Nova Corp. Of Alberta v. R., [1996] 1 CTC 2164, 95 DTC 599

Rip J.T.C.C.:—Appellant’s counsel, Mr. Warren Mitchell, described this appeal from a reassessment for the 1986 taxation year by Nova Corporation of Alberta (“Nova”) as the third in a trilogy of appeals heard by this Court. The two other appeals are those of Mara Properties Ltd. v. R. (sub nom. Mara Properties Ltd. v. Canada), [1993] 2 C.T.C. 3189, 93 D.T.C. 1449 (T.C.C.), and Husky Oil Ltd. v. R. (sub nom. Husky Oil Ltd. v. Canada), [1995] 1 C.T.C. 2184, 95 D.T.C. 316 (T.C.C.). The issue in all appeals was whether the particular appellant corporation that “acquired” capital losses incurred by another taxpayer corporation could apply those losses to reduce its capital gains. In Mara, the Minister of National Revenue (“Minister”) attacked the transactions applying subsections 9(1) and 245(1), as it applied before September 13, 1988, and paragraph 18(l)(a) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp) (the “Act”) and in Husky the Minister applied subsection 245(2). The appellants were successful before this Court and the Crown appealed both judgments. On February 22, 1985, the day after the appeal at bar was heard, the Federal Court of Appeal allowed the appeal of Mara Properties Ltd. v. Canada, [1995] 2 C.T.C. 86, 95 D.T.C. 5168 (F.C.A.) on the basis the rule established by subparagraph 88( 1 )(a)(iii) and paragraph 88(1)(c), as they read at the relevant time, applied. On April 11, 1995, the Federal Court of Appeal dismissed the appeal of the Crown in Husky', in the view of the Federal Court of Appeal as a result of transactions in issue in that appeal, it was held no benefit pursuant to subsection 245(2) was confirmed on Husky. In neither Mara nor Husky did the Minister assess pursuant to subsection 55(1) of the Act. In the appeal at bar the Minister applied subsection 55(1) as it read in 1986; in the alternative he invoked paragraph 245(2)(a) of the Act, as that provision read before September 13, 1986. Counsel for the parties advised me that the Federal Court of Appeal would consider subsection 245(2) as it applied to similar facts shortly and requested me to confine my reasons to the application of the facts to subsection 55(1). I assume counsel were referring to the Husky appeal. Upon receipt of the reasons in Husky, I asked counsel if they wished to express their views as to the relevance to the appeal at bar. I had earlier canvassed their views on Mara.

The parties filed an agreed statement of facts. The respondent also filed two Exhibits and read a short extract from the transcript of the examination for discovery of Mr. Grant, a duly authorized representative of Nova. This material did not add substantially to the agreed statement of facts which read as follows:

AGREED STATEMENT OF FACTS AND ISSUES

For the purposes of this appeal the parties, by their respective counsel, admit the following facts and agree upon the following issues to be decided by the Court. The parties agree that their admission of facts shall have the same effect as if the facts had formally been proved and accepted by the Court as true. The parties each reserve the right to adduce additional evidence which is relevant and probative of any issue before the Court and which is not inconsistent with the facts admitted herein. In this agreed statement of facts the terms “taxable Canadian corporation”, “public corporation”, “capital property”, “disposition”, “proceeds of disposition”, “adjusted cost base”, “allowable capital loss”, “net capital loss” and “taxable capital gain” each have the meaning given to them in the Income Tax Act (the “Act”).

1. The appellant, Nova Corporation of Alberta, is a corporation incorporated by Special Act of the Legislature of the Province of Alberta. The appellant was originally named Alberta Gas Trunk Lines Ltd. and, for a time, was known as Nova, an Alberta Corporation.

2. The appellant’s head office and principal place of business is located at 801 7th Avenue S.W., Calgary, Alberta, T2P 2N6.

3. This appeal relates to a Notice of Reassessment dated December 23, 1993, Number 3828084 (the “Reassessment”), with respect to the appellant’s 1985 taxation year.

4. The appellant is a resident of Canada for purposes of the Act and, at all material times, was a taxable Canadian corporation and a public corporation. Throughout its history the appellant’s taxation year has ended on December 31.

5. The appellant owns and operates a natural gas gathering and transmission pipeline system in Alberta. Throughout its history the appellant has made investments in subsidiaries and affiliates. Its subsidiaries and affiliates have carried on a variety of activities, including exploring for and marketing hydrocarbons, manufacturing and transporting petrochemicals and assembling and selling heavy duty trucks.

6. During its 1986 taxation year the appellant disposed of the shares of two corporations, Allarco Group Ltd. (“Allarco”) and Petralgas Chemicals N.Z. Ltd. (“Petralgas”) which it held as capital property. In each case the appellant reported that its proceeds of disposition were less than the adjusted cost base of the shares and, in each case, the appellant reported a capital loss. The details of the appellant’s claims and the circumstances leading to the acquisition and disposition of the shares are set out in detail below.

