Canada: The Supreme Court Of Canada On Tax Avoidance: Lipson And The General Anti-Avoidance Rule

1. Introduction

On January 8, 2009, the Supreme Court of Canada handed down a split decision on the application of the General Anti-Avoidance Rule (GAAR) in Lipson that one leading tax commentator called "probably the most significant tax decision in the last 70 years; it addresses a very fundamental issue that has been causing tension in tax law for decades, [namely] balancing the rights of the taxpayer to arrange his affairs to minimize tax." Our firm was counsel for the Lipsons at the hearings before the Supreme Court of Canada and the Federal Court of Appeal, and we are pleased to share some of our observations with you in this publication.

Lipson is the third GAAR appeal heard by the Supreme Court of Canada, and the first following its 2005 decisions in Canada Trustco and Kaulius. Of particular note, Lipson is the first appeal to deal with the possible impact of the GAAR on the deductibility of interest expense. Lipson also shows how difficult it is for taxpayers, tax advisors and the Canada Revenue Agency (CRA) to determine when abusive tax avoidance exists and illustrates how different judges and different courts can come to different conclusions on the same set of facts.

The majority of the Supreme Court concluded in Lipson that the GAAR applied to a series of transactions that were considered to result in abusive tax avoidance. The Supreme Court also confirmed that this series of transactions would not have been subject to the GAAR but for the fact that they involved an abuse of the spousal attribution rules. A spousal "twist" that was added to a series of transactions similar to the transactions in the Singleton case, decided in 2001 by the Supreme Court, was found to tip the balance against Earl Lipson. Nonetheless, in applying the GAAR, the Supreme Court provided relief to his spouse, Jordanna Lipson, that had not been considered by the lower courts.

2. Facts

Mr. Lipson owned shares of an investment company (Holdco). Mrs. Lipson borrowed $562,500 from a bank to acquire some of his Holdco shares at their fair market value. As part of the same series of transactions, the Lipsons agreed to purchase a house for $750,000, for which Mr. Lipson used the proceeds from the sale of his Holdco shares. On closing of the house purchase, the Lipsons granted mortgage security on the house for a bank loan to refinance Mrs. Lipson's original bank loan for the Holdco share purchase.

The interest on the refinancing loan was deducted from the taxable dividends on the Holdco shares owned by Mrs. Lipson by virtue of the operation of a number of provisions in the Income Tax Act (Canada). Paragraph 20(1)(c) and subsection 20(3) allowed Mrs. Lipson to deduct interest expense on money borrowed to acquire or refinance the acquisition of an income-producing asset, i.e., the Holdco shares. Subsection 73(1) permitted Mr. Lipson to sell his Holdco shares to Mrs. Lipson without immediate tax consequences, such that any future gain or loss resulting from a disposition by Mrs. Lipson of the Holdco shares would be attributed back to Mr. Lipson. Finally, any income or loss from the Holdco shares held by Mrs. Lipson (the taxable dividends less the interest expense) was attributed back to Mr. Lipson under subsection 74.1(1). As a result of these provisions, Mr. Lipson was entitled to deduct the interest on the loan obtained by Mrs. Lipson to purchase the Holdco shares and the refinancing loan. The Minister disallowed the interest expense claimed by Mr. Lipson on the basis that the GAAR applied to the series of transactions that constituted abusive tax avoidance. The Minister treated the dividend income as taxable to Mr. Lipson and disallowed the deduction of the interest expense by both Mr. and Mrs. Lipson.

The Minister succeeded in both the Tax Court of Canada and the Federal Court of Appeal. As a result, serious issues arose for Canadian taxpayers as to the application of the GAAR to tax planning in a wide range of circumstances and in particular as it might affect the deductibility of interest.

At the Tax Court, the taxpayer agreed that each of the transactions within the series was an "avoidance transaction" resulting in a tax benefit. The only issue before the Tax Court was whether either transaction involved abusive tax avoidance such that the resulting tax benefit was denied by the GAAR. The Tax Court held that the GAAR applied, on the basis that the "overall purpose" and the use to which each of the relevant provisions of the Act was put was to make interest on money used to buy a personal residence deductible. Thus, the Tax Court considered the series of transactions to have misused those provisions.

The Federal Court of Appeal dismissed Mr. Lipson's appeal. It held that, viewed separately, none of the transactions was abusive. However, it concluded that the Tax Court was entitled to consider the transactions as a series and to conclude that the transactions misused the statutory provisions upon which Mr. Lipson relied to obtain tax benefits.

3. Supreme Court of Canada

3.1 The Majority Decision of Mr. Justice LeBel

The Supreme Court dismissed the appeal by a four-to-three majority. Mr. Justice LeBel wrote the reasons of the majority, which included Madam Justice Abella, Madam Justice Charron and Mr. Justice Fish.

