Deans Knight – Federal Court of Appeal finds that the object and spirit of s. 111(5) is abused on an arm’s length acquisition of “actual” (albeit, not de jure) control of a Lossco

The non-capital losses of $90M, and other tax attributes of the taxpayer, were effectively sold to arm’s length investors pursuant to transactions under which:

• The existing shareholders of the taxpayer exchanged their shares for shares of a “Newco” (“New Forbes”) under a Plan of Arrangement
• A private company “facilitator” (Matco) entered into an “Investment Agreement” with the taxpayer and New Forbes pursuant to which Matco (principally in consideration for $3M in cash) acquired a debenture of the taxpayer that was convertible into shares representing 79% of its equity shares but only 35% of its voting shares.
• The taxpayer then transferred its assets (including the proceeds of issuing the debenture) and its liabilities to New Forbes.
• Matco then identified a mutual fund management company which wanted to effect a public offering of shares of the taxpayer and use the proceeds (of $100M) for a new bond trading business to be carried on in the taxpayer.
• The subscription price for the newly-issued common shares under this offering caused the securities of the taxpayer held by New Forbes and Matco to appreciate which, in the case of Matco, effectively was its fee.
• New Forbes sold its remaining shares of Lossco to Matco for a pre-agreed price of $0.8M.

Woods JA set the stage by stating:

[I]t must be remembered that the GAAR is intended to supplement the provisions of the Act in order to deal with abusive tax avoidance. I see nothing inconsistent with the conclusion that the object, spirit and purpose of subsection 111(5) takes into account different forms of control even though the text of the provision is limited to de jure control.

In finding that Mateo acquired “actual control” (albeit, not de jure control) of the taxpayer, she indicated that the Investment Agreement provided “severe restrictions on the actions” that New Forbes and the taxpayer could take including prohibiting the taxpayer from “engag[ing] in any activity other than related to a Corporate Opportunity” (e.g., the offering) and required that “New Forbes shall use commercially reasonable efforts to satisfy (or cause the satisfaction of) its obligation to cooperate with Matco in the implementation of a Corporate Opportunity” (para. 101).

As “the Investment Agreement resulted in New Forbes and the Respondent handing over actual control of the Respondent to Matco,” there was an abuse of s. 111(5), and the tax benefit of the taxpayer’s tax attributes were properly denied by CRA.

Neal Armstrong. Summary of Canada v. Deans Knight Income Corporation, 2021 FCA 160 under s. 245(4).