Citation: 2012 TCC 123
Date: 20120417
Docket: 2009-1(IT)G
BETWEEN:
DR. ROBERT G. MACDONALD,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hershfield J.
Issues
[1] The Appellant was
assessed to include a taxable dividend in the amount of $524,967 in his income
for the 2002 taxation year pursuant to subsection 84(2) of the Income Tax
Act (the “Act”). That subsection deems a dividend to have been
received when a company distributes funds to a shareholder on a winding up,
discontinuance, or reorganization of a business.
[2] The transactions
assessed as invoking this provision of the Act included a non-arm’s length
sale of the Appellant’s shares in Robert G. MacDonald Professional Corporation
Ltd. (“PC”) in 2002 (the “share sale”).
[3] The assessment also
relied on section 245 of the Act, the provision commonly referred to as the
General Anti-Avoidance Rule (“GAAR”).
[4] A further basis for
the assessment was that the share sale, funded by way of a series of related
transactions with funds provided by PC, was a sham. The sham basis for the
assessment was abandoned at trial.
[5] The Appellant had reported
the amount at issue as a capital gain arising from the share sale on the basis
of receiving proceeds of disposition of $525,068 and as having an adjusted cost
base of $101. The Appellant had capital losses and capital loss carry forwards
(net capital losses) available to shelter part of the capital gain triggered on
the share sale. The assessment, applying subsection 84(2), deemed the amount
received by the Appellant on the disposition, less $101 being the paid-up
capital of the shares sold, to have been received as a dividend.
[6] The issue raised by
the appeal is whether subsection 84(2) applies on the facts of this case or
whether, in any event, GAAR applies to give the same result. Further, in the
event the subject amount is to be treated as a dividend, another question was
raised by the Appellant: namely, whether filing his tax return for the subject
year on the basis that he was a resident of Canada at the time of the share sale was,
in fact, correct. Detailed evidence was given at the hearing relating to his
taking up residency in the United States so as to afford the Court the opportunity to answer
that question.
[7] If the Appellant
was not a resident of Canada at the time of the share sale, the deemed disposition
rules in paragraph 128.1(4)(b) of the Act would apply and the tax
payable on the deemed divided would be governed by section 212 of the Act and
by the Canada–United States Income Tax Convention.
How Evidence was Presented
[8] There was a partial
Agreed Statement of Facts filed at the hearing. It is appended to these Reasons
as Schedule 1. It describes the transactions surrounding the share sale. In
effect, it concedes that the manner by which the share sale was carried out was
by way of a non-arm’s length series of transactions designed to give the
Appellant access to essentially all of the assets of PC.
[9] However, the Appellant
also testified at the hearing. His testimony, the credibility and reliability
of which Respondent’s counsel openly acknowledged, provided the background leading
up to the share sale, the related transactions, and the reasons for the manner
chosen to implement those transactions. His elaboration of the transactions
afforded counsel the opportunity to clarify some uncertainties contained in the
partial Agreed Statement of Facts.
[10] As well, his
testimony detailed with some exactitude the events relating to his departure from
Canada and his taking up residence in the United States. This evidence is
relevant to the alternative argument raised by the Appellant in the event that
I found that subsection 84(2) applied, namely whether he was already a resident
of the United States at the time of payment of the deemed dividend arising out
of the application of that provision. On filing his return for the year, the
Appellant took the position that the share sale and the capital gain took place
on June 25, 2002 while he was still a resident of Canada. The Respondent has never taken
issue with this filing position and rejects the Appellant’s alternative position
that his residence changed before the share sale or before any distribution or appropriation
of PC’s assets occurred.
[11] It might be easiest
and fairest to deal with the Appellant’s testimony before looking at, and
elaborating on, the series of transactions implementing the share sale.
Background Facts
[12] As noted, the
testimony of the Appellant was not challenged. Accordingly, his evidence was accepted
as factual, except where it was admitted to be uncertain in terms of his
recollection of certain events going as far back as 2000 when events leading to
his departure from Canada first began.
[13] The Appellant’s
testimony includes the following background:
·
After
completing medical studies in Canada, the Appellant did post-graduate work in the United States
where he met his wife Dale Paley, a US citizen who was then completing her studies in veterinary
medicine. The Appellant was in the United States on a visa that required his return
to Canada on completion of his
studies. His studies resulted in his obtaining a cardiologist’s specialty designation
known as an interventionist heart surgeon. He returned to Canada in 1986 by
taking a position in Halifax. Ms. Paley came with him and they were soon married, a
step that facilitated her Canadian studies in veterinary medicine. Later, in 1991,
the Appellant and his wife moved to New Brunswick where the Appellant took a
position with the New Brunswick Heart Centre at the Saint John Regional Hospital. His association there
lasted until his departure from Canada in 2002.
·
The
Appellant performed his services for the New Brunswick Heart Centre as an
employee of his professional corporation, namely PC, which was incorporated
under the laws of New Brunswick on September 4, 1991. From the incorporation of PC until well after his
departure from Canada in 2002, the Appellant was its sole director and officer. He was the sole
shareholder until the share sale. PC changed its name to 050509 N.B. Ltd. on
June 26, 2002 as part of the series of transactions required as a consequence
of his moving to the United States and of his ending his medical practice in New Brunswick.
·
The
New Brunswick Heart Centre housed many independent practitioners, including the
Appellant’s practice. The hospital leased space to these practitioners, and
provided secretarial help. There was a common billing system among the
practitioners, but each cared for their own patients. Over the decade that the
Appellant spent in Saint John, he had convinced many practitioners to join him at the hospital, but he
remained the sole employee of PC.
·
PC
received income only from Medicare. PC held a billing number which was a
requirement to practise medicine in New Brunswick.
PC billed Medicare for services. Medicare then sent a cheque in PC’s name to
the Appellant. The Appellant would deposit the cheque into an office bank
account. A new cheque would be made out to PC based on its proportionate
entitlement.
·
After
practising medicine for over a decade in Canada, it became apparent to the
Appellant that his wife wanted them to move back to the United States to live. Her
veterinarian’s practice was difficult to maintain and the weather was
problematic for her.
·
The
Appellant started working toward emigrating to the United States in the year 2000. The
process required many steps to be taken and satisfactorily completed in order
for the Appellant to obtain the necessary status to reside and work in the United States with his wife. These
steps include the following:
° Being sponsored by his wife, a United States citizen, as an immigrant;
° Showing an intention
to become a United States resident, including buying a house in the United States and listing his Canadian
house for sale;
° Signing
a letter of agreement to join a practice in Greenville, North Carolina. The Appellant was paid recruiting
expenses and a signing bonus by that practice, which he was obligated to refund
if he did not join the practice;
° Certifying two automobiles he bought in Canada for
export to the United States, including ensuring that the vehicles met US Environmental Protection
Agency regulations and US federal safety requirements.
·
On
June 5, 2002, the United States Consulate in Montreal issued an “Immigrant Visa and
Alien Registration” document. The visa expired at midnight, December 4, 2002, meaning
the Appellant needed to leave Canada and take up residency in the United States by December 4 of that
year.
·
As
required by the visa, the Appellant left Canada prior to its expiry date by
crossing the border with his wife. They crossed at 5:30 p.m., Eastern Standard
Time, on June 25, 2002 taking with them all their personal property.
·
Further
actions taken relating to this departure from Canada included:
° Meeting with the moving company at the border on
June 25, 2002 to ensure records reflected a permanent exporting of their
personal property to the United States;
° Setting up his practice in the United States by joining many medical
societies and associations. He obtained his license from the North Carolina licensing body which
was required for him to practise medicine there. Shortly after, he was licensed
by the South Carolina Medical Association which enabled him to practise medicine
at the medical facility where he still works today;
° Surrendering his New Brunswick driver’s license
and obtaining a North Carolina license;
° Opening
a bank account in North Carolina.
[14] While the forgoing
describes steps taken to affect his immigration to the United States, it is necessary to set
out the evidence relating more specifically to his severance of ties from Canada. I will divide that
evidence into two parts: the Appellant’s additional testimony dealing with the
wind-up of his professional and personal ties and affairs in Canada; and, his evidence
dealing with his investment in PC and the share sale. I will deal firstly with
his evidence dealing with areas of his severance other than those dealing with
his holdings in PC.
[15] In severing his ties
to Canada other than his
investment in PC, his evidence was as follows:
·
Prior
to June 25, 2002 he sold his house in New Brunswick and disposed of many chattels he
no longer needed.
·
Prior
to June 25, 2002, he allowed his New Brunswick medical license to expire, as well as resigning
from his practice and numerous medical associations and societies. However, he
is still a member of Royal College of Physicians.
·
Prior
to June 25, 2002, he gave notice to the Saint John Regional Hospital that he was ceasing to
practise medicine in New Brunswick.
·
He
caused his accountants, Teed Saunders Doyle & Co., to prepare the necessary
T4 form for remuneration from his listed employer, 050509 N.B. Ltd. (formerly
PC). The T4, filed after the Appellant’s departure, was required because
Medicare paid, as it did in the normal course, between six to eight weeks after
a professional invoiced the province for services provided. That is, 050509
N.B. Ltd. was receiving funds after June 25, 2002 for entitlements PC earned prior
to June 25, 2002. Such receipts were accounted for as remuneration paid to the
Appellant as an employee of 050509 N.B. Ltd..
