26 February 1991 Internal T.I. 902807 F - Review of GAAR Course Material - Lesson #3

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

We have now had a chance to complete a technical review of the course material titled "The General Anti-Avoidance Rule".  This memorandum contains our comments on the course material with respect to Lesson 3 and the case studies which you may wish to consider in respect of a future update of the course.

Our comments are as follows:

1.     The last sentence in the second paragraph under the heading Avoidance Transaction on page 4 leaves the impression that auditors will be able to quantify (percentage) each purpose behind a particular transaction.  We recommend that you utilize the wording present in paragraph 4 of information Circular 88-2 (IC88-2) to convey the Department's position   regarding the determination of the primary purpose behind a transaction.  The following sentence may be substituted:  "Primarily implies principally and chiefly.  The primary or principal purpose in undertaking a transaction can only be determined subsequent to a review of all of the circumstances surrounding the transaction.   Paragraph 4 of Information Circular 88-2 (IC88-2) may provide you with more insight on how the Department determines the primary purpose of a transaction."

2.     The last sentence of the first paragraph on page 8 does not convey the message intended by the sentence.   Using the term abusive implies a misuse or abuse of the Act which is contrary to the provisions of subsection 245(4) of the Act and the particular example does not provide a clear avoidance transaction since it may be difficult to prove that the primary purpose of an estate freeze arrangement is not the orderly transfer of wealth to the next generation.  We recommend the following example:

      "An example of such a situation exists where an individual taxpayer transfers his or her business to a corporation primarily to obtain the benefit of the small business deduction.  There is nothing in section 125 of the Act that prohibits an individual from incorporating his or her business.  The incorporation would be Consistent with the Act read as a whole and, therefore, subsection 245(2) would not apply to the transfer of the business to the corporation".

3.     On page 10 the sections of the Act that have been modified as a result of the G.A.A.R. provisions are listed.  Paragraph 20(1)(k) was repealed and it is listed under the repealed sections on Page 9 and, as such, it should not be listed in the modified sections list.  The list also includes a reference to paragraph 53(4)(e) which does not exist in the Act.

4.     The first sentence of the second paragraph under the heading Tax Court of Canada on Page 10 is not complete in its current format.  We recommend the following wording: "The Department is responsible for determining whether or not a transaction is an avoidance transaction.  In order to identify avoidance transactions, the auditors will be required to:".

5.     The second sentence within alternative (B) on page 12 is not correct since the treatment of the preferred shares as an inventory item would not preclude the transferee from claiming a deduction under subsection 112(1) of the Act.  Since this particular alternative would not result in the desired objective of taxing the disposition of property, as such, we do not believe that the Department would consider this alternative in the determination of the tax consequences.

GAAR Case Studies

We have reviewed your recommended solution to each case study and we would agree with your conclusions in case studies 3, 5, 6, 9, 10, 11 and 13. Based on our review of the facts pertaining to case studies 2, 7, and 8, we would conclude differently from the suggested answer currently presented in the participant's course material.  In fact, several favourable advance rulings have been issued with respect to the situation described in case 2.  You may wish to review our recommended solution for each of the case studies to determine how we were able to conclude differently in each particular case.

In 1990, the Federal Court Trial Division overturned the Tax Court decision in Rumack v. M.N.R. 84 DTC 1339 and, for this reason, we recommend that you delete case study #1 from the course material until the Department's appeal has been heard by the Federal Court of Appeal.  We also recommend that you delete questions 1 and 2 from case study #4 in the course material since the sections of the Act dealt with, in the particular case, have changed significantly and the new provisions include avoidance provisions which would apply to redetermine the tax consequences.  We also recommend that you delete case study #12 from the course material since the Department has not finalized its position on that particular type of situation and GAAR has not been utilized to prevent any resultant abuses of the Act.

It is our view that the participants would derive greater benefits from the case studies when the suggested solutions are presented in a manner consistent with the methodology guidelines provided in the course material. The participants would be more apt to follow the guidelines presented in the course material if the solutions were formatted as follows:

(1)       Review of the Law: Review the specifics of the relevant provisions to determine whether there are specific anti-avoidance provisions related to the transaction or to the type of income source.

(2)       Identification of a tax benefit: What are the tax implications?

(3)      Identification of an Avoidance Transaction: Is there a transaction or series of transactions undertaken primarily for bona fide purposes other than to obtain the identified tax benefit.

(4)      Identification of a misuse or abuse of the Act: What, precisely, are the offensive tax aspects? Does the transaction result, directly or indirectly, in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act read as a whole?

(5)      Application of GAAR: Determination of the tax consequences in order to deny the tax benefit which results, directly or indirectly, from the avoidance transaction.

