Date: 20021101
Docket: A-502-01
Ottawa, Ontario, November 1, 2002
CORAM: DESJARDINS J.A.
NOËL J.A.
PELLETIER JJ.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
and
DONAHUE FOREST PRODUCTS INC.
Respondent
JUDGMENT
The appeal is dismissed with costs.
"Alice Desjardins"
Judge
Certified true translation
Suzanne M. Gauthier, C.Tr., LL.L.
Date: 20021101
Docket: A-502-01
Neutral citation: 2002 FCA 422
CORAM: DESJARDINS J.A.
NOËL J.A.
PELLETIER JJ.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
and
DONAHUE FOREST PRODUCTS INC.
Respondent
Hearing held at Montréal, Quebec, October 24, 2002.
Judgment delivered at Ottawa, Ontario, November 1, 2002.
REASONS FOR JUDGMENT BY: NOËL J.A.
CONCURRING: DESJARDINS J.A.
PELLETIER J.A.
Date: 20021101
Docket: A-502-01
Neutral citation: 2002 FCA 422
CORAM: DESJARDINS J.A.
NOËL J.A.
PELLETIER JJ.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
and
DONAHUE FOREST PRODUCTS INC.
Respondent
REASONS FOR JUDGMENT
NOËL J.A.
[1] This is an appeal from the judgment delivered by Judge Archambault of the Tax Court of Canada (2000 D.T.C. 586) allowing the respondent's appeal against an assessment issued under the Income Tax Act (the Act) and referring the matter back to the Minister of National Revenue (the Minister) for reconsideration and reassessment on the basis that Produits Forestiers Donohue Inc. (previously referred to as Donohue St-Félicien Inc. (hereinafter DSF or the respondent)) is entitled, in computing its taxable income, to an allowable business investment loss (ABIL) of $46,657,499.
[2] The issue raised by the appellant pertains to the application of the general anti-avoidance rule (GAAR) in section 245 of the Act. The appellant claims that the tax benefit obtained by the respondent DSF - from a transaction culminating in the sale of the shares it held in Donohue Matane Inc. (DMI) and the resulting ABIL deduction - results in a misuse or abuse of the Act read as a whole. According to the appellant, the trial judge committed a series of errors in law in drawing the contrary conclusion from his analysis.
[3] Section 245, in its relevant aspects, reads as follows:
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245(1) In this section, and in subsection 152(1.11),
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245(1) Les définitions qui suivent s'appliquent au présent article et au paragraphe 152(1.11).
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"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;
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« attribut fiscal » S'agissant des attributs fiscaux d'une personne, revenu, revenu imposable ou revenu imposable gagné au Canada de cette personne, impôt ou autre montant payable par cette personne, ou montant qui lui est remboursable, en application de la présente loi, ainsi que tout montant à prendre en compte pour calculer, en application de la présente loi, le revenu, le revenu imposable, le revenu imposable gagné au Canada de cette personne ou l'impôt ou l'autre montant payable par cette personne ou le montant qui lui est remboursable.
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"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;
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« avantage fiscal » Réduction, évitement ou report d'impôt ou d'un autre montant payable en application de la présente loi ou augmentation d'un remboursement d'impôt ou d'un autre montant visé par la présente loi.
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"transaction" includes an arrangement or event.
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« opération » Une convention, un mécanisme ou un événement sont assimilés à une opération.
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(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.
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(2) En cas d'opération d'évitement, les attributs fiscaux d'une personne doivent être déterminés de façon raisonnable dans les circonstances de sorte à supprimer un avantage fiscal qui, sans le présent article, découlerait, directement ou indirectement, de cette opération ou d'une série d'opérations dont cette opération fait partie.
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(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.
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(3) L'opération d'évitement s'entend :
a) soit de l'opération dont, sans le présent article, découlerait, directement ou indirectement, un avantage fiscal, sauf s'il est raisonnable de considérer que l'opération est principalement effectuée pour des objets véritables -- l'obtention de l'avantage fiscal n'étant pas considérée comme un objet véritable;
b) soit de l'opération qui fait partie d'une série d'opérations dont, sans le présent article, découlerait, directement ou indirectement, un avantage fiscal, sauf s'il est raisonnable de considérer que l'opération est principalement effectuée pour des objets véritables -- l'obtention de l'avantage fiscal n'étant pas considérée comme un objet véritable.
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(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.