[16] This takes me to the
Appellant’s dealings with PC.
[17] As a
preliminary matter, I reiterate what I noted earlier: the Appellant had,
unrelated to the transactions under review in this appeal, suffered personal
capital losses and personal capital loss carry forwards or net capital losses. These
are the losses that sheltered the capital gain triggered by the share sale. I
will frequently refer to these personal capital losses and personal capital
loss carry forwards as such, as did the parties although more technically it
appears that we are talking about the Appellant’s net capital losses.
[18] In any event, the
decision to leave Canada caused the Appellant, as one might expect, to seek tax advice from his
accountant.
[19] His accountant
advised that the departure could cause significant income tax problems given
the deemed disposition rules under the Act. The problem described
to him was that a deemed disposition of his PC shares would trigger capital
gains tax in Canada on his capital gain but that the United States would not
recognize an increase in the cost base of those shares. Accordingly, on the
actual disposition of the PC shares after his departure, the entire capital
gain would be taxable in the United States, based on his residency there.
[20] That is, while the
Appellant could use his personal capital losses and carry forwards to off-set
the capital gain in Canada arising from the deemed disposition under the Act
of his PC shares, that would provide no protection against recognition of a
potential future capital gain in the United States measured from his original
cost of $101. In effect, the Appellant would lose the economic benefit of
applying his personal capital losses against his gain in respect of his shares
in PC.
[21] Based on this
concern, the Appellant was referred by his accountant to tax professionals in both
the legal and accounting fields. As a result, a plan was devised to utilize the
capital losses and loss carryovers available in Canada and while preventing a second
taxable realization of his shares in PC in the United States.
[22] Initially, the
advice was to sell his shares in PC in what I might refer to as an arm’s length
transaction, but that proved impractical, indeed impossible. As a going concern,
providing the services of a medical doctor, there was no market for PC shares:
there was no medical doctor who would want to inherit another doctor’s
corporate issues. Hence, the corporation had to be converted from a
professional corporation to a holding company but again there was no market for
its shares.
[23] A plan was devised
whereby the assets of PC would be liquidated and its shares would be sold to
the Appellant’s brother-in–law J.S., a resident of Canada married to the Appellant’s sister. J.S. was a willing purchaser on being
given a $10,000 spread between what he could extract from the company and what
he would have to pay the Appellant for the shares; and, on being given a complete
indemnity for any third party liability that he might incur as a result of his
purchase of the PC shares. While it is acknowledged that, pursuant to the
provisions of the Act, the
Appellant and J.S. were not dealing at arm’s length, it was not asserted
that the terms of the transactions involving J.S. would have been different, or
required to have been different or substantially different, if J.S. had been
dealing at arm’s length with the Appellant.
[24] The plan, as
described in the Agreed Statement of Facts and elaborated on at the hearing, was
carried out as follows:
·
601798
NB Ltd. (“601 Ltd.”) was incorporated by J.S. under the laws of New Brunswick on June 20, 2002. It acquired
the shares in PC on June 25, 2002 from J.S. after J.S. had acquired them personally
on that same day. The
transactions are well documented and each transaction that occurred on June 25,
2002 identifies the time of execution. The transactions are thereby readily
identifiable as being in a particular sequence.
·
The
purchase by J.S. of the PC shares was paid by delivery of a promissory note by
J.S. to the Appellant (the “J.S. note”). The purchase price was set out as a formula
that gave rise to a total consideration of $525,068.
·
J.S.
transferred the PC shares to 601 Ltd. in consideration of receiving shares in
601 Ltd. and a note payable by 601 Ltd. to J.S. in the amount of $525,068 (the
“601 Ltd. note”).
·
PC
declared two dividends on June 25, 2002, one in the amount of $500,000 and the
other in the amount of $10,000. On the same day, PC issued two cheques to 601
Ltd., as the PC shareholder at the time the dividend was declared, in partial
payment of the $500,000 dividend. One was for $320,000 and the other was for
$159,842. 601 Ltd. in turn endorsed the cheques to J.S. as partial payment of
the 601 Ltd. note and J.S. in turn endorsed the cheques to the Appellant as
partial payment of the J.S. note. The Appellant wrote a cheque to PC in the
amount of an unrelated indebtedness to it, namely, $159,842. The cheques for
$159,842 were off-setting and booked as such although never cashed. The cheque
for $320,000 now held by the Appellant was never cashed or presented for
payment at a bank but was booked as a payable to the Appellant. All such events
occurred on June 25, 2002.
·
As
noted, PC changed its name to 050509 N.B. Ltd. on June 26, 2002. This was
consistent with PC ceasing to be a professional corporation due to the
Appellant no longer being a shareholder of the company and his ceasing to
practise medicine in New Brunswick. For the most part, I will continue to refer
to this company as “PC”.
·
PC declared
a final dividend on September 1, 2002 to 601 Ltd. equal to the amount still
owing on the 601 Ltd. note, namely $25,068. This amount plus the unpaid portion
of the dividend declared on June 25, 2002 was, as an acknowledged indebtedness
to J.S., booked by PC, on the direction of J.S., as an indebtedness to the
Appellant. Such
direction was in satisfaction of J.S.’s remaining obligation under the J.S.
note.
·
On
July 15, 2002, PC by cheque paid 601 Ltd. the amount of $10,000. The cheque
was deposited on August 27, 2002.
·
PC prepared
Articles of Dissolution on July 31, 2002 and it was officially dissolved on
February 4, 2005.
[25] It is important to
note that the parties were in agreement as to the timing of the distribution
and appropriation of PC’s assets. That is, while they are not in agreement as
to the effect of such appropriations or distributions, they are in agreement as
to the time that they occurred.
[26] That is, the
issuance of cheques and promissory notes, despite not being paid or presented
for payment in the usual way, were acknowledged as delivered in the sequences
advanced at the hearing and such deliveries were accepted by the Respondent as the
distributions or appropriations that were the subject of the hearing. The net effect was that it was
acknowledged that the book or journal entries, notional or actual, created
genuine liabilities or book debts that constituted fully distributed and
appropriated amounts. Therefore, it is of no relevance as to when money changed
hands in a more literal sense. That is, it is of no relevance at all when and
how funds were actually, eventually, distributed to the book creditor,
namely the Appellant. The dates of the subject distributions then are as
follows:
|
·
June
25, 2002 prior to the 5:30 PM border crossing:
|
$479,842
|
|
·
September
1, 2002:
|
$45,226
|
[27] While the time of
the distributions and appropriations is not in dispute, the Respondent set out
a number of assumptions in its Reply to the Notice of Appeal (the “Reply”) dealing
with the question of the bona fide purposes of the transactions. Most of
those relate to the assessing position that the subject transactions were a
sham. Since that position was abandoned at trial I will not dwell on those
assumptions save two that the Appellant disputed:
There was no bona fide purpose for
the sale of shares to James Stewart other than to obtain the tax benefit to the
Appellant; and
The Appellant entered into the series of
transactions with the primary intention of accessing the accumulated surplus of
the P.C. in a manner that provided him with a tax benefit;
[28] As well, in
describing the transactions entered into by the Appellant, the following
admitted assumption was set out in the Reply:
…
gg) The gain, as claimed, was
partly sheltered by capital losses that the Appellant incurred during
the year as well as loss carry forwards from prior years;
…
[29] Under the heading
“Grounds Relied on and Relief Sought”, the Reply goes on as follows:
…
18.
Furthermore, the
transactions entered into by the Appellant resulted in an abuse of the Act
since they were part of an arrangement to circumvent the application of
subsection 84(2) of the Act. There was no purpose for the transactions
other than to provide the Appellant with the means for capital gains treatment
and to avoid the ordinary consequences of distributions of corporate assets on
the wind-up and discontinuance of business, as deemed dividends. Accordingly,
the $525,068 is properly included in the Appellant’s income as dividends,
pursuant to section 245 of the Act.
...
[30] Nowhere in the Reply
does the Respondent expressly identify the “tax benefit” that needs to be
identified for the purposes of section 245. Implicitly however, given the
assumption in paragraph (gg) of the Reply referred to above, the benefit must
be taken to be the use of capital losses and loss carry forwards that could not
have been used had subsection 84(2) applied. That was certainly the position
taken at trial although the general avoidance of dividend treatment sought to
be imposed under subsection 84(2), regardless of the particular tax benefit
achieved by avoiding it, seems to be an underlying and relevant concern to the
Respondent in this case.
[31] As such, I do not
think my analysis can ignore that concern even though it appears to me nothing
more than a confusing if not troubling distraction from the “tax benefit”
analysis required by section 245.
Statutory Provisions
[32] The relevant
statutory provisions of the Act will be reproduced as necessary throughout
these Reasons. A brief comment, however, is warranted. Although not expressly
relied upon by the parties, I note here that the Respondent seeks to give
effect to the assessment in a manner that invokes paragraph (c) of
subsection 245(5):
245(5) Determination
of tax consequences -- Without restricting the generality of subsection (2), …
…
(c) the nature
of any payment or other amount may be
recharacterized, and
…
[33] On the other hand, I
note section 246 was not expressly relied upon by the Respondent.
Respondent’s Submissions
[34] The Respondent’s submissions can be broken
down as follows:
a. Subsection 84(2) applies. The words “in any
manner whatever” are broad. The sale complements the winding-up of PC’s
business.
b.