The participant will be required to analyze each case on a step by step basis in order to determine whether or not GAAR would apply to the particular situation.  This format will also highlight the fact that if each particular step is not carefully analyzed then the participant will not be able to determine whether or not GAAR would apply to the particular situation.  For your convenience, we have addressed each step in our review of the solutions to the case studies. You may or may not want to utilize the reformatted solutions in your course material.

Chief, Corporate Reorganizations III SectionReorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch

Recommended Solution

(1)       Review of the Act: There would not appear to be any particular avoidance provisions in the Act to disallow the application of the replacement property rules under section 44.

(2)      Identification of a Tax Benefit: The deferral of the tax consequences on the disposal of the real estate property would constitute a tax benefit.  There would probably be a capital gain and recaptured capital cost allowance on the sale of the real estate property if the replacement property rules were not utilized.

(3)       Identification of an Avoidance Transaction: Since the replacement property rules would not apply to the disposition of the real estate property by Holdco and there is no other business purpose for the transfer of the real estate property from Holdco to Opco then it would be difficult to conclude that the primary purpose of the section 85 rollover is other than to obtain the tax benefit associated with the replacement property rules.

(4)       Misuse or Abuse of the Act: The Act permits a transfer of property to a corporation on a tax deferred basis and in this particular case the transfer of property from Holdco to Opco would be within the object and spirit of the Act.  Neither section 44 nor subsection 248(1) provides any minimum ownership or use period regarding the former business property.  If subsequent to the transfer, the property qualifies as "former business property" then the gain realized on the disposition may be eligible for deferral under the provisions of subsection 44(1) of the Act.  It is our view that, subject to the replacement property being utilized in Opco's active business, the transactions would qualify for exemption from the application of subsection 245(2) pursuant to subsection 245(4).

Other Comments

The Draft Amendments to the Income Tax Act and Related Statutes issued by The Honourable Michael H. Wilson, Minister of Finance, in July 1990 proposes to amend the provisions of section 44 so that a former business property used by the taxpayer or a person related to the taxpayer will be eligible for the rollover.  It will no longer be necessary to transfer the business assets from one corporation to another in a corporate group in order to qualify for the replacement property rules under the provisions of section 44.

Recommended Solution

(1)  Review of the Act: Subsection 18(3.1) of the Act denies the soft costs as a current deduction relating to the construction of a building and adds them to the cost or capital cost of the building of the taxpayer unless the taxpayer meets the exception in subparagraph 18(3.4)(a)of the Act.  The requirement of subparagraph 18(3.4(a) has not been met because Opco and Newco are not dealing at arm's length and therefore the restrictions found within subsection 18(3.1) are applicable.

Although the transactions was structured to reducer taxes, since it is caught by the specific restrictions in 18(3.4)(a)that paragraph will be applied, not 245(2).

It is our view that this particular case, as presented, would be of limited value to the participants and, as such, we recommend that the case be amended to reflect the scenario presented in question 3 of the particular case.  Our reasons for this view are as follows:

(1)       The current facts represent transactions which took place in 1984 based upon the Act at that time.  The GAAR provisions (as we are studying them) did not exist at that time.

(2)       There have been significant revisions and amendments to the Act. The revisions would significantly alter any, conclusions that would be made under the former provisions.  For example, the transfer of shares to minor children would presently fall under subsection 74.1(2).  The provisions of section 110.6 did not exist at the time.

(3)       The application of subsection 245(2) to question 3 of the particular case has been addressed in our response to question 43 at the 1989 Revenue Canada Round Table.

Recommended Solution:

(1)       Review of the Act: There are no specific provisions within the Act which would disallow the particular transactions identified in the case.

(2)       Identification of a Tax Benefit: Shelco would recognize the capital gain and recaptured   cost allowance but would not have any assets available to pay the taxes owed on the transaction.

(3)       Identification of an Avoidance Transaction: In this particular case, the primary purpose of the tax free rollover under section 85 would be to obtain the tax benefit previously identified.

(4)       Misuse or Abuse of the Act: The transfer of property to Shelco under section 85 in to circumvent the taxes on the capital gain and recaptured capital cost allowance would appear to result in a direct misuse of the provisions of the Act. Therefore, the transaction would not qualify for exemption from the application of subsection 245(2).

(5)     Application of GAAR: In assessing the transactions, we would deny the tax free transfer of the property to the "shell" corporation.  Tax would, therefore, be payable by the "real" owner of the property.

Recommended Solution:

(1)       Review of the Act: There are no provisions within the Act which would disallow the rollover of property to the partnership with a subsequent withdrawal of cash from the partnership.