The Carma Transactions

7. In late 1985, both Carma Ltd. (“Carma”) and its wholly owned subsidiary, Allarco, were in serious financial difficulty. By this time both Carma and Allarco were in default on a debt restructuring which had been implemented in 1982. During 1986 Allarco was indebted to The Bank of Nova Scotia (the “Bank”), a Canadian chartered bank, in an amount exceeding $100,000,000 and the aggregate fair market value of its assets was considerably less than this amount. Allarco’s indebtedness to the Bank was guaranteed by Carma.

8. Carma’s guarantee of Allarco’s debt to the Bank was secured by, among other things, a pledge of 825,000 Series “B” 11 per cent Cumulative Redeemable Retractable Preferred Shares which it owned in the capital of Allarco (the “Allarco Preferred Shares”).

9. Immediately before the transactions set out below the Allarco Preferred Shares had an adjusted cost base to Carma of $16,500,000.

10. By June 27, 1986, prior to the appellant’s involvement, virtually all of the value of the Allarco Preferred Shares had been lost due to Allarco’s financial difficulties and the Allarco Preferred Shares had only a nominal market value. Accordingly, if Carma had sold the Allarco Preferred Shares to an arm’s length party for their value at that time it would have realized a capital loss of $16,500,000. As a result of its financial and tax circumstances, Carma did not expect to be able to use that loss but believed the loss might be made available to a corporate purchaser which would be able to utilize it.

11. Carma took the following steps in order to facilitate the transfer of the inherent capital loss in the Allarco Preferred Shares to an unidentified prospective purchaser:

(a) on May 22, 1986, it caused three taxable Canadian corporations, 348840 Alberta Ltd. (“840”), 348841 Alberta Ltd. (“841”), and 348842 Alberta Ltd. (“842”) to be incorporated under the Business Corporations Act of Alberta;

(b) on June 19, 1986, Carma became the sole shareholder of 840, which in turn became the sole shareholder of 841, which in turn became the sole shareholder of 842; and

(c) on June 22, 1986, Carma sold the Allarco Preferred Shares to 842 for $1. The $16,499,999 capital loss which would otherwise have been realized by Carma on the sale to 842 was deemed to be nil by paragraph 85(4)(a) of the Act. As Carma did not own directly any shares in the capital of 842, a like amount of $16,499,999 was required to be added to 842’s adjusted cost base of the Allarco Preferred Shares pursuant to paragraph 53(l)(f. 1) of the Act. Accordingly, 842’s adjusted cost base of the Allarco Preferred Shares became $16,500,000.

12. Once it became the owner of the Allarco Preferred Shares, 842 pledged the shares to the Bank as continuing security for Carma’s guarantee of Allarco’s debt to the Bank. The Bank was prepared to release its pledge of the Allarco Preferred Shares if it were instead granted a right of first refusal to acquire the shares if they were offered for sale.

13. On October 22, 1986, Carma, 842 and 348843 Alberta Ltd., another subsidiary of Carma, being the only shareholders of Allarco, entered into a unanimous shareholders’ agreement in which they agreed to grant the Bank a right of first refusal with respect to the Allarco Preferred Shares. The right of first refusal provided the Bank with the right to purchase the Allarco Preferred Shares if any transfer of the Allarco Preferred Shares were proposed. The right of first refusal did not apply to a proposed transfer to a parent corporation on the winding up of 842 if it was the holder of the Allarco Preferred Shares as long as the parent corporation agreed to assume 842’s obligations under the unanimous shareholders’ agreement. Once the unanimous shareholders’ agreement was signed the Bank released the pledge over the Allarco Preferred Shares which it held as security.

14. On October 22, 1986, the appellant purchased the sole issued share of 842 from 841 for a purchase price of $1,237,500, which was equal to 15 cents for every dollar of allowable capital loss inherent in the only asset of 842, the Allarco Preferred Shares. The change of control of 842 resulting from this transaction did not affect the adjusted cost base of the Allarco Preferred Shares held by 842 which remained at $16,500,000.

15. On October 24, 1986, the appellant commenced the dissolution of its wholly-owned subsidiary, 842. The Allarco Preferred Shares were transferred to the appellant in the course of winding up, and the appellant assumed the obligations of 842 under the unanimous shareholders agreement so that the right of first refusal of the Bank referred to in paragraph 13 did not apply. 842 was legally dissolved and by virtue of subparagraph 88(l)(a)(iii), paragraph 88(1 )(c) and paragraph 54(a) of the Act, the adjusted cost base of the Allarco Preferred Shares to the appellant was deemed to be $16,500,000.

16. The only purpose of the series of transactions described in paragraphs 13 to 15 was to enable the appellant to avail itself of the capital loss inherent in the Allarco Preferred Shares by acquiring those shares as capital property with an adjusted cost base of $16,500,000.

17. On November 19, 1986, as the last step in the series of transactions described in paragraphs 13 to 15, the appellant sold the Allarco Preferred Shares to the Bank for $1 which were its proceeds of disposition. Pursuant to the provisions of paragraph 40(1 )(b) of the Act the appellant calculated that its loss from the disposition of the Allarco Preferred Shares was $16,500,00. Pursuant to the provisions of paragraph 39(1 )(b) of the Act the appellant calculated that its capital loss from the disposition of the Allarco Preferred Shares was $16,500,000. Pursuant to the provisions of paragraph 38(b) of the Act the appellant calculated that its allowable capital loss from the disposition of the Allarco Preferred Shares was $8,250,000.

