Canada: Lipson’s “Spousal Twist” Subject To GAAR

On January 8, 2009, a majority of the Supreme Court of Canada (4:3) dismissed the taxpayer's appeal in Lipson v. The Queen. The facts in Lipson were similar to the facts of the Singleton case (which was decided by the Supreme Court in favour of the taxpayer); however, Lipson involved the transfer of company shares between spouses financed with borrowed funds secured against the taxpayer's residence which triggered the application of the spousal attribution rules. Unlike Singleton, the Minister of National Revenue challenged the transactions in Lipson under the general anti-avoidance rule (the "GAAR") rather than relying on an "economic realities" argument, which had been rejected by the Supreme Court in Singleton. Lipson represents the first time the Supreme Court has had a chance to review the general framework for GAAR's application which it established in The Queen v. Canada Trustco Mortgage Company and Kaulius v. The Queen.


In Lipson, the taxpayer and his wife entered into an agreement to purchase a family residence. The taxpayer's wife borrowed funds from a bank to purchase private corporation shares from the taxpayer. The taxpayer and his wife then borrowed funds secured by a mortgage against the purchase price of a new residence and, on the same day, used the funds to repay the original share purchase loan. The taxpayer took the position that the interest on the mortgage loan was deductible on the basis of paragraph 20(1)(c) and the replacement loan rules in subsection 20(3) which deem funds borrowed to repay a prior loan to be used for the same use as the prior loan. Pursuant to the spousal rollover rules in subsection 73(1) which applied automatically (and were not opted out of), the transfer of shares from the taxpayer to his wife was deemed to have occurred at the taxpayer's cost, resulting in no taxable gain to the taxpayer at the time of the transfer. In addition, the application of the spousal attribution rules in section 74.1 resulted in the net income or loss from the dividend income from the transferred shares as well as the interest deduction on the borrowed funds being attributed back to the taxpayer.

Lower Court Decisions

The Tax Court of Canada held that the GAAR applied in the circumstances, finding that "[t]he overall purpose as well as the use to which each individual provision was put was to make interest on money used to buy a personal residence deductible." In the Court's view, this was "an obvious example of abusive tax avoidance." On appeal, the parties agreed the transactions were avoidance transactions designed to obtain tax benefits, so the only question was whether the transactions resulted in a misuse or abuse of the Canadian tax legislation. The Federal Court of Appeal determined that none of the transactions considered separately resulted in a misuse or abuse of the four relevant tax provisions relied on. However, in affirming the Tax Court's decision, the Court endorsed the Tax Court's overall purpose approach, concluding that "where a tax benefit results from a series of transactions, the series becomes relevant in ascertaining whether any transaction within the series gives rise to an abuse of the provisions relied upon to achieve the tax benefit."

Supreme Court Decision - Majority Reasons

On appeal to the Supreme Court of Canada, a majority of the Court (4:3) dismissed the taxpayer's appeal. Mr. Justice LeBel, writing for the majority, concluded that Singleton was distinguishable from Lipson, since neither the GAAR nor subsection 74.1(1) had been at issue in the former case. Furthermore, the majority considered the taxpayer's argument that Singleton was dispositive of the appeal as in effect reading the GAAR out of the Canadian tax legislation. In the majority's view, the "direct use test" applies only to determine the deductibility of interest under paragraph 20(1)(c) and involves a distinct inquiry from that under the GAAR, in which the Court is required to determine whether otherwise valid transactions (such as those in Singleton and this case) violate the object, spirit and purpose of the provisions relied upon.

Mr. Justice LeBel also addressed the appellants' objection to the overall purpose approach adopted by the lower courts, and the appellants' argument that none of the provisions relied on by the Minister, regarded separately, were frustrated:

"It is true, as the appellants argue, that in assessing a series of transactions, the misuse and abuse must be related to the specific transactions forming part of the series. However, the entire series of transactions should be considered in order to determine whether the individual transactions within the series abuse one or more provisions of the Act. Individual transactions must be viewed in the context of the series. Consideration of this context will enable a reviewing court to assess and understand the nature of the individual parts of the series when analysing whether abusive tax avoidance has occurred. At the same time, care should be taken not to shift the focus of the analysis to the "overall purpose" of the transactions. Such an approach might incorrectly imply that the taxpayer's motivation or the purpose of the transaction is determinative. In such a context, it may be preferable to refer to the "overall result", which more accurately reflects the wording of subsection 245(4) and this Court's judgment in Canada Trustco."