After reviewing the facts, the history in the lower courts, and the parties' arguments, Mr. Justice LeBel rendered his findings. He held that the CRA had established abusive tax avoidance and that the GAAR applied to one transaction within the series of transactions. Consequently, he found that the GAAR denied one of the two tax benefits sought by Mr. and Mrs. Lipson. On that basis, Mrs. Lipson was entitled to deduct the interest expense relating to the purchase of shares from Mr. Lipson, and Mr. Lipson was required to include the dividends in his income but could not deduct the interest expense. Mr. Justice LeBel made careful efforts to distinguish Singleton on the basis that the Singleton decision did not involve either the application of the attribution rules or the GAAR. In commenting on abusive tax avoidance and the application of the GAAR, Mr. Justice LeBel determined that the Duke of Westminster principle, which states that a taxpayer is entitled to arrange his or her affairs to minimize taxes payable, was still alive but circumscribed by the GAAR. The burden was on the CRA to prove, on the balance of probabilities, that the avoidance transaction had resulted in abusive tax avoidance — thus attracting the operation of the GAAR.

Mr. Justice LeBel agreed that two tax benefits existed: one being the deduction of the interest on the share purchase loan by Mrs. Lipson, and the other the attribution of that interest deduction to Mr. Lipson under the attribution rules. According to Mr. Justice LeBel, the GAAR analysis must focus on the individual tax benefits that, in combination, may have led to an overall result in the context of a series of transactions. In reaching his conclusion, Mr. Justice LeBel affirmed the analysis in Canada Trustco for determining abuse. He emphasized that a textual, contextual and purposive approach to statutory interpretation is required, then proceeded to analyze the four statutory provisions giving rise to the two tax benefits to determine their essential object, spirit and purpose. Before doing so, Mr. Justice LeBel identified which of the two tax benefits was associated with which statutory provisions. The interest deduction was available to Mrs. Lipson pursuant to paragraph 20(1)(c) and subsection 20(3) of the Act. The attribution of the interest expense to Mr. Lipson only became available through the application of subsection 73(1) and Section 74.1 of the Act. Mr. Justice LeBel then proceeded to determine whether abusive tax avoidance had occurred. He commented (at paras. 40-42) on whether the avoidance transactions frustrated the object, spirit and purpose of the relevant statutory provisions. Unfortunately, he did so very briefly. He said there was no abuse of the provisions of the Act giving Mrs. Lipson an interest deduction (paragraph 20(1)(c) and subsection 20(3)). However, he found that, contrary to the purpose of Section 74.1, it was abusive for the interest deduction to be attributed to Mr. Lipson. The attribution of the deduction created a result that Mr. Lipson could not have achieved had he not sold the shares to his wife in a non-arm's-length relationship. Mr. Justice LeBel further stated that a specific anti-avoidance rule, Section 74.1, was used to facilitate abusive tax avoidance. He repeated this later (at para. 48).

Mr. Justice LeBel made two other important observations (at paras. 33-34). He first commented that the references to an "overall purpose" made by the lower courts really should have been a reference to an "overall result." He stated that "overall purpose," which might be said to involve motivation, economic substance or true economic purpose, is not determinative in an "abuse" analysis. Motivation, purpose and economic substance are only relevant, as Canada Trustco indicated (at paras. 57-59 of that decision), to establish whether a transaction frustrated the purpose of the relevant statutory provisions. He also indicated that the entire series of transactions should be considered to determine whether the individual transactions within the series abused one or more provisions of the Act. Individual transactions must be viewed in the context of the series.

Mr. Justice LeBel also wrote about the interaction of specific anti-avoidance rules and the GAAR. He made reference to subsection 74.5(11) of the Act, a specific anti-avoidance rule that deals with attribution and stated (in paras. 45, 47) that the provision did not apply on the facts of the case and that its interpretation had not been litigated. He further pointed out that Courts should not refuse to apply the GAAR if a more specific provision might apply and that the GAAR was designed to address the complexity of transactions falling outside the scope of specific anti-avoidance rules.

Having decided to apply the GAAR to deny the attribution of the interest deduction to Mr. Lipson, Mr. Justice LeBel then outlined the "reasonable consequences" of the GAAR's application under subsection 245(5) of the Act. This is the first decision dealing with the operation of subsection 245(5) when the GAAR is applied to a transaction. Mr. Justice LeBel concluded that a reasonable outcome was to disallow the attribution of the "interest expense" to Mr. Lipson, but to allow the deduction of the interest expense (or as he put it) to attribute the interest deduction back to Mrs. Lipson. This analysis is inconsistent with the well-known concept that the attribution rules require the calculation of "income or loss" — a net concept prior to the application of the attribution rules. Under that approach, the net income or loss (i.e., the grossed-up taxable dividends less the interest expense) would have been taxable to Mrs. Lipson alone, and the appeal of Mr. Lipson would have been allowed in part.

In closing, Mr. Justice LeBel made comments about the potential uncertainty from a finding that the GAAR was applicable. He stated (at para. 52) that even though some parties have commented that the decision to apply the GAAR may lead to uncertainty in the interpretation and application of the Act, the GAAR can still apply to transactions dealing with interest deductibility. The "tracing" requirement in paragraph 20(1)(c) does not immunize interest expense from the application of the GAAR in complex transactions in cases such as Lipson and Singleton. He also stated that the GAAR was intended to introduce uncertainty. It is interesting that he made no mention of paragraph 21 of Canada Trustco, in which the Supreme Court said "the GAAR was not intended to introduce uncertainty in tax planning." He emphasized that the GAAR was not a penal provision or a hammer to pound the taxpayers into submission. It was designed to restrain abusive tax avoidance and to make sure that the fairness of the tax system is preserved.

