Date: 20011115
Docket: 1999-2166-IT-G
BETWEEN:
JABIN INVESTMENTS LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor
Judgment
Hamlyn, J.T.C.C.
[1]
These are appeals from the Minister of National Revenue's
(the "Minister") reassessments for the 1992 and 1993
taxation years where the Minister applied the General
Anti-Avoidance Rules section 245 of the Income Tax Act
(the "Act").
INTRODUCTORY FACTS
[2]
The Minister and the Appellant agree that as of October 1989 the
Appellant was indebted to the Bank of Montreal (the
"Bank") for a debt in the amount of $2,278,990 (the
"Debt"). On October 17, 1990 the Bank sold the Debt to
W720 Holdings Ltd. ("W720") for $50,406. W720 was
incorporated for the purpose of "parking" the Debt.
Between certain shareholders and the Appellant it was understood
that the Debt would not be collected, although it would remain
legally enforceable. The purpose of transferring the
Appellant's indebtedness from the Bank to W720 was to avoid
the settlement or extinguishment of the Debt and prevent the
application of section 80, as it then read, of the Act,
thereby preserving the Appellant's accumulated non-capital
losses for future use in reducing its tax payable. In 1992 and
1993 the Appellant deducted non-capital losses in the amounts of
$445,037 and $545,695 respectively in computing its taxable
income. The Minister issued Notices of Reassessment dated March
27, 1997 for the Appellant's 1992 and 1993 taxation years
pursuant to section 245 of the Act, denying the deduction
of the non-capital losses.
ISSUES
[3]
At issue is whether section 245 of the Act applies to the
transfer of the Appellant's Debt from the Bank to W720 such
that the tax benefit to the Appellant may be denied. To determine
whether section 245 of the Act applies I will examine the
following questions:
1.
Did the transfer of the Debt from the Bank to W720 result in a
tax benefit?
2.
What was the primary purpose of the transfer of the Debt from the
Bank to W720?
3.
Did the transfer of the Debt from the Bank to W720 result in a
misuse of any specific provisions of the Act? and
4.
Did the transfer of the Debt from the Bank to W720 result in an
abuse of the Act read as a whole?
AGREED STATEMENT OF FACTS
[4]
At trial the Appellant and the Minister filed and relied on the
following agreed facts:
1.
The Appellant is a corporation with its registered and records
office located at 147 Park Road, Kelowna, British Columbia. The
Appellant is in the business of real estate development.
2.
In 1982 the Appellant's main creditor, the Bank of Montreal
(the "Bank") placed the Appellant into receivership. At
that time the Appellant owed the Bank $2.2 million plus accrued
interest.
3.
The receiver-manager operated the Appellant's business until
1988 at which point the Bank instructed the receiver-manager to
sell all remaining land held by the Appellant. The
receiver-manager remained in place until September 19,
1990.
4.
Prior to April 6, 1988, the sole shareholder of the Appellant was
Mr. Walter Leong.
5.
As of April 6, 1988, the shares of the Appellant were owned as
follows:
a)
51% - Wally Leong
b)
24.5% - Fort Borough Inc., all of the shares of which were owned
by Anson Chan, a business associate of Mr. Leong's
brother-in-law, Mr. Leon Tuey
c)
24.5% - 342101 Ontario, Ltd., all shares of which are owned by
Fay Tuey, Mr. Leong's sister
6.
On April 21, 1988 Oracle Investments Ltd. ("Oracle")
was incorporated. Its shareholders were as follows:
a)
25% - Canyon Falls Investments Inc., all of the shares of which
are owned by Terry Winnick, Mr. Leong's wife
b)
25% - Interval Investments Ltd., (the shares of which are owned
25% by each of Mr. Leong's three Children and 25% by Canyon
Falls Investment Inc.
c)
25% - Fort Borough Inc.
d)
25% - 342101 Ontario Ltd.
7.
In July 1988, the Appellant transferred its real estate to
Oracle, which proceeded over the next years to develop and sell
it as part of a joint venture with the Appellant, as referred to
in paragraph 17 below.
8.
By October 1989 the Appellant was indebted to the Bank in the
amount of $2,278,990, of which Mr. Leong had personally
guaranteed $1,224,114.
9.
By the end of 1989 the Appellant had accumulated large
non-capital losses.
10.
Beginning in early 1990 Mr. Leong attempted to find a way by
which these tax losses of the Appellant could be preserved, it
being understood that the party seeking to utilize the losses
would acquire the indebtedness of the Appellant from the Bank and
that Mr. Leong would be released from his personal guarantee to
the Bank.
11. In
July of 1990, W720 Holdings Ltd. ("W720") was
incorporated in furtherance of Mr. Leong's attempt to find a
way to preserve the Appellant's tax losses. Its shareholders
were as follows:
a)
25% Fort Borough,
Inc.
b)
25% 342101 Ontario
Ltd.
c)
50% Terry Winnick
12.
W720 was incorporated for the sole purpose of purchasing the
Appellant's indebtedness from the Bank and
"parking" it. The reference to "parking" the
debt means that W720, a corporation having certain shareholders
in common with the Appellant, would not attempt to collect any
amount owing by the Appellant on the debt although the debt would
remain legally enforceable.
13.
The efforts of Mr. Leong to find a way in which to utilize the
Appellant's tax losses culminated in an agreement entered
into on October 17, 1990 (a copy of which is attached as Exhibit
A) whereby the Appellant's indebtedness to the Bank was sold
for $50,406 to W720.
