellant was in the financing business - that is what it did.

[85]     According to Mr. Lough, the Appellant sought an approximate $100 million lease investment - the provision of $100 million of financing through the auspices of a lease. And yes, he certainly wanted to make sure the equipment was exempt property, as this would trigger the tax benefits afforded by the Act. The tax did drive the deal, but it was a financing deal. The Appellant was going to make a return on it, better than many other forms of investments. The fact the Appellant borrowed a significant amount from the Royal Bank to extend the financing to TLI, does not change the nature of the acquisition of the equipment from a financing arrangement to something else. As Mr. Lough indicated, it impacted on the Appellant's capital requirements, but had no effect on the equipment purchased or leased.

[86]     Similarly, from the Appellant's perspective, what effect did TLI's use of the money have on the nature of the deal as a financing deal? None. It ultimately reduced risk, but a company in the financing business would be expected to do what it could to reduce risk. That does not mean it is out of the financing game. From the Appellant's perspective, from the steps it took in analyzing this transaction to running it by the Credit Committee and the Board of Directors, to ultimately implementing it, the transaction is indistinguishable from an ordinary sale-leaseback vis-à-vis its characterization as a lease financing arrangement.

[87]     Turning to TLI's perspective, what did it get? It got $120 million from which it met its full lease obligation and pocketed approximately $3.6 million, which Mr. Lough called TLI's net present value benefit. Just because it had predetermined to prepay the lease, does not shift the nature of the cash it received away from a form of financing: a conversion of its assets into cash. No one from TLI gave evidence as to whether any other options were explored as to how to use its money. However helpful that might have been, there is still the fact that TLI made the prepayment and that such was driven by TLI, not by the Appellant. As TLI's decision, it is not a stretch to presume it was in TLI's best economic interest to do so. TLI obtained funds from the Appellant and proceeded to use them in an economically viable manner. This does not suggest to me that because that manner reduced the Appellant's risk in the deal, that it loses the nature of financing.

[88]     Finally, what were the views of others. Most telling was the perspective of the Royal Bank. Firstly, it refers to the deal in its Transactions Outline as a Canadian Cross-Border Leverage Tax Lease. The use of "leverage" and "lease" connote a lease financing arrangement. I refer back to excerpts from the Transaction Request found in paragraphs 12 and 13 and specifically point out the Royal Bank's reference, under 'Purpose', to lowering TLI's financing cost. It goes on to report that TLI can enhance the benefit further by prepaying the lease rentals. Obviously, the Royal Bank sees this as a good financial deal for TLI. The Royal Bank reiterates this position in describing the structure of the deal by again referring to reducing the cost of funds for TLI. Certainly the Royal Bank views TLI as obtaining financing.

[89]     I find that the transaction is not so dissimilar from an ordinary sale-leaseback as to take it outside the object and spirit of the relevant provisions of the Act. The policy applies to a lease financing arrangement, and that is what we have here. All elements of the policy have been met: lease financing arrangement, money invested, acquisition of exempt property, consumption of such property in an income earning process and limitation of CCA to leasing income. I find there has been no misuse of the CCA provisions, specifically in connection with leasing property and specified leasing property rules.

[90]     Is there an abuse of the provisions of the Act read as a whole? What did Parliament intend by "provisions of the Act read as a whole"? It would quickly become an exercise in the absurd to attempt to identify a clear and unambiguous policy of the Act as a whole. It constitutes a plethora of policies, some perhaps trumping others, some as broad as revenue generation, some very specifically focussed and some even contradictory. In this case, it is a specific element of the CCA scheme at issue. I have found no misuse arises at that level. Justice Rothstein found no misuse of a particular provision (subsection 18(13)) of the Act in OSFC, yet went on to find there was an abuse of a greater policy against trading in losses. I can draw no parallel conclusion in the circumstances before me. As framed, the policy already incorporates the more general policy of the scheme of CCA. In effect, the analysis of the misuse of the provisions and the analysis of the abuse having regard to the provisions of the Act read as a whole are inseparable. This arises due to the identification of the policy. I find there is no abuse.

[91]     What this analysis highlights is the difficulty and risk in determining tax issues based on policy. Certainly GAAR invites such an approach, and the Federal Court of Appeal has made it clear that the only way to determine if there has been a misuse or abuse is to start with the identification of a clear and unambiguous policy. No clear and unambiguous policy - no application of GAAR. But at what level do we seek policy? And, as previously mentioned, do "policy", "object and spirit" and "intended use" all mean the same thing? Is there a policy behind each particular provision, a policy behind a scheme involving several provisions, a policy behind the Act itself? Is the policy fiscal? Is the policy economic? Is the policy simply a regurgitation of the rules? Does the identification of policy require a deeper delving into the raison d'être of those rules? How deep do we dig? The success or failure of the application of GAAR left to the Court's finding of a clear and unambiguous policy inevitably invites uncertainty. That is simply the nature of the GAAR legislation in relying upon such terms as misuse and abuse. As many have stated before, this is tax legislation to be applied with utmost caution as it directs the Court to ascertain the Government's intention and then rely on that ascertainment to override legislation. This is quite a different kettle of fish from the accepted approach to statutory interpretation where policy might be sought to assist in understanding legislation. Under GAAR, policy can displace the legislation.

[92]     On balance I have not been convinced this transaction flies in the face of the object and spirit of the legislation. There is no misuse or abuse. Given my findings it is unnecessary to address the issue of the reasonable consequences that should flow to deny the tax benefit.

Conclusion

[93]     The Appellant derived a tax benefit in the form of a deferral in a transaction undertaken primarily to obtain that benefit - an avoidance transaction. As much as the Respondent may not like the end economic result, the Appellant's capturing of the tax benefit in this instance does not run afoul of a Goverment policy to allow CCA on exempt property acquired by a purchaser, where the purchaser/lessor has provided financing to the vendor/lessee. This is one of those paradoxes where the sheer complexity of the series of transactions involving many players tweaks the nose upward on that least scientific of analysis known, in tax vernacular, as the smell test, yet legislation and case precedent guide analysis down a more structured and deliberate path past the olfactory sense and into the more certain realm of reason, though less precise purview of policy, where the GAAR debate, in this case, rages. In following that approach, I have concluded this avoidance transaction is not subject to GAAR, and on that basis I refer the matter back to the Minister for reconsideration and reassessment. Costs to the Appellant.

Signed at Ottawa, Canada, this 7th day of May, 2003.

J.T.C.C.

CITATION:

2003TCC215

COURT FILE NO.:

2002-1155(IT)G

STYLE OF CAUSE:

Canada Trustco Mortgage Company and Her Majesty the Queen

PLACE OF HEARING:

Toronto, Ontario

DATE OF HEARING:

February 17, 18, 26 and 27, 2003

REASONS FOR JUDGMENT BY:

The Honourable Judge Campbell J. Miller

DATE OF JUDGMENT:

May 7, 2003

APPEARANCES:

Counsel for the Appellant:

Al Meghji and Monica Bringer

Counsel for the Respondent:

Alexandra Brown and Michelle Farrell

COUNSEL OF RECORD:

For the Appellant:

Name:

Al Meghji and Monica Bringer

Firm:

Osler, Hoskin & Harcourt LLP

For the Respondent:

Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada

---