3.2 The Dissenting Reasons of Mr. Justice Binnie

Mr. Justice Binnie (Deschamps J. concurring) found for Mr. Lipson, concluding that the GAAR did not apply either to the deduction of the interest or to the attribution of the net income or loss from the Holdco shares. That is, the GAAR did not apply to disallow the effective deduction by Mr. Lipson of the interest on the bank loan and refinancing loan obtained by Mrs. Lipson to purchase the Holdco shares from him. Contrary to the decision of the majority, Mr. Justice Binnie found that Mr. Lipson's reliance on the operation of the spousal attribution rule in subsection 74.1(1) was not abusive, saying (at para. 59):

[T]here 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 transfers attractive. 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.

Mr. Justice Binnie reviewed the attribution provisions challenged by the Minister and concluded that the Minister had failed to identify a specific policy in the attribution rules that had been frustrated by the transactions (as required by Canada Trustco). He conducted a careful review of the language and scheme of the attribution provisions in the Act on a "textual, contextual and purposive" basis, and having done so, concluded that the attribution rules had not been misused or abused, because they operated precisely as they were designed to do in these circumstances. The purpose of subsection 74.1(1) of the Act is to prevent spouses from reducing tax by transferring property between each other. Instead, he concludes that:

... such a reduction in the total amount of tax is the likely result of any interspousal rollover from a higher income spouse to a lower income spouse, a result that s. 74.1 plainly contemplates. Nowhere in the provisions at issue does Parliament indicate that attribution of a loss could only be made from lower income spouses to higher income spouses. (para. 76)

He then focuses on whether, in a proper statutory interpretation of the attribution rules, any policy could be discerned that required only the revenue from transferred property to be attributed to the transferring spouse, as opposed to related expenses. He concludes that the provisions expressly contemplate the contrary (at para. 78):

When Parliament used the words "income or loss" in s. 74.1(1), it expressly contemplated that regardless of the relative income of the spouses, interest expenses incurred by the transferee (here the wife) will in the circumstances dictated by Parliament be attributed to the transferor (here the appellant). Section 74.1(1) ... simply attributes the net income or loss arising from the transferred property to the transferor in circumstances where the transferor has decided not to opt for a deemed disposition and thereby risk capital gains tax.

The attribution rules, which clearly attribute the net income or loss, also clearly attribute both net income and loss whereas, in the words of Mr. Justice Binnie (at para. 83):

In the Minister's view, apparently, the spousal attribution rules provided in this case a narrow bridge over which income may pass, but not losses.

With respect to the scheme of the attribution rules, Mr. Justice Binnie (at para. 81) cited with approval Noel J.A. in the Federal Court of Appeal concerning the operation of subsections 74.1(1) and 73(1) as they applied to the transactions undertaken by Mr. and Mrs. Lipson:

I agree with the Federal Court of Appeal to the extent that it recognized that the specific purposes of s. 74.1(1) and s. 73.1 were fulfilled, not abused. In my view, moreover, the additional fact that the attribution occurred as part of a Singleton "shuffle" does not render the "series of transactions" abusive unless the Singleton shuffle itself is abusive, which is a position the Minister declined to advance.

Finally, in reviewing the overall scheme of the attribution rules, Mr. Justice Binnie considered those provisions that pre-empt the operation of the attribution rules — subsection 74.5(1), which permits a taxpayer to elect not to have the attribution apply (at para. 88), and subsection 74.5(11), a specific anti-avoidance rule (at para. 79) that recognizes that an attribution back to a transferor spouse might be inappropriate in some circumstances. He noted that the Minister had no attempt to apply the latter in this case. He found (at para. 98) that no specific policy in the attribution rules was frustrated or defeated by the series of transactions, and was of the opinion that the Minister had not found "that the abusive nature of this transaction" was "clear," as required by the decision in Canada Trustco.

Mr. Justice Binnie cautioned that the approval by the majority of the Minister's resort to vague generalities concerning the purpose of the attribution rules and of concepts such as the "overriding policy" of the rules increased uncertainty in tax planning.

Mr. Justice Binnie agreed with the majority that the "overall purpose" approach used by the Tax Court was incorrect, as purpose is relevant only to the determination of whether a transaction was an "avoidance transaction" under subsection 245(3), whereas the test for misuse or abuse under subsection 245(4) looks to the result of the transaction. In assessing the result of a transaction, it was necessary to have regard to the entire factual context of the series (at para. 68). Further, he was of the view that the actual legal effect of each transaction in a series had to be respected for what it was in undertaking the GAAR analysis. The Minister was not entitled to take a "general 'overall' conclusory snapshot of the series of transactions."

Mr. Justice Binnie's approach to the interpretation of the GAAR within the framework of the Canada Trustco decision is summed up (at para. 94):

Canada Trustco is emphatic that the GAAR "was enacted as a provision of last resort" (para. 21), and Parliament "intends taxpayers to take full advantage of the provisions of the Income Tax Act that confer tax benefits" (para. 31). The onus of establishing abuse is on the Minister to identify with some precision the "object, spirit or purpose" frustrated by the impugned series of transactions.

