Canada: Copthorne: Supreme Court Of Canada’s Latest Views On Statutory Interpretation And GAAR

Copyright 2011, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Tax, December 2011

A. Overview

On December 16, 2011, the Supreme Court of Canada (the SCC) released its decision and reasons in Copthorne Holdings Ltd. v. Canada (Copthorne). All nine of the SCC judges unanimously determined that the taxpayer's appeal should be dismissed as it had been in the two lower courts below. The decision thoroughly canvasses issues relating to the application and interpretation of section 245 of the Canadian Income Tax Act (the Act), known as the General Anti-Avoidance Rule, or the GAAR.

Not surprisingly, the decision reinforces and consolidates principles enunciated in three earlier GAAR cases decided by the SCC (Canada Trustco, Kaulius and Lipson) and expresses both caution and direction about the future application of the GAAR by tax officials. In doing so, the SCC has also left readers of the decision with a number of impressions about the types of circumstances in which the GAAR should and should not be applied in future and the ability of taxpayers to arrange their affairs in order to minimize taxes payable.

Perhaps most striking in the reasons of the SCC are the latest comments about the appropriate methodology for the interpretation of taxing statutes and the unique methodology that is to be used when the GAAR is in play. The SCC has also openly admonished both the lower courts and readers of tax legislation (including the GAAR) that "determining the rationale of the relevant provisions of the Act should not be conflated with a value judgment of what is right or wrong nor with theories about what tax law ought to be or ought to do" (para. 70). So it seems that judges are not to use a "smell test" or an interventionist approach when deciding tax cases and the so-called "end must not justify the means". However, it remains to be seen whether this admonition will be heeded.

All readers of Copthorne are no doubt trying to discern whether the commentary and analysis of the SCC favours taxpayers or the Crown. It has elements that both sides will embrace. Some aspects will be discussed below. Both sides, however, must realize that it seems unlikely that the SCC will be open to granting leave in another GAAR case any time soon given that the Copthorne reasons (the Reasons) were written by Mr. Justice Rothstein. Justice Rothstein, one of the dissenting justices in Lipson, unanimously expressed the consolidation of earlier principles enunciated in Canada Trustco (Trustco) and the more fractured decision in Lipson. The SCC made it very clear in para. 57 of the Reasons that "Trustco is a very recent decision" and that there must be "substantial reasons to believe the precedent was wrongly decided" in order for it to be revisited. To the extent that any points about the interpretation of GAAR issues are not addressed in Copthorne, one should presume that any applicable comments in Trustco and the other two earlier SCC decisions will govern.

B. Impact of Copthorne

Overall, Copthorne reaffirms past pronouncements and reaffirms through a unanimous bench how the SCC perceives the GAAR is to be interpreted. Its decision may still not create any more certainty, consistency or predictability regarding the application of the GAAR than before its release.

What appeared to offend the SCC in Copthorne was the "double counting " of paid-up capital (PUC) and its "artificial" preservation in a way that frustrated a statutory provision (Reasons, para. 127). Yet the SCC indicates in its Reasons (para. 70) that abuse determinations should not involve value judgments of what is right and wrong and theories about what the tax law ought to be or ought to do. There is no doubt that the lower courts are being told to apply this message when rendering decisions in GAAR cases.

However, each judge's perception of the underlying rationale for a statutory provision may differ, particularly if there is little or no guidance in the Act from statutory provisions throughout the text of the Act. What may be clear to one person may not be clear to another. Nevertheless, the SCC and taxpayers expect that the lower courts will consistently apply the words in paragraphs 68 and 72 of the Reasons:

"... the GAAR can only be applied to deny a tax benefit when the abusive nature of the transaction is clear" (Trustco, at para. 50), and
"... the Minister must clearly demonstrate that the transaction is an abuse of the Act, and the benefit of the doubt is given to the taxpayer."