14. Had
the Bank merely forgiven the Appellant's indebtedness, the
Appellant's non-capital losses would have no longer been
available for future use because the debt would have been
"settled or extinguished" within the meaning of section
80 of the Income Tax Act (the "Act").
15. The
purpose of transferring the Appellant's indebtedness from the
Bank to W720 was to avoid there being a settlement or
extinguishment of the debt and thereby to preserve the
Appellant's accumulated non-capital losses for future use in
reducing its tax payable.
16.
Under the agreement of October 17, 1990, Mr. Leong was also
relieved of his obligation under his guarantee of the
Appellant's indebtedness. As a precondition to releasing Mr.
Leong from his guarantee, the Bank required that Mr. Leong
provide a statutory declaration setting out his assets and
liabilities. In his statutory declaration (appended to the
October 17, 1990 agreement) Mr. Leong disclosed assets of
$3,000 and liabilities in excess of $2.3 million.
17. By
an agreement dated for reference May 15, 1991 but effective as of
April 6, 1988 (attached as Exhibit B), the Appellant and
Oracle entered into a joint venture for the development of the
real estate transferred by the Appellant to Oracle in July 1988.
Under the agreement the Appellant was entitled to 75% of the
profits from the joint venture. The joint venture had the
following profits in the years ended June 30:
1989 $151,784
1990 $312,823
1991 $545, 873
1992 $1,032,617
18. The
Appellant received income from the joint venture of $312,823 in
1991, $445,037 in 1992 and $774,463 in 1993. It purported to
deduct non-capital losses of $445,037 in 1992 and $545,695 in
1993 in determining its taxable income.
19.
The Appellant has not paid any amount under the debenture to
W720. W720 has not taken any steps to collect any amount owing by
the Appellant under the debenture and has forgiven all interest
on the indebtedness.
20. In
reassessing the Appellant, the Minister assumed that section 80
of the Act, as it then read, was inapplicable to the sale
of the Appellant's indebtedness by the Bank to W720 Holdings
Ltd. and, accordingly, issued reassessments relying wholly on
section 245 of the Act.
EVIDENCE AT TRIAL
[5]
At the outset, counsel for the Appellant stated that his
submissions would focus on the narrow issue of whether or not the
sale of the Debt from the Bank to W720 resulted in a misuse of
the provisions of the Act or an abuse of the Act
taken as a whole.
[6]
The Appellant conceded that the transaction in question resulted
in a "tax benefit" pursuant to section 245 of the
Act. The Appellant chose not to present any argument on
the issue of whether or not the sale of the Debt from the Bank to
W720 was an avoidance transaction. It was open to the Appellant
to argue that the "primary purpose" of the transaction
was not to obtain a tax benefit. However, both the Appellant and
the Respondent took the opportunity to read in portions of
examinations for discoveries that in essence provided evidence to
support their positions on the "primary purpose" aspect
of the section 245 analysis.
The Appellant read in from the examination for discovery of
Mark Marichuk, a Crown officer:
[7]
Mr. Marichuk testified that there was no debate that W720
purchased the Debt from the Bank. Further, that there was no
argument that the documents transferring the Debt were
ineffective or the transaction could be considered a sham. He
confirmed that Mr. Leong had a personal guarantee to the
Bank in the neighbourhood of $2 million and that as a result of a
series of transactions Mr. Leong was absolved of his
personal guarantee. Finally, counsel for the Respondent conceded
in discovery that the release of a personal guarantee could have
a business purpose, and that the Minister was not asserting that
there was no business purpose in the present case.
The Minister read in from the examination for discovery of
Walter Leong, principle shareholder of the
Appellant:
[8]
Mr. Leong testified in his examination for discovery that he was
authorized to provide answers that were binding on the Appellant
in these proceedings. He confirmed that the funds W720 used to
purchase the Debt from the Bank came from the joint venture
between Oracle and the Appellant. He confirmed that income
reported in the Appellant's 1990 tax return from the sale of
land was in fact income from the joint venture between Oracle and
the Appellant, as all of the Appellant's lands had already
been sold to Oracle in 1988. He was unable to confirm whether or
not the receiver that had been appointed to manage the Appellant
was aware of the joint venture project between Oracle and the
Appellant. The Minister sought explanation in the discovery for
the discrepancy between the allocation of income shown on the
Appellant's financial statements and that called for under
the joint venture agreement. During the discovery counsel for the
Appellant objected to the relevance of the questions being asked
of Mr. Leong. The Minister stated that the evidence sought
was relevant to the Appellant's purpose in carrying out the
transaction. In response, counsel for the Appellant stated:
We admit the purpose. We admit the purpose in doing the
transaction: this was to circumvent the provisions of section
80.
[9]
Counsel for the Respondent responded that it was his
understanding that the Appellant was also asserting that the
purpose of the transaction was to have Mr. Leong released
from his personal guarantee to the Bank and that at the time
Mr. Leong did not have sufficient funds to obtain a release
of his personal guarantee. Counsel for the Respondent stated that
the purpose of the questions being posed was to determine whether
or not Mr. Leong had funds available to obtain a release of
his personal guarantee from the Bank. Counsel for the Appellant
offered to obtain answers regarding the discrepancy in the
allocation of income shown on the Appellant's financial
statement and that called for in the joint venture agreement
between Oracle and the Appellant.
