Introduction – GAAR and the Use of Corporate Losses
The general anti-avoidance rule (GAAR) in section 245 of the Income Tax Act is one of the most powerful tools available to the Canada Revenue Agency (CRA) when it determines that a taxpayer has structured transactions primarily to obtain a tax benefit. The case of Madison illustrates how GAAR can be applied to so-called "corporate restart" transactions involving unused tax losses.
A financially distressed public mining corporation with no remaining operations but substantial non-capital and net capital losses was restructured. The mining assets were spun out, leaving behind an empty corporate shell.
Two real estate entrepreneurs, Sam Grippo and Raymond Heung, injected profitable real estate assets into the shell in exchange for a dual-class share structure that gave their companies nearly all of the economic value but less than half of the voting control. Over the following years, the corporation—renamed Madison Pacific Properties Inc.—applied its accumulated losses to offset income and capital gains from its new business.
The CRA reassessed, concluding that the entire plan was designed solely to preserve and use losses that would otherwise have been denied under the loss restriction rules in subsection 111(4) of the Income Tax Act.
Both the Tax Court of Canada and the Federal Court of Appeal upheld the CRA reassessments, finding that the transactions had no bona fide purpose other than to access the losses and that the scheme frustrated the object, spirit, and purpose of the Act.
The courts further held that under subsection 248(10), the "series of transactions" included not only the corporate transformation but also the subsequent claiming of the losses, since this was the very purpose of the restart. This case highlights the CRA's readiness to scrutinize transactions aimed at preserving and utilizing tax losses, serving as a reminder that consulting an expert Canadian tax lawyer is essential before implementing complex corporate reorganizations.
The Architecture of the GAAR and the Burden of Proof
The GAAR in section 245 of the Income Tax Act operates as Parliament's broad safeguard against tax avoidance that, while formally compliant with the statute, defeats its underlying rationale. As established by the Supreme Court of Canada in Canada Trustco and reaffirmed in Copthorne, the GAAR analysis follows a three-step structure:
(1) identifying a tax benefit,
(2) determining whether there is an avoidance transaction not undertaken primarily for a bona fide non-tax purpose, and
(3) assessing whether the transaction is abusive by frustrating the "object, spirit or purpose" of the relevant provisions.
The third step—the misuse or abuse analysis—requires the Court first to determine the rationale of the provision(s) allegedly abused and then assess whether the transactions subvert that rationale. The taxpayer bears the onus of disproving the existence of a tax benefit and avoidance transaction, while the Minister bears the persuasive burden of establishing abusive tax avoidance.
In interpreting the underlying policy, the courts apply a unified textual, contextual, and purposive approach, examining both the statutory language and permissible extrinsic aids such as explanatory notes and legislative history. Although determining the policy is a question of law, its application to the facts is a mixed question of fact and law.
The Supreme Court in Canada Trustco emphasized that the CRA must clearly demonstrate abuse, with any uncertainty resolved in the taxpayer's favour. In practice, this division of onus aims to maintain fairness: once the taxpayer has shown formal compliance with the Income Tax Act, it is for the CRA—who possesses superior institutional knowledge of legislative intent—to justify invoking GAAR by proving that the transactions frustrate the Act's scheme.
Because GAAR cases often require identifying the "object, spirit, or purpose" of specific provisions, the CRA's reliance on internal or non-public policy materials becomes contentious. While section 241 of the Income Tax Act restricts disclosure of taxpayer information, it grants the CRA limited discretion to provide documents necessary to understand an assessment.
The CRA often resists broader disclosure, arguing that legislative purpose is a pure question of law; however, courts have increasingly recognized that taxpayers are entitled to examine relevant non-privileged documents considered during CRA audits or by the GAAR Committee.
This interplay between evidentiary access and interpretive methodology underscores why GAAR litigation blurs the boundary between law and fact, and why disclosure is vital to ensure balance between taxpayers and the state in determining whether a transaction truly frustrates the intent of the Income Tax Act.
In this environment, an expert Canadian tax lawyer is crucial to navigate the procedural and evidentiary complexities of GAAR litigation effectively, interpret evolving jurisprudence, and safeguard your rights throughout the dispute process.
Policy Foundations of GAAR and Loss Restrictions
In this sense, corporate "restarts" typically arise where an inactive or distressed corporation retains significant tax attributes (for example, non-capital or net capital losses) but has ceased the business that generated those attributes.
New owners introduce profitable assets or a different business and then deploy the historical losses to shelter subsequent income or gains. The Income Tax Act permits loss carryovers, but only within guardrails designed to ensure that losses remain with the taxpayer who actually sustained them. Where a restart is structured primarily to preserve losses for the benefit of new stakeholders—particularly by skirting the loss-restriction rule—GAAR scrutiny becomes likely.
Subsection 111(4) restricts the use of net capital losses after an acquisition of control. As the jurisprudence explains, the provision safeguards continuity in two dimensions: (i) continuity of controlling shareholders (de jure control), and (ii) continuity of the business that generated the losses.
The policy animating subsection 111(4) is that new shareholders should not deploy old losses against income or gains from a fundamentally different venture simply by acquiring the loss company.
In this context, formal de jure control—tied to voting rights in the constating documents—provides administrable certainty. Yet courts also recognize that the loss-restriction rationale can be frustrated where transactions replicate the economic outcome of a change in control without meeting its strict textual threshold.
Subsection 248(10) expands the analytical lens from a single step to a series of transactions that are pre-ordained to produce a given result or are logically connected to that result. In GAAR disputes involving restarts, this means the court can examine not only the initial restructuring (for example, asset injections, share redesign, or spin-outs), but also the later claiming of losses where those claims form the contemplated outcome of the series.