Section 245 applies.
i.
There is a tax benefit.
It allowed a receipt to be categorized as a capital gain as opposed to a
dividend, avoiding tax on the receipt by shielding the gain with off-setting
net capital losses.
ii.
There was no bona
fide purpose for the share sale.
iii.
There was a misuse or
abuse of subsection 84(2) and the Act as a whole. The Act
addresses surplus stripping with many provisions, including section 245.
c. Dr. MacDonald was a Canadian resident at the time the
deemed dividends were received.
[35] Except subparagraph
b(i) above, which needs no elaboration, I will elaborate, albeit somewhat
summarily, on Respondent’s arguments supporting these submissions.
The requirements of subsection
84(2) are met:
·
The appropriation was
made on winding-up or discontinuance of PC’s business. That is, Dr. MacDonald
was winding-up his Canadian medical practice, which was run through PC. The
Respondent also submits that the appropriation was made on a reorganization of
PC’s business: that is, PC was reorganized from being a professional
corporation to being a holding company.
·
RMM Canadian
Enterprises Inc. v. R. is relied on. In particular reliance is
placed on Justice Bowman’s, as he then was, broad interpretation of the phrase “in
any manner whatever” as used in that subsection. Addressing Dr. MacDonald’s
submission that the funds were received as a creditor, the Respondent
emphasizes a passage in RMM where Justice Bowman said the share sale and
winding-up of Equilease’s business complement each other. “The sale was merely
an aspect of the transaction described in subsection 84(2) that gives rise to
the deemed dividend.”
This is to say that the status of creditor is inextricably bound to the
distribution qua shareholder.
·
Having
abandoned the sham argument as the basis for the assessment, it might have been
difficult for the Respondent to argue that the transactions undertaken and
effected did not give rise to J.S. having legal and beneficial ownership in the
shares of PC at the time he transferred them to 601 Ltd.. Nonetheless,
Respondent’s counsel has, in effect, made that argument. Further, with respect
to subsection 84(2), the Respondent’s counsel argued that PC had effectively
wound-up or discontinued its business prior to the time of the appropriation of
its assets to the benefit of the Appellant so that the other requirements of
subsection 84(2) were met.
Section 245 – no bona fide purpose for the share
sale:
·
The Respondent relies
on there being no business purpose to the transactions.
·
The
avoidance of double taxation is said not to be of relevance to the GAAR
analysis. Reliance is placed on RMM. In RMM, Justice Bowman said the primary purpose
of a transaction must be determined in the context of Canadian tax law, and
international implications were not to be considered.
Section 245 - there was a misuse
or abuse of subsection 84(2) and the Act as a whole:
·
The Respondent submits
that the rationale of section 84 is to prevent a corporation from converting a
taxable dividend into a capital gain. The Respondent sets out a history of
“surplus stripping”, including its origin in the pre-1972 Act. There is
a significant discussion on former subsection 247(1). Citing a Department of
Finance technical note, the Respondent submits tax applies when extracting the
funds from an entity in excess of the amount invested. When GAAR was introduced
and subsection 247(1) repealed, transactions covered by subsection 247(1) were
intended to be covered by GAAR.
·
The Respondent submits
the courts have agreed avoidance is inappropriate in the case of non-arm’s length
transactions resulting in “extraction of corporate funds by ‘manufacturing’ a
capital gain eligible for the deduction provided by section 110.6 of the Act”. Four cases are
cited in support.
In particular, Justice Bowman’s comments in RMM regarding surplus
stripping as an abuse of the Act as a whole are cited.
·
The Respondent submits
the relevant time to tax deemed dividends is when they are earned, not
withdrawn from a bank account. Citing Interpretation Bulletin IT-221R3, the Respondent
submits Dr. MacDonald was a Canadian resident until some time after Dr.
MacDonald entered the United
States. The reasons for this
are:
° Dr.
MacDonald signed the agreements before he left Canada;
° The
agreements acknowledge Dr. MacDonald’s Canadian residency;
° Dr. MacDonald signed the US Customs
declarations as a US non-resident;
° Dr. MacDonald maintained Canadian bank accounts, his
New Brunswick driver’s license, and his vehicles’ New Brunswick registration after June 25, 2002.
·
In the alternative, the
Respondent submits the earliest Dr. MacDonald’s residency could terminate was
when he crossed the border. The dividends would still be earned before he
crossed the border. This was the Appellant’s filing position. He intended that his residence
be fixed in Canada at least until he crossed the border. It can be said that his attention
to the details of his move support and ensure that result. In effect, the
argument is that the evidence is not clear enough to rebut the Respondent’s
presumption of the Appellant’s residence in Canada at the relevant times.
·
No cases on the
residency issues were submitted. Regarding a Canada Revenue Agency (“CRA”)
letter saying Dr. MacDonald was a non-resident as of June 25, 2002, the
Respondent submits that the CRA has since done a more detailed review and as a
result changed its opinion. Citing Ludco v. R., the Respondent
submits the letter is not binding on the CRA.
[36] More generally, the
Respondent’s argument inherently suggests that subsection 84(2) should be
applied whenever a shareholder accesses retained earnings, directly or
indirectly, to ensure the receipt is characterized as a dividend. That is
asserted to be its intended purpose. That is, the Respondent wants subsection
84(2) to be applied to ensure dividend treatment as it was intended to apply and
thereby frustrate the asserted abusive purpose of the taxpayer in this case.
That will focus my analysis of subsection 84(2) in terms of its intended scope
and purpose as an avoidance provision. Failing my finding that subsection 84(2)
applies here, the Respondent turns to section 245. Applying GAAR, the
Respondent would ensure the amount the Appellant received from PC is found to
be a dividend received by him as a shareholder while resident in Canada.
Appellant’s Submissions
[37] The Appellant’s submissions can be dealt
with under the section headings of the two provisions that are at issue, namely
subsection 84(2) and section 245. The alternative argument respecting the
residence of the Appellant will be addressed under the residence heading.
Subsection 84(2):
·
The
Appellant’s argument is that at the time of the distribution or appropriation
of PC assets he was not a shareholder. Citing Maccala v. The Queen as authority, he asserts that
subsection 84(2) cannot apply in his case because at the time of the appropriation
or distribution he was a creditor of the corporation, not a shareholder. The
distribution here was to the shareholder of record – namely, 601 Ltd. not the
Appellant.
·
As
well, if there was a benefit conferred on him qua shareholder it was not
a benefit conferred on the winding-up or discontinuance of PC’s business since
its activities in respect of that business, such as dealing with receivables continued
after the appropriation that benefited him.
·
The
Appellant also relies on the fact the transactions were carried out at fair
market values. The provisions of section 69 of the Act have no relevance;
and there were no benefits that accrued to him in the course of carrying out
the subject transactions by virtue of his non-arm’s length relationship with
J.S.
Section 245:
·
The
Appellant asserts that there was no tax benefit in this case as the
transactions were motivated to avoid a US tax by creating a capital gain in
Canada prior to his departure to the US.
·
Citing
Evans v. R., he
submits that there is no avoidance transaction. It is submitted that the
Minister of National Revenue (the “Minister”) ought not to be able to
re-characterize transactions that are permitted by the Act as a means
identifying tax avoidance.
·
The
Appellant further asserts that the transactions were not abusive. They did not
frustrate a specific provision that the Act sought to prevent the
outcome achieved; nor did they misuse any provision of the Act, defeat
the object, spirit or purpose of any of the Act’s provisions or abuse
any provision having regard to the Act read as a whole.
·
A
Senate debate and a House of Commons debate were cited to reflect the
parliamentary intention to relieve double taxation. As well, the use of accrued
capital losses to shelter capital gains was clearly relief contemplated by the
Act.
·
More
broadly put, the Appellant argues that it is not a misuse or abuse of the
provisions of the Act to engage in a transaction that allows for the
utilization of genuine historical losses. Further, it is asserted that if it is
found on the facts of this case that the purpose of the transactions was to
re-characterize income, the bona fide primary purpose of same was not to
enjoy the tax benefit of utilizing available capital losses and loss carry
forwards but was to avoid double tax that would arise given the deemed
disposition rules in Canada and the failure of the US taxing provisions at the
time to recognize the stepped-up cost base in the shares of PC.
The
Appellant’s Residence:
·
As
an alternative argument the Appellant asks me to consider that he was not a
resident of Canada, at the relevant time, should I find that the alleged distribution or
appropriation must be treated as a dividend.
·
It
is asserted that this alternative would result in the Act imposing only
a withholding tax on the dividend at a rate of 15% or even 5% depending on the
application of the provisions of the Canada – United States Treaty.
Analysis
Subsection 84(2)
[38] Subsection 84(2)
reads:
84(2) Distribution on winding-up, etc. -- Where funds or property of a corporation resident in Canada
have at any time after March 31, 1977 been distributed or otherwise appropriated
in any manner whatever to or for the benefit of the shareholders of any class of shares in its
capital stock, on the winding-up, discontinuance or reorganization of its business, the corporation shall be
deemed to have paid at that time a dividend on the shares
of that class equal to the amount, if any, by
which,
(a) the amount or value of the
funds or property distributed
or appropriated, as the case may be,
exceeds
(b)
the amount, if any, by
which the paid-up capital in
respect of the shares of that class is reduced on
the distribution or appropriation, as the case may be,
and
a dividend shall be
deemed to have been received at that time
by each person who held any of
the issued shares at that time equal to that proportion of the amount of the excess
that the number of the shares of that class held by the person immediately
before that time is of the number of the issued shares of that class outstanding
immediately before that time.