[10] During
the examination for discovery it was admitted that the Appellant
had not made any payments on the Debt to W720 and that no demand
for payment had been made.
[11] Mr. Leong
stated that he had arranged the sale of the lands from the
Appellant to Oracle and that the sale of the lands was his first
and only business dealing with his brother-in-law, Leon Tuey and
another individual named Anson Chan, that after 1988 when
the Appellant had sold its remaining undeveloped land to Oracle,
it had no other assets and that under the joint venture agreement
it was the Appellant's responsibility to develop the lands
and it did in fact develop the lands.
[12] In answer
to the question why the Appellant became entitled to a larger
share of the income from the joint venture, Mr. Leong
responded that the joint venture would be worthless if the lands
were not developed and that development of the lands was the
responsibility of the Appellant.
The following are answers to the undertakings given by the
Appellant which were read in at trial:
[13] The
discrepancy in the income reported on the Appellant's tax
returns and that called for in the joint venture agreement was
explained to be an offset of a previous year's unequal
division of income. The Appellant stated that by the end of 1991
the historical allocation of the joint venture income was equal
to the allocation called for in the joint venture agreement.
[14] It was
admitted that prior to the settlement agreement being entered
into the Appellant had received income in excess of $312,000 from
the joint venture.
RELEVANT LEGISLATION
Section 245:
245. [General Anti-Avoidance Rule — GAAR] — (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;
"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;
"transaction" includes an arrangement or event.
(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.
(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.
(4) Where subsection (2) does not apply — 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.
(5) Determination of tax consequences — Without
restricting the generality of subsection (2),
(a) any deduction in computing income, taxable income,
taxable income earned in Canada or tax payable or any part
thereof may be allowed or disallowed in whole or in part,
(b) any such deduction, any income, loss or other
amount or part thereof may be allocated to any person,
(c) the nature of any payment or other amount may be
recharacterized, and
(d) the tax effects that would otherwise result from
the application of other provisions of this Act may be
ignored,
in determining the tax consequences to a person as is
reasonable in the circumstances in order to deny a tax benefit
that would, but for this section, result, directly or indirectly,
from an avoidance transaction.
Section 80, as it then read:
History for ITA subsection 80(1)
[15] History:
Subsection 80(1) was amended by S.C. 1995, c. 21, s. 27(1). For
its application, see S.C. 1995, c. 21, s. 27(2), reproduced after
section 80.
[16]
Subsection 80(1) formerly read:
80. Debtor's gain on settlement of debts —
(1) Where at any time in a taxation year a debt or other
obligation of a taxpayer to pay an amount is settled or
extinguished after 1971 without any payment by the taxpayer or by
the payment of an amount less than the principal amount of the
debt or obligation, as the case may be, the amount by which the
lesser of the principal amount thereof and the amount for which
the obligation was issued by the taxpayer exceeds the amount so
paid, if any, shall be applied
(a)
to reduce, in the following order, the taxpayer's
(i) non-capital losses,
(i.1) farm losses,
(ii) net capital losses, and
(iii) restricted farm losses,
for preceding taxation years, to the extent of the amount of
those losses that would otherwise be deductible in computing the
taxpayer's taxable income for the year or a subsequent year,
and
(b) to the extent that the
excess exceeds the portion thereof required to be applied as
provided in paragraph (a), to reduce in prescribed manner
the capital cost to the taxpayer of any depreciable property and
the adjusted cost base to the taxpayer of any capital
property,
unless
(c) the taxpayer is, at that
time, a bankrupt within the meaning of section 128,
(d) the debt or obligation was
such that
(i)
where interest was paid or payable by the taxpayer in respect of
it pursuant to a legal obligation, or
(ii)
if interest had been paid or payable by the taxpayer in respect
of it pursuant to a legal obligation,
no amount in respect of the interest was or would have been
deductible under this Part in computing the taxpayer's income
if this Act were read without reference to subsections 18(2),
(3.1) and (4) and section 21,
(e) section 79 is applicable in
respect of the debt or obligation,
(f) the excess is
otherwise required to be included in computing the taxpayer's
income for the year or a preceding taxation year or to be
deducted in computing the capital cost to the taxpayer of any
depreciable property, the adjusted cost base to the taxpayer of
any capital property or the cost amount to the taxpayer of any
other property,
(g) the excess would be deemed
by subsection 39(3) to be a capital gain of the taxpayer for the
year from the disposition of a capital property if this Act were
read without reference to this subsection, or
(h) the debt or obligation is
settled or extinguished by way of bequest or inheritance.
RECENT JURISPRUDENCE
[17] In
determining whether section 245 of the Act is applicable
this Court has reviewed the recent decision of the Federal Court
of Appeal in OSFC Holdings Ltd. v. Her Majesty The
Queen, [2001] F.C.J. No. 1381 (Q.L.),
("OSFC").
[18] According
to Rothstein J.A., speaking for the majority of the Federal Court
of Appeal, the proper manner to apply section 245 of the
Act is as follows:
1.
Determine whether section 245 applies:
To determine whether section 245 of the Act applies you
must first look at subsection 245(2), the charging provision. It
provides that section 245 will only apply where a tax
benefit would result from a transaction that is an
"avoidance transaction" or from a
"series" of transactions that includes an
"avoidance transaction". I will briefly discuss
each of these preconditions.
a.
