Tax Avoidance

A tax avoidance scheme failed to achieve the targeted income tax shelter. In particular, relief under SI 1993/2004, Reg. 2B(3), which allowed a deduction from total income for a manufactured overseas dividend paid, was not available. Patten LJ stated (at para. 44) in finding that the principles originating in Ramsay applied:

[T]he significant aspect of regulation 2B(3) is the relief which it gives to the borrower in being able to avoid a tax charge on the dividends or interest from the securities and this is clearly intended to benefit the parties to real-world, commercial transactions involving the lending of marketable securities and not to transactions which lack those characteristics and whose only purpose is to obtain tax relief. The position seems to me to be exactly analogous to that is UBS and, for the same reasons, I would dismiss Mr. Chappell's appeal… .

In order to avoid income tax employees of the respondent banks were not paid bonuses in cash, but instead were awarded redeemable shares in offshore companies. These awards were intended to qualify for an exemption for “restricted securities” (defined as shares which were subject to provision for their forfeiture if a contingency occurred) contained in s. 425(3) in Chapter 2 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003. In the case of the DB employees, the contingency was being dismissed for misconduct or voluntarily resigning within the next six weeks. In the case of the UBS employees, the contingency was a rise in the FTSE 100 within the next three weeks of greater than 6.5%, thereby triggering a requirement for the shares of the offshore company to be sold for 90% of their market value to a UBS employee benefit trust (but with such an increase being hedged against through the purchase by the offshore company of call options so as to increase its NAV by 10% in such event so that the employee would suffer less than a 1% loss).

In the course of discussing the Ramsay doctrine, Lord Reed stated (at para. 66):

The position was summarised by Ribeiro PJ in Arrowtown Assets, para 35, in a passage cited in Barclays Mercantile:

“The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically.”

In finding that these arrangements were contrary to the purpose of Chapter 2, and before finding that the employees were taxable on the value of the shares when received by them (with a small reduction in the shares’ value to reflect the restrictive conditions), Lord Reed stated (at paras. 73, 77-78):

[B]earing in mind that Part 7 generally, and Chapter 2 in particular, are extensive and highly detailed, counsel argued that it was impossible to attribute to Parliament an unexpressed intention to exclude schemes of the present kind from the ambit of Chapter 2. It cannot be denied that these are forceful arguments, and the Court of Appeal found them persuasive.

… [T]he fact that Chapter 2 was introduced partly for the purpose of forestalling tax avoidance schemes self-evidently makes it difficult to attribute to Parliament an intention that it should apply to schemes which were carefully crafted to fall within its scope, purely for the purpose of tax avoidance. Furthermore, it is difficult to accept that Parliament can have intended to encourage by exemption from taxation the award of shares to employees, where the award of the shares has no purpose whatsoever other than the obtaining of the exemption itself… .

More specifically, it appears from the background to the legislation that the exemption…was designed to address the practical problem which had arisen of valuing a benefit which was, for business or commercial reasons, subject to a restrictive condition involving a contingency. The context was one of real-world transactions having a business or commercial purpose. There is nothing in the background to suggest that Parliament intended that section 423(2) [respecting “restricted securities”] should also apply to transactions having no connection to the real world of business, where a restrictive condition was deliberately contrived with no business or commercial purpose but solely in order to take advantage of the exemption… .

In order to shelter a capital gain which he had realized, the UK taxpayer purchased two options on the FTSE 100 index to be settled in cash: a put option (Option 1"); and a call option ("Option 2") with essentially the same strike price. Several months later (while still in the same tax year) he closed out Option 1 at a loss - and closed out Option 2 at a gain several days later in the next tax year in which he was a non-resident who was not subject to UK tax.

By itself, this arrangement would have resulted in the taxpayer being unhedged between the times of closing out Options 1 and 2. Accordingly, at the same time that he acquired Options 1 and 2, the taxpayer wrote physical-settlement options on British gilts (which, as such, were exempt from UK tax), but with the strike prices based on the FTSE 100 index rather than the value of gilts - so that they effectively were a put option ("Option 3") or a call option ("Option 4") on that index in favour of the (same) counterparty. The taxpayer closed out Options 3 and 4, respectively, at the same time as he closed out Options 1 and 2, respectively.

After quoting from Ramsay (including the statement therein that "the transactions regarded together, and as intended, were from the outset designed to produce neither gain nor loss:...they were self-cancelling"), Chancellor Morritt found that the Ramsay principle applied to the option transactions before him (so that the loss on Option 1 should not be recognized for UK capital gains tax purposes) on the basis of the finding below that "the four options in this case were parts of an overall preordained scheme designed to produce neither a gain nor a loss" (para. 36).

