Canada: Taxation Law @ Gowlings - December 15, 2009

Last Updated: December 23 2009

Edited by Mark L. Siegel


  • Volume 9, Issue 34:
    GAAR Case Comment: Landrus (FCA) - Economic Substance, Privilege and Proper Behaviour
  • Volume 9, Issue 35:
    Failure to Complete Voluntary Disclosure on Timely Basis Fatal: McCracken v. The Queen

GAAR Case Comment: Landrus (FCA) - Economic Substance, Privilege and Proper Behaviour
By Brian Kearl and Nadia Talakshi


Historically, taxpayers have been free to organize their affairs in a tax efficient manner. Such freedom stemmed from the decision of the House of Lords in Inland Revenue Commissioners v. Duke of Westminst1 wherein the court stated "[e]very man is entitled, if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be". Known as the Duke of Westminster principle, this interpretation of tax law was reaffirmed by the Supreme Court of Canada in The Queen v. Canada Trustco Mortgage Co.2, modified to the extent that transactions are offside the general anti-avoidance rule ("GAAR") contained in the Tax Act3.

In order for GAAR to apply, the taxpayer must have enjoyed a tax benefit (i.e. an income tax deduction), have entered into an avoidance transaction (e.g. a transaction undertaken primarily for tax reasons), and engaged in abusive tax avoidance (e.g. the tax benefit enjoyed as a result of the avoidance transaction frustrated or defeated a specific provision of the Tax Act).

Due to the factual nature of each step in the requirements for GAAR, any application of GAAR to a series of transactions will inevitably lead to a level of uncertainty, inconsistency and unpredictability for taxpayers. It is important, therefore, to consider GAAR whenever a transaction or series of transactions is proposed and to be cognizant of how the courts are applying GAAR.

Summary of Facts

In Landrus v. R.4, the taxpayer was a limited partner in a partnership (the "Partnership") which was formed to acquire and operate a condominium building (the "Building"). Another partnership (the "Other Partnership") was formed to acquire and operate a separate condominium building (the "Other Building") next to the Building. The taxpayer's interest in the Partnership was tied to a specific condominium unit in the Building, but his share of Partnership income and loss was based on his percentage interest in the Partnership. As a result of the economic downturn of the early-1990s, the cash flow generated by the Building was less than expected and the resale values of the condominium units in the Building was less than their original cost. The same was true of the Other Partnership and the Other Building.

In an effort to access the tax losses imbedded in their interests in the Partnership and the Other Partnership, the members of both partnerships agreed to form a new partnership (the "New Partnership") and have the partnerships transfer the buildings to the New Partnership. The transfer of the Building triggered a terminal loss in the Partnership, a portion of which was allocated to the taxpayer. The Partnership and the Other Partnership were then wound up.

The Canada Revenue Agency ("CRA") denied the terminal losses claimed by the members of the Partnership and the Other Partnership, including the taxpayer, on the basis that GAAR applied.

Avoidance Transaction

The tax benefit in this case was the terminal loss claimed by the taxpayer on his tax return and was conceded by the taxpayer. The taxpayer claimed that the primary purpose of the transfer of the Building by the Partnership to the New Partnership was not to trigger a terminal loss, but was to achieve greater cost efficiency by operating one partnership rather than two, having one management contract rather than two, and reducing the competition between the two buildings. The trial judge rejected the taxpayer's assertions and found that the transfer of the buildings to the New Partnership was an avoidance transaction, because the significant tax benefits achieved dwarfed the minimal cost savings.

I am also not satisfied that the Appellant has proven that the primary goal of the restructuring was to save costs and eliminate competition between the buildings. The Appellant was unaware of any work done to determine whether the anticipated savings in operating expenses would outweigh the costs of the restructuring, and there is no evidence that any cost/benefit analysis or financial projections relating to the restructuring were ever prepared for the partners of Roseland I or II. This contrasts with the effort put into obtaining legal and accounting advice on the restructuring and the estimation of the terminal loss for each partner prior to the special meetings of the partners. Furthermore, no evidence was led to show that cost savings were in fact achieved as a result of the restructuring or to show that any attempt was ever made to monitor the performance of the properties after the restructuring to determine whether the anticipated benefits had been realized.5

The appellate court accepted the trial judge's finding that an avoidance transaction existed.