On that basis, Mr. Justice LeBel concluded that while the results of a series of transactions are not relevant in determining whether the general interest deductibility provision in paragraph 20(1)(c) applies, they are relevant to determining whether there is a misuse or abuse of a provision of the Act under subsection 245(4) of the GAAR. Consistent with Kaulius, Mr. Justice LeBel concluded that "the individual tax benefits must be analysed separately, but always in the context of the entire series of transactions and bearing in mind that each step may have an impact on the others, in order to determine whether any of the provisions relied upon for each tax benefit was misused and abused." However, Mr. Justice LeBel cautioned, in keeping with the principles established in Canada Trustco, that motive, purpose and economic substance are relevant to the analysis under subsection 245(4) only insofar as they establish whether the transaction frustrates the purpose of the relevant provisions. Ultimately, the majority of the Court noted that though the term "overall purpose" was used by the lower courts, in their view, the lower courts appeared to have focused on the result, rather than the purpose, of the transactions in accordance with their approach described above.

Mr. Justice LeBel was attracted to the appellants' argument that there were in fact two tax benefits stemming from the transactions and further that the GAAR analysis should be conducted in respect of each of those benefits.

"The appellants sought an overall result, that is, the deduction of the interest payments on the mortgage from their income. Nevertheless, the legal analysis required by the GAAR cannot stop at this level. Its focus must be on the individual benefits – which may in combination have led to the overall result – in the context of the series of transactions."

Dividing the tax benefits then permitted the Court to conclude that neither paragraph 20(1)(c) nor subsection 20(3) had been misused or abused and that the sale of the shares to the taxpayer's wife and the purchase of the residence with the sale proceeds were "unimpeachable" to that point. Any tax benefit in the form of an interest deduction would have been attributed to the taxpayer's wife as a result of these transactions. However, in the majority's view, the problem arose when the taxpayer took further steps in the series of transactions by relying on subsection 73(1) and 74.1(1) to attribute to the taxpayer his wife's interest expense on the borrowed funds and the dividend income on the transferred shares. The attribution to the taxpayer of the interest expense and dividend income on the transferred shares by operation of subsection 74.1(1), which would not have occurred if the taxpayer was dealing at arm's length with his wife, qualified as abusive tax avoidance, in the Court's view, because it frustrated the purpose of the attribution rules.

In the majority's view, subsection 74.1(1) "is designed to prevent spouses from benefiting from their non-arm's length relationship by attributing, for tax purposes, any income or loss from property transferred to a spouse back to the transferring spouse". The majority's reasons for judgment suggest that it considered subsection 74.1(1) to be abused in this case because, rather than preventing income splitting by attributing income back to the higher income earning taxpayer, the operation of subsection 74.1(1) resulted in the reduction of the total amount of tax payable by the taxpayer on the income from the transferred property.

Finally, the majority of the Court concluded that the disallowance of the interest expense in computing the income or loss attributed to the taxpayer and the allocation of that interest expense back to his wife was a reasonable outcome of the application of the GAAR, even though the result was more detrimental to the taxpayer than if the specific anti-avoidance rule in subsection 74.5(11) had applied to the transactions.

Supreme Court Decision – Dissenting Reasons

Mr. Justices Binnie And Deschamps

In dissenting reasons, Mr. Justice Binnie found for the appellants and disagreed with the majority's conclusion that the appellants' reliance on the operation of the spousal attribution rule in subsection 74.1(1) was abusive:

"If the tax plan in Singleton is not abusive, the Minister has failed to establish that Singleton with a spousal twist is abusive tax avoidance either. There is nothing in the Act to discourage the transfer of property at fair market value between spouses. Indeed, by allowing a spouse to transfer property to the other spouse at the transferor's adjusted cost base, Parliament intended to make such inter-spousal transfers attractive".

Mr. Justice Binnie pointed out the contradiction in the Minister's position that subsection 74.1(1) should apply to attribute net dividend income on the transferred shares to the taxpayer, but subsection 74.1(1) is abused if a net loss from the shares is similarly attributed to the taxpayer. Subsection 74.1(1) makes no distinction between the attribution of income and losses, and Mr. Justice Binnie noted that the Minister's counsel readily acknowledged that subsection 74.1(1) can result in a loss being transferred from the lower income earning spouse to the higher income earning spouse. In contrast to the majority's view, the minority dissent found that the outcome of the appellants' transactions "was not so much an abuse 'of the specific provisions' as it was a fulfillment of them".

Furthermore, in their view, the Minister had failed to identify a specific policy that had been frustrated by the appellants' transactions (as required by Canada Trustco). In that regard, Mr. Justice Binnie cautioned that the majority's approval of the Minister's resort to vague generalities or 'overriding policy' will increase the uncertainty in tax planning that Canada Trustco had sought to avoid:

"Here, the application of the GAAR would mean paying lip service to the [Duke of Westminster] principle that taxpayers are entitled to arrange their affairs to minimize the amount of tax payable, without taking seriously its role in promoting consistency, predictability and fairness in the tax system".