C. Summary of Copthorne Facts

By a series of transactions, two corporations that had been parent (Copthorne I) and subsidiary (VHHC Holdings) became "sister" corporations, that is, corporations owned directly by the same shareholder. The sister corporations were then amalgamated — a "horizontal" amalgamation. Had they remained as parent and subsidiary, the PUC of the shares of VHHC Holdings would have been cancelled on amalgamation. As sister corporations, the PUC of their respective shares was aggregated to form the PUC of the shares of the amalgamated corporation. The amalgamated corporation then redeemed a large portion of its shares and paid out the aggregate PUC attributable to the redeemed shares to its non-resident shareholder. That payment was not treated as taxable income to the shareholder but instead as a return of capital.

No provision of the Act expressly required the return of PUC in this case to be treated as a taxable payment. Nonetheless, the Minister of National Revenue (the Minister) considered the transactions by which the parent and subsidiary became sister corporations to have circumvented certain provisions of the Act in an abusive manner and thus to have contravened the GAAR. Applying the GAAR, the Minister concluded that the PUC of the shares of the former subsidiary should have been cancelled upon amalgamation with its former parent corporation. If the PUC of the shares of the amalgamated corporation was reduced, the amount paid to the shareholder in excess of the reduced PUC would have constituted a deemed dividend subject to tax. The Minister reassessed the amalgamated corporation for unpaid withholding tax on the deemed dividend portion of the amount paid to the non-resident shareholder upon redemption. The Tax Court of Canada and Federal Court of Appeal upheld the reassessments.

D. Summary of Reasons of Mr. Justice Rothstein

The GAAR scheme is set out in subsections 245(1) to (5) of the Act and requires a determination of three questions: (1) was there a tax benefit? (2) was the transaction giving rise to the tax benefit an avoidance transaction? and (3) was the avoidance transaction giving rise to the tax benefit abusive?

1. Tax Benefit

The burden is on the taxpayer to refute the Minister's assumption of the existence of a tax benefit. Where the Tax Court judge has made a finding of fact on the existence of a tax benefit, it is only appropriate for a reviewing court to overturn such a finding where an appellant can show a palpable and overriding error. The existence of a tax benefit can be established by comparing the taxpayer's situation with an alternative arrangement that could reasonably have been carried out but for the existence of the tax benefit. The vertical amalgamation comparison used by the Minister was appropriate (Reasons, paras. 34-35) and the finding of the Tax Court that there was a tax benefit was affirmed.

2. Avoidance Transaction

Under the GAAR, a transaction will be an avoidance transaction if it results in a tax benefit, and is not undertaken primarily for a bona fide non‑tax purpose. An avoidance transaction may operate alone to produce a tax benefit, or may operate as part of a series of transactions to produce a tax benefit. Where the Minister assumes that the tax benefit resulted from a series of transactions, rather than a single transaction, it is necessary to determine if there was a series, which transactions make up the series, and whether the tax benefit resulted from the series (Reasons, paras. 39-41, 59 and 64).

2.1 Series of Transactions

The starting point is the common law test for a series upon which "each transaction in the series is pre‑ordained to produce a final result". Subsection 248(10) of the Act extends the meaning of "series of transactions" to include any related transactions or events completed in "contemplation" of the series. A Court must decide whether the series was taken into account when the decision was made to undertake the related transaction in the sense that it was done, on a balance of probabilities, "in relation to" or "because of" the series. Each case will be decided on its own facts. The length of time between the series and the related transaction may be a relevant consideration in some cases, as would intervening events taking place between the series and the completion of the related transaction. Although the "because of" or "in relation to" test does not require a "strong nexus", it does require more than a mere possibility or a connection with an extreme degree of remoteness.

"Contemplation" in subsection 248(10) of the Act should be read both prospectively and retrospectively. The text and context of subsection 248(10) leave open when the contemplation of the series must take place. Nothing in the text specifies when the related transaction must be completed in relation to the series. Specifically, nothing suggests that the related transaction must be completed in contemplation of a subsequent series. The Tax Court and the Federal Court of Appeal correctly concluded that the redemption transaction was part of the same series as the prior sale and amalgamation, and that the series, including the redemption transaction, resulted in the tax benefit (Reasons, paras. 43-56).