He responded (para. 96) to the accusation in the majority decision that his analysis would "gut" the GAAR and "read it out of the Act":

... 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.

The analysis by Mr. Justice Binnie adheres closely to the principles laid down in Canada Trustco for the application of the GAAR, namely that (i) the GAAR is a provision of last resort; (ii) the GAAR is not intended to override express provisions of the Act based on vague "overriding policies"; (iii) the abusive nature of the transaction must be clear before the GAAR applies; and (iv) there is a broad policy that the interpretation of the Act must promote consistency, predictability and fairness in the tax system.

3.3 The Dissenting Reasons of Mr. Justice Rothstein

In the second dissent, Mr. Justice Rothstein agreed (at para. 100) with both the majority and the dissent of Mr. Justice Binnie insofar as they concluded that the GAAR did not apply to taxpayers who arranged their affairs so as to finance their personal assets out of equity and income-earning assets out of debt. However, he further held that the GAAR did not apply because there was a specific anti-avoidance rule in subsection 74.5(11) of the Act that precluded the use of the GAAR, which the Minister should have applied. The failure to apply a specific rule was fatal to the reassessment. Mr. Justice Rothstein went on to find that if the Minister had applied the specific anti-avoidance rule, the effect would have been to disallow the use of the attribution rules and to leave the dividend income and interest deduction in the hands of Mrs. Lipson, without affecting the tax-deferred sale by Mr. Lipson.

4. Common Ground and Themes

Readers might conclude that there was little common ground amongst the Justices, given some of the harsh comments made in the judgments (for example, at paras. 52, 96 and 98). However, there were many points on which the Justices agreed.

4.1 The Continued Application of Canada Trustco and Kaulius

The Justices confirmed many of the principles set out in Canada Trustco and Kaulius. The textual, contextual and purposive approach to statutory interpretation was affirmed. The methodology for determining when the GAAR is to apply was affirmed. The need to determine reasonable consequences under subsection 245(5) was analyzed. The need to determine what tax benefits was observed. The need to determine which tax benefits arose from which statutory provisions was emphasized. The need to determine whether the avoidance transaction frustrated the object, spirit and purpose of the relevant statutory provisions was highlighted. All of these concepts established by the Canada Trustco and/or Kaulius decisions were again affirmed, emphasized and utilized in the Lipson decision. Collectively, the Justices quoted nineteen different paragraphs of Canada Trustco and six different paragraphs of Kaulius. It is quite clear that the principles in Canada Trustco and Kaulius live on.

4.2 The Role of the Entire Series of Transactions

The entire series of transactions must ultimately be taken into consideration to determine whether the tax benefit results from an abuse of the provisions relied upon. This is a concept that was referred to in Kaulius (at paras. 46, 58) and also by Mr. Justice Noel in the Federal Court of Appeal in Lipson. The Supreme Court quite openly emphasized this point: Mr. Justice LeBel referred to it in five places (at paras. 22, 34, 36-37, and 40) and Mr. Justice Binnie referred to it once (at para. 68).

4.3 No Re-Characterization or Regard for Economic Substance

The GAAR does not permit re-characterization, the ignorance of legal steps or an analysis based on economic substance, motivation or purpose. Mr. Justice LeBel did not express it precisely this way (see paras. 38, 39 and 51). Yet, he did not accept the argument of the Crown that the interest expense was incurred to purchase the home because he had allowed the interest deduction to "attribute" to Mrs. Lipson. Mr. Justice Binnie (at paras. 69, 87, 90 and 91), states that there should not be regard to an "'overall' conclusory snapshot without regard to the legal relationships" created between the parties. Therefore, Lipson further confirms that there should be no re-characterization or ignorance of legal steps in order to first apply the GAAR. The Crown had been pushing for acceptance of this principle in order to deny the deduction of the interest expense by Mr. Lipson on the basis that he was deducting a personal expense.

4.4 Relevance of Overall Purpose

"Overall purpose" is a phrase used by the lower courts in its analysis of the Lipson issues. Its use was considered to be an error of law by both Mr. Justice Binnie and Mr. Justice LeBel. Subsection 245(4) only deals with "results" and not with motivation or purpose or economic substance except to the extent indicated in (at paras. 57-59) the Canada Trustco decision.

4.5 The Role of Subsection 74.5(11)

Although differences emerged, the Justices all spoke of the role of subsection 74.5(11) of the Act. It is obvious there was no consensus about its role in the GAAR analysis.

4.6 The Deductibility of Interest Expense

"There is no reason why taxpayers may not arrange their affairs to finance personal assets out of equity and income-producing assets out of debt." These are the express words of Mr. Justice Rothstein (at para. 100). Mr. Justice Binnie also reached this conclusion (at paras. 56-59 and 70-73). The comments of Mr. Justice LeBel are a bit more oblique. Nonetheless, he stated (at para. 41) that Mrs. Lipson had financed the purchase of income producing property with debt and Mr. Lipson had financed a purchase of a residence with equity and that the transactions were "unimpeachable."

4.7 The GAAR is a Provision of Last Resort

This was affirmed by Mr. Justice Binnie (at para. 94), by Mr. Justice Rothstein (at para. 104), and by Mr. Justice LeBel (at para. 47).