(2)       Identification of a Tax Benefit: The land developer disposes of land on a tax deferred basis and receives cash equal to the fair market value of the land transferred to the partnership.  The tax deferred on the disposal would constitute a tax benefit for the purposes of subsection 245(1)

(3)       Identification of an Avoidance Transaction: We would question the actual existence of a partnership whereby the land developer would have a partner's capital account balance of negative nine million dollars and the partnership profit allocation is based on each partner's capital account balance. It would appear that the primary purpose of the rollover of the property to the partnership is to obtain the identified tax benefit.

(4)       Misuse or Abuse of the Act: This series of transactions would result in a misuse of the rollover provisions under subsection 97(2) of the Act.  The avoidance transaction would, therefore, not  qualify for the exemption from the application of subsection 245(2) available pursuant to subsection 245(4).

(5)  Application of GAAR: We would treat the cash withdrawal as proceeds received disposition of the property to the partnership.  The partnership could have its cost of the property adjusted accordingly through a request for adjustment pursuant to subsection 245(6).

Other Comments: You may wish to refer to paragraph 12 of the Information Circular 88-2 (IC882) where this example is presented and analyzed with respect to GAAR.  Also, you may wish to refer to the case of Haro Pacific Enterprises Ltd. v. The  Queen  (90 DTC 6583)  which addresses this situation in a pre-GAAR context.

Recommended Solution

(1)       Review of the Act: There are no specific provisions within the Act which would disallow the interest expense or restrict the  capital cost allowance claimed by the partnership.  Interest on funds utilized to invest in a partnership would be deductible by the partner.

(2)       Identification of a Tax Benefit: If the partnership were to borrow the funds directly to purchase the rental property then the amount of capital cost allowance that  could be claimed by the partnership would be restricted pursuant to subsection 1100(11) of the Regulations.  This ability to claim both interest and capital cost allowance on a rental property which would result in a loss in the hands of the partner would constitute a tax benefit for the purposes of subsection 245(1).

(3)       Identification of an Avoidance Transaction: In this particular case, it would appear that the partners would have an excellent argument that the primary purpose of borrowing the funds personally then investing the funds in the partnership would be to allow the partnership to buy the rental property.  It would be very difficult to prove that an avoidance transaction exists in this particular case.  Remember a taxpayer can arrange his affairs to attract the least amount of tax which is accomplished in this particular case.   Without an avoidance transaction, the provisions of subsection 245(2) would not apply to the transactions.

Other Comments

You may wish to review the 1989 Round Table question 42 where the Department has expressed its position concerning this particular case.  The question also addresses other similar cases where GAAR would probably apply.

Recommended Solution:

(1)       Review of the Act: There are no specific provisions within the Act which would disallow A from making the successor election  (paragraph 66.7(7)(e)) to transfer its resource pools to the third party.

(2)       Identification of a Tax Benefit: A large proportion of the resource pool relates to the mining properties which will be retained by A.  The pool should be apportioned between the mining properties and the oil and gas properties whereas, as structured by A, the entire pool would be transferred with its sale of the oil and gas properties.

(3)       Identification of an Avoidance Transaction:  In this case there appears to be a series of transactions where A transfers mining properties to a wholly-owned subsidiary under subsection 85(1) of the Act.  Immediately thereafter, A sells its oil and gas business and A wishes to make a successor election under paragraph 66.7(7)(e) to transfer its resource pools to the third party.  If the primary purpose of the transfer of mining  properties is to meet the conditions required for eligibility for the successor election then it would be reasonable to conclude that there exists an avoidance transaction.  If A can demonstrate that the purpose of the series of transactions is primarily for bona fide business purposes then the existence of an avoidance transaction may be questionable.  It is essential to review all of the facts in order to determine which of all of the reasons for exercising the transaction would qualify as the primary purpose.  Based upon the limited facts available, the limitation as a result of the right of first refusal could be eliminated through another  alternative thus making it very difficult for A to argue that this could be the primary purpose of the series of transactions.

Since it is given that the primary purpose of this particular series of transactions is to meet the successor rules that all or substantially all of its resource properties be sold to the successor.   The subsection 85(1) rollover would constitute an avoidance transaction for the purposes of subsection 245(3).

(4)       Misuse or Abuse of the Act: In  this  series  of  transactions, the  entire  pool  would  be transferred with its sale of the oil and gas properties.  Normally as a matter of Departmental policy, an apportionment of the resource pool costs between the mining properties and the oil and gas properties would be acceptable.  However, as a policy matter, it is considered to be a misuse of the provisions of the Act to allocate the entire pool exclusively to the oil and gas properties. The utilization of a subsection  85(1) transfer in order to circumvent the conditions present within paragraph 66.7(7)(e) would constitute a misuse of the provisions of the Act.