If there is a series that results, directly or indirectly, in a tax benefit, it will be caught by subsection 245(3) as an avoidance transaction unless each transaction within the series could reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain a tax benefit. This determination is to be objectively considered, and must be based on all of the evidence available to the court. The Tax Court was correct to find that the sale of the shares to the non‑resident parent corporation was not primarily undertaken for a bona fide non‑tax purpose. Because there was a series of transactions which resulted in a tax benefit, the finding that one transaction in the series was an avoidance transaction satisfied the requirements of subsection 245(3).

3. Abusive Tax Avoidance (Reasons 65-73)

In order to determine whether a transaction is an abuse or misuse of the Act, a court must first determine the object, spirit or purpose of the provisions that are relied on for the tax benefit, having regard to the scheme of the Act, the relevant provisions and permissible extrinsic aids. While an avoidance transaction may operate alone to produce a tax benefit, it may also operate as part of a series of transactions that results in the tax benefit.

While the focus must be on the transaction, where it is part of a series, it must be viewed in the context of the series to enable the court to determine whether abusive tax avoidance has occurred. In such a case, whether a transaction is abusive will only become apparent when it is considered in the context of the series of which it is a part and the overall result that is achieved. The analysis will lead to a finding of abusive tax avoidance: (1) where the transaction achieves an outcome the statutory provision was intended to prevent; (2) where the transaction defeats the underlying rationale of the provision; or (3) where the transaction circumvents the provision in a manner that frustrates or defeats its object, spirit or purpose. These considerations are not independent of one another and may overlap.

3.1 Abused Statutory Provision – Subsection 87(3) of the Act

To determine if there was abuse, subsection 87(3) of the Act, which deals with the PUC of shares of amalgamated corporations, must be at the centre of the analysis. The text of subsection 87(3) ensures that, in a horizontal amalgamation, the PUC of the shares of the amalgamated corporation does not exceed the total of the PUC of the shares of the amalgamating corporations. Subsection 87(3) also provides, in its parenthetical clause, that the PUC of the shares of an amalgamating corporation held by another amalgamating corporation is cancelled. Having regard to the text, context and purpose of subsection 87(3), the object, spirit and purpose of the parenthetical portion of the section is to preclude preservation of the PUC of the shares of a subsidiary corporation upon amalgamation of the parent and subsidiary where such preservation would permit shareholders, on a redemption of shares by the amalgamated corporation, to be paid amounts as a return of capital without liability for tax, in excess of the amounts invested in the amalgamating corporations with tax‑paid funds.

The taxpayer agreed that subsection 87(3) would have led to a cancellation of the applicable PUC of the shares if there had been a vertical amalgamation with Copthorne I. Instead of amalgamating the two companies, Copthorne I sold its VHHC Holdings shares to the non‑resident parent corporation in order to avoid the vertical amalgamation and cancellation of the PUC of the shares of VHHC Holdings. The transaction obviously circumvented application of the parenthetical words of subsection 87(3) upon the later amalgamation of Copthorne I and VHHC Holdings, now as sister corporations.

3.2 Finding of Abuse (Reasons, paras 127-128)

The sale by Copthorne I of its VHHC Holdings shares, which was undertaken to protect C$67,401,279 of PUC from cancellation, while not contrary to the text of subsection 87(3), does frustrate and defeat its purpose. The tax‑paid investment here totalled C$96,736,845. To allow the aggregation of an additional C$67,401,279 to this amount would enable payment, without liability for tax by the shareholders, of amounts well in excess of the investment of tax‑paid funds, contrary to the object, spirit and purpose or the underlying rationale of subsection 87(3). The sale of VHHC Holdings shares circumvented the parenthetical words of subsection 87(3) and in the context of the series of which it was a part, achieved a result the section was intended to prevent and thus defeated its underlying rationale. The transaction was therefore abusive and the assessment based on application of the GAAR was appropriate.

