Canada: Supreme Court of Canada Considers the General Anti-Avoidance Rule

Last Updated: December 14 2005

Originally published in the Tax Bulletin November 2005

On October 19, 2005, the Supreme Court of Canada released its first two decisions on the application of the Income Tax Act (Canada) (the "ITA") general anti-avoidance rule (the "GAAR"). In Canada Trustco,1 legitimate tax planning (provided by McMillan Binch Mendelsohn) survived a Canada Revenue Agency (the "CRA") GAAR challenge. In Mathew,2 the CRA succeeded in having the GAAR applied to deny the tax benefits of a structured series of transactions. These decisions are important because they provide the Supreme Court's analytical framework for determining whether a transaction should be considered an "abusive avoidance transaction" for purposes of the GAAR.

Legitimate tax minimization continues to be possible after the Canada Trustco and Mathew decisions. However, the intensively fact-specific analysis required under the Supreme Court's GAAR framework highlights the need for thorough tax analysis prior to undertaking any tax-motivated transaction.


In general terms, the GAAR will apply to deny the tax benefits associated with a transaction or series of transactions where:

(i) a taxpayer receives a tax benefit (e.g., a reduction, deferral or avoidance of tax) from the transaction or series of transactions;

(ii) the transaction (or any transaction in the series) is an "avoidance transaction" for purposes of the GAAR (i.e., the primary purpose of the transaction is to receive the tax benefit); and

(iii) the transaction or series results in a misuse or abuse of the provisions of the ITA.

In each of the Canada Trustco and Mathew decisions (the facts of which are summarized at the end of this bulletin), the taxpayer had conceded that the transaction under scrutiny had given rise to a tax benefit and was an "avoidance transaction". Accordingly, in each decision the sole issue was whether the transaction in question resulted in a misuse or abuse of the ITA.

Abusive Tax Avoidance

The Supreme Court's framework for determining whether a transaction constitutes an abusive avoidance transaction is summarized below:

  1. To determine whether a transaction is an abusive avoidance transaction it is necessary to first determine the object, spirit and purpose of the ITA provision that has purportedly been abused or misused. This must be determined using a "unified textual, contextual and purposive" approach to interpreting the provisions of the ITA in respect of which an avoidance transaction relates (discussed more fully in the commentary below).
  2. Abusive avoidance will be found where a transaction defeats or frustrates the object, spirit or purpose of the provisions of the ITA. This will be the case, for example, where:
  3. (i) a taxpayer relies on particular provisions of the ITA to achieve a result that those provisions were meant to prevent;

    (ii) a transaction defeats the underlying rationale of the provisions of the ITA relied upon; or

    (iii) a transaction circumvents the application of particular provisions of the ITA in a manner that frustrates or defeats the object, spirit or purpose of those provisions.

    In general, abusive avoidance will be found where the relationships and transactions as expressed in the relevant documentation lack a "proper basis" relative to the object, spirit or purpose of the ITA provisions that are purported to confer the tax benefit, or where they are wholly dissimilar to the relationships or transactions contemplated by the provisions.

  4. If the existence of abusive tax avoidance is unclear, the benefit of the doubt goes to the taxpayer.


The Supreme Court decisions makes it clear that a tax benefit arising from technical compliance with the provisions of the ITA will be denied under the GAAR where allowing the benefit would frustrate the object, spirit or purpose of the provisions (i.e. where a transaction giving rise to the benefit is an "abusive avoidance transaction"). Under the "textual, contextual and purposive" approach to statutory interpretation, the object, spirit and purpose of an ITA provision will be determined by considering the literal interpretation of the provision, the scheme of the ITA and using "permissible" extrinsic interpretive aids, such as Department of Finance Technical Notes. In the words of the Supreme Court "even where the meaning of particular provisions may not appear to be ambiguous at first glance, statutory context and purpose may reveal or resolve latent ambiguities." Once the purpose of a tax provision is ascertained, the inquiry turns to whether the relationships and transactions giving rise to the tax benefit have the proper basis relative to this purpose or are wholly dissimilar to the relationships and transactions contemplated by the subject provisions.

