Canada: Mr. Lipson Goes To Ottawa: Clarifying Interest Deductibility But Not The General Anti-Avoidance Rule

Singleton-Type Interest Deductibility Planning More Certain

On January 8, 2009 the Supreme Court of Canada released its decision in Lipson1. While the appellant in this case was not ultimately successful in obtaining the benefit of his spouse's interest deduction, this decision does provide a measure of comfort for other taxpayers in that Singleton2-type interest deductibility tax planning appears to be alive and well.

The transactions undertaken by the appellant and his spouse in the present case may be characterized into two categories: (1) the interest deductibility transactions; and (2) the spousal attribution transactions. The interest deductibility transactions include the initial loan received by the appellant's spouse, the use of those loan proceeds to acquire certain investment company shares from the appellant and the refinancing of the initial loan. The spousal attribution transactions undertaken include not electing out of the tax-deferred inter-spousal rollover provisions in subsection 73(1) of the Income Tax Act (Canada) (the "Tax Act") (unless otherwise stated herein, all further statutory references are to the Tax Act) and the attribution of the dividend income received on the shares and the interest expense paid on the refinanced loan pursuant to subsection 74.1(1).

The majority and dissenting judgments in this case agreed on the essential object, spirit and purpose of the interest deductibility provisions in paragraph 20(1)(c) and subsection 20(3). LeBel J., writing for the majority, stated:

Section 20(1)(c) allows taxpayers to deduct interest on borrowed money used for a commercial purpose. The purpose of this provision is to "create an incentive to accumulate capital with the potential to produce income" (Ludco Enterprises Ltd. v. Canada, 201 SCC 62, [2001] S.C.R. 1082, at para. 63), or to "encourage the accumulation of capital which would produce taxable income" (Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622, at para. 57). Section 20(3) was enacted "[f]or greater certainty" in order to make it clear that interest that is deductible under s. 20(1)(c) does not cease to be deductible because the original loan was refinanced. It serves "a practical function in the commercial world of facilitating refinancing" (Tax Court judgment, at para. 20).3

The appellant's interest deductibility transactions were found to be consistent with the purpose of paragraph 20(1)(c) and subsection 20(3). As such, the court determined that the general anti-avoidance rule (the "GAAR") did not apply to deny the interest deduction to the appellant's spouse, even if it ultimately applied to deny the attribution of this interest deduction to the appellant.

The court effectively blessed Singleton-type tax planning, acknowledging that the result of the interest deductibility transactions was acceptable since the appellant's spouse financed the purchase of income-producing property with debt. Indeed, it described the interest deductibility transactions as "unimpeachable" and found there was no misuse or abuse of the interest deductibility provisions of the Tax Act.4 In his dissent, Binnie J. similarly held that "Singleton illustrates the proposition that there is nothing abusive in principle for a taxpayer to rearrange his or her capital (borrowed or non-borrowed) in a tax efficient manner."5 In other words, the GAAR did not apply to the impugned interest deductibility transactions and to deny the interest deduction to the appellant's spouse.

Going forward, taxpayers may feel comfortable arranging their affairs such that the direct use of their loan is for the purpose of earning income, even if the loan proceeds merely "filled the hole" left as a result of rearranging their business or investment financing, whether alone (as in Singleton) or a with another family member (as in Lipson). Undoubtedly taxpayers and their advisors will continue to look for ways to structure their debts within the parameters of paragraph 20(1)(c) and subsection 20(3).

The General Anti-Avoidance Rule Less Certain

As the appellant discovered, the GAAR places limits on structures and transactions which will be respected. Each tax benefit claimed from the interest deductibility and spousal attribution transactions must be evaluated in light of the whole series of transactions. Transactions which do not result in an abuse or misuse in one context might well be considered abusive in another context even, as in this case, where the direct use of a loan is for the purpose of earning income. Although the interest deduction to the appellant's spouse was not abusive, that same interest deduction attributed to the appellant was held to be abusive.

The appellant chose not to dispute the Minister's assertions that he had enjoyed a "tax benefit" and had engaged in an "avoidance transaction", both preconditions to the GAAR. Consequently, the only issue to be decided by the court was whether the transactions constituted abusive tax avoidance, that is, whether there had been a misuse or abuse of the interest deductibility or spousal attribution provisions of the Tax Act. As noted above, the court rejected the Minister's claim that the interest deductibility provisions had been misused or abused.

The court found that the purpose of subsection 73(1) is to facilitate inter-spousal transfers of property on a rollover basis for the reason that "it is undesirable and perhaps unfair, to impose a tax on transactions that do not involve a fundamental economic change in ownership, even though there may be a change in form or legal structure."6 Consequently, when the appellant sold shares to his spouse no gain was realized. Additionally, pursuant to subsection 74.1(1) the net income or loss derived from the shares was attributed to the appellant. This allowed him to reduce the dividend income attributed to him by the interest paid on the loan that financed his spouse's purchase of the shares.

LeBel J. stated: "the purpose of s. 74.1(1) is to prevent spouses from reducing tax by taking advantage of their non-arm's length relationship when transferring property between themselves. [. . .] It seems strange that the operation of s. 74.1(1) can result in the reduction of the total amount of tax payable by Mr. Lipson on the income from the transferred property. The only way the Lipsons could have produced the result in this case was by taking advantage of their non-arm's length relationship. Therefore, the attribution by operation of s. 74.1(1) [. . .] qualifies as abusive tax avoidance."7 However, Binnie J., in his dissent, found that "what LeBel J. believes s. 74.1(1) is designed to prevent is actually a reasonable statement of what s. 74.1(1) seeks to permit."8 He continued: "far from constituting an indicia of abuse, the spousal relationship is precisely the reason Parliament permits the attribution of income or loss back to the transferor."9 Binnie J. also noted that "[i]n my view, Parliament must have contemplated that by giving taxpayers a choice under s. 73(1), they would exercise it in a tax-minimizing manner."10 Binnie J. concluded that the Minister had not shown that the abusive nature of the impugned transactions under subsection 74.1(1) was clear, and, therefore, the GAAR should not apply.