Benefit: Whether or not there is a benefit is a question of
fact. There are no words in section 245 that express or imply
that the person who obtains the "tax benefit" must
necessarily have been the person that undertook or arranged the
transaction in question, in other words it does not matter who
obtained the benefit.
b.
Series: A transaction is part of a "series" under
subsection 245(2) if:
i.
a series of transactions within the common law meaning
exists,
ii.
the particular transaction is "related" to the common
law series; and
iii.
the
related transaction is completed in contemplation of the
series.
The common law definition of a "series of transactions"
adopted by the Federal Court of Appeal is found in Furniss
v. Dawson, [1984] A.C. 474 (H.L.). At paragraph 24,
Rothstein J.A. summarized the test as follows:
... for there to be a series of transactions, each transaction
in the series must be pre-ordained to produce a final result.
Pre-ordination means that when the first transaction of the
series is implemented all the essential features of the
subsequent transactions are determined by persons who have a firm
intention and ability to implement them. That is, there must be
no practical likelihood that the subsequent transaction or
transactions will not take place.
This common law definition is broadened by subsection 248(10),
which reads:
248(10) For the purposes of this Act, where there is a
reference to a series of transactions or events, the series shall
be deemed to include any related transactions or events completed
in contemplation of the series.
The related transaction does not need to be pre-ordained and
there is no restriction on when the transaction needs to be
completed. As long as the transaction has some connection with
the common law series, it will, if it was completed in
contemplation of the common law series, be included in the series
by operation of the deeming provision in subsection 248(10).
A related transaction will be considered to be completed in
contemplation of the common law series if the parties to the
related transaction knew of the common law series, such that it
could be said that they took it into account when deciding to
complete the related transaction.
c.
Avoidance Transaction: Once it is determined that a series of
transactions results in a tax benefit, any of the transactions
that is part of that series may be found to be an "avoidance
transaction". The question is the primary purpose of each of
the transactions in the series. If the primary purpose of any
transaction is to obtain a tax benefit it is considered an
"avoidance transaction". Determining the primary
purpose of a transaction is an objective test, assessed at the
time the transaction in question was undertaken.
The primary purpose of a transaction will be determined on the
facts of each case. Rothstein J.A. stated at paragraph 58:
... I would stress that the primary purpose of a transaction
will be determined on the facts of each case. In particular, a
comparison of the amount of the estimated "tax benefit"
to the estimated business earnings may not be determinative,
especially where the estimates of each are close. Further, the
nature of the business aspect of the transaction must be
carefully considered. The business purpose being primary can not
be ruled out simply because the tax benefit is significant.
Once it is determined that there is a tax benefit resulting
from an avoidance transaction or from a series of transactions
that include an avoidance transaction then section 245 will apply
unless, the avoidance transactions does not result in a misuse of
a specific provision or an abuse of the Act read as a
whole. Subsection 245(4) of the Act is a relieving
provision that will prevent the application of section 245 of the
Act where it can be shown that the impugned transaction is
not a misuse of a particular provision or an abuse of the
Act read as a whole.
According to Rothstein J.A., determining whether or not a
transaction results in a misuse of a particular provision or an
abuse of the Act, read as a whole is a two-step
process, he stated at paragraph 67:
Determining whether there has been misuse or abuse is a
two-stage analytical process. The first stage involves
identifying the relevant policy of the provisions or the Act as a
whole. The second is the assessment of the facts to determine
whether the avoidance transaction constituted a misuse or abuse
having regard to the identified policy.
The inquiry should proceed as follows:
2.
Determine whether any of the avoidance transactions result in a
misuse or abuse:
a.
Whether it may reasonably be considered that an avoidance
transaction results in a misuse of a specific provision:
i.
first, determine what the policy of the specific provision is;
and
ii.
second, assess the facts to determine whether the avoidance
transaction constituted a misuse having regard to the identified
policy.
b.
Whether it may reasonably be considered that any of the avoidance
transactions would result in an abuse of the Act?
i.
first, determine the relevant policy of the Act as a
whole; and
ii.
second, assess the facts to determine whether the avoidance
transaction constituted an abuse having regard to the identified
policy.
Generally the Minister will set out the policy by reference to
the provisions of the Act or extrinsic aids. However,
ultimately it is a question of interpretation and it is the duty
of the Court to determine what the relevant policy is. Once the
policy is determined the onus remains on the taxpayer to prove
the necessary facts to refute the Minister's assumption of
fact that the avoidance transaction in question results in a
misuse of a specific provision or an abuse of the Act read
as a whole.
If it is found that the avoidance transaction does result in a
misuse or abuse of the Act then the tax benefit will be
denied under subsection 245(5).
SUBMISSIONS
Appellant:
[19] At the
outset of the Appellant's submissions, counsel stated that in
light of the recent decision by the Federal Court of Appeal in
OSFC, supra the Appellant would be focusing his argument
on the issues of whether or not the sale of the Debt from the
Bank to W720 resulted in a misuse of any specific provisions of
the Act or an abuse of the Act, read as a whole.
Counsel contended that in order for the Court to apply section
245 of the Act, the Minister must first show a cogent
policy behind the specific provision or the Act read as a
whole.
[20] The
Appellant conceded that the transaction resulted in a "tax
benefit", and further that he was not debating the avoidance
transaction issue. Argument was limited to the assertion that the
transaction did not result in a misuse of a specific provision or
an abuse of the Act read as a whole.