4.8 The GAAR is Not a Penal Provision or a Hammer to Pound Taxpayers into Submission

Mr. Justice LeBel expressly said this (at para. 52). It is clear from the reasoning and language in the dissents of Justices Binnie and Rothstein that they would concur.

4.9 The GAAR was Designed to Restrain Abusive Tax Avoidance But to Maintain Certainty and Fairness

Both Mr. Justice Binnie (at para. 54) and Mr. Justice LeBel (at paras. 21, 52) discuss the issue of whether the GAAR introduces uncertainty into tax planning. Many commentators would agree that predictability, also emphasized as desirable in Canada Trustco, will be more difficult to obtain.

5. Points of Disagreement in the Reasons

5.1 Did the Minister Establish Abusive Tax Avoidance?

The existence of two differing dissenting views suggests a high level of disagreement. Even more striking, however, were the personal remarks. Mr. Justice LeBel referred to Mr. Justice Binnie's decision or approach as "gutting" the GAAR and "reading it out of the Act" (at para. 52). Mr. Justice Binnie stated that Mr. Justice LeBel's approach would merely be paying "lip service" to the Duke of Westminster (at para. 98). Clearly there was no agreement as to the fundamental application of the GAAR. Mr. Justice Binnie best described the fundamental difference between himself and Mr. Justice LeBel (para. 96) in this case. It was 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." Mr. Justice Binnie did not consider that the majority had shown that the Minister had clearly met the onus in this particular fact situation.

5.2 The GAAR and Specific Anti-Avoidance Rules

Mr. Justice Rothstein diverged from the decisions of both Mr. Justice Binnie and Mr. Justice LeBel. Mr. Justice LeBel wrote that it was not open for the Court to even consider subsection 74.5(11), the specific anti-avoidance rule, because it had not been argued at any level and it had been expressly disavowed by both the taxpayer and the Crown. "It was a matter to be left for another day." Mr. Justice Rothstein expressed strong disagreement. Not only did Mr. Justice Rothstein think it was appropriate to deal with it at this point in time and not leave it for another day, but he applied it to the particular circumstances on the basis that there was sufficient material in front of the Court to make that determination.

5.3 Reasonable Consequences — Subsection 245(5) of the Act

One of four results could have occurred in Lipson. Mr. Justice LeBel wrote that Mr. Lipson should include the dividends in income and Mrs. Lipson could deduct the interest expense. This view prevailed. Yet Mr. Justice Binnie would have seen Mr. Lipson accounting for the net income or loss (dividends less interest expense). Mr. Justice Rothstein would have decided that the net amount should have remained with Mrs. Lipson. The Crown argued and assessed on the basis that the interest expense was not deductible and the dividends were taxable to Mr. Lipson.

6. What's New or Different in Lipson from Canada Trustco / Kaulius?

The Lipson decision includes a number of points that may be regarded as new concepts, elements or developments in the interpretation of the GAAR modifying the discussion found in the decisions of the Supreme Court in Canada Trustco and Kaulius. Whether any or all of them find acceptance or development in future decisions on the GAAR remains to be seen. These themes, which affect the interpretation or application of the GAAR, include the following:

6.1 Rejection of "Overall Purpose" Test

The "overall purpose" of the transaction as a test for finding abuse under subsection 245(4) was rejected in the decision of Mr. Justice LeBel, writing for the majority, and in the decision of Mr. Justice Binnie. This was the test that had been applied by former Chief Justice Bowman at trial to conclude that the transactions in Lipson were abusive. Rather, the Supreme Court stated that the true test was the determination of the "overall result" of the transaction or series of transactions in order to determine whether "abusive tax avoidance" had occurred, as this "more accurately reflects the wording of subsection 245(4) and this Court's judgment in Canada Trustco" (at paras. 34, 36). Essentially, the Court is to look at an avoidance transaction in the context of the entire series that includes this transaction in order to determine whether the overall result is a misuse of a provision of the Act or an abuse of the Act read as a whole. The "result" test does not depend on the intention, motive or purpose of the particular taxpayer (at paras. 34, 39). The "result" test is derived from the language of subsection 245(4), which states that the GAAR applies "only if it may reasonably be considered that the transaction ... would ... result directly or indirectly" in misuse or abuse of provisions of the Act. In view of this language, the assessment of whether a transaction has an abusive result requires a broad analysis in assessing whether an avoidance transaction results in misuse or abuse of provisions of the Act, as a court is required to look at indirect, as well as direct, abuse. In this connection, Mr. Justice Binnie (at para. 63) underscored the principle laid down in Canada Trustco that should be applied to this analysis:

Canada Trustco recognized that the line between legitimate tax minimization and abusive tax avoidance is "far from bright" (para. 16). This has proven to be an understatement, and must be read together with the rule in Canada Trustco that
[i]f the existence of abusive tax avoidance is unclear, the benefit of the doubt goes to the taxpayer. [para. 66, point 3]
6.2 Onus of Establishing Misuse or Abuse