18. The price of the share of 842 was determined in negotiations between the appellant on the one hand, and Carma on the other hand, with Carma attempting to maximize its receipt and the appellant attempting to minimize its payment. In these negotiations with respect to price the appellant and Carma were each acting in their own self-interest.

19. The appellant was not a party to any of the transactions described in paragraphs 11 to 13 inclusive and did not control or direct them. Before October 22, 1986, the appellant had no right or obligation to purchase the sole issued share of 842, but before completing that purchase, the appellant completed a due diligence review of the documentation relating to the transactions described in paragraphs 11 to 13 inclusive and satisfied itself that the transactions had occurred, that 842 owned the Allarco Preferred Shares, and that the adjusted cost base of the Allarco Preferred Shares in 842’s hands was $16,500,000.

20. All of the documents relating to the transactions set out in paragraphs 11 to 17 herein were legally effective and binding upon the parties thereto and the transactions forth in the documents truly represent the agreements between the parties and were not shams.

21. The Minister examined all of the relevant documents in the course of an audit of the appellant and concluded that the appellant’s adjusted cost base of the Allarco Preferred Shares was $16,500,000 immediately before it sold the shares to the Bank.

The Petralgas Transactions

22. Among the appellant’s investments in 1986 was an interest in Alberta Gas Chemicals Ltd. (“AGCL”), a taxable Canadian corporation which owned and operated several methanol plants in Canada. At all material times the issued and outstanding shares of AGCL were owned as to 50 per cent by the appellant and as to 50 per cent by Allarco.

23. AGCL owned 49 per cent of the issued and outstanding shares of Petralgas which was a New Zealand corporation. AGCL had acquired its interest in Petralgas in 1980. The remaining 51 per cent of the shares of Petralgas were owned by Petroleum Corporation of New Zealand (“Petrocorp”), a New Zealand corporation which was controlled by the Government of New Zealand. Petralgas owned and operated a methanol plant in New Zealand.

24. An agreement between AGCL and Petrocorp obliged them to provide capital and other financial support to Petralgas in proportion to their respective shareholdings. By early 1986, AGCL had invested $25,425,000 in Petralgas, but its interest in Petralgas had only nominal fair market value because Petralgas had encountered serious financial difficulties.

25. Immediately before the transactions described below, AGCL’s adjusted cost base of its shares of Petralgas (the “Petralgas Shares”) was $25,425,000. Accordingly, if AGCL had sold the Petralgas Shares to an arm’s length party for their value at that time it would have realized a capital loss of $25,425,000.

26. By May of 1986, AGCL was also in financial difficulty and had commenced negotiations With its major creditors with respect to a restructuring of its own debts. AGCL’s financial position was made worse by its funding obligations for Petralgas. AGCL’s financial difficulties made its continuing involvement in Petralgas uneconomic and, at the insistence of its creditors, AGCL approached Petrocorp to determine if Petrocorp would be prepared to acquire its interest and assume its funding obligations in respect of Petralgas. During May of 1986, Petrocorp agreed in principle that it would be prepared to take over AGCL’s 49 per cent interest in Petralgas and its continuing funding obligation.

27. AGCL also owned all of the issued shares of Alberta Gas Chemicals Resources Ltd. (“AGCR”), which, in turn, owned all the issued shares of 346976 Alberta Ltd. (“976”), a corporation newly incorporated for the purposes of the transactions described in paragraphs 28 and 29 below.

28. Between June 2 and September 22, 1986, the following steps were taken in order to facilitate the transfer of the inherent capital loss on the Petralgas Shares to the appellant:

(a) AGCR granted the appellant an option to purchase the shares of 976 for $100, subject to the condition that 976 be the owner of the Petralgas Shares at the time of the exercise of the option;

(b) AGCL sold the Petralgas Shares to 976 for $1,000,000 and paid by way of a demand non-interest bearing promissory note. The $24,425,000 capital loss which would otherwise have been realized on that sale was deemed to be nil by paragraph 85(4)(a) of the Act and a like amount of $24,425,000 was required to be added to 976’s adjusted cost base of the Petralgas Shares pursuant to paragraph 53(l)(f. 1) of the Act;

(c) the appellant exercised its option to purchase the shares of 976 from AGCR for $100. The change of control of 976 resulting from this transaction did not affect the adjusted cost base of the Petralgas Shares held by 976 which remained at $25,425,000; and (d) 976 then sold the Petralgas Shares to the appellant for $1,000,000. The $24,425,000 capital loss which would otherwise have been realized on that sale by 976 was deemed to be nil by paragraph 40(2)(e) of the Act and a like amount of $24,425,000 was required to be added to the appellant’s adjusted cost base of the Petralgas Shares pursuant to paragraph 53(l)(f.l) of the Act.