Overview of facts. The two individual taxpayers devised a scheme to: generate artificial capital gains of $110 million in some home-grown companies; pay the supposedly resulting capital dividend accounts (CDAs) of $55 million to another company (1915); generate artificial capital losses in the home-grown companies to offset their capital gains; effectively sell negotiated portions of the CDA to 3^rd-party purchasers by having them subscribe for preferred shares at a 21% premium to their redemption amount with the shares' redemption amounts effectively being flowed out to the 3^rd parties as purported capital dividends; and then pocketing such subscription "premiums" as capital dividends paid out to them. A more detailed summary of the facts is under s. 83(2).

Gains generated on income account. After finding that the daylight loan used in the transactions and the promissory notes issued in the transactions issued in the transactions generating capital gains were not shams, and finding that the share premiums generated by 1915 were business income, Noël JA found that the "gainmaking" shares which were acquired for the purpose of their immediate resale so as to give rise to such gains were acquired on income account, given that "property acquired for resale is held on account of revenue" (para. 73).

Elections were shams. Given that these shares were acquired on income account, the subsidiaries in making capital capital dividend elections to flow out their CDAs to 1915 were making a misrepresentation which rendered such elections shams, and similarly the subsequent capital dividend elections by 1915 also were shams.

In finding that the trial Judge has erred in finding that the investment of the taxpayer's RRSP in worthless shares as a result of fraudulent misrepresentation represented a sham, Malone J.A. stated, after citing the Snook v. London & West Riding Investments Ltd. case stated (at p. 5114):

"In other words, the elements of a sham require that the parties to a transaction together have deliberately set out to misrepresent the actual state of affairs to a third party ... ."

Before going on to find that the taxpayers had not become partners of a putative partnership by virtue of their arrangements because they lacked the requisite intention to carry on business in common, the Court stated (at p. 5154) that "this Court has repeatedly held that a tax motivation does not derogate from the validity of transactions for tax purposes ... . The question at this stage is whether the taxpayer can establish an intention to make a profit, whether or not he was motivated by tax considerations".

Major J. stated (at p. o) that:

"The Court in Shell emphasized that taxpayers are entitled to structure their transactions in a manner that reduces taxes ... . The fact that the structures may be complex arrangements does not remove the right to do so."

Before going on to find that the taxpayer had effectively generated net deductions by investing in a tax-deferred offshore investment, Iacobucci J. stated (at p. o) that:

"Given that the Income Tax Act has many specific anti-avoidance provisions and rules, it follows that courts should not be quick to embellish the provisions of the Act in response to concerns about tax avoidance when it is open to Parliament to be precise and specific with respect to any mischief to be prevented ... . To do otherwise would be to fail to give appropriate weight to the well-established principle that, absent a provision to the contrary, taxpayers are entitled to arrange their affairs for the sole purpose of achieving a favourable position regarding taxation ... ."

The Court affirmed (at p. 6466) the findings of the trial judge that a series of complex transactions comprising 43 stages that were completed within a few days, whose apparent purpose was to transmute an income-account gain into a capital gain, "did not reflect the actual transactions completed and did not correspond to the actual relationships formed between the parties: in short, it constituted a deception, a subterfuge, a sham".

In finding that a purported partnership agreement was not a sham, Robertson J.A. stated (at p. 5330):

"In short, to qualify as a sham, the taxpayer must say one thing to the Minister, and do another in an attempt to avoid its tax obligations."

After referring to arguments, based on decisions in Bronfman Trust and Stubart, that courts should look through transactions that impose tax according to their true economic and commercial effects, McLachlin J. stated (at p. 5677):

"However, this Court has made it clear in more recent decisions that, absent 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 ... ."

She also indicated (at p. 5677) that inquiring into the "economic realities" of a particular situation:

"wrongly invites a rule that where there are two ways to structure a transaction with the same economic effect, the Court must have regard only to the one without tax advantages."

After referring to the statement in Neuman (98 D.TC 6297) that "taxpayers can arrange their affairs in a particular way for the sole purpose of deliberately availing themselves of the tax reduction levies" and noting that this included the use of corporate structures for the sole purpose of avoiding tax, Linden J.A. stated (at p. 5111) that "it follows that other structures, including trusts, may also be used to save tax, as long as proper legal documentation is prepared to accomplish the purpose desired".