E. Principles of Statutory Interpretation of Taxing Statutes

Paragraphs 6 and 70 of the Reasons expressly confirm that the interpretive approach used by the SCC requires: a determination of the object, spirit or purpose of legislation by applying a "unified textual, contextual and purposive approach" (Trustco,at para. 47; Lipson at para 26). In a traditional statutory interpretation approach, the textual, contextual and purposive analysis determines what the words of the statute mean.

F. What is Abusive Tax Avoidance? The Need to Search for Object, Spirit or Purpose in the Act

1. Methodology

Paragraphs 65-73 of the Reasons set out the general principles about when an avoidance transaction giving rise to a tax benefit is abusive. They consolidate the statements made in both Trustco and Lipson. Justice Rothstein (Reasons, para. 66) indicates that a court, involved in a GAAR analysis, has the "unusual duty" of going behind the words of the legislation to determine the object, spirit or purpose of the provision or provisions relied on by the taxpayer. Paragraph 69 of the Reasons states the following:

"[69] In order to determine whether a transaction is an abuse or misuse of the Act, a court must first determine the "object, spirit or purpose of the provisions ... that are relied on for the tax benefit, having regard to the scheme of the Act, the relevant provisions and permissible extrinsic aids" (Trustco, at para. 55). The object, spirit or purpose of the provisions has been referred to as the "legislative rationale that underlies specific or interrelated provisions of the Act" (V. Krishna, The Fundamentals of Income Tax Law (2009), at p. 818)."

Paragraph 70 of the Reasons then outlines the uniqueness of the analysis in a GAAR situation:

"... In a GAAR analysis the textual, contextual and purposive analysis is employed to determine the object, spirit or purpose of a provision. Here the meaning of the words of the statute may be clear enough. The search is for the rationale that underlies the words that may not be captured by the bare meaning of the words themselves. However, determining the rationale of the relevant provisions of the Act should not be conflated with a value judgment of what is right or wrong nor with theories about what tax law ought to be or ought to do."

2. Role of the Courts

Consistent with statements made in paragraph 50 of Trustco, "the GAAR can only be applied to deny a tax benefit when the abusive nature of the transaction is clear" (Reasons, para. 68). The court's role must therefore be to conduct an objective, thorough and step-by-step analysis and explain the reasons for its conclusion (Reasons, paras. 68 and 71). When doing so, the court must consider whether the transaction falls within or frustrates the identified purpose (Trustco, para. 44).

While an avoidance transaction may operate alone to produce a tax benefit, it may also operate as part of a series of transactions that results in the tax benefit. While the focus must be on the transaction, where it is part of a series, it must be viewed in the context of the series to enable the court to determine whether abusive tax avoidance has occurred. In such a case, whether a transaction is abusive will only become apparent when it is considered in the context of the series of which it is a part and the overall result that is achieved (Lipson, para. 34).

3. When Will Abusive Tax Avoidance Be Found? Clear Burden on the Crown

Paragraphs 72 and 73 of the Reasons again affirm the analysis set out in Trustco:

"[72] The analysis will then lead to a finding of abusive tax avoidance: (1) where the transaction achieves an outcome the statutory provision was intended to prevent; (2) where the transaction defeats the underlying rationale of the provision; or (3) where the transaction circumvents the provision in a manner that frustrates or defeats its object, spirit or purpose (Trustco, at para. 45; Lipson, at para. 40). These considerations are not independent of one another and may overlap. At this stage, the Minister must clearly demonstrate that the transaction is an abuse of the Act, and the benefit of the doubt is given to the taxpayer.
[73] When applying this test, there is no distinction between an "abuse" and a "misuse". Instead, there is a single unified approach (Trustco, at para. 43)."