[21]
Counsel's argument on the issue of whether the transaction
resulted in a misuse was extremely brief. Asserting that since
section 80 of the Act, as it read then, did not apply, it
was never used and could therefore not have been misused.
[22] The focus
of counsel's argument was whether or not the transaction
resulted in an abuse of the Act read as a whole. Counsel
stated that where borrowed monies are used to purchase property,
the Act allows for the cost of that property to be
deducted. The purpose behind section 80 of the Act, as it
read then, was to disallow deductions related to the cost of
property purchased with borrowed funds where the debt associated
with the purchase of property was legally forgiven. Counsel
pointed out that there is a distinction between the policy behind
the pre-1994 section 80 and the post-1994 section 80. Under the
new provision the transfer of a debt to a non-arm's length
creditor would result in a deemed settlement, however if a debt
that was deemed to be settled is subsequently repaid the
provision provides relief in the form of a deduction available at
the time the debt is repaid. The old provision only applied to
legally extinguished debts, and thus there was no relieving
provision. Counsel for the Appellant summarized that the relevant
policy before 1994 was that for section 80 of the Act
to apply there had to be a legal extinguishment.
[23] According
to the Appellant the Minister was asserting that although the
Debt remained legally enforceable, because it was in the hands of
a friendly creditor the economic effect was the same as if it
were settled or extinguished. However, ignoring the legal effect
of the transaction, the possibility that at some future time a
debt may be enforced was overlooked. Counsel submitted that if in
the present case W720 went into receivership, the receiver would
attempt to collect this legally enforceable Debt.
[24] Counsel
submitted that the GAAR analysis should be limited to the
examination of the actual transactions, not the economic
consequences resulting from the transactions. In support of this
principle counsel directed the Court to the words of Bonner
T.C.J. in Canadian Pacific Ltd. v. Her Majesty The
Queen, 2000 DTC 2428 at page 2431:
[10] At this
point I will note that I do not agree with the Respondent's
assertion that "issuing the debt in A$ rather than the
needed C$ ... converted non-deductible Canadian principal
repayments to a deductible expense thereby inflating the cost of
borrowing solely for tax purposes". While that statement may
be accurate as a condensed description of overall economic effect
it is not what happened at all and it is important for purposes
of the s. 245 analysis to be clear on what did happen. What the
Appellant did was choose to satisfy its need for capital for use
in its business by borrowing money. It made a second choice,
namely, to achieve its objective by means of a borrowing of A$.
That second choice carried with it a burden and a benefit. The
burden was the obligation to pay interest on the borrowed money
at 16.125%, the market rate for A$ borrowings. That rate was
substantially higher than the rate which the Appellant would have
been obliged to pay had it borrowed C$ directly. The benefit was
the opportunity to engage in a profitable foreign exchange
transaction. The Appellant was able to sell for immediate
delivery the A$ which it had borrowed. It was able to buy in 1989
for delivery in 1994 the A$ required to retire the debentures at
maturity. The difference between the exchange rate applicable to
1989 sales of A$ for immediate delivery and the rate applicable
to purchases in 1989 of A$ for delivery in 1994 yielded the
Appellant an enormous foreign exchange profit. There can be no
doubt that the high interest rate on A$ borrowings was linked to
the inflationary conditions which made the A$ delivered in 1994
worth less than the A$ delivered in 1989 but that economic
linkage does not support a conclusion that the principal
repayments on the debentures were in some way
"converted" into a deductible expense. S. 245 does not
permit the recharacterization of an event for purposes of
determining whether s. 245(2) applies. Recharacterization is
permissible under s. 245(5)(c) only where it can be found
that s. 245(2) applies on the basis of transactions which have
not been subjected to recharacterization.
[25] Counsel
submitted that in the present case the Minister was attempting to
use section 245 of the Act to retroactively apply the
broadened policy, encompassing deemed extinguishments, found in
the post-1994 provision. Counsel submitted that attempting to
retroactively apply the new section 80 was an improper use of
section 245, relying on the words on Bowman, A.C.J.T.C. in
Geransky v. The Queen, 2001 DTC 243 where he stated
at page 250:
[42] Simply
put, using the specific provisions of the Income Tax Act
in the course of a commercial transaction, and applying them in
accordance with their terms is not a misuse or an abuse. The
Income Tax Act is a statute that is remarkable for its
specificity and replete with anti-avoidance provisions designed
to counteract specific perceived abuses. Where a taxpayer applies
those provisions and manages to avoid the pitfalls the Minister
cannot say "Because you have avoided the shoals and traps of
the Act and have not carried out your commercial transaction in a
manner that maximizes your tax, I will use GAAR to fill in any
gaps not covered by the multitude of specific anti-avoidance
provisions".
[43] That is
not what GAAR is all about.