The Supreme Court decisions highlight the need for thorough tax analysis prior to undertaking any tax-motivated transaction. While some tax-minimization strategies will survive a GAAR challenge, others will not. Winning tax strategies will be distinguished from the losers based upon their specific facts as they relate to the object, spirit and purpose of the tax provisions giving rise to the purported tax benefit.

The Supreme Court Decisions

Canada Trustco

In Canada Trustco, the taxpayer ("CTMC") completed a series of transactions that resulted in a before-tax return of approximately $8.5 million. Using its own money and borrowings of approximately $100 million, CTMC purchased trailers from a vendor (TLI) for $120 million. CTMC then leased the trailers to an intermediary company (MAIL) who in turn subleased the trailers back to TLI, the original owner. TLI then prepaid all amounts owing to MAIL under the sublease. MAIL placed an amount equal to the loan on deposit for purposes of supporting lease payments due to CTMC and a bond was pledged as security to guarantee a purchase option payment to CTMC at the end of the lease. The transactions allowed CTMC claim over $31 million in capital cost allowance (CCA) on the leased trailers for its 1997 taxation year, with relatively little financial risk in respect of the transactions.

The CRA argued that CTMC's CCA claims were abusive and should be denied on the basis that CTMC had minimized its economic risk with respect to the trailers. It is clear from a literal reading of the CCA provisions that entitlement to a CCA claim is based on a taxpayer's tax cost of an asset. However, the CRA argued that the purpose of the CCA provisions was to allow CCA deductions only where taxpayers have the economic risk associated with the asset. The Supreme Court rejected the Minister's arguments that the CCA provisions were abused by CTMC in these circumstances. The Supreme Court held that the subject provisions clearly permitted CCA deductions based on the tax cost of assets, irrespective of whether a taxpayer has economic risk in respect of the asset. Further, the Supreme Court held that the transaction in question was not so dissimilar from ordinary sale-leaseback transactions as to take it outside the object, spirit and purpose of the relevant CCA provisions.


The Mathew decision is a "loss-trading" case. In Mathew, the CRA attacked tax loss deductions claimed by investors in a partnership that had been established to utilize the tax losses of an arm's length entity. The losses originated from certain underperforming mortgages that the partnership acquired from a vendor. Since the vendor and the partnership were not at arm's length at the time the mortgages were acquired, the partnership was deemed under an ITA provision (the "loss denial rule") to have acquired the mortgages at their original cost to the vendor. Subsequent to the acquisition of the mortgages, the vendor sold its interest in the partnership to an arm's length party who, in turn, sold the partnership interest to another partnership of which the taxpayers were partners. The partnership realized a substantial loss for tax purposes on the disposition of the mortgages and the taxpayers were allocated their proportionate share of such tax loss.

The CRA argued that the transactions giving rise to the taxpayer's tax loss claims were abusive avoidance transactions because they misused technical provisions of the ITA to permit the taxpayers to use losses of a non-arm's length party (i.e. the original owner of the mortgages). The Supreme Court agreed, holding that (a) the purpose of the loss denial rule was to prevent certain non-arm's length taxpayers from realizing a superficial loss, (b) the purpose for the broad treatment of loss sharing between partners is to promote an organizational structure that allows partners to carry on a business in common in a non-arm's length relationship, and (c) Parliament could not have intended that the combined effect of these rules would preserve and transfer a loss to be realized by a taxpayer who deals at arm's length with the original transferor. On this basis, the Supreme Court held that the transactions resulted in abusive tax avoidance.


1. 2005 SCC 54.

2. 2005 SCC 55.

The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.

© Copyright 2005 McMillan Binch Mendelsohn LLP

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