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(4) Il est entendu que l'opération dont il est raisonnable de considérer qu'elle n'entraîne pas, directement ou indirectement, d'abus dans l'application des dispositions de la présente loi lue dans son ensemble -- abstraction faite du présent article -- n'est pas visée par le paragraphe (2).
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[4] The facts are set out in detail by the trial judge (reasons, paragraphs 1 to 45) and need not be repeated. It will suffice, for the purposes of this appeal, to recall the following.
[5] DSF was part of a group of corporations (Donohue Group) controlled by Donohue Inc. (Donohue). Starting in 1988, the Donohue Group invested considerable amounts of money in DMI to finance the construction of a pulp and papermill, improvements to four sawmills and the operation of those mills. The four sawmills were in Marsoui and Grande-Vallée (the shore sawmills) and Lac-au-Saumon and St-Léon-Le-Grand (the valley sawmills).
[6] For this project, Donohue formed a partnership with the Société de récupération, d'exploitation et de développement forestier du Québec (Rexfor) and each of the partners held 50% of DMI's common shares. Donohue's portion was composed of 62,150,000 shares reflecting an investment of $62,150,000.
[7] All the pulp production and sawmill operations had to be interrupted following the collapse in the price of wood pulp. At the end of 1991, Donohue's investment in DMI was no longer worth anything while the adjusted cost base of the shares it held was $62,210,000.
[8] To deduct the economic loss resulting from that investment, Donohue, with Rexfor's co-operation, restructured its investment in DMI. After Donohue had first assigned its investment in DMI to DSF and this investment had been written off its books, the restructuring proceeded as follows:
(i) On November 12, 1993, a new company, Donohue Matane (1993) Inc. (DMI 1993) was formed, in which DMI subscribed for one common share. The articles of DMI 1993 allowed the issuance of shares having characteristics similar to those of the capital stock of DMI;
(ii) On November 15, 1993, DMI transferred to DMI 1993 almost all its assets and liabilities, i.e. essentially the Matane pulp mill, the two shore sawmills and the wood preparation centre, worth a total of $165,124,833, and liabilities in an equivalent amount. All that was left in DMI were the two valley sawmills, worth $2.5 million, and a $2.5 million debt to the Société de développment industriel du Québec (SDI);
(iii) On November 17, 1993, the paid-up capital of DMI's common shares was reduced to $1. That same day, DSF and Rexfor, each holding 50% of DMI's shares, also became 50% shareholders each in DMI 1993, and the holders of DMI's preferred shares (Rexfor and the SDI) became the preferred shareholders of DMI 1993;
(iv) On December 22, 1993, DMI's common shares were sold to Cèdrico Inc. (an unrelated third party) by DSF and Rexfor for $2, the effect of which was to realize in the respondent's hands the decrease in value inherent in the shares it held in DMI;
(v) DSF was able to deduct the ABIL resulting from this sale against its income for the 1990 taxation year.
[9] In its relevant tax aspects, the transaction was structured to maintain the adjusted cost base of the DMI shares at $62,210,000 and to produce in the respondent an ABIL of $46,675,499 (75% of the recorded loss), which it was able to apply in full against its 1990 income. The transaction also meant that, apart from the two valley sawmills, the assets previously held by DMI remained under the control of DSF and Rexfor as shareholders of DMI 1993.
[10] The disputed assessment assumes that the operation described above is in all respects consistent with the letter of the Act and produces all the effects anticipated by the respondent, subject to the application of section 245.
[11] Counsel for the respondent conceded before the trial judge that the operation in question is an avoidance transaction within the meaning of subsection 245(3) and that it produced for the respondent a tax benefit within the meaning of subsection 245(1) ($15 million if we include the federal and provincial taxes and $10 million if we include only the federal tax). However, he managed to persuade the trial judge that this transaction did not directly or indirectly result in an abuse of the provisions of the Act read as a whole, thus ruling out the application of the GAAR (see subsection 245(4)).
[12] The appellant submits that the trial judge could not conclude that there was no abuse of the Act read as a whole. She alleges that the trial judge:
(i) disregarded the context in which the general anti-avoidance rule set out in section 245 of the Income Tax Act was adopted;
(ii) misunderstood subsection 245(4) of the Act and placed the onus of demonstrating an abuse entirely on the Minister;
(iii) failed to adopt the basic principle of the Act read as a whole, according to which only genuine losses are deductible;
(iv) disregarded the practical result of the avoidance transactions that were made, namely, the obtaining of a loss while retaining the property (the pulp mill) to which the loss was attributable; and
(v) failed to recognize that the deduction of the loss attributable to the property that was retained conflicted with the basic principle referred to in (iii) (Appellant's Memorandum, paragraph 38).