4. Textual Review in a GAAR Analysis

In Copthorne, the SCC comments more on how to consider text, context and purpose in a GAAR analysis than in previous decisions. With respect to text, paragraph 88 of the Reasons states the following:

"[88] In any GAAR case the text of the provisions at issue will not literally preclude a tax benefit the taxpayer seeks by entering into the transaction or series. This is not surprising. If the tax benefit of the transaction or series was prohibited by the text, on reassessing the taxpayer, the Minister would only have to rely on the text and not resort to the GAAR. However, this does not mean that the text is irrelevant. In a GAAR assessment the text is considered to see if it sheds light on what the provision was intended to do."

5. Contextual Review in a GAAR Analysis

The notion of "context" was first discussed in Trustco. It is again described in paragraph 91 of the Reasons:

"[91] The consideration of context involves an examination of other sections of the Act, as well as permissible extrinsic aids (Trustco,at para. 55). However, not every other section of the Act will be relevant in understanding the context of the provision at issue. Rather, relevant provisions are related "because they are grouped together" or because they "work together to give effect to a plausible and coherent plan" (R. Sullivan, Sullivan on the Construction of Statutes (5th ed. 2008), at pp. 361 and 364)."

Based on the analysis found in paragraphs 92—112 of the Reasons, it is first necessary to isolate the statutory provisions in the Act allegedly being abused and to then determine the reasons for the existence in the Act for each element of the statutory scheme and "other related provisions in the Act" (Reasons, para. 92). To some extent, it seems that context and purposive analysis are being conflated by the SCC. From the conclusion reached by the SCC in paragraph 112 of the Reasons, it appears that the rationale for the enactment of the alleged abused statutory provision (subsection 87(3) of the Act, para. 86 of the Reasons) is to be interpreted by reference to other statutory provisions within the Act.

The most troubling aspect of the analysis relating to context is found in the discussion in paragraphs 108 – 111 of the Reasons:

"[108] Copthorne argues that Parliament has enacted a number of PUC provisions which are intended to prevent taxpayers from inappropriately increasing or preserving PUC. It argues that the detail of the PUC provisions, such as s. 87(3), suggests that where the taxpayer's actions are not caught by a provision, the actions cannot abuse the purpose of the provision. I interpret this argument as what Professor Sullivan calls "implied exclusion". In essence the argument is that "there is reason to believe that if the legislature had meant to include a particular thing within its legislation, it would have referred to that thing expressly" (Sullivan, at p. 244). Section 89(1) is a definition section. As such, I would agree with Copthorne that when the definition lists a series of "grinds", without any indication of the possibility of making additions to that list, that it may be assumed that the list is exhaustive. Thus, if this were a case of traditional statutory interpretation, an argument that the series of transactions here are somehow contemplated by the listed grinds could fail.
[109] However, that is not the nature of a GAAR analysis. When the Minister invokes the GAAR, he is conceding that the words of the statute do not cover the series of transactions at issue. Rather, he argues that although he cannot rely on the text of the statute, he may rely on the underlying rationale or object, spirit and purpose of the legislation to support his position.
[110] I do not rule out the possibility that in some cases the underlying rationale of a provision would be no broader than the text itself. Provisions that may be so construed, having regard to their context and purpose, may support the argument that the text is conclusive because the text is consistent with and fully explains its underlying rationale.
[111] However, the implied exclusion argument is misplaced where it relies exclusively on the text of the PUC provisions without regard to their underlying rationale. If such an approach were accepted, it would be a full response in all GAAR cases, because the actions of a taxpayer will always be permitted by the text of the Act. As noted in OSFC, if the Court is confined to a consideration of the language of the provisions in question, without regard to their underlying rationale, it would seem inevitable that the GAAR would be rendered meaningless (para. 63)".

Based on this analysis, one must question how the abuse of a provision is to be determined under the GAAR in the context of statutory provisions with "bright-line" tests or where the text of a provision expressly provides for certain transactions to be exempted or caught.

6. Purposive Review in the GAAR Analysis

Paragraph 113 of the Reasons again follows the lead in Trustco: "Tax provisions are intended to "promote purposes related to specific activities" (Trustco, at para. 52). This step seeks to ascertain what outcome Parliament intended a provision or provisions to achieve, amidst the myriad of purposes promoted by the Act."