29. As the final step in the series, on September 22, 1986 the appellant sold the Petralgas Shares to Petrocorp for $1 which were its proceeds of disposition. Pursuant to the provisions of paragraph 40(1 )(b) of the Act the appellant calculated that its loss from the disposition of the Petralgas Shares was $25,425,000. Pursuant to the provisions of paragraph 39(1 )(b) of the Act the appellant calculated that its capital loss from the disposition of the Petralgas Shares was $25,425,000. Pursuant to the provisions of paragraph 38(b) of the Act the appellant calculated that its allowable capital loss from the disposition of the Petralgas Shares was $12,712,500.

30. The only purpose of the series of transactions described in paragraph 28 was to enable the appellant to avail itself of the capital loss inherent in the Petralgas Shares by acquiring those shares as capital property with an adjusted cost base of $25,425,000.

31. 976 used the $1,000,000 received from the appellant to pay the promissory note it had issued to AGCL.

32. The $1,000,000 purchase price paid by the appellant for the Petralgas Shares was slightly less than 8 cents for every dollar of allowable capital loss inherent in them. That price was determined in negotiations between AGCL and the appellant, with AGCL attempting to maximize its receipt and the appellant attempting to minimize its payment. In these negotiations with respect to price the appellant and AGCL were each acting in their own self-interest.

33. The appellant, as the owner of 50 per cent of the shares of AGCL, reflected its share of the loss of the value of the AGCL investment in Petralgas in its own consolidated financial statements.

34. All of the documents relating to the transactions set out in paragraphs 28 and 29 were legally effective and binding upon the parties thereto and the transactions as set forth in the documents truly represent the agreements between the parties and were not shams.

35. The Minister examined all of the relevant documents in the course of an audit of the appellant and concluded that the appellant’s adjusted cost base of the Petralgas Shares was $25,425,000 immediately before it sold the shares to Petrocorp.

Particulars of Tax Filings and Reassessments

36. In filing its return for its 1986 taxation year, the appellant reported an allowable capital loss (the “Allarco Allowable Capital Loss”) of $8,250,000 for its 1986 taxation year in respect of the sale of the Allarco Preferred Shares, such loss having been computed pursuant to paragraphs 40(1 )(b), 39(l)(b)and 38(b) of the Act.

37. In determining its income under section 3 of the Act for its 1986 taxation year, the appellant did not deduct any amount under paragraph 3(b) of the Act in respect of the Allarco Allowable Capital Loss.

38. In filing its return for its 1986 taxation year, the appellant reported an allowable capital loss (the “Petralgas Allowable Capital Loss”) of $12,712,500 for its 1986 taxation year in respect of the sale of the Petralgas Shares, such loss having been computed pursuant to paragraphs 40(1 )(b), 39(l)(b) and 38(b) of the Act.

39. In determining its income under section 3 of the Act for its 1986 taxation year, the appellant did not deduct any amount under paragraph 3(b) of the Act in respect of the Petralgas Allowable Capital Loss.

40. The appellant made a timely claim for the deductions of $8,250,000 for the Allarco Allowable Capital Loss and $12,712,500 for the Petralgas Allowable Capital Loss in computing its taxable income for its 1985 taxation year in respect of the carry-back of these losses pursuant to paragraphs 11 l(8)(a) and 11 l(l)(b) of the Act. These losses were applied against its reported taxable capital gain of $82,549,667 which had been realized upon the disposition of its head office building in 1985. Prior to any in depth audit, the Minister reassessed the appellant’s 1985 taxation year to carry back these 1986 losses.

41. On December 23, 1993 the Minister issued the Reassessment reducing the net capital losses carried back from 1986 as follows:

(a) Allarco Allowable Capital Loss:

Claimed: $8,250,000

Disallowed: $7,631,250

Allowed: $618,750

(b) Petralgas Allowable Capital Loss:

Claimed: $12,712,500

Disallowed: $12,212,500

Allowed: $500,000

42. At the time of issuing the Reassessment the Minister concluded that but for paragraph 55(1 )(c) of the Act, the Allarco Allowable Capital Loss and the Petralgas Allowable Capital Loss as reported by the appellant in 1986 would have been allowable capital losses of the appellant in 1986 and the net capital loss claimed in 1985 would have been properly deducted. The appellant takes issue with the conclusion that subsection 55(1) has any application to these transactions.

43. Upon being advised by the Minister of the proposed reassessment for 1985 the appellant requested the Minister to allow it to claim additional discretionary deductions for its 1985 taxation year so as to minimize the tax payable by the appellant as a result of the 1986 net capital loss carry back being reduced.

44. The result of the Reassessment was to reduce by $19,843,750 the 1986 net capital loss available to be carried back to the appellant’s 1985 taxation year and deducted in computing its taxable income for that year.

45. By Notices of Objection filed on the 25th day of January, 1994 the appellant objected to the Reassessment.

46. By Notification dated March 30, 1994, the Minister confirmed the Reassessment.

47. By Notice of Appeal dated March 30, 1994 the appellant appealed to this Court.

ISSUE TO BE DETERMINED

The issue to be determined is whether the appellant disposed of the Petralgas Shares and the Allarco Preferred Shares under circumstances such that it may reasonably be considered to have artificially or unduly created or increased the amount its loss from the disposition of those properties within the meaning of subsection 55(1) as it read in 1986.

