Canada: Québec Court Of Appeal Applies The GAAR

On January 30th, 2009, the Québec Court of Appeal rendered its judgment in the case of OGT Holdings Ltd. v. Le Sous-ministre du Revenu du Québec. This case deals with Québec's general anti-avoidance rule as it applies to provincial tax legislation, more particularly in this case: the Taxation Act (Québec). The Court had postponed its decision until the Supreme Court of Canada ruled in the matter of Lipson, also dealing with the general anti-avoidance rule but as it applies to the federal tax legislation.

Essentially in this case, to avoid paying Québec tax on the capital gain on the sale of shares of two subsidiaries, the Québec vendors transferred beforehand the shares to be sold to an interposed company in Ontario. By filing rollover elections in Québec and none for federal purposes, the vendors avoided Québec tax and Ontario tax on the ensuing capital gain when the shares were ultimately sold to the third party purchaser, thus only bearing federal tax.


In this case, Nike Acquisition Inc. ("Nike"), a third party purchaser, wanted to acquire Canstar Sports Inc., which was held by two Canadian corporations: 3098958 Canada inc. and 3098966 Canada Inc. (collectively: "309 Canada Inc."), which were in turn held by two other Canadian corporations: 161578 Canada Inc. and 161709 Canada Inc. (collectively: the "Vendors"). To do so, the Vendors would have sold the shares of 309 Canada Inc. to Nike and would have incurred Québec and federal tax on the resulting capital gain. Instead however, the Vendors first transferred, via a tax-deferred rollover, the 309 Canada Inc. shares to a wholly owned Ontario corporation, which in turn sold the said shares to the ultimate purchaser, Nike.

The cause of concern was the use by the Vendors of the interposed Ontario corporation to ultimately sell the shares of 309 Canada Inc. and eliminate Québec tax on the capital gain generated by the sale of the said shares. The Court accepted the argument that the parties had attempted to subject the capital gains only to the federal tax thereby avoiding Québec provincial tax on the said gain. This goal was accomplished by the transfer of the 309 Canada Inc. shares to the Ontario corporation by way of a tax-deferred rollover. Generally, a tax-deferred rollover allows an asset to be transferred to a corporation by deferring the taxation of any ensuing capital gains. To achieve the deferral, the parties must jointly elect proceeds of disposition of the said asset at an amount that varies usually between the fair market value and the cost. In Québec, this requires filing an election form with the federal tax authorities and filing another election form with the Québec tax authorities.

For Québec tax purposes, the Vendors elected proceeds of disposition, for the transfer of the 309 Canada Inc. shares, at cost resulting in the deferral of the taxation of the capital gains for Québec purposes only.

However, for federal tax purposes, the Vendors opted not to effect a tax deferred rollover and consequently transferred the shares of 309 Canada Inc. to the Ontario corporation at their fair market value, which in turn resulted in taxation of the ensuing capital gains at the federal level only.

Once the interposed Ontario corporation was the owner of the shares of 309 Canada Inc., it then sold them to the intended purchaser, Nike without attracting Ontario provincial tax because for Ontario tax purposes, the cost of these shares were equal to their fair market value. Ontario's tax legislation provides that the cost base of such shares is equal to the same cost as determined under the federal tax legislation.

In other words, this strategy of using a Québec rollover election without a corresponding election for federal purposes allowed the Vendors to bear tax on the capital gains generated on the sale of the 309 Canada Inc. shares only at the federal level and avoid paying the corresponding tax at the provincial level, be it either Québec or Ontario.

This mechanism is commonly called the "Québec Shuffle".


In its reasons, the Québec Court of Appeal accepts that nothing prevents the filing of different rollover elections one for federal tax purposes and one for Québec tax purposes and that, consequently, the provincial taxation of a capital gain is deferred indefinitely. Furthermore, the Court acknowledges that the Vendors had the right to transfer beforehand their shares of 309 Canada Inc. to an Ontario corporation and that such a transfer was not a sham.

Having said this, the Court nonetheless refuses to validate the strategy put in place by the Vendors and subjects Québec Shuffle in this case to Québec's general anti-voidance rule.

Given that all the legal requirements of the Québec Taxation Act were satisfied with respect to the tax deferred rollover, it begs the question if it is incumbent on a taxpayer to correct any anomalies contained in the tax legislation where such anomalies result in side stepping Québec's taxation basis.

The Court does not really provide an in-depth analysis of whether or not the Québec Shuffle constitutes a transaction subject to the general anti-avoidance rule. This analysis should have been based on the teachings of the Supreme Court of Canada in the matters of Trustco and Lipson.

The Court contents itself by simply stating that the goal of a tax-deferred rollover is to defer the taxation of a capital gain but not to eliminate it all together. The Court concludes only that «what was denatured here were not the legal operations to take advantage of section 518 of the Taxation Act (Québec) [this section provides for the tax deferred rollover]; it is rather the use of this section which was perverted.» [Translation]

Furthermore, the Court states that the tax deferred rollover in this case may have been void due to the fact that the acquirer of the shares of 309 Canada Inc., the Ontario corporation, was not a " taxable" corporation. Indeed, section 518 of the Québec Taxation Act requires that the acquirer be a "taxable Canadian corporation", which is a defined term. Pursuant to this definition, the Ontario corporation does not cease to be a "taxable Canadian corporation" because in this particular transaction it had no taxes to pay. For a corporation to be "not taxable", it must have a statutory exemption from tax, such as not for profit corporations or corporations with a charitable vocation. However, it is granted that this was not the ratio decidendi of the judgment.

Moreover, the Court concluded that the fact that the Ontario corporation was not subject to Ontario tax was irrelevant for its analysis, as it does not have jurisdiction to intervene in Ontario tax matters.

Finally, the Court fails to address the fact that had the Vendors also filed a corresponding federal rollover election, similar to the Québec rollover election, the sale of the 309 Canada Inc. shares would still have not been subjected to Québec provincial tax. In such as case, the Ontario corporation would have been taxed on the capital gain at the federal level and the at Ontario provincial level. Given that, in such a case, the federal election and Québec election would have been filed, but Québec provincial tax would not still be payable, would this sort of strategy still be subject to the general anti-avoidance rule? In other words, where a Québec taxpayer decides to transfer assets to a different province, by filing similar elections at the Québec level and the federal level, to bear tax only in that other province (and federal tax), it this strategy subject to Québec's general anti-avoidance rule merely because Québec did not tax the capital gain on the transfer? If the answer were affirmative, then a tax-deferred rollover would only be available in Québec where the asset remains in Québec, which to us cannot be what the Québec legislator intended.

By its lack of in-depth analysis of what constitutes a transaction caught by Québec's general anti-avoidance rule, the Québec Court of Appeal, in this case, does not add much to the on-going debate between taxpayers and tax authorities on this subject. In any event, the Québec tax legislation was later amended, prior to the release of this judgment, so that the strategy adopted by the parties in this case would have been prohibited at the time they entered into it.

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