In paragraphs 113 – 121 of the Reasons, the SCC identifies that statutory provisions may have more than one purpose and that a provision may have both a tax and non-tax purpose if the same context is employed in another statute.(Reasons, paras.117 – 118). It is only the tax reason for a statutory provision that is relevant to the analysis.

7. Does the Existence of a General Policy in the Act Contribute to a Finding of Abusive Tax Avoidance?

In paragraph 41 of Trustco, the SCC admonished that courts should not search for an overriding policy of the Act that is not based on a unified, textual, contextual and purposive interpretation of the specific provisions in issue. Paragraph 118 of the Reasons affirms this:

"[118] Copthorne submits that such a conclusion could only rest upon a general policy against surplus stripping. It argues that no such general policy exists and therefore the object, spirit and purpose of s. 87(3) cannot be to prevent surplus stripping by the aggregation of PUC. This argument is based upon this Court's admonition in Trustco that "courts cannot search for an overriding policy of the Act that is not based on a unified, textual, contextual and purposive interpretation of the specific provisions in issue" (para. 41). What is not permissible is basing a finding of abuse on some broad statement of policy, such as anti-surplus stripping, which is not attached to the provisions at issue. However, the tax purpose identified in these reasons is based upon an examination of the PUC sections of the Act, not a broadly stated policy. The approach addresses the rationale of the PUC scheme specifically in relation to amalgamation and redemption and not a general policy unrelated to the scheme under consideration."

G. The Obligations of the Minister to Promote Consistency, Predictability and Fairness When Interpreting and Applying the GAAR – Is GAAR Intended to Create Uncertainty?
In Trustco, there was much mention of the need for interpretation to be done so that these principles are served:

"[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. Canada, [1999] 3 S.C.R. 622:
[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:

"[i]t 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."

At the same time, the Chief Justice and Justice Major, speaking for the unanimous court in Trustco, expressed the following:

"[21] The second requirement for application of the GAAR is that the transaction giving rise to the tax benefit be an avoidance transaction within s. 245(3). The function of this requirement is to remove from the ambit of the GAAR transactions or series of transactions that may reasonably be considered to have been undertaken or arranged primarily for a non-tax purpose. The majority of tax benefits claimed by taxpayers on their annual returns will be immune from the GAAR as a result of s. 245(3). The GAAR was enacted as a provision of last resort in order to address abusive tax avoidance, it was not intended to introduce uncertainty in tax planning."

In Lipson, Justice LeBel, speaking for the other three majority justices, stated the following:

"[52] The appellants and several commentators have warned of the potential for uncertainty should this Court find that the GAAR applies in the instant case. The appellants argue that to maintain certainty for taxpayers, the direct use of the borrowed funds — as determined by tracing — should be determinative of whether the GAAR applies to deductions claimed under s. 20(1)(c) (Appellants' Factum, at para. 82). As I mentioned above, such an approach would effectively read the GAAR out of the ITA, since the "direct use" test applies only to determine whether interest is deductible under s. 20(1)(c) and involves an inquiry that is distinct from the one under s. 245, in which it must be asked whether otherwise valid transactions, such as those in Singleton and in the present case, frustrate the object, spirit and purpose of the provisions relied on. Indeed, contrary to the judgments in Canada Trustco and Kaulius, my colleague Binnie J. essentially guts the GAAR and reads it out of the ITA under the guise of an exercise in legal interpretation. To the extent that it may not always be obvious whether the purpose of a provision is frustrated by an avoidance transaction, the GAAR may introduce a degree of uncertainty into tax planning, but such uncertainty is inherent in all situations in which the law must be applied to unique facts. The GAAR is neither a penal provision nor a hammer to pound taxpayers into submission. It is designed, in the complex context of the ITA,to restrain abusive tax avoidance and to make sure that the fairness of the tax system is preserved. A desire to avoid uncertainty cannot justify ignoring a provision of the ITA that is clearly intended to apply to transactions that would otherwise be valid on their face."