[39] The property
that the Appellant received, at least at the beginning of the chain of events,
is a promissory note – the J.S. note. That is not PC property.
[40] Following the series
of events, the Appellant received payment of the J.S. note as a creditor of PC
and he was paid as such with funds from PC.
[41] The Respondent wants
me to find then that the Appellant has received those funds from PC in the
capacity of a shareholder.
[42] On the other hand,
the Respondent has conceded that each transaction in the series leading to the
Appellant receiving PC funds was a legally effective transaction creating
genuine liabilities among all the parties involved in the series.
[43] The distribution of
PC funds as a dividend paid to 601 Ltd. as its sole shareholder was then a
legally effective dividend.
The transactions that followed that resulted in the Appellant being a creditor
of PC were also legally effective transactions. Therefore, at law, there really
should be no dispute that the Appellant received the PC funds qua creditor.
[44] My reference to
the series of “legally effective transactions” derives from the abandonment of the
assessing position that the subject transactions were a sham. That being the
case, I have concluded, on the facts of this case, that the subject
transactions were legally effective, giving rise to the rights and liabilities
created by the terms of those transactions.
[45] Put another way,
it is my view that any entitlement that the Appellant arises as consideration
from the share sale. That is not an entitlement vis-à-vis the Appellant
and PC. That is, the right to receive $525,068 is not an entitlement
vis-à-vis the Appellant and the company.
[46] That being the case,
subsection 84(2), on its express terms, cannot apply to deem a dividend to the
Appellant in this case.
[47] Still, the
Respondent essentially makes three arguments. First, reliance is placed on the
phrase “in any manner whatever”. Second, reliance is placed on RMM.
Third, reliance is placed on a purposive rather than literal construction of
the subject provision. This third argument led to the argument that subsection
84(2) was an anti-avoidance provision that, more specifically, dealt with what
has been commonly referred to as surplus stripping. In answer to this aspect of
the Respondent’s argument, the Appellant referred the Court to a related CRA
advance income tax rulings dealing with surplus strip transactions in a
post-mortem context. I will deal with that as an adjunct to the Respondent’s
third argument.
[48] As to the
Respondent’s reliance on the phrase “in any manner whatever”, such reliance is,
in my view, ill-fated. The manner of distribution of PC property in this case
was a dividend. The party benefiting from that distribution was the shareholder,
601 Ltd.. The express language of “in any manner whatever” does not redirect to
whom the dividend was paid. It is the manner of effecting the distribution to
the shareholder at the time of that distribution that the subject provision is aimed.
Any manner of distribution to 601 Ltd. other than as a dividend would, pursuant
to subsection 84(2), result in 601 Ltd. being deemed to have received a
dividend (whether or not that invokes a tax consequence to that shareholder at
that time).
[49] The entitlement of
the Appellant derives from his being a creditor of the third party purchaser.
Compare the language in subsection 84(2) with that in subsection 84(3). The
latter provision addresses an acquisition of shares and deems a dividend to the
extent the amount paid for the shares acquired exceeds the paid-up capital of
those shares. While that provision deals only with the acquisition by a company
of its own capital stock, it confirms that a provision dealing more broadly
with amounts paid for shares acquired could have expressly been subject to a
similar formulation of the deemed dividend component where the company directly
or indirectly financed the payment of the purchase price. That subsection 84(2)
has no such express language, demonstrates to me that its scope was not
intended to cover payments arising as consideration on a share sale.
[50] Indeed, as I have already said, the express language of
subsection 84(2) ensures that
it is only a shareholder at the time of the distribution or appropriation who
can be deemed to be the recipient of a dividend. That language, set out again
with emphasis, is:
Where funds or property of a corporation … have … been
distributed or otherwise appropriated in any manner whatever to or for the
benefit of the shareholders … on the winding-up, discontinuance or
reorganization of its business, the corporation shall be deemed
to have paid at that time a dividend on the shares of
that class equal to … and a dividend shall be deemed to
have been received at that time by
each person who held any of the
issued shares at that time equal to … [Emphasis added].
[51] Such language does not
permit a finding in this case that it can apply to deem the share sale price
paid to the Appellant to be a dividend.
[52] Further, the
Appellant’s ongoing management of PC’s affairs does not speak at all to the
capacity in which he received his entitlement to PC’s assets. It does not
establish a beneficial ownership in PC shares that differed from the legal ownership.
601 Ltd. held both legal and beneficial ownership in the PC shares. That 601
Ltd. was holding shares in a company that had liquid assets equal in value to its
liabilities, and that it acquiesced to or agreed to leave the sole creditor of
the company at its helm as the sole officer and director, do not in themselves
trigger principles of law that would convert the creditor to the status of
shareholder.
[53] In any event, the
Respondent raised no such principles of law that suggest such a leap. For
example, no argument of an agency or trust arrangement existing was made. If
such argument had been made, it would have been rejected. At best, in the absence of saying the transfer of
legal ownership was artificial or a sham, the material contractual trail here
is the one attaching to the funds. Even if it could be said, following that
trail, that the distributions received by 601 Ltd. were held for the indirect benefit
of the Appellant, his entitlement would still be qua creditor. At that
point in time he was a creditor of J.S., who was a creditor of 601 Ltd.. That
601 Ltd. might be said to have assumed J.S.’s obligation to the Appellant in
satisfaction of its debt to J.S. does not alter the fact that the Appellant’s
entitlement is qua creditor.
[54] That takes me to the
Respondent’s second argument, which was reliance on RMM. It is the principle
authority relied on by the Crown for the position that I should recognize the
Appellant as the recipient of PC property qua shareholder for the
purposes of subsection 84(2). A
passage in RMM was cited where Justice Bowman, as he then was, said the
share sale and winding-up of a business complemented each other. “The sale was
merely an aspect of the transaction described in subsection 84(2) that gives
rise to the deemed dividend.”
This was to say that the status of creditor was inextricably bound to the
distribution qua shareholder.
[55] I am not persuaded
that the distinction between a shareholder and a creditor can be ignored in
this case. It is true, in the case at bar, that the share sale and the
liquidating distributions contemplated each other, and that via a friendly
intermediate buyer, corporate funds ended up in the hands of a “former”
shareholder, namely the Appellant. In RMM, a buyer of shares was also
introduced as a convenient intermediary to allow the value of the acquired
company to end up in the hands of the former shareholder, thereby, in that
case, avoiding Canadian withholding tax. It is true then that the facts in RMM
are not easily distinguished from the case at bar other than the assessing
target in RMM was the avoidance of Canadian withholding taxes which is
not the target the Respondent has aimed at in the case at bar.
[56] However, RMM stands
in contrast to McNichol
v. The Queen. In
McNichol, Justice Bonner came to a different conclusion on subsection
84(2): the sale of shares of a corporation with cash as its only asset did not trigger
subsection 84(2) even though the purpose of the sale was to permit the share
vendor to access the capital gains exemption instead of a dividend.
[57] In that case, much
like the one at bar, a compliant corporate buyer (that later amalgamated with the
corporation) was used, although the corporate funds used to pay the share
vendors their proceeds of disposition was borrowed money. Ultimately, the
purchasing intermediary used the corporation’s cash to pay off the loan it incurred
to fund the share purchase. Justice Bonner applied the language of subsection
84(2) strictly in finding that it did not apply although he held against the
taxpayers under GAAR.
[58] In RMM, Justice
Bowman distinguished McNichol.
The distinction made by Justice Bowman appears to be based on the blatant
or transparent use of the intermediary in RMM. One might argue that the McNichol
transactions were similarly blatant and transparent.
[59] With the greatest
respect then, I do not agree that the distinctions drawn in RMM ought to
limit the scope of the decision in McNichol. In my view, the McNichol
approach which was to look to section 245 when subsection 84(2) does not apply
on a strict construction of its language, is the correct approach. I will
expand on that view momentarily in my discussion of surplus stripping which is
at the heart of what I have referred to as the Respondent’s third argument and
again in my discussion of that topic in the GAAR analysis that follows.
[60] First, I note that
there is another aspect of McNichol that
warrants mention. It is true that the agreement to sell the shares of PC in the
case at bar must have contemplated the use of corporate funds as a means to
finance the purchase. The vendor shareholder, while still a shareholder, had the
benefit of knowing that the series of transactions following the sale were being
structured to do just that. That was also the case in McNichol where it was understood by all involved that the
post-share sale events were going to be undertaken. Still, Justice Bonner did
not consider that knowledge as an obligation to undertake those events.
[61] In any event, it is
not the promise or foreseeability of a benefit while a shareholder that
triggers the operation of subsection 84(2). The requirement of that provision is
that there be a distribution or appropriation in any manner whatever for the
benefit of a person who is a shareholder at the time of that
distribution or appropriation. A structure undertaken while a shareholder that
ensures, by a series of transactions, access to corporate funds to satisfy a
debt created as a result of ceasing to be a shareholder, is not the same as
being in receipt of such funds, or being in receipt of a benefit, qua
shareholder.