Mr. Justice LeBel states that the Minister bears the burden of proving that the avoidance transaction results in misuse or abuse under subsection 245(4), on "a balance of probabilities" (at para. 21). This reference is to the standard of proof that applies, in civil litigation, to findings of fact. However, the interpretation of provisions of the Act to determine their purpose, spirit, intent or policy is a matter of law and relies on the rules of statutory construction, not on a burden of proof. It is not clear from the decision of Mr. Justice LeBel what the Minister is required to do to establish abuse on "a balance of probabilities," namely, whether the Minister is to show only the factual basis for abuse or also to identify the policy of the relevant provisions of the Act and show how and why it has been abused. While the decision in Canada Trustco states that the onus is on the Minister to establish misuse or abuse, and that such abuse must be "clear," it does not discuss how that onus is to be met. Canada Trustco states that a finding of misuse or abuse involves a two-step inquiry that first analyzes the meaning, purpose and policy of the particular statutory provisions and then undertakes the factual inquiry as to whether the transaction misuses or abuses those provisions. The balance of probabilities is relevant only to the factual aspects of this inquiry. However, Canada Trustco also states that the determination of abuse is a question of mixed fact and law, which is a single inquiry. Arguably, the decision of Mr. Justice LeBel may be read as a reduction of the burden on the Minister to make a case on the "abuse" issue, and thereby to have watered down the principle laid down in Canada Trustco. Certainly, Mr. Justice Binnie, in concluding that the attribution rules had not been abused, was of the view that the CRA had not made out a case for the application of the GAAR and had failed to identify the policy that had been offended by the transactions, as required by Canada Trustco.

6.3 The Retreat from the Requirement and Desirability for Certainty

Canada Trustco stated that it was the "overall policy of Parliament that tax law be certain, predictable and fair, so that taxpayers can intelligently order their affairs." This fundamental principle was reasserted in the decision of Mr. Justice Binnie, who emphasized the need for predictability and certainty of results under the Act, and rejected casting the judiciary into the role of formulating tax policy. In contrast, the majority decision in Lipson states:

[t]o 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" (at para. 52).

This is a significant retreat from the framework for the application of the GAAR established in Canada Trustco by allowing for more judicial activism in the application of the GAAR. The majority decision considers Mr. Justice Binnie's application of the principles in Canada Trustco to conclude that there was no abuse of the attribution rules in Lipson as a reading of the GAAR out of the Act. These two positions are not reconcilable.

6.4 Reasonable Consequences — Subsection 245(5) of the Act

The majority decision in Lipson is the first discussion of the options under subsection 245(5) of the effect of applying the GAAR to disallow the tax results stipulated by the provisions of the Act and substituting "reasonable tax consequences" that deny the tax benefit arising from an abusive avoidance transaction. In Lipson, the majority ruled that it was reasonable for the attribution rules to operate so as to ignore the statutory provisions setting out the spousal attribution rules that attribute net income or loss from the transferred property, namely the shares sold by the taxpayer to his wife, but to attribute the gross dividend income from the transferred shares to the taxpayer and leave the related interest expense deduction on the share purchase loan with the taxpayer's wife. This application of subsection 245(5) indicates that the GAAR will not necessarily operate only so as to deny the tax benefit, but may present opportunities to develop alternative tax consequences without regard to the express statutory provisions of the Act. This freedom to develop creative "fair" alternatives may offer considerable scope in negotiating settlements of proposed GAAR reassessments.

6.5 Specific Anti-Avoidance Rule v. the GAAR?

Mr. Justice Rothstein was of the opinion that the specific anti-avoidance rule in subsection 74.5(11) denied the attribution of Mrs. Lipson's net loss resulting from the interest deduction on the share purchase loan to her husband — and that, as a result, the GAAR was simply not applicable. He decided that because the specific anti-avoidance rule was applicable, the Minister should have reassessed under the specific rule rather than the GAAR. The majority and Mr. Justice Binnie were of the view that the particular specific anti-avoidance rule was not in issue in the case before them and that, accordingly, this was a question for another day. However, the decision of Mr. Justice LeBel effectively considers the GAAR to be applicable where a specific anti-avoidance rule was being used to facilitate abusive tax avoidance. Mr. Justice LeBel found that the attribution rules were anti-avoidance rules and that in this case they had been used to achieve a tax benefit that was abusive. Lipson raises a number of interesting questions that touch the interaction between specific anti-avoidance rules and the GAAR. These will likely see considerable discussion and development in future GAAR jurisprudence.

7. The Significance of this DecisionGeneral Comments

Although the majority in Lipson dismissed the appeal, the Supreme Court made it clear that taxpayers may arrange or rearrange their affairs so as to permit a matching of interest expense to income-producing or business assets and freeing up equity for non-income-producing purposes. The deductibility of interest that satisfies the requirements of paragraph 20(1)(c) of the Act will generally be difficult to attack under the GAAR, given that courts in prior decisions have found its policy to be to encourage accumulation of income-producing assets, which should be readily demonstrable in most commercial situations.

The three different views of the Supreme Court also demonstrate that there are many aspects of the GAAR that will be developed in future jurisprudence. These may include the ability to look at the entire series of transactions in determining whether one of the steps in a series results in a misuse or abuse and the interplay between the operation of specific anti-avoidance rules and the GAAR.

