Custeau – Quebec Court of Appeal finds that Copthorne does not require the s. 248(10) “in contemplation of” test to be applied on a backwards-looking basis
When a family small business corporation (the “Corporation”) was in financial difficulty, two Quebec regional development funds agreed in 1997 and 1998 (with an objective of saving jobs) to inject equity capital in the Corporation on terms largely dictated by them. As a result of paid-up capital averaging that occurred in the 1998 transactions, the PUC of the common shares of the taxpayers (two brothers) was boosted by a significant amount. In 2003 and 2004, they engaged in capital gains crystallization transactions, which resulted in them holding their shares through respective Holdcos whose shares had a stepped-up ACB and a PUC that reflected the PUC that had effectively been transferred to them. The funds’ common shares of the Corporation were repurchased in 2005 (the Corporation had done quite well), and the taxpayers had their Holdcos distribute most of their PUC in cash during 2006.
The ARQ considered this to be abusive surplus-stripping, and applied the Quebec general anti-avoidance rule to treat most of the paid-up capital distributions as taxable dividends. Dortélus JCQ had found that the utilization by the taxpayers of their stepped-up PUC in 2006 was not part of the same series of transactions as the 1998 PUC-averaging transactions, stating that in order to analyze the nexus between the 1998 and 2006 transactions “it is necessary to place oneself in 1998, at the time of the first transaction and not to apply a backwards-looking analysis.” The ARQ submitted that this approach had erred by not recognizing that Copthorne had found that the assimilation to a series of transactions - of related transactions completed “in contemplation” of the series - included backwards-looking contemplation (i.e., the 2006 transactions were effected “in contemplation” of the previous PUC step-up in 1998.)
In rejecting this submission, Schrager JCA found that, consistently with Copthorne, the question of whether the “in contemplation of” test as to a series should be applied prospectively or retrospectively, depended “on the circumstances of the case.” In the circumstances of this case, including that “none of the players in 1998 could have foreseen that the business would generate sufficient cash six or eight years later to allow the shares to be redeemed,” Dortélus JCQ had not erred by applying the “in contemplation of” test looking forward from 1998 rather than backwards from 2006. It followed that the 1998 PUC-averaging transactions and the use of that PUC in 2006 were not avoidance transactions for GAAR purposes.
Neal Armstrong. Summary of Agence du revenu du Québec v. Custeau, 2020 QCCA 1496 under s. 248(10).