[62] Accordingly, it
remains my view that the words of subsection 84(2) do not impose a requirement
to re-characterize payments to a creditor as payments to a shareholder.
[63] That takes me to what I see
as the Respondent’s third argument. Inherently, by pleading for a purposive rather
than literal construction of subsection 84(2), the Respondent asserts an abuse
of the Act in this case broader than one that relates to the interaction
of capital gains and capital losses in the calculation of income and taxable
income. As stated earlier in these Reasons, referring to paragraph 18 of the
Reply, the broader concern is the avoidance of the ordinary consequences of
distributions of corporate assets, as dividends, that are meant to arise on a
wind-up or discontinuance of business. More specifically it is a concern, not
so much as to a particular tax benefit that might arise from the tax difference
between shareholders accessing retained earnings as a dividend versus receiving
capital gains treatment, it is a concern stemming from a view that the purpose of
subsection 84(2), as it was brought in by legislation affecting post-1971
dispositions of capital property, was to prevent capital gains treatment. The
suggestion is that it was, and remains, an anti-avoidance provision the
language of which must be construed more broadly to ensure dividend treatment
when a taxpayer indirectly receives the retained earnings of a company that he
was entitled to receive as a shareholder.
[64] In my view, that
suggestion is tenuous. It is even more of a leap to suggest that the post-1971
provision, following the former model, was intended to ensure the post-1971
restrictions on the use of capital losses when neither such losses nor such
restrictions existed in the pre-1972 Act. In fact, the historical
references relied on by the Respondent underline that this third argument is
all about an attack on surplus stripping transactions per se.
[65] This strikes me
as a GAAR issue, however before taking the analysis there, the Respondent’s
suggestion that this rationale to 84(2) dictates against a literal construction
of that provision, requires more to be said about surplus stripping in the
context of that provision.
[66] In my view, there
is nothing in the language of subsection 84(2) that warrants a finding of a
rationale other than liquidating distributions out of a corporation’s earnings to
its shareholders - holding a particular class of shares - are to be treated
as dividends to the extent the distribution exceeds the paid-up capital of the particular
class of shares held by persons receiving the distribution. That
rationale formulation is set out in paragraphs 84(2)(a) and (b). More
generally, that rationale is part of a consistent theme that retained earning
of a corporation are a source of dividends and their use or withdrawal for the
benefit of shareholders should not be subject to different tax treatment than
applicable to dividends.
[67] That said, it is
dubious whether subsection 84(2) was ever an anti-avoidance provision in the
sense of ensuring this result in the case of a so-called surplus strip which is
what the Appellant’s tax plan accomplished. The surplus strip here was having
the Appellant’s shares acquired with corporate funds funnelled through a related
corporation as a tax-free dividend. This classic strip in the old system was
subject to a specific anti-avoidance provision; namely section 138A of the old,
pre-1972 Act. That provision was replaced in 1972 with section 247 which
was repealed in 1988. The section that survived is, of course, section 245.
That is the provision to look at in these circumstances. Essentially that is
what Justice Bonner concluded in McNichol and I agree.
[68] In coming to
this conclusion, I cannot ignore the Supreme Court of Canada decision in Smythe
et al. v. Minister of National Revenue
even though the parties made no direct reference to it. In that case, the Crown
was successful in applying the subsection 81(1) of the pre-1972 Act (the
predecessor to subsection 84(2)) to a dividend strip. While the Supreme Court
of Canada found it unnecessary to express any opinion on the scope of subsection
137(2) of the pre-1972 Act as a condition of applying the former section
81(1), it is interesting to note that the Exchequer Court did rely on that
former provision as an anti-dividend stripping provision. Subsection 137(2) was
an artificial transactions provision. If a transaction artificially conferred a
benefit, the benefit was deemed to have been conferred “notwithstanding the form
or legal effect of the transactions”. The Supreme Court of Canada just relied
on the artificiality of the transaction that gave rise to the dividend strip
without reliance on the former subsection 137(2). In the case at bar, no
assertion was made that the subject transactions were artificial. Furthermore, and
importantly, as noted earlier in these Reasons, former subsection 137(2) was
replaced in the post-1971 Act by the former section 247 which became the
current section 245 in 1988. All
this is to say that the appropriate provision to apply in the case at bar given
the withdrawal of the sham basis for the subject assessment, in my view, is section
245 of the Act.
[69] Accordingly, I
see no basis to find that a purposive contextual analysis of subsection 84(2) would
invite a less literal interpretation of its language than that I have found must govern,
although there remains one last aspect of this argument that needs to be
addressed.
[70] I noted above that there is another aspect of the
Minister’s anti-surplus stripping position that needs to be addressed. It was
raised by Appellant’s counsel who referred me to what was suggested to be an
analogous tax planned surplus strip strategy where the CRA had issued advance income tax rulings.
I will refer to this strategy momentarily as post-mortem pipeline tax plans.
[71] Needless to say
CRA’s ruling practices normally carry little weight in this Court’s
determination of how the language of any provision of the Act must be
interpreted and applied. However, CRA’s practices in respect of surplus
stripping tax planning strategies in another context, does tend to underline
the difficulty of administering subsection 84(2) where abuse is not the sole
focus of the analysis.
[72] The context in respect of which the subject ruling practices on surplus
strips is relevant is the avoidance of double taxation on death. Post-mortem tax plans typically
seek to avoid double taxation by ensuring or preserving either dividend
treatment or capital treatment to an estate in respect of the distribution of
funds to an estate from a company owned by the deceased at death.
[73] Double taxation results from the deemed disposition of
capital assets on death, which could trigger a capital gain on shares held by
the deceased at death, and a subsequent taxable dividend - or deemed dividend
under subsection 84(2) - on the distribution of corporate funds to the estate. That
distribution diminishes the value of the shares and creates a capital loss for
the estate on the retirement of the shares inherited at a high adjusted cost
base (acb) as result of the deceased’s deemed disposition at fair market
value (fmv).
If this liquidation of the company is done in the first year following death,
the estate’s capital loss can be carried back to the deceased’s year of death,
wiping out the capital gain that arose from the deemed disposition pursuant to subsection 164(6). This avoids double tax in the
sense that the retained earnings of the company have only been taxed once as a
dividend to the estate. What is most important here is that it also illustrates
that the Act, in this case at least, is not preoccupied with the
difference between capital gains treatment and dividend treatment. That is,
dividend treatment, fully integrated or not, is acceptable.
[74] While it can be argued that this is an exceptional
circumstance, it is not so much exceptional in allowing the capital gain to be
converted to dividend treatment. It is exceptional in allowing a capital loss
to be transferred to a different taxpayer in a different taxation year. In any
other circumstance it would likely trigger GAAR if accomplished by way of an
avoidance transaction.
[75] Even if it is exceptional in allowing the capital gain
to be converted to dividend treatment, it does so as part of a final accounting
or reconciliation of a deceased person’s capital gains and losses. A similar
situation exists in the context of a departure from Canada. Ensuring a similar result by an
avoidance transaction does not strike me as abusive.
[76] That said, I note that the advance income tax ruling
referred to by Appellant’s counsel concerns the use by the estate of a newly
formed holding company. The estate transfers the shares of the company that
were owned by the deceased at death (the “deceased’s company”) to the new
holding company. The consideration for the transfer is a note equal in value to
the fmv of the transferred shares, which does not trigger a capital gain
given the estate’s high acb in the shares of the deceased’s company. The
deceased’s company pays a liquidating dividend to the holding company, which
uses the funds to pay the note held by the estate. This avoids double tax: the
retained earnings of the deceased’s company have only been taxed once, as a
capital gain to the deceased in the year of death.
[77] This latter post-mortem plan is sometimes referred to
as the post-mortem pipeline. The post-mortem pipeline, like the case at bar,
attempts to avoid dividend treatment by employing steps that ensure that the
tax planner receives the liquidating dividend qua creditor. The choice
is made to accept capital gains treatment on death as opposed to dividend
treatment on the estate’s receipt of corporate assets.
[78] The CRA has issued advance income tax rulings that such
post-mortem pipeline transactions will not be subject to subsection 84(2) if
the liquidating distribution does not take place within one year and the
deceased’s company continues to carry on its pre-death activities during that
period.
[79] This post-mortem plan clearly parallels the Appellant’s
tax plan in the case at bar. Both plans provide access to a corporation’s
earnings in a manner that avoids dividend treatment. As well, both situations
deal with a time of reconciliation – death and departure from Canada. The conditions imposed on the
post-mortem transactions, if imposed in the case at bar, would show that the
CRA’s assessing practice was consistent in trying to apply subsection 84(2).
The message seems to be: do the strip slowly enough to pass a contrived smell
test and you will be fine.
[80] This is not a
satisfactory state of affairs in my view. The clearly arbitrary conditions
imposed are not invited by the express language in subsection 84(2). I suggest
that they are conditions imposed by the administrative need not to let go of,
indeed the need to respect, the assessing practice seemingly dictated by RMM.
Make it “look” less artificial and the threat of subsection 84(2) disappears.
This unsatisfactory state of affairs more properly disappears once it is
accepted that subsection 84(2) must be read more literally in all cases and GAAR
applied in cases of abuse.