In 1986 subsection 55(1) provided that:

For the purposes of this subdivision, where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatever is that a taxpayer has disposed of property under circumstances such that he may reasonably be considered to have artificially or unduly

(a) reduced the amount of his gain from the disposition,

(b) created a loss from the disposition, or

(c) increased the amount of his loss from the disposition,

the taxpayer’s gain or loss, as the case may be, from the disposition of the property shall be computed as if such reduction, creation or increase, as the case may be, had not occurred.

Appellant’s Submissions

Effective September 13, 1988, the Act was amended by the addition of a general anti-avoidance rule (“GAAR”) to combat what the fisc viewed as aggressive tax planning practices: section 245. Appellant’s counsel argued that the assessment in issue was an attempt by the Minister to import GAAR principles into transactions that predated GAAR by attacking transactions effected solely to bring about favourable tax results. I agree with counsel that the courts have consistently rejected this approach: tax motivation by itself does not bring transactions within subsection 245(1). However subsection 55(1) may well apply if transactions, tax-motivated or not, artificially or unduly create or increase a taxpayer’s loss.

Appellant’s counsel reviewed Kempo J.T.C.C.’s reasons in Mara and Husky. In each case the taxpayer acquired shares of a stranger company, which company owned assets having a tax cost in excess of fair market value. In Mara, the company’s asset was land. In each case the taxpayer caused its newly-acquired subsidiary to be liquidated. By virtue of the “rollover” provisions of the Act, i.e. paragraph 88(1 )(a), the subsidiary was deemed to have disposed of those assets at its tax cost, and by virtue of paragraph 88(1 )(c) the taxpayer was deemed to have acquired those assets at what was the tax cost to the subsidiary. In both cases, its taxpayers disposed of the assets, thereby realizing a loss for tax purposes. Mara sold the land to a third party and claimed a loss on the disposition. Husky, as in the appeal at bar, sold shares of Allarco to the bank. The transactions took place before January 15, 1987, the date on which the Act was amended to reduce the tax cost of the assets to their fair market value on change of control of a subsidiary.

Kempo J.T.C.C. held that the transactions in Mara were not artificial. She held the cost of the land was not a deduction, disbursement or expense as required by the wording of subsection 245(1). She stated that the loss was the result of a statutory deeming provision and was not created by the taxpayer. At page 3201 (D.T.C. 1458), my colleague stated:

It was argued that the loss amount claimed was artificially derived and that allowance of the deemed cost would result in an undue or excessive reduction in income. While that may be the result, it ignores the reality that the amount of that cost was not created by any act on the part of the appellant but rather was the product of a statutory deeming provision which must by given effect ...which the appellant recognized and utilized in its favour.

On page 2 of his reasons for judgment in Mara, supra, Marceau J., Stone J. concurring, stated that:

... Subsection 245(1) of the Act, concerning artificial transactions, has no role to play in the factual context of this case. The series of operations by which the respondent acquired the Maple Ridge property does not constitute a sham, whatever may be the ulterior economic motive of the scheme. The transactions were real and nothing was hidden behind them. Even if subsection 88(1) operates to allow the respondent to consider the difference between the deemed cost and the actual proceeds of sale as a loss sustained in the course of its business, this loss could not be said to be “artificial” or “undue” as it would arise by specific operation of the Act.

See also MacDonald J., page 12 of his reasons in Mara. Jackett, C.J. was of the opposite view in R. v. Alberta and Southern Gas Co. Ltd., [1977] C.T.C. 388, 77 D.T.C. 5244 (Fed. C.A.) at page 395 (D.T.C. 5247):

..1 cannot agree that the rule of interpretation...excludes the application of section 245(1) to an amount that would otherwise be deductible under section

66. If it does, it is difficult to think of any case where section 245(1) would apply inasmuch as, in relation to any provision providing for a deduction in computing income, section 245(1) is always, by its nature, a general provision.

Parliament must have intended the provision to have some effect and a non-statutory rule of interpretation is merely a crystallization of the judicial reasoning employed in ascertaining Parliament’s intention in enacting a particular provision.

Counsel for the appellant argued that the facts in this appeal are not essentially different from those in Mara and Husky: subsection 55(1) ought not to strike down essentially the same transaction as in the two earlier cases. The appellant neither created nor increased the amount of the loss. It is subsection 88(1) which dictates an artificial result and to deny that result as being artificial is inconsistent with the Act. Subsection 88(1) defers the recognition of gains or losses on the winding-up of a wholly-owned subsidiary and brings those gains or losses to account when the parent actually disposes of the property to a stranger. Subsection 88(1) is an exception to the general rule in subsection 69(5). Counsel says subsection 88(1) brings about artificial results and reasons that if subsection 55(1) is to be applied to deny the artificial results that subsection 88(1) causes, it must neces- sarily apply in every case when an accrued loss on property is deferred on a liquidation to which subsection 88(1) applies. The opening words of subsection 88(1), “Notwithstanding any other provision of this Act”, excludes the operation of any other provision that would negate its effect. Subsection 88(1) necessarily brings about an artificial result to accomplish its desired purpose.