In this vein, the "series" concept prevents taxpayers from isolating the loss utilization as a separate, innocent event divorced from the restart architecture that made such utilization possible.
Coordinated Conduct and Dual-Class Equity: Avoiding Formal Control while Preserving Losses
Corporate restarts often feature dual-class share structures or dispersed voting held by friendly parties so that the acquirers obtain most of the economic value with less than 50% of the votes. In this context, courts will consider whether multiple actors acted in concert to implement the plan (for example, board appointment control, voting understandings, synchronized subscriptions, or cross-holdings) such that there is a functional concentration of power even without a formal acquisition of de jure control.
While subsection 111(4) speaks in de jure terms, GAAR permits a purposive assessment of whether the transactions, taken together, subvert the provision's rationale.
GAAR in Action: Lessons from the Madison Case
In Madison Pacific Properties Inc. v. Canada, the courts examined how GAAR applies to corporate restart transactions involving the use of accumulated losses. A publicly traded mining corporation with no active operations but significant unused non-capital losses of $9.7 million and net capital losses of $72.7 million spun out its mining assets, leaving a shell with accumulated losses.
Two real estate companies controlled by Sam Grippo and Raymond Heung transferred commercial properties into the shell in exchange for shares. The corporation subsequently changed its name to Madison Pacific Properties Inc.
The share structure created through the plan left the Grippo- and Heung-controlled companies with 92.82% of the equity but 46.56% of the votes. Other voting shares were held by business associates, which, if included, would exceed 50% of the votes. Between 1998 and 2013, Madison applied its unused losses to offset income and capital gains from its new business.
The CRA reassessed, concluding that the transactions were structured to preserve and use losses that would otherwise have been denied under subsection 111(4) of the Income Tax Act.
Subsection 111(4) is a loss-restriction rule that denies a corporation's net capital losses where there has been an acquisition of de jure control by a person or by a group of persons; its purpose, as articulated by the courts, is to prevent unused net capital losses from being deducted against new capital gains for the benefit of new shareholders who did not incur them.
At trial, the Tax Court found that two sets of companies—Madison Venture Corporation and its affiliates (the "Madison Group," led by Mr. Grippo) and Vanac Development Corp. and its affiliates (the "Vanac Group," led by Mr. Heung)—acted in concert to implement and benefit from the restart.
The Court emphasized that these groups, together with aligned parties, operated collectively; they controlled board appointments, entered into voting understandings, and utilized a dual-class share structure that preserved access to losses while avoiding the acquisition of de jure control.
The Tax Court also found that Madison and Vanac placed an explicit value on the losses—$2.8 million—and indirectly compensated prior shareholders for allowing access. The Court determined that the steps resulted in a fundamental transformation of the corporation: the mining business was spun out, the Madison and Vanac groups contributed new assets, prior employees ceased employment, the shareholder base was substantially replaced, and the board was reconstituted with nominees of the new groups.
On appeal, the Federal Court of Appeal endorsed these findings and added a necessary clarification on the scope of the "series of transactions."
Under subsection 248(10), a series extends to transactions that are pre-ordained or logically connected to its outcome. The Court held that the later claiming of the losses was not separate from the corporate transformation but rather its contemplated purpose.
Accordingly, the losses claimed between 1998 and 2013 formed part of the series and were denied adequately under the GAAR.
This progression from the Tax Court to the Federal Court of Appeal illustrates how Canadian courts approach loss trading under GAAR: the factual findings about concerted conduct and the legal framework of subsections 111(4) and 248(10) work together to deny the preservation of losses when they are transferred to new shareholders.
This case illustrates how courts analyze the use of losses under GAAR and highlights the value of obtaining guidance from an expert Canadian tax lawyer when planning or reviewing corporate reorganizations.
Pro Tax Tip – Upholding the Purpose of the GAAR
The Madison Pacific Properties decision reaffirms that the GAAR remains a cornerstone of Canada's tax integrity framework, ensuring that transactions, though compliant in form, do not defeat the broader intent of the Income Tax Act.
The case illustrates that courts will look beyond technical compliance to assess whether a series of transactions has genuine commercial substance or merely seeks to exploit statutory gaps.
It also underscores that maintaining robust documentation of the business purpose—such as contemporaneous records, valuation analyses, and correspondence—can be decisive in demonstrating that a transaction was undertaken for legitimate, non-tax reasons.
Ultimately, the decision serves as a reminder that clarity, consistency, and transparency in structuring and record-keeping are critical to withstand GAAR scrutiny and preserve the credibility of a taxpayer's position before the CRA or the courts.
FAQ – Tax Losses, GAAR, and Corporate Restarts
When does a "corporate restart" raise red flags under Canadian tax law?
A corporate restart occurs when a corporation with unused tax losses is effectively transformed into a new business with new shareholders while retaining the ability to apply those losses against future income. Courts closely scrutinize such transactions under GAAR—especially when the restart appears designed to transfer losses to new owners who did not incur them.
Why does subsection 111(4) of the Income Tax Act matter in these cases?
Subsection 111(4) denies a corporation's ability to carry forward and use net capital losses once there has been an acquisition of control. Its purpose is to prevent new shareholders from using losses they did not sustain, ensuring that loss carryovers stay with the business that actually incurred them.
What should corporations with unused losses consider before reorganizing?
Before proceeding with any reorganization, corporations should ensure that the transaction has a clear business purpose and is supported by contemporaneous documentation. Engaging qualified tax advisors early in the process helps confirm that the plan aligns with the object, spirit, and purpose of the Income Tax Act and reduces the risk of GAAR reassessment.