[81] The analysis in Canada
Trustco Mortgage Co. v. Canada
fits nicely in support of this overall approach:
11 …
the particularity and detail of many tax provisions have often led to an
emphasis on textual interpretation. Where Parliament has specified precisely
what conditions must be satisfied to achieve a particular result, it is
reasonable to assume that Parliament intended that taxpayers would rely on such
provisions to achieve the result they prescribe.
12 The
provisions of the Income Tax Act must be interpreted in order to achieve
consistency, predictability and fairness so that taxpayers may manage their
affairs intelligently. As stated at para. 45 of Shell Canada Ltd. v. R.,
[1999] 3 S.C.R. 622 (S.C.C.):
[A]bsent a specific
provision to the contrary, it is not the courts’ role to prevent taxpayers from relying on the
sophisticated structure of their transactions, arranged in such a way that the
particular provisions of the Act are met, on the basis that it would be
inequitable to those taxpayers who have not chosen to structure their
transactions that way. [Emphasis added.]
See also 65302 British Columbia, at para. 51, per
Iacobucci J. citing P. W. Hogg and J. E. Magee, Principles of
Canadian Income Tax Law (2nd ed. 1997), at pp. 475-76:
It would introduce
intolerable uncertainty into the Income Tax Act if clear language in a detailed
provision of the Act were to be qualified by unexpressed exceptions derived
from a court’s view of the object and purpose of the provision.
13
The Income Tax Act remains an instrument dominated by
explicit provisions dictating specific consequences, inviting a largely
textual interpretation. Onto this compendium of detailed stipulations,
Parliament has engrafted quite a different sort of provision, the GAAR. This is
a broadly drafted provision, intended to negate arrangements that would be
permissible under a literal interpretation of other provisions of the Income
Tax Act, on the basis that they amount to abusive tax avoidance. To
the extent that the GAAR constitutes a “provision to the contrary” as discussed
in Shell (at para. 45), the Duke of Westminster principle and the
emphasis on textual interpretation may be attenuated. Ultimately, as
affirmed in Shell, “[t]he courts’ role is to interpret and apply the Act
as it was adopted by Parliament” (para. 45). The court must to the extent
possible contemporaneously give effect to both the GAAR and the other
provisions of the Income Tax Act relevant to a particular transaction.
[82] This strikes me
as the appropriate approach in this case. In the circumstances of this case, there
is nothing in subsection 84(2) of the Act that invites the CRA or this
Court to change either who the recipient of a benefit is, or the legal status
or capacity of the recipient. To re-characterize or ignore the Appellant’s
legal status in this case invites consideration of the application of section 245
of the Act. Subsection 245(5) allows just that in certain circumstances.
In those circumstances, and only in those circumstances, should the subject transactions
be re-characterized. Put another way, where GAAR would not apply to
re-characterize the legal effect of a series of transactions, other provisions
of the Act should not be too readily stretched to give that result where
a strict reading of them does not invite such result. This is simply a
re-statement of a principle set out by the Supreme Court of Canada in Canada
Trustco:
16
… The GAAR’s purpose is to deny the tax benefits of certain arrangements
that comply with a literal interpretation of the provisions of the Act, but
amount to an abuse of the provisions of the Act. …
[83] I add here that reading
further in these Reasons, the parties will learn that even applying GAAR, the
Appellant is successful. In fact, this may well be described as a case where it
benefited the taxpayer to seek refuge in GAAR. Uncertainties in the application
of another provision of the Act, such as subsection 84(2), to a
particular avoidance scheme might be resolved by looking at GAAR at least where
the application of GAAR reinforces the construction of the other provision
advanced by the taxpayer in a particular case. In such cases, GAAR might be
viewed as a shield. That the authorities demand that it not be used as a further
sword where another has failed to strike down a taxpayer, does not suggest the possibility that
in some cases it can be used as a shield in the sense of being a better litmus
test to apply to prevent improper avoidance as opposed to looking to expand the
scope of a carefully worded provision like subsection 84(2).
[84] As to the
Appellant’s argument that the business of PC had not been wound–up, I do not
agree. “On the winding-up” as used in subsection 84(2) refers to a course of
events that are part of the winding-up process. There is no question in my mind
that the distributions at issue in this case were in the course of winding-up
PC’s business.
[85] Even if that were
not the case there was at least a reorganization of PC’s business. It went from
carrying on a medical business that fed its investment activities to a holding
vehicle. However,
even the holding function existed only to effect the
total distribution of its assets. Viewed as a whole, the distributions here
were clearly part of a winding-up process and were made then “on the
winding-up” for the purposes of subsection 84(2).
[86] Nonetheless, for the
reasons set out above, subsection 84(2) does not apply in this case.
Section 245
[87] The charging
provision in section 245 is found in subsection 245(2):
245(2) General anti-avoidance provision
[GAAR] -- 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.
[88] The terms “tax
avoidance” and “tax benefit” are defined in section 245 and even where such requirements
of this charging provision are met, there are exceptions to its operation set
out in subsection 245(4).
[89] The overall manner
of dealing with the application of these components of section 245 was laid out
by the Supreme Court of Canada in Canada Trustco, and summarized in Copthorne
Holdings Ltd. v. R., as
follows:
1. Was there a tax
benefit?
2. Was the
transaction giving rise to the tax benefit an avoidance transaction?
3. Was the
avoidance transaction giving rise to the tax benefit abusive?
Was there a tax benefit?
[90] “Tax benefit” is a
defined term in subsection 245(1):
(1) Definitions -- In this section,
"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,
and includes a reduction, avoidance or deferral of tax or other amount that would be
payable under this Act but for a tax treaty or an
increase in a refund of tax or other amount under this Act
as a result of a tax treaty;
[91] It is interesting to
note that the definition of a “tax benefit” does not expressly address whether
the benefit was one to which the taxpayer would have been entitled even if the
transactions that gave rise to it had not been carried out. On the other hand,
that comparables might be relevant in a case like this was noted by the Supreme
Court of Canada in Canada Trustco and reiterated in Copthorne
at paragraph 35:
As found in Trustco,
the existence of a tax benefit can be established by comparison of the
taxpayer’s situation with an alternative arrangement (para. 20). If a
comparison approach is used, the alternative arrangement must be one that
“might reasonably have been carried out but for the existence of the tax
benefit” (D. G. Duff, et al., Canadian Income Tax Law (3rd ed.
2009), at p. 187). By considering what a corporation would have done if it did
not stand to gain from the tax benefit, this test attempts to isolate the
effect of the tax benefit from the non-tax purpose of the taxpayer.
[92] By reporting the
consideration received from J.S. as a capital gain rather than as a dividend
from PC, the Appellant was able to use net capital losses on hand to off-set
the gain. Aside from the Respondent’s underlying concern over surplus strips
and the avoidance of dividend treatment on the wind-up of a business, the use
of capital losses is the only actual tax benefit that the Respondent has
identified. If a comparison approach is used, we would ask: what would likely have
been done but for the purpose of deriving this benefit?
[93] My answer might well
be that the Appellant would have left Canada a shareholder of PC. In that case, he would have
the very tax benefit that his impugned arrangement gave rise to which is to say,
comparatively, there is no tax benefit at all. That is, if the Appellant moved
to the United States still holding his shares in PC, he would have had the benefit
of the use of the subject losses simply by virtue of the deemed disposition
provision referred to earlier in these Reasons.
[94] Logically then, one
could conclude that there is no tax benefit here or at least not the tax
benefit relied on by the Respondent as relevant. On the other hand, the
Respondent did not rely on a comparative approach to identifying the tax
benefit in this case.
[95] I have no doubt that
the assessment can proceed without reliance on a comparison. This is made clear
in Canada Trustco. At paragraphs 19 and 20 the Court found as
follows:
19 …
Whether a tax benefit exists is a factual determination, initially by the
Minister and on review by the courts, usually the Tax Court. …
20 If a deduction against
taxable income is claimed, the existence of a tax benefit is clear, since a
deduction results in a reduction of tax. In some other instances, it may be
that the existence of a tax benefit can only be established by comparison with
an alternative arrangement. …..
[96] While the Court goes on in that paragraph 20 to include
the case of the benefit of a capital gain versus business income in examples of
cases where a comparable might be used, I do not find that to be sufficient to
force the analysis in this case beyond accepting the simple and clear tax
benefit identified by the Respondent; namely, the creation of a capital gain
enabling the use of capital losses which resulted in a reduction of tax
payable.
[97] Further, I note that looking beyond that clear
tax benefit identified by the Respondent, would not be consistent with the
analytical approach set out in Canada Trustco and left undisturbed in Copthorne.
[98] At paragraph 63 of Canada Trustco under
the heading “Burden of Proof” the Court noted:
The
determination of the existence of a tax benefit and an avoidance transaction
under s. 245(1), (2) and (3) involves factual decisions. As such, the
burden of proof is the same as in any tax proceeding where the taxpayer
disputes the Minister’s assessment and its underlying assumptions of
facts. The initial obligation is on the taxpayer to “refute” or challenge
the Minister’s factual assumptions by contesting the existence of a tax benefit
…
[99] This requires that the Minister’s assumptions be sufficient
to identify a particular tax benefit that is the focus of the section 245
analysis. That is, I do not accept this reference to the taxpayer’s burden to
refute the existence of a tax benefit as relieving the Minister of the
responsibility to identify with certainty the tax benefit that the avoidance
transactions have given rise to and that are asserted to be abusive. There
should be no doubt about what it is that the Appellant has to rebut. There is a
burden on the Minister in this regard.