In finding that the transactions under consideration had successfully avoided the change-of-control provisions of the Act, Iacobucci C.J. stated (at p. 6350) that "it is well established in the jurisprudence of this Court that no 'business purpose' is required for a transaction to be considered valid under the Income Tax Act, and that a taxpayer is entitled to take advantage of the Act even where a transaction is motivated solely by the minimization of tax".

Before finding that the taxpayer had failed to accomplish a tax-motivated plan because it had failed, in law, to establish a partnership with two other parties, Linden J.A. quoted a statement of the Tax Court Judge that "if the legal reality that underlies the ostensible legal relationship is the same as that which appears on the surface, there is no sham", and then stated (at p. 6359):

"Absent the essential component of deceit, the present transaction cannot be considered a sham according to current Canadian law."

Before finding that former s. 245(1) applied to deny the deduction of resource pools that otherwise would have been available to the taxpayer because of a "seeding transaction" (i.e., a transfer, prior to its acquisition of resource interests, of a minute interest in the property by it to the vendor), Strayer J.A. noted (at p. 5673) that "these were legal transactions which had the effect of transferring and retransferring interests so as to make possible the claim by the respondent for the deductions".

Before finding that a mortgage interest rate subsidy was not a taxable benefit, notwithstanding that other methods of compensating the employee-taxpayer would have been taxable, Linden J.A. stated (at p. 5606):

"Form may not rule, but it does matter. And because form matters, one may structure one's affairs so as to minimize the tax payable on certain transactions. There is nothing wrong with this. Subject to provisions such as section 245, it is neither illegal nor immoral."

Before going on to find that the value of textiles donated to the Royal Ontario Museum did not give rise to a charitable deduction to the taxpayer because the documentation failed to establish that the taxpayer had ever acquired title to the textiles, Linden J.A. stated (at p. 6032):

"In tax law, form matters. A mere subjective intention, here as elsewhere in the tax field, is not by itself sufficient to alter the characterization of a transaction for tax purposes. If a taxpayer arranges its affairs in certain formal ways, enormous tax advantages can be obtained, even though the main reason for these arrangements may be to save tax ... . If a taxpayer fails to take the correct formal steps, however, tax may have to be paid. If this were not so, Revenue Canada and the courts would be engaged in endless exercises to determine the true intentions behind certain transactions."

Before finding that an arrangement which had been described in the relevant documents as an agency relationship should be respected as such, McCullough J. stated (p. 5030):

"The citizen is entitled to order his affairs in such a way that the tax properly attaching to his dispositions is less than it might otherwise be, however unappreciative the Commissioners of Inland Revenue or the Commissioners of Customs and Excise may be of the result."

An argument that a U.S. subsidiary of the taxpayer - which had no business premises, no employees and no function other than to on-lend a loan to the taxpayer - had no independent existence, was rejected.

The landlord, by separate but identical agreements entered into contemporaneously, granted a young man and his girlfriend the purportedly non-exclusive right to occupy a flat. A joint tenancy was created and the power of the "licensor" to use the rooms or to permit others to use the rooms was a pretence only intended to deprive the applicants of the protection of the Rent Acts.

Lord Oliver stated:

"As the law currently stands, the essentials emerging from Furniss v. Dawson appear to me to be four in number:

1. that the series of transactions was, at the time when the intermediate transaction was entered into it, preordained in order to produce a given result;
2. that the transaction had no other purpose than tax mitigation;
3. that there was at that time no practical likelihood that the pre-planned events would not take place in the order ordained, so that the intermediate transaction was not even contemplated practically as having an independent life, and
4. that the pre-ordained events did in fact take place."

With respect to the transfer of shares to a Manx company in exchange for treasury shares of the Manx company, followed by the sale of the shares by the Manx company to the ultimate purchaser, it was uncertain at the time of the transfer of the shares to the Manx company that the subsequent disposal would occur, and it was only later that negotiations with the ultimate purchaser were resumed. The Ramsay principle accordingly was not applied.

The receiver-manager of three companies was negligent for realizing recapture and a capital gain on the sale of one of the company's depreciable assets. Since the other two companies had losses, he would have been advised to first amalgamate the three companies.

A captive Bermudan insurance company was found to be a legal entity distinct from its ultimate Canadian parent, and accordingly interest income and foreign exchange gains of the Bermudan company were found not to be income of the Canadian parent.