GAAR did not exist in 1986. There was no provision in the Act in 1986 to permit a court to deny the loss to the parent simply because the loss was inherited from a subsidiary after a change of control, counsel concluded.

Respondent’s Submissions

In the respondent’s view any transaction on capital account producing a capital gain or loss which can be properly described as an avoidance transaction should be subject to the scrutiny of subsection 55(1), an antiavoidance provision. Respondent’s counsel says that subsection 55(1) does not automatically apply to a capital gain or loss where the transaction is an avoidance transaction but inquiry must be made to determine whether the gain or loss falls within the language and intent of subsection 55(1).

Counsel argues that the transactions whereby Nova bought the capital losses of Carma and AGCL in the total amounts of $41,900,000 at a cost of $2,238,000 are tax avoidance transactions because they directly involved the deduction of losses (allowable capital losses) in the total amount of $20,950,000 without having suffered actual losses of capital in the amount of $41,900,000.

The Act discourages the transfer of losses, either non-capital or capital, from one corporation to another, argued counsel. There is nothing in the Act which countenances the transfer of capital losses from one corporation to another. Subsection 111(4) denies the carry forward of unused capital losses where there has been a change of control in the year. This provision was amended in 1984 to deny the carry back of net capital losses to a year before the change of control occurred. Subsections 111(5.1) and (5.2) were added to the Act in 1981.

Respondent’s counsel suggested that the mechanism whereby the prima facie result is achieved of transferring unrealized capital losses from one corporation to another requires the creation of first and second-tier subsidiaries and the use of paragraph 53(l)(f. 1) in a manner not contemplated by Parliament. Paragraph 53(l)(f. 1 ) was added to the Act in 1977 to relieve the harshness of the result of paragraph 40(2)(e) which deemed nil the loss upon the sale of property to a corporation which was controlled by a corporation which controlled the seller. Paragraph 53(l)(f. 1) permitted the amount of the denied loss to be added to the adjusted cost base of the transferred property so that the capital loss could be realized on the subsequent sale to an arm’s length purchaser. In fact, counsel suggested, paragraph 53(1 )(f. 1) is to relieve a hardship, but in the case at bar it was used for something else.

In the respondent’s view, the fact that the result of a series of trans actions and the application of a number of provisions produces the mathematical result of a capital loss under the Act does not obviate the application of subsection 55(1). On the contrary, counsel declares, unless there is a mathematical capital loss as a result of the application of the provisions of the Act, paragraphs 55(1 )(b) and (c) do not come into play at all. He says these paragraphs are triggered only when, as a result of one or more transactions of any kind whatever, a taxpayer has disposed of property in circumstances such that he may reasonably consider to have artificially or unduly created a loss from the disposition, or increased the amount of his loss from the disposition. Subsection 55(1) then applies specifically to situations in which the application of provisions of the Act yield the result of a loss. The question to be asked is: was the result of one or more sales, exchanges, declarations of trust or other transactions of any kind whatever the disposition of property by the taxpayer under circumstances under which it may reasonably be considered to have artificially or unduly increased the amount of its loss from the disposition. In reply to the suggestion by counsel for the appellant that any artificial results are created by the Act itself including section 85, counsel for the respondent says that the artificial result is not caused by the application of the Act; it is the very intention of the provision. He states that there is nothing in the context of capital losses upon which the appellant may rely to achieve a similar intended result.

In any event, counsel for the respondent suggests, the application of a general tax avoidance section is not obviated by the existence of a provision of the Act which, prima facie, gives the taxpayer the entitlement to relief claimed: R. v. Alberta and Southern Gas Co., supra. Where subsection 55(1) applies, it does not affect the applicability of other sections of the Act. The subsection comes into play at the point where other provisions of the Act have been applied to yield the result of a reduced gain or the creation of an increased capital loss. Subsection 55(1) directs the Minister to compute the capital loss as if the creation of a loss in paragraph 55(1 )(b) or the increase in the amount of the taxpayer’s loss in paragraph 55(1 )(c) had not occurred.

Counsel for the respondent submitted that in construing a tax provision, a court is to follow the interpretive approach described by the Supreme Court of Canada in Québec (Communauté urbaine) c. Corp. Notre-Dame de Bon-Secours, [1994] 3 S.C.R. 3, [1995] 1 C.T.C. 241, 95 D.T.C. 5017 at page 17 (C.T.C. 250; (D.T.C. 5022) thereof:

In light of this passage (from Bronfman Trust v. The Queen), there is no longer any doubt that the interpretation of tax legislation should be subject to the ordinary rules of construction. At page 87 of his text Construction of Statutes (2nd ed. 1983), Driedger fittingly summarizes the basic principles: “... the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament”. The first consideration should therefore be to determine the purpose of the legislation, whether as a whole or as expressed in a particular provision.