For instance, the fact that the tax benefit achieved in this case dwarfed the costs to be saved supports the finding that tax benefit was the prime motivator. In addition, the Tax Court judge considered documentary evidence which showed that at the planning stage, exclusive emphasis was placed on the "significant income tax benefits" which the proposal would produce. There was also evidence that ACC had prior experience in obtaining the type of tax benefit which the transactions in issue procured.6

Abusive Tax Avoidance

The taxpayer ultimately succeeded at trial and before the Federal Court of Appeal on the basis that he had not engaged in abusive tax avoidance. The trial judge found that subsection 20(16), the provision relied upon by the Partnership and the taxpayer in claiming the terminal loss, did not prevent the claiming of terminal losses where the depreciable property in question was disposed of to a related party. Furthermore, while there are specific provisions in the Tax Act which prevent the claiming of terminal losses in specific circumstances, the Tax Act does not contain an overall policy prohibiting the claiming of losses in circumstances similar to the present one. The trial judge held, "...where there is a general provision in the Act allowing for the deduction of a loss, subject to a restriction or exception in certain circumstances, the limited nature of the exception can be seen as underscoring the general policy of the Act to allow the loss."7 In addition, the trial judge stated, "...Parliament has chosen to define the circumstances in which the terminal loss will be denied on transfers of depreciable property between partnerships in subsection 85(5.1) (now subsection 13(21.2)) and in doing so would appear to have chosen to allow taxpayers who are not within the circumstances set out in that provision to claim their terminal losses."8

The Federal Court of Appeal agreed with the Tax Court and stated that "[t]he specificity of these rules is indicative of the fact that they are exceptions to a general policy of allowing losses on all dispositions"9 and "...where it can be shown that an anti-avoidance provision has been carefully crafted to include some situations and exclude others, it is reasonable to infer that Parliament chose to limit their scope accordingly."10

Lessons Learned

Firstly, this case reaffirmed the position taken by Bowman A.C.J. in Geransky v. R.,11 that the Minister cannot use GAAR to fill in gaps left by Parliament.

Simply put, using the specific provisions of the Income Tax Act in the course of a commercial transaction, and applying them in accordance with their terms is not a misuse or an abuse. The Income Tax Act is a statute that is remarkable for its specificity and replete with anti-avoidance provisions designed to counteract specific perceived abuses. Where a taxpayer applies those provisions and manages to avoid the pitfalls the Minister cannot say "Because you have avoided the shoals and traps of the Act and have not carried out your commercial transaction in a manner that maximizes your tax, I will use GAAR to fill in any gaps not covered by the multitude of specific anti-avoidance provisions".12

Secondly, this case provides some insight into the threshold between an avoidance transaction and an abusive avoidance transaction. The Court looked to the overall result when determining whether the transaction frustrated the object, spirit and purpose of the relevant provisions. The Court stated that the transactions may have been abusive if the legal rights and obligations of the taxpayer had been wholly unaffected, but in this case, the transactions altered the taxpayer's legal rights and obligations.

I accept that the transactions in issue would be arguably abusive if they had given rise to the tax benefit in circumstances where the legal rights and obligations of the respondent were otherwise unaffected. However this is not what happened here.

The transactions altered the respondent's legal rights and obligations. He ceased to be a partner in Roseland II and joined RPM, thereby becoming associated with the former partners of both Roseland I and Roseland II. As a result, he acquired an undivided interest in assets double in size and shared in an extended rental pool which accounted for the revenues generated by both Roseland I and Roseland II. These changes were material both in terms of risks and benefits. The appellant has a selective view of the evidence when it asserts that nothing changed as a result of the transactions.13

The Court emphasized that the legal rights and obligations of the taxpayer had been affected and that this was not simply a transaction that gave rise to a tax benefit. As such, it is imperative that a transaction undertaken primarily for tax reasons carries with it real economic substance and is not otherwise artificial. The Court stated in Canada Trustco, "...s. 245(4) does not consider a transaction to result in abusive tax avoidance merely because an economic or commercial purpose is not evident."14 That said, to the extent that there is economic substance behind an avoidance transaction, it will help to solidify the taxpayer's position that the transaction was not abusive.

Thirdly, the courts finding of an avoidance transaction was partly based on the discoverable tax planning documents of the tax advisors. If the taxpayer were able to claim solicitor-client privilege on these documents, the courts findings at the avoidance transaction stage may have been different. While we cannot state this for certain, there can be no doubt that to the extent a taxpayer can claim solicitor-client privilege on tax planning memos, his strategic position in respect of any CRA GAAR attacks will be enhanced.

Fourthly, the trial judge identified several indicia, at paragraphs 90-92 quoted above, that may have assisted the taxpayer in further proving that this transaction was not primarily tax motivated. The court noted: (i) there was no cost/benefit analysis performed nor financial projections undertaken in relation to the restructuring; (ii) the taxpayer was not aware of any work done to determine if the cost savings would outweigh the restructuring costs; and (iii) the taxpayer failed to lead evidence showing actual cost savings. The trial judge contrasted these facts with the level of legal and accounting advice received in relation to the tax benefits of the impugned transaction. This case provides an important reminder that a taxpayer must behave in a consistent manner with the non-tax reasons motivating a tax plan. If the primary reason the taxpayer agreed to the reorganization of the Partnership was greater economic efficiencies, he should have been better informed as to the estimated and actual cost savings.


