Magren Holdings - Tax Court of Canada finds that transitory acquisitions and redemptions of income fund units were shams

The appellants, were private companies controlled by a resident individual (Grenon), whose RRSP held 58% of the units of a publicly traded income fund (“FMO”). They engaged in a series of transactions that were intended to result in the realization by them of substantial capital gains (resulting in additions to their capital dividend accounts (CDAs), that were immediately distributed by them), followed by the realization of largely offsetting capital losses later that day.

In very general terms, significant elements of the series of transactions included:

1. Grenon’s RRSP transferring its units of FMO to a newly-formed unit trust (“TOM”) -in exchange for units of TOM representing close to 100% of the issued and outstanding TOM units.
2. The appellants acquiring such FMO units from TOM in consideration for issuing $161M in promissory notes.
3. Various transaction being engaged in “beneath” FMO that resulted in capital gains being realized on the indirect transfer of subsidiary entities to a new unit trust (“New FIF”) that was intended to be the replacement public vehicle for FMO and those gains being allocated to, or otherwise realized by, FMO.
4. The public transferring their units of FMO to New FIF in exchange for units of New FIF.
5. After various steps to clean up the structure, FMO distributing essentially all its assets (being units of New FIF) to the appellants, and treating this as a distribution of the capital gains realized by it in 3 above. (These were the capital gain referred to above that were treated as CDA additions to be distributed.)
6. The units of FMO being repurchased by FMO for nominal consideration. The appellants had full (FMV) cost for their FMO units when acquired in step 2, and the capital gains distributions did not reduce the ACB of their units by virtue of s. 53(2)(h)(i.1)(A) and (B)((I). Accordingly, such repurchases resulted in the realization of largely offsetting capital losses (and, in light of the intervening distribution of the transitory increase to their CDAs, also resulted in negative CDAs.)

In finding that the appellants had not acquired the FMO units in step 2 above (which continued to be beneficially owned by the RRSP) and, therefore, did not realize a capital loss in step 6 above, Smith J stated:

Since it was intended … that the FMO units allegedly acquired from TOM on December 23, 2005 would be repurchased for cancellation on December 28, 2005 resulting in the alleged capital losses, I find as a fact that the Appellants had “absolutely no discretion” … as to the disposal of those units. The only role of the Appellants was to hold legal title to the units for a few days. …

[I]t cannot be said that the Appellants enjoyed “the three key attributes of ownership, namely, risk, use and possession” … .

In the course of going on to find that the acquisitions and repurchases also were shams, he stated, inter alia:

[I]t cannot be said that the alleged transaction by which FMO repurchased its units for cancellation resulted in ‘real’ capital losses. These were mere paper transactions ... allegedly supported by demand promissory notes that the Appellants would never be called upon to honour and that were issued and cancelled on December 28, 2005.

I agree with the Respondent, relying on Triad Gestco ... “that the Appellants did not enjoy a ‘real’ economic gain nor a real economic loss”.

He further found that because the s. 184(3) election to convert excess capital dividends into ordinary dividends

is intended to allow corporations “to correct their mistake and avoid the special tax provided under Part III” but it is not intended that the provision will apply where “the initial CDA was sham (sic), and those claiming the benefit of Part III are the authors of the sham”

such elections were invalid.

Finally, in finding, in the alternative, that GAAR would apply to deny the CDA additions, he stated:

It can be said that the “object, spirit and purpose” of the CDA regime is to ensure that it mirrors the tax treatment of capital gains for an individual and that the Minister can only seek to tax gains that give rise to ‘real’ economic gains. By the same token, only one half of the ‘real’ economic gains realized by a corporation can be added to the CDA.

Neal Armstrong. Summaries of Magren Holdings Ltd. v. The Queen, 2021 TCC 42 under s. 185(3), s. 185(1), General Concepts – Ownership, General Concepts – Sham, s. 184(3) and s. 245(4).