Respondent:
[26] Counsel
for the Respondent submitted that the policy behind section 80 of
the Act was to deal with the economic substance of debt
forgiveness. Counsel submitted that the rationale behind section
80 of the Act can be traced to the recommendations of the
Carter Commission, which preceded the tax reform of 1972. Prior
to 1972 there was no specific provision dealing with the tax
consequences resulting from the forgiveness of debt. In 1966 the
Carter Commission recommended that the cancellation or
forgiveness of debt should be treated as income. Counsel referred
the Court to the following statement of the Commission:
We believe that when a debt is cancelled the debtor has, in
effect, received income. For, as the cancellation of liabilities
increases a person's net assets, his economic power is
increased by the amount of the debt cancelled. Where a debtor who
is in business has one or more of his debts cancelled, he has
claimed expenses or has recorded assets which in fact will cost
him nothing. Income in prior years has, therefore, been
understated, and it appears only reasonable to require an
offsetting adjustment in the current year. Because as an
adjustment will usually only arise when there is a loss, it will
serve to reduce the loss rather than to create taxable income. [1]
[27] Counsel
conceded that Parliament did not accept the recommendation for a
straight income inclusion, but instead accepted the Carter
Commission's secondary proposal, which was to reduce the
non-capital losses and the capital losses of the taxpayer's
property at the time the debt was forgiven. Counsel submitted
that this approach still reflected the recognition of an economic
gain to a taxpayer on a settlement of debt, that the underlying
rationale for section 80 was to determine the tax consequences of
the debt relief, whether it was a legal or de facto
settlement or extinguishment.
[28] Counsel
contended that Parliament did not intend to just address legal
extinguishment. On this point counsel referred the Court to the
fact that the Carter Commission had initially recommended that
the Act address deemed debt forgiveness, where they
stated:
The debt should be deemed to be cancelled at the earliest of
the following times: the time of acknowledgement of the
cancellation of the debt by the debtor; the time the court
approved the arrangement under the Bankruptcy Act; or the
expiry of the limitation period. (page 535)
[29] Counsel
asserted that a debt being deemed extinguished at the expiration
of the limitation period would be analogous to the present case,
in that it would not be legally extinguished. If a taxpayer made
a payment subsequently there would have been no relief under the
Act. The fact that Parliament did not provide a relieving
provision in section 80 prior to 1994 is not indicative of a
policy to only deal with legally extinguished debts. The proposed
inclusion of a provision to deem extinguished debts that were
statute barred is, according to counsel for the Respondent,
indication that Parliament's intention in enacting section 80
was not simply to address legally forgiven debts.
[30] Counsel
for the Respondent asserted that in the present case it is clear
that the Appellant has an economic gain from the sale of the Debt
to W720 because it is admitted in the Agreed Statement of Facts
that there would be no attempt to collect the Debt. The Debt,
while legally enforceable, has, from an economic perspective,
been extinguished.
[31] Counsel
for the Respondent stated that the Crown was not attempting to
re-characterize the transactions, as was the case in
Geransky, supra and Canadian Pacific, supra.
Rather, given the intention of the parties in the present case,
the transaction on its face amounts to a de facto
extinguishment.
[32] Counsel
for the Respondent asserted that it was not open for this Court
to look at the 1994 amendments to section 80 as illuminating in
any way the intention of Parliament with respect to the earlier
provision. The Court was referred to United States v.
Dynar, [1997] 2 S.C.R. 462 where the Supreme Court of Canada
stated at page 484:
What legal commentators call "subsequent legislative
history" can cast no light on the intention of the enacting
Parliament or Legislature. At most, subsequent enactments reveal
the interpretation that the present Parliament places upon the
work of a predecessor. And, in matters of legal interpretation,
it is the judgment of the courts and not the lawmakers that
matters. It is for judges to determine what the intention of the
enacting Parliament was...
Moreover, to consult "subsequent legislative
history" as an aid to the interpretation of prior enactments
would be to give the subsequent enactments retroactive effect;
and, as this Court has often observed, statutes are not to be
given retroactive effect except in the clearest of cases.
ANALYSIS
[33] Issue 1:
Did the transfer of the Debt from the Bank to W720 result in a
tax benefit? The Appellant has conceded that the sale of the Debt
from the Bank to W720 has resulted in a tax benefit. In any case,
given the broad definition ascribed to "tax benefit" in
subsection 245(1) of the Act, I would conclude that the
preservation of the Appellant's non-capital losses through
the sale of the Debt to W720 and the deduction of these
non-capital losses in the 1992 and 1993 taxation years was a
"tax benefit" within the meaning of section 245 of the
Act.
[34] Issue 2:
What was the primary purpose of the transfer of the Debt from the
Bank to W720? Neither the Appellant nor the Minister presented
argument at trial regarding the primary purpose of the sale of
the Debt from the Bank to W720. However, both read in evidence
from examinations for discoveries, which was relevant to the
issue of whether the primary purpose of the transaction was to
obtain a tax benefit.
What can be gleaned from the evidence presented is that aside
from the preservation of the Appellant's non-capital losses
the sale of the Debt from the Bank to W720 resulted in the
Appellant's principle shareholder being released from
personal guarantees to the Bank on the debt instrument.
Whether the release of the personal guarantee could be considered
to be the primary purpose of the transaction need not be dealt
with in this decision. Despite presenting evidence that would
lead the Court to believe the Appellant would be asserting that
the primary purpose of the transaction was to relieve Mr. Leong
of his personal guarantee to the Bank, counsel for the Appellant
conceded during discovery (exhibit R-2) that the purpose of the
transaction was to circumvent section 80 of the Act.
Circumventing section 80 of the Act was necessary for the
Appellant to preserve its significant non-capital losses.
Preservation of these non-capital losses was a "tax
benefit", therefore the primary purpose of the transaction
was to obtain a tax benefit.
[35] Issue 3:
Did the transfer of the Debt from the Bank to W720 result in a
misuse of any specific provisions of the Act? On the issue
of whether the sale of the Debt from the Bank to W720 resulted in
a misuse of a specific provision of the Act, I accept the
Appellant's contention that to avoid the application of a
specific provision does not result in a misuse. The word
"misuse" is defined in the Concise Oxford Dictionary as
follows:
misuse v. & n. - v. tr.