7.1 Impact of Lipson on the Duke of Westminster Principle

The Lipson decision mentions a principle from the Duke of Westminster, a 1935 decision of the House of Lords. This oft-quoted principle generally refers to the notion that taxpayers may order their affairs so as to minimize the amount of tax payable. Mr. Justice LeBel quoted it (at para. 21), then went on to say that this principle "remains the case" but that the "principle never is absolute," as the GAAR was enacted to "limit the scope of allowable avoidance transactions yet maintain certainty" (at para. 21). Nonetheless, it is difficult to discern from the analysis of the majority in the Lipson decision whether the Duke of Westminster is alive, needs a get-well card, or his family needs a sympathy card. The concern is evident in the decision of Mr. Justice Binnie, who asks (at para. 54), about the health of the Duke of Westminster and then concludes that there is cause for concern. He goes on (at para. 98) to specifically say that to apply the GAAR in Lipson would be "paying lip service to the Duke of Westminster principle without taking seriously its role in promoting consistency, predictability and fairness in the tax system."

Mr. Justice Rothstein (at para. 100) seems to recognize that the principle in the Duke of Westminster still exists, because he says "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."

Overall, there is a consensus among members of the Court that the principle enunciated in the Duke of Westminster continues but that the enactment of the GAAR has had some impact on it. In question is the extent to which taxpayers may order their affairs so as to minimize the amount of tax payable. The decision of the majority clearly indicates that the principle is circumscribed by the GAAR.

7.2 Interest Deductibility, Interpretation Bulletin IT-533 and Singleton

It is quite significant that all the Justices essentially concurred that the interest expense on the borrowings was deductible and acknowledged the right of taxpayers to plan their affairs to achieve tax-deductible interest expense for their income-producing assets and business operations. This finding is therefore consistent with the principles in the Singleton decision, even though Mr. Justice LeBel distinguished Singleton as inapplicable because it was decided without the application of the GAAR and it dealt with different facts. Yet the first part of the planning was identified by Mr. Justice LeBel as "unimpeachable" and involved steps taken to achieve interest deductibility — namely the borrowing for income-earning purposes and use of the proceeds to acquire a personal residence.

Singleton did not involve the spousal attribution rules. Nevertheless, Lipson confirms interest deductibility. Mr. Justice LeBel looked at the purpose of the interest deduction provision (as established by the earlier Supreme Court cases such as Ludco and Shell Canada) and looked at paragraph 20(1)(c) and subsection 20(3). Mr. Justice LeBel confirmed (at para. 41) that the purpose of these statutory provisions had not been abused or misused and that the CRA did not prove otherwise. He also stated (at para. 48) that "in summary, the tax benefit of the interest deduction resulting from the refinancing of the shares of the family corporation by Mrs. Lipson is not abusive viewed in isolation." Therefore, the doubt that the Lipson decision was causing as to whether the principles established in Singleton were still operative has effectively been lifted. The principles in Singleton were accepted by the CRA in its published Interpretation Bulletin IT-533, which dealt with deductibility of interest. At a number of recent tax conferences, advisors have been raising the question with CRA officials regarding the effect of the Lipson decision in the lower courts on those provisions of IT-533 that deal with cash damming and refinancings. The CRA said it would wait to see what the Supreme Court of Canada did with Lipson before commenting on whether the Lipson lower court decision made any impact on the previous CRA statements.

It is anticipated that the CRA will announce shortly that Lipson confirms the CRA's position as set out in IT-533 regarding tracing of the use of borrowed funds and the ability to arrange one's affairs to obtain interest deductibility.

7.3 Impact on Tax Advice, Planning and Opinions

Lipson should not significantly change the basic framework for the analysis of when the GAAR applies, as set out by the Supreme Court in Canada Trustco and Kaulius.

The majority decision in applying the GAAR focuses on the particular facts and "attribution rules" in the Act. It does not apply the GAAR to the interest deduction and effectively supports the restructuring of financing to achieve tax-deductible interest. It confirms the result in Singleton under the GAAR, which was decided on the basis of avoidance arguments other than the GAAR. The Supreme Court confirmed that taking steps to match debt to eligible purposes, even if the debt and the ineligible uses are created in the arrangements and involved non-arm's-length parties, is not abusive.

Opinions dealing with the impact of the GAAR on planning strategies and transactions will continue to be given, although the decision in Lipson will require comment and may result in additional qualifications in certain situations. Our expectation is that opinions will be no higher than a "should opinion" or a "more-likely-than-not opinion," and frequently qualified by the phrase "not without doubt." It is likely also that as a result of the majority decision in Lipson, it will be more difficult to give favourable GAAR opinions on certain types of transactions or certain specific transactions, based on factual circumstances.

The test requiring the "overall result" of a series to be considered in the analysis of whether a particular avoidance transaction within the series is subject to the GAAR will require greater caution and analysis in multi-step transactions. While this exercise was generally undertaken by tax advisors prior to Lipson, it was principally as a matter of discipline rather than part of the express legal analysis. One consequence of Lipson is that the "overall result" analysis will be part of the formal opinion.

Consideration will likely be given to seeking advance rulings on a broader range of transactions to address the uncertainties created by certain aspects of the majority decision in Lipson.