Mr Justice Binnie further concluded that the Tax Court's adoption of an overall purpose approach was "an error of law that invites our intervention". The purpose of a transaction is relevant to determining whether it is an "avoidance transaction" under subsection 245(3). However, the principal focus of the misuse or abuse analysis under subsection 245(4) shifts to results, not purpose. It was not sufficient for the Minister to put forth "a general 'overall' conclusory snapshot [e.g., the purpose of the scheme was to make the interest on the mortgage on the home deductible] of the series of transactions without regard to the legal relationships thereby created". As Kaulius states, the entire factual context of the series must be considered and applied. The Minister's argument that there was no rearrangement of capital in this case (unlike Singleton) ignored completely the sale of the shares by the taxpayer to his wife as the initial step in the series of transactions. The transactions resulted in a change in the taxpayer's position with real economic substance, as the taxpayer's wife became the owner of the transferred shares legally and would have been taxed on the dividends on those shares if not for the operation of the spousal attribution rules.

Mr. Justice Binnie also responded to Mr. Justice LeBel's assertion that following the reasoning in Singleton would read the GAAR out of the Canadian tax legislation:

"My colleague LeBel J. says that the foregoing analysis would essentially 'gut[t]' the GAAR provision and 'read it out of the ITA' (para. 52), but, with respect, this seems a somewhat apocalyptic verdict on a disagreement about whether or not the Minister has met his onus of demonstrating abuse of a specific 'object, spirit or purpose' arising out of the 'specific provisions' relied upon by the taxpayers to claim the tax benefit. It cannot be right that whenever a lower income spouse borrows money to purchase shares from a higher income spouse there is an abuse of the spousal attribution rules unless the transferring spouse opts out of ss. 73(1) and 74.1(1), and thereby forfeits a tax benefit clearly available under the Act. As stated in Canada Trustco:

Where Parliament has specified precisely what conditions must be satisfied to achieve a particular result, it is reasonable to assume that Parliament intended that taxpayers would rely on such provisions to achieve the result they prescribe. [para. 11]"

Mr. Justice Rothstein

In separate dissenting reasons, Mr. Justice Rothstein held that that the GAAR did not apply in this case since a specific anti-avoidance rule contained in subsection 74.5(11) existed, which prescribed the limits for avoidance for purposes of the spousal attribution rules. In Mr. Justice Rothstein's view, the GAAR is a provision of last resort and, by its express terms, does not apply if there is a specific anti-avoidance rule that pre-empts its application. Mr. Justice LeBel had concluded that it was not open to the Court to consider subsection 74.5(11) because it had been "expressly disavowed by all parties throughout the proceedings". However, Mr. Justice Rothstein stated that it was not open to the Court to assist the Minister by permitting him to ignore subsection 74.5(11) and instead rely on the GAAR. Mr. Justice Rothstein also disagreed with the majority's comment that both the GAAR and subsection 74.5(11) may be concurrently applicable: "The GAAR is a supplementary rule. It is not a catch-all provision that the Minister can choose to deploy any or every time that he suspects a taxpayer of abusive tax avoidance". Mr. Justice Rothstein also took issue with Mr. Justice Binnie's approach to the GAAR analysis, contending that it was impossible to define the proper limits of the GAAR while failing to recognize that the GAAR is, by its express terms, a provision of last resort.


The Supreme Court has clearly confirmed the textual, contextual and purposive approach to the GAAR from its earlier decisions in Canada Trustco and Kaulius, and has adopted (in paragraph 40) the test for abusive transactions set out in Canada Trustco. The Court has also confirmed the need for certainty in tax planning which, however, is not absolute and must be balanced against the GAAR which limits allowable avoidance transactions. Furthermore, the majority and Mr. Justice Binnie in his minority dissent have clearly accepted that even though individual tax benefits must be considered separately, the entire series of transactions must be looked at to determine whether each individual transaction within the series results in a misuse and abuse of the relevant statutory provisions.

However, uncertainty still remains with the statements Mr. Justice Rothstein made in his minority dissent regarding the role of the GAAR where a specific anti-avoidance rule may apply to a transaction. The majority of the Court seems to suggest that if neither of the parties opts to address the application of a specific anti-avoidance rule, then the Minister may choose to challenge a transaction, which may be covered by the specific anti-avoidance rule, under the GAAR rather than the specific anti-avoidance rule. However, the Court did not address what the result would be if the Minister opts to challenge a transaction both under a specific anti-avoidance rule and the GAAR and loses the challenge under the specific anti-avoidance rule. Can the GAAR still apply? Mr. Justice Rothstein states in his minority dissent that if a specific anti-avoidance rule applies, then the GAAR cannot be used. However, the majority's general comments may suggest that if the Minister loses his challenge on the specific anti-avoidance rule, then the GAAR may still be available as a last resort.

From a practical perspective, the Court's decision indicates that taxpayers planning mortgage financing transactions similar to Singleton for the purposes of satisfying the requirements of interest deductibility under paragraph 20(1)(c) and subsection 20(3) should not run afoul of the GAAR. However, planning which involves the use of other provisions of the Income Tax Act, such as the spousal attribution rules in Lipson, may be a step too far and trigger the application of the GAAR.

The full text of the Supreme Court's judgment is available at:

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