Notwithstanding the majority's finding that the spousal attribution rules had been misused, more disturbing was their apparent reduction of the burden placed on the Minister in establishing abusive tax avoidance. In Canada Trustco11 the Supreme Court determined that "[i]f the existence of abusive tax avoidance is unclear, the benefit of the doubt goes to the taxpayer."12 Yet, in this case, the majority stated, with no apparent analysis, the test for abusive tax avoidance could be met "on a balance of probabilities".13 If correct, this distinction could represent a dramatic shift for GAAR cases in the future.

Another important issue that the Supreme Court has yet to shed much light on is the role of the GAAR when specific anti-avoidance rules may be applicable. In the present case, Rothstein J., writing in dissent and on his own, rejected the application of the GAAR because the specific anti-avoidance rule in subsection 74.5(11) should have applied. In this respect he stated, "[t]he GAAR was enacted as a provision of last resort"14 and "all other relevant provisions of the Act [must] be read before the Minister may have recourse to the GAAR."15 Since the Minister had recourse to assess the appellant under subsection 74.5(11), Rothstein J. found that the GAAR did not apply.

Both LeBel J. and Binnie J. disagreed with Rothstein J.'s analysis and preferred to leave the question of subsection 74.5(11) to another day. Among their reasons was that this provision was not relied on by the Minister as a basis for reassessment and was not raised by the appellant as a reason the Minister's GAAR claim should fail. LeBel J. stated "where the language of and principles flowing from the GAAR apply to a transaction, the court should not refuse to apply it on the ground that a more specific provision - one that both the Minister and the taxpayers considered to be inapplicable throughout the proceedings - might also apply to the transaction".16 To this, Rothstein J. replied that "[t]he fact that the parties did not rely on s. 74.5(11) - either as a basis for reassessment or as the reason why the Minister's claim should fail - does not change the fact that the section applies in law. [. . .] It is not open to this court to assist the Minister by allowing him to ignore the applicable specific anti-avoidance rule and instead rely on the GAAR."17

Once the GAAR was held to apply, the final challenge was for the court to decide exactly what tax adjustments should be made. The Minister's position was to deny the interest deduction to the appellant while at the same time attributing the dividend income to him. The appellant argued that subsection 74.1(1) only attributes the net income or loss and that neither it nor the GAAR contemplates parsing the dividend income separately from the related interest deduction. With no analysis, the court disallowed the interest deduction to the appellant and attributed the same interest deduction to his spouse without the corresponding dividend income. Unfortunately, this interest deduction cannot ultimately be used, because the appellant's spouse's relevant tax reassessments were not appealed. It is not completely clear how subsection 245(5) can be interpreted in a manner that permits these adjustments. The court acknowledged such adjustments are only permitted under the GAAR if the court determines that they are reasonable in the circumstances. Without discussing what standards for reasonableness might apply or why the adjustments might be reasonable in these circumstances, the court simply stated that its decision was a "reasonable outcome".


This decision of the Supreme Court truly is a mixed-bag for taxpayers. On the one hand, interest deductibility tax planning is more certain. On the other hand, the GAAR has not been clarified in a meaningful way, and its reach and scope may in fact be expanded. This expansion may occur from the court lowering the bar for abusive tax avoidance from the clearest of cases (where any doubt is to be decided in the favour of taxpayers) to a balance of probabilities standard. This decision also suggests that the GAAR may no longer be seen as a provision of last resort, but might be used in cases where other specific anti-avoidance provisions could have applied. And the court, without explanation, used the GAAR to make adjustments that were arguably outside the scope of the adjustments permitted by subsection 245(5). The appellant's decision not to dispute the avoidance transaction pre-condition to the GAAR denied the court the opportunity to clarify the uncertainty that has emanated from lower court, post-Canada Trustco analyses of this issue.

Hopefully, the Supreme Court will agree to hear the taxpayers' appeal in MacKay18, and will provide further clarification with respect to the standard of proof for abusive tax avoidance, answer whether the GAAR truly is a provision of last resort, make clear what constitutes an avoidance transaction and explain the "reasonable" adjustments that may be made pursuant to subsection 245(5).


1.Lipson v. Canada, 2009 SCC 1 ("Lipson").

2. Singleton v. R., 2001 SCC 61, [2001] 2 S.C.R. 1046 (S.C.C.) ("Singleton").

3. Lipson, supra note 1, at paragraphs 29 and 30.

5. Ibid., at paragraph 60.

6. Ibid., at paragraph 31, citing Vern Krishna, The Fundamentals of Canadian Income Tax (9th ed. 2006), at p. 1112.

7. Ibid., at paragraph 42.

8. Ibid., at paragraph 80.

9. Ibid., at paragraph 81.

10. Ibid., at paragraph 92.

11. Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2 S.C.R. 601 ("Canada Trustco").

12. Ibid., at paragraph 66, item 3.

13. Lipson, supra note 1, at paragraph 21.

14. Ibid., at paragraph 104, citing Canada Trustco, supra note 11, McLachlin C.J. and Major J. at paragraph 21.

15. Ibid., at paragraph 108.

16. Ibid., at paragraph 45.

17. Ibid., at paragraph 118.

18. MacKay v. R., [2008] 4 C.T.C. 161 (F.C.A.).

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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