It was found by the trial judge that management companies, which two professional engineers ("Parsons" and "Vivian") had incorporated and interposed between themselves and an engineering firm ("Design") of which they had been employees until that time, "(1) had no bona fide business purpose, (2) had, primarily, the purpose of directly reducing their income tax liabilities [and] (3) had, secondarily, an estate planning purpose which ... must be taken to have also been solely motivated by tax and personal, not business, considerations." Nonetheless, it was held that the arrangements were not a sham and were effective for tax purposes because the legal rights and obligations which the parties purported to create, they had succeeded in actually creating.

Although the operations of a Bermudan company were directed and conducted by its parent companies, the Bermudan company nonetheless was treated as having a separate existence for Canadian tax purposes.

A transaction should not "be disregarded for tax purposes solely on the basis that it was entered into by a taxpayer without an independent or bona fide business purpose." However, the formal validity of a transaction may be insufficient where giving full effect to the transaction would defeat the object and spirit of an allowance or benefit provision, or go contrary to a legislative intent to restrict the benefit of such provision to rights that had accrued prior to the transaction, or where the relevant provisions of the Act relate to an identified business function.

A transfer by the taxpayer of its flavouring business to an affiliated company with a history of losses (coupled with the agreement of the taxpayer to act as the affiliated company's agent respecting that business) was a legally effective transaction and also was effective for tax purposes.

Where a pre-ordained (or pre-contracted) series of transactions contains steps that were inserted without any commercial purpose apart from obtaining a tax advantage, then the inserted steps will be disregarded in determining the end result of the transactions (the end result being what is relevant for fiscal purposes). It is irrelevant whether the series of transactions is "self-cancelling", i.e., designed to return the taxpayer to his original position.

Here, the taxpayers, rather than selling their shares in operating companies directly to a purchaser, instead exchanged those shares on a roll-over basis for shares of a newly-incorporated Isle of Man company ("Greenjacket"). Greenjacket then sold the shares of the operating companies to the purchaser. "If the sale had taken place in 1964 before capital gains tax was introduced, there would have been no Greenjacket." The taxpayers accordingly were to be taxed as if they had disposed of their shares directly to the ultimate purchaser.

There is no need for a purchase by a private company to be recorded in minutes or other written memoranda in order for such purchase to be effective.

Where there was no allegation of facts in the Queen's Statement of Defence which would establish a sham, lack of valid business purpose, artificial transactions under section 245, tax avoidance under section 246 or dividend stripping under section 247, and where essentially the only matter at issue was who controlled a corporation for an 11-day period, then the Motions Judge was right in striking out the Queen's pleading that "the Plaintiff entered into a scheme described in said paragraphs with the hope and expectation of avoiding tax on the distribution of dividends".

A preordained series of transactions that had the apparent result of the taxpayer suffering a loss of almost the whole price that it had paid for shares, did not result in a real loss for tax purposes because it got back virtually all of the money that it had paid.

It was accepted (before finding against the taxpayer on another ground) that he was in the stockbrokering business on his own account notwithstanding that all his trading activities were effected through a company of which he was an employee.

In order to realize a capital loss that could be deducted from a chargeable gain that had been realized by him, the taxpayer bought shares in a newly-formed investment company and, at the same time, made two loans to the company for 20 and 31 years respectively at an 11% interest rate. The following year, the interest rates on the two loans were changed to 22% and 0% respectively, and the low-interest-rate loan was sold to a finance company at its reduced market value. The company was then wound-up, with a loss being realized by the taxpayer on his shares.

Before finding that the taxpayer had not realized a loss on the shares for UK capital gains purposes, Lord Wilberforce stated (at p. 326):

"The capital gains tax was created to operate in the real world, not that of make-belief. As I said in Aberdeen Construction Group Ltd. v. Inland Revenue Commissioners [1978] A.C. 885, it is a tax on gains (or I might have added gains less losses), it is not a tax on arithmetical differences. To say that a loss (or gain) which appears to arise at one stage in an indivisible process, and which is intended to be and is cancelled out by a later stage, so that at the end of what was bought as, and planned as, a single continuous operation, there is not such a loss (or gain) as the legislation is dealing with, is in my opinion well and indeed essentially within the judicial function."

The taxpayer knowingly assisted its suppliers to defraud the Department of National Revenue or dispose of stolen property, by paying them in cash. (The payments and sales were purportedly made through an intermediary company, in an attempt to avoid being involved in illegality, but in fact the taxpayer dealt directly with its suppliers.) The cash expenditures for the purchased goods nonetheless were held to be deductible, because they were made for business purposes.

