Copyright 2011, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Tax, December 2011
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:
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
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:
Paragraph 70 of the Reasons then outlines the uniqueness of the analysis in a GAAR situation:
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:
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:
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:
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:
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:
G. The Obligations of the Minister to Promote
Consistency, Predictability and Fairness When Interpreting and
Applying the GAAR – Is GAAR Intended to Create
In Trustco, there was much mention of the need for interpretation to be done so that these principles are served:
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:
At the same time, the Chief Justice and Justice Major, speaking for the unanimous court in Trustco, expressed the following:
In Lipson, Justice LeBel, speaking for the other three majority justices, stated the following:
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:
H. Reassurance for Taxpayers that the GAAR Will Not
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:
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:
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.
In speaking for the majority in Lipson, Mr. Justice LeBel expressed reservations about the applicability of the Duke in the GAAR context:
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:
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.
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