Lee – Court of Quebec finds deductible interest on a note that could be settled with property worth less than the amount owed and that the tax shelter definition is applied on a property-by-property basis

The ARQ did not lose heart with the victory by a representative investor in a tax shelter in Drouin (where CRA unsuccessfully argued that no business was carried on) and, for the same tax shelter and for the same year (as well as other years) was successful before the Court of Quebec in having most of the claimed deductions denied. For two of the years, there was a prescribed benefit in the form of limited recourse debt, which resulted in all the deductions being denied under the Quebec equivalent of ITA s. 231.7(6), as no tax shelter registration had been made. For two subsequent years, such registration had been made, but there nonetheless were tax shelter investments under Quebec equivalent of s. 143.2, so that the limited recourse nature of the debt again resulted in CCA denials under that provision and the equivalent of Reg. 1100(20.1). However, interest deductions on the limited recourse debt was allowed for those years, notwithstanding that the taxpayers could extinguish their obligations under the notes by surrendering their franchises (which in fact occurred, once the targeted deductions were claimed).

For some further taxation years, the promoters once again failed to file tax shelter registrations. The taxpayers argued that the franchises for those years did not satisfy the numerical tax shelter test because the cost of their acquisition of the property (being a single franchise property for these purposes comprised of the software licence and the membership right) included all the interest they had covenanted to pay. Fournier JCQ rejected this interpretation of “cost”, stating:

The term "cost" must therefore be assimilated to the price that the taxpayer agreed to pay to acquire the property, excluding other expenses incurred in respect of the property, including interest payable on money borrowed by the taxpayer to acquire the property.

He also rejected the single property argument, stating that the tax shelter definition “militates in favour of an individual analysis of the property in question in order to determine whether or not it qualifies as a tax shelter.” Accordingly, the Class 12 CCA claims for those latter years respecting the cost of the software were also denied, whereas the eligible capital amounts claimed for the membership right were deductible.

Neal Armstrong. Summaries of Lee v. Agence du revenu du Québec, 2020 QCCQ 780 under s. 20(1)(c)(ii) and s. 237.1(1) - tax shelter.