[13] The appellant's thesis is essentially that the loss realized on the sale of the DMI shares is attributable to the decrease in the value of the DMI assets and that the realization of that loss, while the respondent retains through DMI 1993 the major portion of the assets in question, produces a result that conflicts with a "basic principle" underlying the Act (Appellant's Memorandum, paragraphs 69 to 71 and 76 to 78). According to this principle, the Act read as a whole contemplates a form of matching between the value of a corporation's property and the value of the corporation's shares so that the transaction between DSF and Cèdrico Inc. would not have resulted in an "actual disposition" or an "actually realized" loss (Appellant's Memorandum, paragraphs 58 and 60).
[14] In my view, the trial judge rightly refused to recognize the existence of the "basic principle" enunciated by the appellant in her submissions and held that accordingly there could not be any abuse of the Act in this case. In OSFC Holdings Ltd. v. The Queen, 2001 FCA 260, the Federal Court of Appeal held that subsection 245(4) envisages a two-stage analytical process. The first stage involves identifying the basic principle or general policy on which the Minister relies, and the second is to assess whether the avoidance transaction constitutes a misuse or abuse of this principle or policy (OSFC, paragraph 67).
[15] Rothstein J.A. explained what this first stage entailed as follows:
[68] Ascertaining the relevant policy is a question of interpretation. As such it is ultimately the duty of the Court to make this determination. There is no onus to be satisfied by either party at this stage of the analysis. However, from a practical perspective, the Minister should do more than simply recite the words of subsection 245(4), and allege that there has been misuse or abuse. The Minister should set out the policy with reference to the provisions of the Act or extrinsic aids upon which he relies. Otherwise he places the taxpayer and the Court in the difficult position of trying to guess the relevant policy at issue. Trying to ascertain the policy of a specific provision or of an act as a whole, in the case of an act as complex as the Income Tax Act, is a difficult exercise, particularly when the transaction in question conforms to the letter of the act. Therefore, the Court requires the assistance of the parties to enable it to reach a correct conclusion. Nonetheless, with or without that assistance, the Court must attempt to determine the relevant policy.
[16] He then went on to add the following comment, which was recently restated in Water's Edge Village Estates (Phase II) v. The Queen, 2002 CAF 291 (paragraph 52):
[69] It is also necessary to bear in mind the context in which the misuse and abuse analysis is conducted. The avoidance transaction has complied with the letter of the applicable provisions of the Act. Nonetheless, the tax benefit will be denied if there has been a misuse or abuse. This is not an exercise of trying to divine Parliament's intention by using a purposive analysis where the words used in a statute are ambiguous. Rather, it is an invoking of a policy to override the words Parliament has used. I think, therefore, 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.
[17] The approach adopted by the trial judge is entirely consistent with the one recommended in the above quoted passages. He first attempted to determine from an analysis of the Act whether the basic principle on which the Minister relied could be identified. But after an exhaustive search, he was forced to conclude that not only was there no clear and unambiguous policy, but that the principle on which the Minister relied simply does not exist.
[18] Under corporate law, a business corporation's property belongs to the corporation and not the shareholders. The Act recognizes this legal reality, as it recognizes the effects of private law. The entire system of taxation of corporations and their shareholders is conceived in terms of this legal reality. This is what explains, as the trial judge notes, that a gain or loss may be realized at the same time by a shareholder in respect of his shares and by the corporation in respect of its own property (reasons, paragraph 76). There is no principle that would allow the effect of these transactions to be consolidated by matching them. The principle underlying the Act, if there is one, is contrary to the one invoked by the Minister.
[19] Parliament is of course free to override corporate law and to take into account the assets of a corporation for the purpose of altering the tax consequences of a sale of shares. Paragraph 40(2)(h) is the only provision within the Act which contemplates a form of matching. Its effect is to reduce the loss from a sale of shares of a corporation by deducting therefrom the loss registered in respect of certain underlying assets. This provision only applies to the sale of shares of a controlled corporation and in certain very specific circumstances. This measure has obviously no application in the case at hand (reasons, paragraphs 68 and 75) and I do not see how it can be argued that a matching principle of general application arises from this provision.