[100] However, at this point I must also note that the
selective identification of one particular tax benefit as opposed to another
has an element of arbitrariness that is somewhat unsettling in this case. It
was clearly open for the Minister to assess the subject transactions on the
basis that the tax benefit was the elimination of Part XIII tax.
[101] Reliance could readily have been made on the comparable
of the Appellant moving to the United States without engaging in the share sale,
using his capital losses, then winding up PC after the move. In effect, that is
the result that the Appellant is willing to accept in his alternative argument.
However, that comparable is not the subject of this appeal. The Minister
accepted that the impugned transactions were effectively completed, as planned,
by a resident of Canada. Still, as I have suggested before, I am not satisfied that my analysis will be complete
if all I do is focus on the tax benefit relied upon by the Minister in this
case. The GAAR analysis will only be complete, in my view, if I address the
Respondent’s underlying concern in this appeal head-on, namely the issue of
surplus stripping per se. I will deal with that concern, under a
separate “abuse” heading where I have concluded that it is doubtful whether in an integrated
corporate/shareholder tax system, a surplus strip per se can be said to
abuse the spirit and object of the Act read as a whole.
[102] That aside, it is clear that the proper focus of the GAAR
analysis must be on the particular tax benefit that the Minister relied on as
having arisen as a result of the subject surplus strip, namely the utilization
of the Appellant’s net capital losses.
[103] That was the benefit afforded by the strip and under GAAR
it is that benefit that is of pivotal relevance.
[104] Consider the following
passage from Canada Trustco:
64
… The Federal Court of Appeal (in OSFC) held that there is no burden on
either party at the stage of interpreting the provisions at issue, since this
is a question of law, which is ultimately for the court to decide. It went on
to state at para. 68 that “from a practical perspective, … [t]he Minister
should set out the policy with reference to the provisions of the Act or
extrinsic aids upon which he relies”.
65
For practical purposes, the last statement is the important one. The
taxpayer, once he or she has shown compliance with the wording of a provision,
should not be required to disprove that he or she has thereby violated the
object, spirit or purpose of the provision. It is for the Minister who
seeks to rely on the GAAR to identify the object, spirit or purpose of the
provisions that are claimed to have been frustrated or defeated, when the
provisions of the Act are interpreted in a textual, contextual and purposive
manner. The Minister is in a better position than the taxpayer to make
submissions on legislative intent with a view to interpreting the provisions
harmoniously within the broader statutory scheme that is relevant to the
transaction at issue.
[105] The object and
spirit of a particular provision of the Act can only be said to have
been abused in relation to affording a particular unintended tax benefit. The
issue here is then about the objectives and policies of the Act that relate
to the limited use of capital losses, not about some general theme concerning access
to corporate retained earnings other than as a dividend. That is, the asserted
unintended tax benefit created by the strip - the use of capital losses - should
be the focus of the analysis.
[106] Accordingly, I will
proceed on that basis.
Was the transaction giving rise to
the tax benefit an avoidance transaction?
[107] GAAR can only apply
where there is an avoidance transaction, as defined in subsection 245(3):
245(3) Avoidance transaction -- 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.
[108] It is well established
that: “an avoidance transaction may operate alone to produce a tax benefit, or
may operate as part of a series of transactions which produces a tax benefit.”
[109] Given the “tax
benefit” identified above, it is not, strictly speaking, necessary for me to
consider the series of transactions here. The tax benefit was secured on the
sale of the Appellant’s PC shares to J.S.. However, it is fair to say that the
sale of the shares here does not exist in a vacuum: each transaction, from
beginning to end, was entered into and completed in contemplation of each other.
The remainder of the series of transactions gave rise to other tax benefits,
domestic and foreign, but they are not relevant in the context of the tax
benefit under consideration in this appeal. More specifically, if I look beyond
the share sale and acknowledge that the Appellant has by the series of
transactions accessed PC funds as a creditor so as to avoid both Part XIII tax
and double tax in the United States, that does not alter the fact that the
share sale per se was not for any other purpose than to obtain the tax
benefit of utilizing his capital losses in Canada.
[110] Accepting that the share
sale to J.S. gives rise to the tax benefit, it is clear the Appellant undertook
that transaction primarily, indeed only, to obtain the tax benefit. Although
that finding seems unremarkable since the use of his capital losses was assured
even if he did nothing but move to the United States with his PC shares in
hand, it is a transaction that resulted in the tax benefit identified by the
Respondent.
[111] At the risk of being
redundant, having found that the primary purpose of the share sale was to
utilize capital losses, I want to make it clear that I do not accept the Appellant’s
evidence that the non-Canadian tax benefit of avoiding double taxation in the US
was the primary purpose of the share sale. Such assertion is overly simplistic.
It was a purpose that needed to be addressed in a manner that did not cause him
to lose the benefit of utilizing his capital losses. To achieve that
purpose, he determined that the share sale was required while he was a resident
of Canada. The only purpose of
the share sale per se then was, as stated, to utilize his capital loses
as maintained by the Respondent. Further, even if the purpose of the series of
transactions was the avoidance of a foreign tax, the effect of achieving that purpose
would be to preserve the economic benefit of utilizing his Canadian capital
loses. As such it would not, in my view, alter my finding that his primary
purpose was preserving the benefit of utilizing his capital losses.
Was the Share Sale Abusive in Creating a
Capital Gain Which Would be Off-set by Capital Losses?
[112] Subsection 245(4) can
be thought of as a saving provision, ensuring GAAR does not apply to legitimate
tax minimization transactions:
245(4) Application of subsec. (2) -- Subsection
(2) applies to a transaction
only if it may reasonably be considered that the transaction
(a) would, if
this Act were read without reference to this section, result directly or
indirectly in a misuse of the provisions of any one or more of
(i) this Act,
(ii) the Income
Tax Regulations,
(iii) the Income
Tax Application Rules,
(iv) a tax
treaty, or
(v) any other
enactment that is relevant in computing tax or any other amount
payable by or refundable to a person under this Act
or in determining any amount that is relevant for the purposes of
that computation; or
(b) would
result directly or indirectly in an abuse having regard to those provisions,
other than this section, read as a whole.
[113] The analysis of this issue was framed by Chief
Justice McLachlin and Justice Major in Canada Trustco:
The heart of
the analysis under s. 245(4) lies in a contextual and purposive interpretation
of the provisions of the Act that are relied on by the taxpayer, and the
application of the properly interpreted provisions to the facts of a given
case. The first task is to interpret the provisions giving rise to the tax
benefit to determine their object, spirit and purpose. The next task is to
determine whether the transaction falls within or frustrates that purpose. The
overall inquiry thus involves a mixed question of fact and law. The
textual, contextual and purposive interpretation of specific provisions of the
Income Tax Act is essentially a question of law but the application of these
provisions to the facts of a case is necessarily fact-intensive.
[114] The Respondent submits that subsection 84(2)
is abused by the share sale. In my view, that is an erroneous submission. While
there is the question already raised and dealt with, namely the purpose of
subsection 84(2) which I have concluded is not an anti-surplus stripping provision
and does nothing more than deal with shareholder access to corporate funds
beyond the paid-up capital of the shares held by that shareholder, what is
clearer still is that subsection 84(2) cannot be said to have
anything to do with a purpose in the Act to prevent capital losses from
sheltering income other than capital gains. Indirectly, that provision may have
that effect in this case, but that cannot be said to be its purpose. The
provision of the Act that establishes that purpose is section 3. The
real question then is whether section 3 of the Act has been abused.
[115] That is, the share
sale changed the nature of a receipt funded by distributions from PC from
dividend income to a capital gain, and thereby frustrated the statutory
objective expressed in section 3. That section prevents using capital losses to
shelter anything but capital gains and, as a starting point, suggests that it
would be abusive to structure transactions in a way that defeats that objective.
However, even accepting that as the case that the Appellant has to meet,
notwithstanding that it was not argued quite that precisely by the Respondent,
I am not satisfied that that legislative policy can be so rigidly applied
considering how the Act as a whole tends to be permissive of various
ways to use capital losses even by somewhat artificial means.
[116] Indeed, triggering
capital gains to utilize capital losses is not discouraged by the Act in
any way. Transfers to a corporation without a section 85 election
can be used to realize capital gains as can transfers between spouses. There is
nothing abusive about realizing capital gains for no other purpose than to utilize
available net capital losses.
[117] After triggering a
capital gain on a disposition one presumably can re-acquire the identical asset
back and enjoy a stepped-up cost base. The capital gain realized in that case
is somewhat artificial or superficial. However, there is no rule against
superficial gains crystallized for no other purpose than to utilize capital
losses.
[118] In the case at bar, I
do not see how then the transaction creating the tax benefit can be seen as
abusive. Indeed, in light of the superficial loss provisions in the Act,
and other express loss restriction rules, one might consider the possibility, if
not the likelihood, that a specific anti-avoidance rule in the case of a tax
planned realization of a capital gain was rejected as a matter of policy.
[119] The Act’s
tolerance to the utilization of genuine capital losses reflects that the Act
is still largely based on fundamental equitable principles: it seeks to impose
tax on increments in economic power which is an approach based on ability to
pay. While it is true that the tax treatment for income losses and capital
losses are distinct, fundamentally a capital loss can have a dramatic influence
on one’s ability to pay. The losses here are not artificial, they are not
superficial. They are genuine and to suggest that planning one’s affairs in a
manner that would ensure recognition of such losses is not abusive in my view.