(5)       Application of GAAR: In assessing the transaction, we would deny the successor election under paragraph 66 7(7)(e) and re-instate the pool in A.

Recommended Solution:

(1)       Review of the Act; Since T Ltd. owns 51% of Holdco and Holdco is a CCPC which in turn controls Pubco and the chairman and at least 3/4 of the directors are Canadian citizens then it would appear that Pubco would qualify as a "Canadian newspaper or periodical" since it satisfies the conditions present in subparagraph 19(5)(v) of the Act.

(2)       Identification of a Tax Benefit: The current ownership structure allows Pubco to qualify as a "Canadian newspaper or periodical" even though it may in fact be controlled by France Co.   If each issue  of the periodical satisfies the conditions present in paragraph 19(5)(a) then a deduction for the paid advertising placed in that issue would not be denied under subsection 19(1).

(3)       Identification of an Avoidance Transaction:  With the very limited facts available, it would be very difficult to determine whether or not the share structure was selected primarily for bona fide business purposes or primarily to obtain the tax benefit.  For analysis purposes, we shall assume that an avoidance transaction exists in this particular case.

(4)       Misuse or Abuse of the Act:

For purposes of section 19 of the Act, France Co. does not control Holdco or Pubco and, as such, the provisions  of clause 19(5)(b)(v)(C) have been met with regard to control.  Where the publication complies with the Canadian content rules, it would be difficult to argue that the object and spirit of section 19 have not been met.  The transactions would, therefore, not result in   the misuse of the provisions or an abuse having regard to the provisions of the Act read as a whole.

Other Comments: There does not appear to be a "blatant" tax avoidance scheme forwarded in this particular case.

21(1)(b)

Recommended Solution

(1)       Review of the Act

     The provisions of paragraph 20(1)(a) of the Act and subparagraph 1100(1)(a)(x) of the Regulations restrict the amount of capital cost allowance that may be claimed by a taxpayer for a class 10 film for each taxation year to 30% of the undepreciated capital cost.

(2)       Identification of a Tax Benefit: Full CCA was claimed twice in the same year and this would constitute a tax benefit for the purposes of subsection 245(1).

(3)       Identification of an Avoidance Transaction: It would appear that the sole (primary) purpose of the transaction was to obtain the maximum CCA deduction twice in one year on the same film.  Consequently there exists an avoidance transaction for the purposes of subsection 245(3).

(4)       Misuse or Abuse of the Act: There  would  appear to be an abuse of the provisions paragraph 20(1)(a) of the Act and subsection 1100(1) of  the Regulations in allowing CCA to be claimed twice in the same year on the film.  Therefore, the transactions would not be exempt from the application of subsection 245(2) pursuant to subsection 245(4)

(5)       Application of GAAR: Subsection 245(2) would be invoked to prevent "B"  from deducting the maximum CCA for the film in 1988 following the dissolution of "A".

It is our view that this particular case should not be presented in the course, at this particular time.  Our reasons for this view are as follows:

21(1)(b)

Recommended Solution

(1)       Review of the Act: The provisions of section 17 of the Act deal with loans non-resident person.  Since Canco has not made the loan to Canco Germany then subsection 17(1) cannot apply to offset the interest expense claimed by Canco.

(2)       Identification of a Tax Benefit: Canco has interest expenses which it will utilize to income taxes and the interest income earned with the funds will be taxed in Germany where Canco Germany, a wholly-owned subsidiary, has losses. In effect, the losses of the German subsidiary are being transferred to Canada.  This reduction of taxes would  constitute a tax benefit for the purposes  of subsection 245(1).

(3)       Identification of an Avoidance Transaction: There does not appear to be any business purpose for undertaking the series of transactions other than to circumvent the provisions of subsection 17(1).  The series of transactions effected by Canco would be considered to have been undertaken to obtain the identified tax benefit.  The borrowing of the funds in Canada would constitute an avoidance transaction for the purposes of subsection 245(3).

(4)       Misuse or Abuse of the Act:  The series of transactions results in a direct abuse of the provisions of the Act read as a whole and the transactions, as such, would not qualify for subsection 245(4) exemption from the application of the provision of subsection 245(2).

(5)       Application of GAAR: Since the series of transactions was undertaken to circumvent the provisions of subsection 17(1), subsection 245(2) would apply to subject the Canadian debt to the provisions of subsection 17(1).  Note, however, that it is not known if the loan was outstanding in excess of one year.  If it was not, then subsection 17(1) would not apply and, consequently, it would be extremely difficult to apply subsection 245(2) to the series of transactions.