7.4 The CRA's Possible Future Approach to Tax Audits and Tax Disputes

Lipson demonstrates how close the CRA came to losing. The decision in the Supreme Court was 4 to 3, even though in unanimous decisions the lower courts had found against the taxpayer. Lipson therefore clearly illustrates that there is litigation risk in GAAR cases for the CRA, as well as for taxpayers. It is unlikely that the CRA will use the reasoning in Lipson to apply the GAAR on an indiscriminate basis. However, it is possible that the CRA may choose to raise the GAAR as a basis for assessment and then see how the lower courts will apply it. In particular, the CRA may do so in border-line situations if it believes that Mr. Justice LeBel has set a lower threshold for the CRA to prove abusive tax avoidance.

The GAAR statistics released by the CRA through the Canadian Tax Foundation proceedings in November 2008 in Calgary indicate that the GAAR was applied roughly 69% of the time in circumstances when consideration of the GAAR came before the GAAR Committee. The GAAR was used 47% of the time as the primary basis for challenge and 53% as the secondary basis for challenge. Notwithstanding the comments of Mr. Justice LeBel regarding the paramountcy of the GAAR, the CRA will likely consider applying specific anti-avoidance rules more rigorously in future to avoid the prospect of having Mr. Justice Rothstein's argument succeed at another time. There will also likely be an increase in a willingness or appetite for settlement for both the CRA and taxpayers because it is obvious, just by virtue of the uncertainty flowing from the differing views from the Justices, that litigation risk exists. However, the degree of risk will differ in every case based on the specific facts and the tax law alleged to have been abused.

7.5 Possible Impact of Lipson on the Lower Courts

Lower court judges must respect the views of the Supreme Court of Canada and will see, from reading Lipson, that Canada Trustco is still good law with the various modifications as pointed out above. It will be clear to lower court judges that it may be difficult for taxpayers and the CRA to reach a clear consensus on the existence of abusive tax avoidance. Consequently, consistent with the principle in Canada Trustco (at paras. 62, 66), the CRA should continue to be pushed to prove clear abuse. The CRA might argue that the threshold for abusive tax avoidance has been lowered, given the degree of analysis and comments of Mr. Justice LeBel (at paras. 21, 41). Yet, with a number of GAAR cases currently before the courts, it will quickly become apparent whether the lower court judges will agree with this approach. Will the CRA settle on a reasonable basis, or just let cases work through the court system to see how judges react to the Lipson comments? The CRA will likely allow a number of cases now in the court system to go forward to see how things shake out before deciding how to amend or modify assessing practices. Overall, it will be "business as usual" for the lower courts, for taxpayers and for the CRA. There are going to be disagreements and there is going to be resolution, whether by settlement or through decisions of the lower courts.

8. The GAAR Litigation After Lipson

8.1 Before the Supreme Court of Canada

On January 15, 2008, the Supreme Court of Canada denied the leave to appeal filed by the taxpayers in the MacKay decision. This was a case dealing with the interpretation of subsection 245(3) of the Act and the meaning of "avoidance transaction." The narrow view expressed by the Federal Court of Appeal regarding the interpretation of subsection 245(3) may, in some cases, make it more difficult for a taxpayer to argue that one or more transactions within a series was not an "avoidance transaction."

8.2 Before the Federal Court of Appeal

There are three cases now before the Federal Court of Appeal. The Landrus case was scheduled to be heard on January 20, 2009 in Toronto. However, the matter was adjourned in light of the release of the Lipson decision. The parties will be making submissions within the next month to address the impact of Lipson, and no new date has yet been set for the hearing. It deals with the issues of "avoidance transaction" and abusive tax avoidance and involved the avoidance of subsection 85(5.1), one of the stop-loss rules in the Act. This case may deal with the issue that Mr. Justice Rothstein and Mr. Justice LeBel were debating regarding the interaction of the GAAR with specific anti-avoidance rules. On February 11, 2009, the Copthorne appeal will be heard in Toronto. The court has advised the parties to be prepared to address the impact of Lipson at the hearing. This appeal involves "surplus stripping" and will focus on both defences in subsections 245(3) and 245(4) of the Act. In the Tax Court, the taxpayer in Landrus was successful, whereas in Copthorne, the taxpayer was not. The third appeal is Remai, for which no hearing date has yet been set. This appeal deals with claims for charitable donation tax credits and will consider both the issues of "avoidance transaction" and abuse. The taxpayer was successful in arguing that the series of transactions was not abusive even though determined to be an "avoidance transaction."

8.3 Before the Tax Court of Canada

There are at least 25 cases before the Tax Court and at least three decisions are pending and under reserve. These include the Garron Family Trust case, which deals with Barbados trust estate freezes; the Collins and Aikman case, which involves surplus stripping; and the Lehigh Cement case, which deals with interest deductibility and withholding tax.

8.4 Before the Provincial Courts — The Application of the Provincial GAAR

Provincial tax authorities are aggressively using general anti-avoidance rules found in provincial tax legislation to audit and reassess various transactions undertaken in previous years. There is a case before the Québec Court of Appeal, OGT Holdings, which deals with the "Québec shuffle" to avoid Québec income tax. The appeal was heard on November 29, 2007, and the decision has been under reserve pending the result in Lipson. It will be interesting to see what will happen given the Supreme Court's comments in Lipson. In the lower court in Québec, the taxpayer was unsuccessful in arguing that the Québec GAAR did not apply.

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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