Canada: MacKay: A Potential Threat To The Duke

On March 19, 2008, the Federal Court of Appeal (the "FCA") rendered its decision in the MacKay appeal,1 reversing the judgment of the Tax Court of Canada (the "TCC") which had found that the GAAR2 did not apply as none of the transactions at issue constituted an avoidance transaction under paragraph 245(3)(b) of the Income Tax Act (the "Act").

In general terms, the TCC had suggested that in analyzing the primary purpose of each transaction within a series under paragraph 245(3)(b) of the Act, the Court should not merely consider in isolation the direct purpose of each such transaction. Instead, the TCC posited that the primary purpose of the series of transactions, as a whole, should also be a relevant, though not necessarily determinative factor in determining whether each particular transaction constitutes an avoidance transaction.

But, at the same time, the Court stated, in concluding its decision, that it did inter alia find that none of the transactions, when considered apart from the others, constituted an avoidance transaction.

The Transactions

The series of transactions at issue (the "Series") can be summarized as follows:

  1. In 1992, the National Bank of Canada (the "Bank") commenced foreclosure proceedings in respect of the Northills Shopping Centre (the "Shopping Centre"). The amount owed to the Bank was approximately $16 million and the Shopping Centre was listed for sale at $12.5 million.

  2. By August 1993, the taxpayers and the Bank had agreed in principle to transfer the Shopping Centre to the taxpayers for $10 million. It was understood that this transfer would be effected by the assignment of the Bank's interest in the foreclosure proceedings (and therefore the assignment of the Bank's mortgage receivable).

  3. Following the above agreement in principle, the taxpayers proposed to structure the transaction so as to obtain the benefit of the $6 million loss that had been incurred by the Bank on the mortgage receivable. For the purposes of the appeal, the FCA assumed that the taxpayers would have proceeded with the acquisition regard less of whether they would be afforded the benefit of the $6 million loss based on the fact that this use of the loss had not been discussed between the parties before agreeing to the $10 million sale price.3

  4. Accordingly, in November 1993, the Bank and a newly incorporated subsidiary thereof ("GPco") formed a limited partnership (the "Partnership") under which the Bank was a limited partner and GPco was the general partner. The Partnership's first fiscal period would end on December 31, 1993.

  5. The Bank then assigned the mortgage receivable and its interest in the foreclosure proceedings to the Partnership in exchange for limited partnership units with an aggregate value of $10 million, being the fair market value of the mortgage receivable and the interest in the foreclosure proceedings. On a direct sale to the taxpayers of such assets, the Bank would have realized a loss of $6 million. However, since the Bank and the Partnership did not deal at arm's length, subsection 18(13) of the Act applied to prevent the deduction by the Bank of the $6 million loss and, instead, added the amount of such loss to the Partnership's cost of such assets — increasing such cost from $10 million to $16 million.

  6. On December 29, 1993, the taxpayers acquired general partnership units of the Partnership for $2 million.

  7. The Bank then loaned $9.7 million to the Partnership, $8.6 million of which amount was to finance the redemption of the Bank's limited partnership units.

  8. The Partnership then acquired the Shopping Centre by completing the foreclosure. The Partnership's cost of acquiring the Shopping Centre was equal to its cost in the mortgage receivable and the interest in the foreclosure proceedings, being $16 million as noted above.

  9. On December 30, 1993, the Partnership redeemed $8.6 million of the Bank's limited partnership units and, on December 31, 1993, the Partnership redeemed the balance for $1.4 million, using part of the amount contributed to the Partnership by the taxpayers. Presumably, the balance of the capital of the Partnership was to be used in the development of the Shopping Centre.

  10. Lastly, on December 31, 1993, the Bank sold the shares of GPco to two of the taxpayers.

  11. At year end, the Partnership took a write-down of its cost in the Shopping Centre (which it considered to be inventory) to its fair market value of $10 million, resulting in a $6 million loss which was allocated proportionately to its partners, the taxpayers.

To read the document in its entirety please click here.


1. The Queen v. MacKay et al. (2008 DTC 6238, 2008 FCA 105), reversing 2007 DTC 425, 2007 TCC 94.

2. The so-called General Anti-Avoidance Rule, expressed at section 245 of the Act.

3. One may speculate as to whether the taxpayers made a strategic decision to proceed in this manner in order to avoid having the Bank use the potential loss as a bargaining chip. However, the record before the FCA would not justify such speculation.

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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