/misju:z/ 1. use wrongly; apply to the wrong purpose.
2. ill-treat. -n. /mis'ju:s/ wrong
or improper use or application.
By "parking" the Debt the Appellant avoided the
application of section 80 of the Act, as it read
then. Avoiding the application of a specific provision of
the Act does not logically fall within the ambit of the
word "misuse". It is self-evident that if section 80
was not used it could not be misused.
[36] Issue 4:
Did the Transfer of the Debt from the Bank to W720 result in an
abuse of the Act read as a whole? While evidence relevant
to other aspects of the application of section 245 was filed by
consent of the parties, the Court was asked to focus its
attention on the misuse and abuse portion of the section 245
analysis. Having determined that the avoidance of a particular
section of the Act does not constitute a misuse, the
primary question to be resolved in this appeal is whether or not
the transaction in question results in an abuse of the Act
read as a whole.
[37] In
OSFC, supra Rothstein J.A., speaking for the majority of
the Federal Court of Appeal, addressed the test to be applied in
determining whether there has been an abuse of the Act,
stating:
[67]
Determining whether there has been misuse or abuse is a two-stage
analytical process. The first stage involves identifying the
relevant policy of the provisions or the Act as a whole. The
second is the assessment of the facts to determine whether the
avoidance transaction constituted a misuse or abuse having regard
to the identified policy.
[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. Of course, at the next stage, once the policy is
determined, the onus remains on the taxpayer to prove the
necessary facts to refute the Minister's assumptions of fact
that the avoidance transaction in question results in a misuse or
an abuse.
[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.
[70] In answer
to the argument that such an approach will make the GAAR
difficult to apply, I would say that where the policy is clear,
it will not be difficult to apply. Where the policy is ambiguous,
it should be difficult to apply. This is because subsection
245(4) cannot be viewed as an abdication by Parliament of its
role as lawmaker in favour of the subjective judgment of the
Court or particular judges. In enacting subsection 245(4),
Parliament has placed the duty on the Court to ascertain
Parliament's policy, as the basis for denying a tax benefit
from a transaction that otherwise would meet the requirements of
the statute. Where Parliament has not been clear and unambiguous
as to its intended policy, the Court cannot make a finding of
misuse or abuse, and compliance with the statute must govern.
[38] Both
counsel for the Appellant and the Respondent submitted arguments
regarding the relevant policy of the Act with respect to
the settlement of debts. The Appellant asserted that in order for
section 80 of the Act, as it read then, to apply there had
to be a legal settlement of the Debt, whereas the Minister stated
that the intention of Parliament in enacting section 80 of the
Act was to tax the economic gain to a taxpayer that
resulted from a debt forgiveness. The Minister's assertion
encompassed more than just legally extinguished debts.
[39] I agree
with counsel for the Respondent that this is not a case where the
Minister has attempted to re-characterize the transactions. Had
the Minister argued that section 80 applied, or even that the
Debt was legally extinguished, that would amount to a
re-characterization of the transaction.
[40] In this
case the issue of whether or not there has been an abuse of the
Act read as a whole can be resolved by simply determining
whether the policy behind section 80 of the Act, as
it then read, was to apply tax consequences where a debt was
legally forgiven or whether the policy was broader, broad enough
to catch de facto extinguishment.
[41] The
Minister asserted that the policy behind section 80 could be
gleaned from the Carter Commission's report, which preceded
the enactment of section 80 in 1972. I accept that the Carter
Commission's report, on the whole, was directed at taxing
economic effects. The often quoted phrase "a buck is a buck
is a buck" is an accurate reflection of the Report's
contention that taxes should be allocated based on changes in
economic power. However, the sweeping changes proposed by the
Carter Commission in 1966 were not adopted by Parliament in the
new Income Tax Act that was introduced in 1972.[2] With respect to the
Commission's recommendations regarding debt cancellation,
Parliament rejected the primary recommendation for a straight
income inclusion where a debt was cancelled. Instead, Parliament
enacted a mechanical provision that reduced tax pools, such as
non-capital losses, where there had been a debt forgiveness. The
question remains whether Parliament intended this provision to
apply only where there was a legal extinguishment or whether it
was intended to apply where a taxpayer obtained an "economic
gain" as a result of the debt forgiveness.
[42] Even if
it is accepted that Parliament's intention can be determined
from the Carter Commission's recommendations, I would surmise
that the Commission itself only intended the specific provisions
to apply where there was a legally forgiven debt. At page 528 of
the Commission's report they state:
Cancellation of a debt occurs when there is no longer any
legal obligation binding upon a debtor to pay all or some part of
his debts. Examples are court-approved or voluntary arrangements
by which a liability is reduced or cancelled or the involuntary
cancellation that occurs by the operation of the Statute of
the Limitations under which the right to enforce
collection is lost.
The Commission went on to acknowledge that there was a problem
in determining when a debt was cancelled, stating at pages
529-530:
There is a problem in determining when cancellation should
give rise to a deemed receipt of income. Cancellation of a debt
usually requires some overt act on the part of the creditor.