That view is buoyed all the more considering that the plan ensured recognition
of his losses without diminution by adverse foreign consequences. This is not a
case like 1207192 Ontario Limited v. The Queen where Justice Paris found the loss in
question did not result in a diminution of the taxpayer’s economic power.
[120] The reasons not to
find the use of capital losses an abuse in the case at bar are even more
compelling given the mandate in the Act to account for capital gains and
losses on a departure from Canada. That very mandate ensures taxpayers the
opportunity to reconcile their tax liabilities in Canada. This is expressly provided in paragraph
128.1(4)(b) of the Act:
128.1(4)
Emigration -- For the purposes of this Act, where at any particular time a taxpayer ceases to be resident in Canada,
…
(b) Deemed disposition -- the taxpayer is deemed to
have disposed, at the time (in this paragraph and paragraph (d) referred
to as the "time of disposition")
that is immediately before the time that is immediately before the particular
time, of each property owned by the taxpayer other than,
if the taxpayer is an individual,…
for
proceeds equal to its fair market value at the time of disposition,
which proceeds are deemed to have become receivable and to have been received
by the taxpayer at the time of disposition;
[121] The Appellant’s
departure from Canada would have triggered the very same capital gain realized
on the share sale thereby ensuring reconciliation of his capital gains and
losses. To deny a tax benefit to which he was entitled by an express provision
of the Act because he achieved it by a different legally effective means
is, frankly, bizarre.
[122] “Bizarre” might be
putting it too strongly, but in a manner of speaking it does underline my point
that the real concern here is not so much about the use of the capital losses –
it is about the acceptance or non-acceptance of surplus strips per se. That
appears to be an issue with which the Minister struggles in a variety of
circumstances.
[123] However, the
circumstances of the case at bar do not invite a struggle. In this case, it
just cannot be said that the purpose of the Act, to limit the use of
capital losses to off-set capital gains, is frustrated by the surplus strip.
[124] Accordingly, having determined the
object and spirit of those provisions that limit the use of capital losses is
not as restrictive as asserted by the Respondent in the context of tax plans
aimed at triggering capital gains; and having determined that the creation of
the subject gain in this case did not frustrate the object and spirit of those
provisions, I am satisfied that the avoidance transaction giving
rise to the tax benefit here was not abusive. Indeed, I regard the
Appellant’s use of his capital losses not only did not frustrate the object and
spirit of the capital loss provisions of the Act but rather assured him
of achieving a tax benefit to which he was entitled without adverse
consequences.
[125] The decision in Canada Trustco
assures taxpayers that the principle in the Inland Revenue Commissioners v.
Duke of Westminster has not been abandoned and that the legitimate tax planning engaged in
here should not be undermined by GAAR. To the contrary, the tax benefit in
this case reflects nothing more than a plan undertaken not so much to minimize
taxes payable, a legitimate plan in itself, but to ensure reconciliation of his
capital gains and losses in Canada prior to his departure while ensuring that
there were no adverse tax consequences in achieving that end. GAAR affords
ministerial and judicial leeway in determining whether a transaction may
reasonably be considered not to result in an abuse. In spite of the myriad of principles Parliament has laid out in the Act,
that determination must be grounded in the fair application of those
taxing principles that must be taken as governing a particular case.
Was the Share Sale Abusive in Avoiding
Dividend Treatment on the Distribution of Retained Earnings?
[126] As I said earlier in
these Reasons, a driving force
of the assessment was an attack on the surplus strip aspect of the impugned
series of transactions.
[127] I allowed that it was implicit that the Respondent’s
position was that subsection 84(2) is there to prevent capital gains treatment
in the case of a surplus strip or more particularly where, on a wind-up or
discontinuance of a business, the retained earnings of a company have financed
a share purchase. However, it is a position that does not expressly identify a
tax benefit. Without that, a section 245 analysis cannot be undertaken.
[128] Insisting that the
maintenance of a dividend regime per se is required to maintain the
integrity of the scheme of the Act in the context of the distribution of
retained earnings on a winding up or discontinuance of a business, requires
that subsection 84(2) be found to operate beyond its express language. I have
found to the contrary. That sits well, in my view. A proper reading of the
subject provisions dictates only one approach: find the abusive benefit and
look to GAAR to maintain the integrity of the scheme of the Act in the
context of the distribution of retained earnings on a winding up or
discontinuance of a business.
[129] While that should be
the end of the matter, there is another aspect of the anti-surplus stripping
position, which is at the heart of the Minister’s concern with the instant
appeal, that I feel compelled to address.
[130] The reality in this
case is that aside from the Appellant’s use of losses, the tax on capital gains
in New
Brunswick
in 2002 differed considerably compared to the tax on dividends. Indeed, in the
case of a privately-held corporation, like PC, the lack of integration, at the
time the subject transactions were undertaken, favoured capital gain treatment
by some nine percent in New Brunswick relative to the tax on a dividend of the same
amount. The
question could arise then as to whether a surplus strip per se can be
abusive just because it frustrates the operation of two very different tax
regimes.
[131] That might invite a
different approach as to how GAAR needs to operate or a different construction
of subsection 84(2). In my view, any such change in approach would be wholly
unwarranted.
[132] The tax avoidance and
tax benefit resulting from a lack of integration in this case is systemic. There is no unintended tax slippage in
this sense, and in such circumstances GAAR cannot be used to prevent a tax
planned approach to accessing retained earnings. Said differently, neither subsection
84(2) nor GAAR
can be used to fill a gap between two approaches to taxing an individual
shareholder’s realization of accumulated after-tax funds in a company. There must be more.
Subsection 84(2) does not employ language that attacks tax abuse issues arising
from surplus strips. Section 245 does. As stated earlier in these Reasons – it
is a better litmus test to identify strips that offend the spirit and objects
of the Act read as a whole. Unless, an abusive tax benefit results from
the avoidance series of strip transactions, the tax result stands undiminished.
Avoidance transactions alone do not frustrate the principles set out in the Duke
of Westminster.
[133] Accordingly, I
reiterate my finding under the previous heading, dealing more specifically with
the tax benefit relied on by the Respondent in applying section 245, that the
strip transactions as engaged in by the Appellant do not constitute a misuse of
the provisions of the Act or an abuse having regard to the provisions of
the Act read as a whole. Again, section 245 does not apply.
[134] Lastly, it should be
mentioned that it is implicit in these Reasons that I have not found that either
employing a series of transactions with related parties on substantially arm’s
length terms or ensuring the availability of funds through asset liquidations to
enable a payment to the Appellant to be relevant factors in the circumstances
of this case in the determination that the impugned transactions were not abusive.
They simply enabled a well-planned departure from Canada.
Change in Residency
[135] The Appellant concedes
that if the subject PC distributions are to be re-characterized as dividends, he
could be liable under Part XIII of the Act. He does so on the basis that
his residence could be found to have changed prior to those distributions being
made.
[136] I do not find it
necessary to engage in an in-depth analysis of the residence issue. The
Appellant did not ask me to reconsider his residency unless I found the subject
distributions were to be re-characterized as dividends. I have not made that
finding. As well, I accept the Appellant’s filing position as to his residence
in Canada until he crossed the
border on June 25, 2002. It is not without merit to allow an accepted filing
position which reflects a studied sequence of events aimed at ensuring that the
Appellant was a resident of Canada until he crossed the US border with an immigration permit
which entitled him entry as a resident there. While such a clear line cannot always
be drawn, given the preparatory efforts required for a change in residence, which
require both a severance of ties to Canada and the establishment of new
residential ties to another country, it may not be unreasonable in cases such
as this to look to the date and time of the physical departure as the date and
time of a change of residence. In this case, a finding that is that precise, as
to a moment in time, is possible; it reflects and coincides with the
Appellant’s mental, familial and personal detachment from Canada as the place he resided
until he crossed the border, is possible.
[137] Further, and perhaps
most importantly, there was an assumption made, as set out in the Reply, that
the Appellant was a resident of Canada at the time of the distributions that
are the subject of this appeal. The Appellant has not met the burden of proof
imposed to him to dispel this assumption.
Conclusion
[138] Having found that
subsection 84(2) does not apply to change the character of the Appellant’s
receipts in this case, and that the avoidance transaction in respect of the
Appellant’s utilization of his net capital losses was not abusive and that the
tax benefit inferentially asserted by the Respondent in respect of the surplus
stripping aspect of the subject series of transactions was neither material nor
abusive, I conclude that the appeal must be allowed.
[139] In closing, I add that
in not applying GAAR to the share sale I am mindful of what was enunciated on
more than one occasion in Canada Trustco; namely, that the
analysis of GAAR requires consideration of fairness. Indeed in the opening
paragraph of Canada Trustco, the Supreme Court of Canada said the GAAR
framework should achieve fair results. The allowance of this appeal ensures a
fair result. A tax plan that ensures the reconciliation of genuine capital
losses should not be the subject of a GAAR assessment, at least in these
circumstances, unless the Act expressly denies it.
[140] For all these Reasons,
the appeal is allowed, with costs.
Signed at Ottawa,
Canada this 17th day of April 2012.
“J.E. Hershfield”
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