And at page 16 (C.T.C. 249; D.T.C. 5021-22):

Such a rule also enabled the Court to direct its attention to the actual nature of the taxpayer’s operations, and so to give substance precedence over form, when so doing in appropriate cases would make it possible to achieve the purposes of the legislation in question. (See Johns-Manville Canada Inc. v. R. (sub nom. Johns-Manville Canada Inc. v. The Queen), [1985] 2 S.C.R. 46, [1985] 2 C.T.C. Ill, 85 D.T.C. 5373, and R. v. Imperial General Properties Ltd. (sub nom. The Queen v. Imperial General Properties Ltd., [1985] 2 S.C.R. 288, 1 C.T.C. 4, 85 D.T.C. 5045. It is important, however, not to conclude too hastily that this latter rule (giving substance precedence over form) should be applied mechanically, as it only has real meaning if it is consistent with the analysis of legislative intent.

On page S.C.R. 19 (C.T.C. 251; D.T.C. 5023), the Court declared:

... first, recourse to the presumption in the taxpayer’s favour is indicated when a court is compelled to choose between two valid interpretations, and second, this presumption is clearly residual and should play an exceptional part in the interpretation of tax legislation.

The respondent’s position is that the result of the transactions in question, that is, the Carma Transaction and the Petralgas Transaction, was that Nova disposed of property under circumstances such that it may reasonably be considered to have artificially or unduly increased the amount of its loss from the dispositions. In the Carma Transaction, the amount of the capital loss is the difference between the amount paid for the Allarco shares and the amount received for them upon their disposition, that is $1,238,000. The capital loss claimed was $16,499,999. In the Petralgas Transaction, the difference between the amount paid for the Petralgas Shares and the amount received upon their disposition was $1,000,000. The capital loss claimed was $24,425,000. The respondent’s view is that the amount of the capital loss claimed in excess of the $1,238,000 and $1,000,000 respectively constituted an artificial or undue increase in the amount of Nova’s capital loss within the meaning of paragraph 55(1 )(c). In other words counsel appears to suggest that to determine whether a taxpayer may reasonably be considered to have artificially or unduly increased the amount of his loss from a disposition, one must take into account the taxpayer’s real economic or monetary loss, that is, the difference between the cost and selling prices of the property.

The word “artificial” has had ascribed to it the meaning of “fictitious or simulated”. An amount paid for oil which was a real amount in that it represented market value could not be said to be fictitious or artificial: R. v. Irving Oil Ltd. (sub nom. The Queen v. Irving Oil Ltd.), [1991] 1 C.T.C. 350, 91 D.T.C. 5106 (F.C.A.) at page 360 (D.T.C. 5114). [1] Counsel for the respondent says that this is to be contrasted to the case at bar in which the amount of capital loss claimed exceeded by nearly twenty times the amount of the actual capital lost in the transactions.

Counsel also referred to the meaning of “artificial” in several other cases: Shulman v. Minister of National Revenue, [1961] C.T.C. 385, 61 D.T.C. 1213 (Can. Ex. Ct.) at page 399-400 (D.T.C. 1221); affd without reasons (1961) 61 D.T.C. 1166 (S.C.C.); Don Fell Ltd. et al., supra, at page 376 (D.T.C. 5292) and Mark Resources Inc. v. R. (sub nom. Mark Resources Inc. v. The Queen), [1993] 2 C.T.C. 2259, 93 D.T.C. 1004 (T.C.C.) at page 266 (D.T.C. 1009). In these cases the word “artificial” has been interpreted to include “unnatural”, “not in accordance with normality” and not “within accepted norms of commercial reality”.

In any event, counsel for the respondent concludes, the claim of a capital loss of over $40,000,000 when the amount of capital lost economically is in fact not more than $2,238,000 satisfies any of the meanings to be ascribed to the word “artificial”. Also, the claim of the capital loss of over $40,000,000 in the circumstances satisfies the meaning given to the word “unduly” in Irving Oil Ltd., supra, at page 360 (D.T.C. 5114); Shulman, supra,', and Don Fell Ltd., supra', that is, “excessive” or “unreasonably”.

Analysis

It is not the transaction or the transactions themselves that are described as artificial in subsection 55(1). The transactions may be and often are real. However if, as a result of the transactions, a taxpayer’s gain from the disposition is reduced or a loss is created from the disposition or the amount of the loss from the disposition is increased, then the taxpayer may be caught by subsection 55(1) [2] . In other words it is the loss or increase in the loss that is artificial or undue for subsection 55(1) to apply.

The transactions described in paragraphs 11 to 13 and 28, 29 and 31 of the agreed statement of facts were transactions which were real and legally effective. So were the transactions described in paragraphs 14, 15 and 17. As a result of the operation of the Act to these transactions Nova incurred a capital loss of $16,500^000 from the disposition of the Allarco Preferred Shares and a capital loss of $25,712,500 from the disposition of the Petralgas Shares. Based on Nova’s actual cost of the shares of 842 and the Petralgas Shares, its losses on the dispositions were $1,237,500 and $1,000,000 respectively.