In paragraphs 66, 67 and 123 of the Reasons, Justice Rothstein attempts to reconcile all of these prior views regarding the interaction of the need for consistency, predictability and fairness and the concern about uncertainty:

"[66] The GAAR is a legal mechanism whereby Parliament has conferred on the court the unusual duty of going behind the words of the legislation to determine the object, spirit or purpose of the provision or provisions relied upon by the taxpayer. While the taxpayer's transactions will be in strict compliance with the text of the relevant provisions relied upon, they may not necessarily be in accord with their object, spirit or purpose. In such cases, the GAAR may be invoked by the Minister. The GAAR does create some uncertainty for taxpayers. Courts, however, must remember that s. 245 was enacted "as a provision of last resort" (Trustco, at para. 21).
[67] A court must be mindful that a decision supporting a GAAR assessment in a particular case may have implications for innumerable "everyday" transactions of taxpayers. A decision affecting PUC is a good example. There are undoubtedly hundreds, and perhaps thousands of share transactions each year in which the PUC of a certain class of shares may be a relevant consideration. Because of the potential to affect so many transactions, the court must approach a GAAR decision cautiously. It is necessary to remember that "Parliament must ... be taken to seek consistency, predictability and fairness in tax law" (Trustco, at para. 42). As this Court stated in Trustco:
Parliament intends taxpayers to take full advantage of the provisions of the Income Tax Act that confer tax benefits. Indeed, achieving the various policies that the Income Tax Act seeks to promote is dependent on taxpayers doing so. [para. 31]"
"[123] While Parliament's intent is to seek consistency, predictability and fairness in tax law, in enacting the GAAR, it must be acknowledged that it has created an unavoidable degree of uncertainty for taxpayers. This uncertainty underlines the obligation of the Minister who wishes to overcome the countervailing obligations of consistency and predictability to demonstrate clearly the abuse he alleges."

H. Reassurance for Taxpayers that the GAAR Will Not Always Apply

Judges sometimes address the "floodgates" arguments raised by counsel in the event that the GAAR may or may not be applied. As mentioned above, Justice LeBel did so in paragraph 52 of Lipson. In paragraphs 119 – 121 of the Reasons, Justice Rothstein commented on the implications of an adverse decision relating to PUC:

"[119] Copthorne argues that upholding the decision of the Tax Court would leave taxpayers under the "Damoclesian menace of the GAAR" (A.F., at para. 57). It suggests that taxpayers would not be able to determine whether PUC which had been validly created in a downstream investment would be subject to cancellation if it was sold to a third party or to an unrelated non-resident party. Copthorne says that this will leave taxpayers in a state of impermissible uncertainty. However, before the GAAR may be applied in any circumstance, there must be an avoidance transaction which results in a tax benefit. In the absence of a specific transaction undertaken primarily to obtain a tax benefit, a sale of shares to a third party or to an unrelated non-resident party primarily for a bona fide non-tax purpose will not trigger the GAAR. In such a case, PUC will continue to be a valid attribute which allows for a return of an amount equivalent to PUC to be paid to new shareholders without inclusion in their income.
[120] I should emphasize that the purchase of shares may have a tax purpose, but that does not necessarily mean that the tax purpose will always be the primary reason for the transaction. In the numerous share transactions taking place each year, the party acquiring shares of a corporation will likely be aware of the tax implications of the existing PUC. However, where a transaction takes place primarily for a non-tax purpose, there will be no avoidance transaction. In the absence of an avoidance transaction, the fact that a transaction may have a secondary tax benefit purpose will not trigger the GAAR. Whether the transactions are between parties at arm's length or not at arm's length should be immaterial (Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536).
[121] Copthorne also argues that the Act does not contain a policy that parent and subsidiary corporations must always remain as parent and subsidiary. I agree. There is no general principle against corporate reorganization. Where corporate reorganization takes place, the GAAR does not apply unless there is an avoidance transaction that is found to constitute an abuse. Even where corporate reorganization takes place for a tax reason, the GAAR may still not apply. It is only when a reorganization is primarily for a tax purpose and is done in a manner found to circumvent a provision of the Income Tax Act that it may be found to abuse that provision. And it is only where there is a finding of abuse that the corporate reorganization may be caught by the GAAR."