Debts may, however, become unenforceable by reason of the
Statute of Limitations. We believe it reasonable to
deem that income has arisen upon the expiry of the limitation
period. Therefore income should arise at the earliest of: the
time of the acknowledgement of the cancellation of the debt by
the debtor; the time the court approved an arrangement under the
Bankruptcy Act; or the expiry of the limitation
period. It should be noted that, because the limitation period
does not bar the right but only the remedy, it would not prevent
collection unless specifically pleaded in the action to collect
the debt. Furthermore, the limitation might cease to apply
because of a subsequent acknowledgment of the debt or part
payment by the debtor. Nevertheless, because the limitation
period is fixed, we think that it should be the latest time to
which the recording of income should be deferred by the debtor.
In any case, whenever the debtor pays an amount which he had
previously included in income on the ground that his indebtedness
to pay the amount was cancelled, he should be allowed a deduction
from income. This should effectively prevent any hardship arising
from the inclusion in income of the cancelled debt
[43] Here the
Commission was recommending a deemed extinguishment of debts
under a given set of circumstances. This indicates that where the
Commission refers to "cancelled", they are referring to
legally cancelled debts. It is noted that these deemed
cancellations were not adopted by Parliament in the 1972 reforms.
Neither was the Commission's recommendation to allow for a
deduction in the event that a taxpayer later paid a debt that had
previously been included in income by operation of a deemed
cancellation. The exclusion of a relieving provision indicates
that when Parliament enacted section 80 in 1972, they intended
that it would only apply to legally extinguished debts, as such a
relieving provision was not necessary.
[44] While it
is not open to the Court to look at the amendments made to
section 80 in 1995 to interpret the intention of the Parliament
in 1972, because this would merely reveal the interpretation that
the Parliament of 1995 placed upon the work of its predecessor.
It is open to this Court to draw logical inferences both from
what was and what was not included in the legislation in
determining Parliament's intention. Counsel for the
Appellant's lengthy submissions on the distinction between
the policy behind the pre-1994 section 80 and the post-1994
section 80 directed that in not providing a relieving provision
in the earlier legislation it is logical to infer that Parliament
only intended the provision to apply to legally extinguished
debts. I accept this inference, and note that where the Carter
Commission refers to "deemed extinguishments", they too
would have provided a relieving provision. It is logical that if
Parliament in 1972 had chosen to tax the broad economic gain,
they would have provided a relieving provision.
[45] I also
accept the argument that although at the present time the Debt is
not being enforced, it is possible in the future the Debt could
be collected; as long as the Debt remains legally enforceable, a
change in the control of W720 or the appointment of a receiver
could result in the Debt being enforced.
CONCLUSION
[46] I
conclude that from 1972 through 1994, when the major revisions to
section 80 of the Act took effect, the policy
intended by Parliament was to impose tax consequences where a
debt was legally extinguished. In the present case:
(i)
the transfer of the Debt from the Bank to W720 did result in a
tax benefit;
(ii)
the primary purpose of the transfer was to obtain a tax
benefit;
(iii)
the "parking" of the Debt avoided the application of
section 80, therefore section 80 was not being used, it
was not therefore misused; and
(iv) the
Debt in question was not legally extinguished and the policy
behind the Act with respect to settlement of debts has not
been abused. Therefore, the transfer of the Debt from the Bank to
W720 does not result in an abuse of the Act, so as to
invoke the application of section 245 of the Act.
DECISION
[47] From the
foregoing the appeals are allowed and the reassessments are
referred back to the Minister of National Revenue for
reconsideration and reassessment on the basis that the
application of section 245 of the Act does not apply to
the transfer of the debt in issue .
[48] The
Appellant is entitled to costs.
Signed at Ottawa, Canada, this 15th day of November 2001.
"D. Hamlyn"
J.T.C.C.
COURT FILE
NO.:
1999-2166(IT)G
STYLE OF
CAUSE:
Jabin Investments Ltd. and
Her Majesty the Queen
PLACE OF
HEARING:
Vancouver, British Columbia
DATE OF
HEARING:
September 17, 2001
REASONS FOR JUDGMENT
BY:
The Honourable Judge D. Hamlyn
DATE OF
JUDGMENT:
November 15, 2001
APPEARANCES:
Counsel for the
Appellant:
Warren J.A. Mitchell, Q.C.,
Douglas H. Mathew, Terry Gill
Counsel for the
Respondent:
Robert Carvalho, Brent Paris,
Eric A. Douglas
COUNSEL OF RECORD:
For the
Appellant:
Name:
Warren J.A. Mitchell, Q.C.,
Douglas H. Mathew, Terry Gill
Firm:
Thorsteinssons
Vancouver, British Columbia
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
1999-2166(IT)G
BETWEEN:
JABIN INVESTMENTS LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on September 17, 2001 at
Vancouver, British Columbia, by
the Honourable Judge D. Hamlyn
Appearances
Counsel for the
Appellant: Warren
J.A. Mitchell, Q.C., Douglas H. Mathew, Terry Gill
Counsel for the Respondent: Robert
Carvalho, Brent Paris,
Eric A. Douglas
JUDGMENT
The
appeals from the assessments made under the Income Tax Act
(the "Act") for the 1992 and 1993 taxation years
are allowed, and the assessments are referred back to the
Minister of National Revenue for reconsideration and reassessment
on the basis that the transfer of the transaction in question
does not result in an abuse of the Act read as a whole
such as to invoke the application of section 245 of the
Act.
The
Appellant is entitled to costs.
Signed at Ottawa, Canada, this 15th day of November 2001.
J.T.C.C.
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