Notwithstanding the taxpayer's successful rebuttal of CRA's GAAR attacks in Landrus, this case (and all GAAR cases) should be mined for important principles which may assist taxpayers and their tax advisors in developing, implementing and reporting their tax plans in the face of the uncertainty radiating from all things GAAR.


1. [1936] AC 1 ( (UK HL).

2. [2005] 5 CTC 215 [Canada Trustco].

3. Section 245 of the Income Tax Act (Canada), RSC 1985, c. 1 (5th Supp.) (the "Tax Act").

4. 2008 TCC 274 [Landrus TCC]; 2009 FCA 113 [Landrus FCA].

5. Landrus TCC, supra note 4 at para. 90-92.

6. Landrus FCA, supra note 4 at para. 75.

7. Landrus TCC, supra note 4 at para. 120.

8. Landrus TCC, supra note 4 at para. 123.

9. Landrus FCA, supra note 4 at para. 45.

10. Ibid. at para. 47.

11. [2001] 2 CTC 2147 (TCC [General Procedure]).

12. Ibid. at para. 42.

13. Landrus FCA, supra note 4 at paras. 56 and 57.

14. Supra note 2 at para. 57.

Failure to Complete Voluntary Disclosure on Timely Basis Fatal: McCracken v. The Queen
By Stevan Novoselac and John Sorensen

In McCracken v. The Queen1 ("McCracken"), the Federal Court refused to overturn the Canada Revenue Agency's ("CRA") decision to reject a voluntary disclosure ("VD") that was incomplete. The VD was incomplete because the taxpayer, Mr. McCracken, was waiting to get information to report his income from eBay, instead of reporting the income based on his banking records. The McCracken case provides taxpayers and counsel with guidance on the importance of managing and completing VDs in a timely manner.

The four requirements for a valid VD are:

  1. Voluntary: The VD must be initiated voluntarily and not as a result of a pending audit, investigation or other enforcement action.
  2. Complete: The taxpayer must provide full and accurate facts and documents for all taxation years for which there was previously inaccurate, incomplete or unreported information.
  3. Penalty: The VD must involve the application or potential application of a penalty.
  4. One Year Past-Due: The VD must include information that is at least one year past due.

Mr. McCracken was an eBay "Powerseller" with sales between 2000 and 2006 of approximately one million dollars.2 While Mr. McCracken had copies of his banking records, he requested further records from eBay to help him prepare amended income tax and goods and services tax returns. When eBay did not provide the requested records, Mr. McCracken's counsel asked the CRA for an extension of time to complete the VD, which was granted. However, when the eBay records were still not forthcoming and a second extension was requested, the CRA refused. Mr. McCracken was accordingly denied relief under the CRA's VD Program.

Mr. McCracken requested a "second level review" of the CRA's decision to deny his VD and a further 60 days to complete the VD. Almost six months after requesting the further review, the VD had still not been completed, and in a conversation with Mr. McCracken's counsel, the CRA indicated that it remained open to receiving Mr. McCracken's amended tax returns based on his banking records. No returns and supporting documents were filed, ostensibly because eBay had not provided the requested records. Ultimately, the CRA's patience simply ran out and the earlier decision to reject Mr. McCracken's VD was maintained, thereby substantially increasing Mr. McCracken's exposure for tax, interest and penalties.

Mr. McCracken brought an application before the Federal Court to challenge the CRA's decision to reject his VD. The Court however held that Mr. McCracken and his counsel were given "ample opportunity" to provide information and make submissions and that the CRA's decision to reject the VD was made fairly on the basis of the evidence and arguments provided. In the Court's view, Mr. McCracken had the means at his disposal to make a reasonable effort to complete the VD. The Court further held that the CRA's decisions on VDs should be shown deference and given "broad latitude". The CRA's decision was upheld as reasonable and the Court declined to intervene on Mr. McCracken's behalf. The Court criticized some of the CRA's apparent mistakes on the file which, although immaterial, were said to demonstrate incompetence and lack of attention. The Court also stated that the same criticism could be made of some of the actions taken on behalf of Mr. McCracken.

The McCracken case illustrates that although the CRA's VD program is intended to provide taxpayers with relief, the onus remains on taxpayers and their counsel to provide required information and documents on a timely basis. A failure to do so within defined timelines can be fatal.


1. 2009 FC 1189.

2. In August, 2009 in Vol. 9, Issue 26 of this newsletter, we reported on the CRA's press release announcing its intention to commence in-depth audits of so-called eBay "Powersellers". The CRA had obtained information concerning eBay Powersellers pursuant to the Federal Court of Appeal judgment in eBay Canada Ltd. and eBay CS Vancouver Inc. v. M.N.R., 2008 FCA 348, which we reported on in Vol. 9, Issue 3 of this newsletter in January, 2009. The saga continues.

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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