The purported interposition between the taxpayer and his employer of a management corporation was legally ineffective, and thus, also ineffective for tax purposes, because (1) he failed to have his existing employment contract cancelled (or effectively assigned to the management corporation) and, in fact, he later entered into a similar employment contract with the same employer, which contract made no reference to the management corporation, and (2) the dealings between the taxpayer and his employer were consistent only with their being in an employer/employee relationship. [C.R.: 18(1)(a) - "Related Companies"]

It was stated that the question of whether a "quotation letter", which the Crown submitted set an artificially high purchase price for oil, was a legally binding contract should be determined without reference to extrinsic evidence as to whether the parties treated themselves as bound by the letter. [See also S.245(1).]

"There is no relationship of principal and agent between the shareholders of a company and the company. The fact that the sole shareholder of a company is another company, as is the case here, does not alter that."

As there was no evidence to support the taxpayer's contention that fees for performing construction work were earned by a company controlled by him rather than in his personal capacity, other than the payments of those fees being deposited in the company's bank account, such fees were treated as income.

The fact that the taxpayer surgeon responded to regulations, requiring that OHIP be billed in the name of an individual doctor, by billing for surgical services he had performed as employee of a private hospital owned by him, then assigning those fees to the hospital, did not mean that the hospital was engaged in the illegal practice of medicine. The employment contract between the surgeon and the hospital was not illegal, and the assigned fees had been earned by the hospital, not by him. [C.R.: 18(1)(a) - "Related Companies"]

It was found "that to look at the true situation realistically", the individual taxpayer was acting on behalf of his company when he signed a contract in his own name. Income generated under the contract accordingly was his company's income.

After finding that an income-splitting "scheme" was ineffective because two supposed trusts had not been properly established, Urie, J. stated: "it is the duty of the Court to carefully scrutinize everything that a taxpayer has done to ensure that everything which appears to have been done, in fact, has been done in accordance with applicable law."

The taxpayer, wished to sell land to the City of Calgary in consideration for two annual instalments in order to defer a portion of the gain to its second taxation year, but was informed that the City was precluded by statute from purchasing land over a period of years. As a result: the taxpayer sold the land to a trust company for the same purchase price, but payable in two instalments with the second instalment bearing interest at 7.5% per annum, and with a clause in the purchase agreement that the trust company could elect within 60 days of the date of the agreement of sale to void the agreement; and the trust company sold the land to the City for the same purchase price, paid in cash. Title was transferred directly from the taxpayer to the City.

Cattanach J. found that the transactions were not a sham as the intended legal rights of the three parties were exactly those described in the documents. For example, the Trust Company had the use of the money received on its sale to the City for a protracted period, which it could and did turn to profit on its own account.

Cattanach J., after noting that, in fact, the Trust Company did not pay interest until the time it received money on the sale to the City, rather than from the earlier date provided in the agreement, stated (at p. 6016):

"The delay in payment exceeded the estimated date and there is no impediment to the parties not to strictly comply with the agreement in this respect although the benefiting party is entitled to do so and the party detrimentally affected is bound by the agreement."

After noting that the trust company did not record a liability in its book of account to the taxpayer until the time it receiving payment from the City, Cattanach J. stated (at p. 6016):

"I do not think that bookkeeping entries or the lack of an entry can be accepted as contradicting the clear provisions of a written agreement."

The amounts paid by a wholly-owned Bermudan subsidiary ("Span") for purchases of steel were found to constitute the taxpayer's cost of that steel, rather than the higher price charged by Span to the taxpayer, because Span was a puppet of the taxpayer, and the business of the taxpayer accordingly included the activities or purported activities of Span. A vice-president of the taxpayer "controlled every step of the operations of Span from the purchase price to the selling price of off-shore steel" and in fact was permitted by the Articles of Association of Span to exercise the powers of its board.

Fees paid by a company ("Ablan Leon Distributors") to a second company ("Nor-Mar") which was owned by its sole employee ("Leon") in respect of management services that Nor-Mar provided were held to be the income of Leon rather than Nor-Mar. "[I]t is my view that the complete absence of a bona fide business purpose for the interposition of Nor-Mar into the provision of Norman Leon's services to Ablan Leon Distributors is sufficient to stamp that transaction a sham." [C.R.: 18(1)(a) - "Related Companies"]

Before concluding (at p. 6557) that "the purchase by the Appellant by means of an option does not constitute a sham in the legal sense," and after quoting the "excellent definition of a financial sham" in Snook, Addy J stated (at p. 6556):

"[I]n order to determine if a document constitutes a sham or not and for this reason must necessarily attract financial consequences, one must not take an exaggerated view of the motives of the parties for the sole purpose of arriving at an interpretation favourable to the taxing authority."

"The company is not an agent of the owners."