[20] The appellant also drew the trial judge's and our attention to a series of provisions (including subsection 85(4), subsection 85(5.1), paragraph 40(2)(e) and subsection 97(3)), the effect of which is to defer or minimize the realization of losses in certain circumstances. But, as noted by the trial judge, these provisions apply in respect of transactions between persons who do not deal at arm's length, while in the instant case the DMI shares were indeed sold by DSF to Cèdrico Inc., a corporation that DSF did not control and with which it had no non-arm's length relationship (reasons, paragraph 78).
[21] The fact that the DMI shares were indeed sold and that this sale was complete and absolute also answers the appellant's arguments based on subparagraph 40(2)(g)(i) and the notion of "superficial loss" reflected in this provision (reasons, paragraph 55). This notion, which is aimed at countering the manipulation of losses (where there is a sale and reacquisition of the property sold or an identical property within the prescribed period, see section 53(i)), in no way supports the "basic principle" cited by the Minister.
[22] As the trial judge indicates, there is nothing in the Act that bars a taxpayer from realizing a loss on the sale of shares to arm's length third parties, even if a significant portion of the assets to which the loss on the shares may be attributed remains within the group of corporations (reasons, paragraph 80). Persuasive evidence of this may be found in the case of a winding up. The Act allows a person holding less than 90 percent of a corporation's shares to realize a loss on the shares when the corporation is wound up while at the same time obtaining ownership of a portion of the corporation's underlying assets. The trial judge's analysis in this regard was not disputed by the appellant in the context of the appeal.
[23] In the final analysis, once it is recognized that the sale of the shares by DSF to Cèdrico Inc. was an arm's length transaction and that it attests to a true decrease in value, it becomes impossible to argue that there was any misuse or abuse within the meaning of subsection 245(4). Indeed, there is no statutory provision and no extrinsic factor that would allow us to recognize the existence of the "basic principle" invoked by the Minister in respect of a sale of shares between persons dealing at arm's length.
[24] In this regard, the appellant maintained at trial that Cèdrico Inc. had "accommodated" the Donohue Group. She criticizes the judge below for not taking into account the evidence that would support "[translation] this finding of fact" on which the Minister relied (Appellant's Memorandum, paragraph 32).
[25] I must say that this argument completely escapes me. The Minister's recognition of the loss realized by DSF (subject to section 245) presupposes that DSF and Cèdrico Inc. were dealing at arm's length (see subparagraph 39(1)(c)(ii), which states that an ABIL is available only in respect of a disposition "to a person with whom [the transferor] was dealing at arm's length"). It follows that in arguing that Cèdrico Inc. "accommodated" the Donohue Group, the appellant is not claiming that Cèdrico Inc. and DSF were not dealing at arm's length (see paragraph 251(1)(b)). This being the case, the appellant's submission carries no consequence recognized by the Act, which no doubt explains why the judge below did not linger on it.
[26] In any event, the record unequivocally discloses that in acquiring the DMI shares the executives of Cèdrico Inc. obtained exactly what they wanted. There is nothing to suggest that they subordinated themselves to the interests of the Donohue Group or that they acted in anything other than the best interest of Cèdrico Inc. (see Peter Cundill and Associates Ltd. v. Canada, [1999] 1 C.T.C. 197 (F.C.T.D.), aff'd [1991] 2 C.T.C. 221 (F.C.A.) and the cases referred to therein). The facts put in evidence do not establish any non-arm's length relationship between Cèdrico Inc. and the Donohue Group.
[27] I would dismiss the appeal, with costs.
"Marc Noël"
Judge
"I concur with these reasons.
Alice Desjardins J.A."
"I concur.
J.D. Denis Pelletier J.A."
Certified true translation
Suzanne M. Gauthier, C.Tr., LL.L.
FEDERAL COURT OF CANADA
APPEAL DIVISION
NAMES OF COUNSEL AND SOLICITORS OF RECORD
FILE NO: A-502-01
STYLE: THE QUEEN v. DONOHUE FOREST PRODUCTS INC.
PLACE OF HEARING: Montréal, Quebec
DATE OF HEARING: October 24, 2002
REASONS: Noël J.A.
CONCURRING: Desjardins J.A.
Pelletier J.A.
DATE OF REASONS: November 1, 2002
APPEARANCES:
Chantal Jacquier FOR THE APPELLANT
Jane Meagher FOR THE APPELLANT
Wilfrid Lefebvre FOR THE RESPONDENT
SOLICITORS OF RECORD:
Chantal Jacquier FOR THE APPELLANT
Wilfrid Lefebvre FOR THE RESPONDENT
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