In the case at bar, therefore, the issue is whether the Allarco Preferred Shares and the Petralgas Shares were disposed of by Nova under circumstances such that Nova may reasonably be considered to have artificially or unduly increased the amount of its losses from the dispositions. [3]

With respect to the Carma Transactions, Nova was not a party to any transaction until October 22, 1986 when it purchased the issued share of 842. Prior to October 22, 1986 Carma and companies controlled directly or indirectly by it or its wholly owned subsidiary corporations (“Carma Group”) entered into transactions which resulted in 842 owning Allarco Preferred Shares with an adjusted cost base of $16,500,000.

Nova participated in these transactions: It purchased the share of 842 for $1,237,500. Nova then wound up 842 and on the winding-up received the Allarco Preferred Shares having an adjusted cost base of $16,500,000. Nova did nothing to increase its adjusted cost base of the Allarco Preferred Shares. The last transaction undertaken by Nova was to sell the Allarco Preferred Shares to the Bank for one dollar.

I cannot find that as a result of the transactions entered into by Nova, or the prior transactions entered into by the Carma Group, Nova disposed of the Allarco Preferred Shares to the Bank under circumstances that Nova may reasonably be considered to have artificially or unduly increased the amount of its loss from the disposition. Nova acquired an asset which had an adjusted cost base of $16,500,000. Nova did nothing to alter the adjusted cost base of asset. Nova was not an actor in the incorporation of first and second-tier corporations, that is, of 840, 841 and 842 nor in the transfer of the Allarco Preferred Shares from Carma to 842. The transfer of adjusted cost base from one tier subsidiary to another tier subsidiary, complained of by respondent’s counsel, took place at the time Carma controlled these subsidiaries. Carma served up the Allarco Preferred Shares to Nova on a fiscally advantaged plate.

Carma took steps to facilitate the transfer of the capital loss in Allarco Preferred Shares to persons with whom it dealt with at arm’s length, including Nova. Nova was not an actor in any transaction leading to 842 acquiring an asset having a low market value and a high adjusted cost base, that is, the Allarco Preferred Shares. Paragraph 55(1 )(c) provided that for Nova to be caught the circumstances of the disposition to the Bank must be such that Nova “may reasonably be considered to have artificially or unduly increased the amount of (its) loss from the disposition” to the Bank. This is the plain meaning of paragraph 55(1 )(c): see Stubart Investments Ltd. v. R. (sub nom. Stubart Investments Ltd. v. The Queen), [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305, at C.T.C. page 317 (D.T.C. 6324). Nova cannot reasonably be considered to have done anything to increase the amount of its loss from the disposition of the Allarco Preferred Shares.

Indeed, there was no increase to Nova in the amount of its loss from the disposition of the Allarco Preferred Shares. When Nova acquired the share of 842 for $1,237,500, the Allarco Preferred Shares already had an adjusted cost base of $16,500,000. A disposition of those shares at market value would incur a loss. Nova’s loss for tax purposes on the Allarco Preferred Shares was never increased. Nova knew what its loss on the disposition of the Allarco Preferred Shares would be at the time it acquired those shares. The machinations to make these losses available to Nova were performed by Carma.

With respect to the Petralgas Transactions, here too Nova was not a participant in the transfer of the capital losses on the Petralgas Shares from AGCL to 976 for $1,000,000. Nova purchased the shares of 976 and then caused 976 to sell the shares of Petralgas, having a market value of $1,000,000 and adjusted cost base of $25,425,000. Nova then sold the Petralgas Shares to Petrocorp, for one dollar, thus incurring the capital loss. Nova did nothing to increase the amount of the loss on the sale of the Petralgas Shares. My comments with respect to the Carma Transactions in this regard apply to the Petralgas Transactions as well.

The loss in paragraph 55(1 )(c) is a capital loss, not an economic or actual dollar loss. The loss from the disposition of property is the amount by which a taxpayer’s adjusted cost base of the property exceeds the proceeds of disposition of the property: subparagraph 40(l)(b)(i) and paragraph 39(1 )(b) of the Act. Paragraph 55(1 )(c) is contained in Part I, Division B, subdivision c of the Act, which sets out rules for taxable capital gains and allowable capital losses. There is no question that economically Nova’s loss on the dispositions was equal to the amount paid for the shares of 842 and 976, that is, the aggregate respectively of $1,237,500 and $1,000,000, less the amounts Nova received for the Allarco Preferred Shares and Petralgas Shares. However for purposes of subsection 55(1), one is concerned only with a loss from a disposition of property determined under subdivision c previously referred to.

The transactions orchestrated by Carma Group and AGCL were designed to market their losses and no doubt offend most taxpayers. These schemes were not what the average person would consider normal: Don Fell Ltd., supra. This does not mean that the dispositions by Nova are tainted. As I have already said, Nova did nothing to increase the adjusted cost base of the assets it acquired and disposed of and did not contrive, create or simulate an increase in the losses on the dispositions. On acquiring the shares of 842 and 976 Nova knew of the existence of a potential tax loss that Carma Group and AGCL had created. Nova was well aware economically that its real or monetary exposure was its cost of the shares of 842 and 976. However the losses in issue must be defined by the rules of the Act. Nova took what it had purchased and disposed of it. Under the rules of the Act, Nova is entitled to the losses claimed.

The appeal ts allowed with costs.