I. The Duke of Westminster Principle (the Duke) – How Healthy is the Duke? Is the Duke on Life Support?

There are two references in the Reasons (paragraphs 49 and 65) to this 1936 decision of the House of Lords and the pithy aphorism about tax minimization that taxpayers and judges enjoy quoting:

"[49]... Copthorne says that the question of whether a transaction was related must therefore be decided by determining whether a prior related transaction was completed in contemplation of a subsequent series, not by considering, with the benefit of hindsight, whether the series had been contemplated when a subsequent transaction was completed; that retrospective assessment of the connection between a series and a related transaction impermissibly expands the reach of s. 248(10); and that such consideration would create unacceptable uncertainty and trench upon the Duke of Westminster principle that taxpayers are entitled to arrange their affairs to minimize the amount of tax payable (see Commissioners of Inland Revenue v. Duke of Westminster, [1936] A.C. 1 (H.L.))."
"[65] The most difficult issue in this case is whether the avoidance transaction was an abuse or misuse of the Act. The terms abuse or misuse might be viewed as implying moral opprobrium regarding the actions of a taxpayer to minimize tax liability utilizing the provisions of the Income Tax Act in a creative way. That would be inappropriate. Taxpayers are entitled to select courses of action or enter into transactions that will minimize their tax liability (see Duke of Westminster)."

The open question is the practical impact of these statements. Perhaps it is easiest to answer this by first tracing the recent SCC references to the Duke. For example, in Lipson, both dissenting sets of reasons written by Justices Binnie and Rothstein referred to the Duke.

"[54] Binnie J. (dissenting) — How healthy is the Duke of Westminster? There is cause for concern. Although this Court in Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2 S.C.R. 601, affirmed, at para. 11, the continuing viability of the principle that taxpayers are entitled to arrange their affairs to minimize the amount of tax payable (a principle enshrined in Commissioners of Inland Revenue v. Duke of Westminster, [1936] A.C. 1 (H.L.)), the traditional approach is now tempered by the application of the general anti-avoidance rule ("GAAR"). The question in these appeals, as it was in Canada Trustco, is where the appropriate balance is to be struck."
Rothstein J. (dissenting) —
"[100] I have had the benefit of reading the reasons of my colleagues Binnie J. and LeBel J. I am in agreement with their analyses insofar as ss. 20(1)(c) and 20(3) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) ("Act"), are concerned. There is no reason why taxpayers may not arrange their affairs so as to finance personal assets out of equity and income earning assets out of debt."

In speaking for the majority in Lipson, Mr. Justice LeBel expressed reservations about the applicability of the Duke in the GAAR context:

"[21] It has long been a principle of tax law that taxpayers may order their affairs so as to minimize the amount of tax payable (Commissioners of Inland Revenue v. Duke of Westminster, [1936] A.C. 1 (H.L.)). This remains the case. However, the Duke of Westminster principle has never been absolute, and Parliament enacted s. 245 of the ITA, known as the GAAR, to limit the scope of allowable avoidance transactions while maintaining certainty for taxpayers (Canada Trustco, at para. 15)."

On the face of the comments made in the Reasons, it seems that the views about the health of the Duke have been reconciled without reservation and that the principle survives. However, we offer these two caveats. First, as a general comment, one must be mindful of the unanimous comments of the SCC in paragraph 13 of Trustco:

"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."

Second, the result in the Copthorne case itself demonstrates the limitations of the Duke in light of the GAAR. As paragraphs 124 – 127 of the Reasons indicate, the taxpayer had one of two amalgamation options to pursue: vertical or horizontal. It chose the one which gave rise to the optimal tax planning. Yet it lost. Therefore, perhaps it is best to state that the Duke still lives on as long as one does not acquire a tax benefit through an abusive avoidance transaction, which can be denied under the GAAR.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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