In 3295940,1 the Tax Court of Canada decided that the GAAR applied to the circumvention of subsection 55(2) on a cross-redemption of shares. The plan involved circulating the capital dividend account ("CDA") of a parent company to its subsidiary (on the first redemption), then back to the parent (on the second redemption). Through such "CDA recycling", the parent company indirectly obtained a bump of its subsidiary's low basis shares prior to their sale in a context where paragraph 88(1)(d) was otherwise unavailable.2 The decision has been appealed to the Federal Court of Appeal.
Summary of Findings
The facts of this case are complex. In essence, the parent formerly operated a pharmaceutical business3 and the purchaser was not interested in acquiring its high basis shares. The plan allowed the taxpayer to sell its operating subsidiary and obtain the tax benefit that would have resulted from the sale of the parent company shares.
The Court concluded that the purpose of the CDA regime is to trace corporate surpluses that can be distributed tax free to shareholders. In the present case, the CDA regime did not allow the tracing of surpluses towards the top of the corporate structure: a CDA balance was artificially circulated in a corporate group back to its original starting point. The application of subsection 55(2) was avoided in the process as capital dividends are not targeted by that provision.4
The Court also found that no double taxation resulted from the fact that the taxpayer was not able to benefit from the cost in its own shares as part of the sale of its assets.5
Relevance of Alternative Transactions for the GAAR Analysis
It is well-established that alternative transactions can be relied on to demonstrate the presence of a tax benefit.6 More recently, their potential relevance as part of the abuse analysis was confirmed in Univar:7
In GAAR cases the issue is whether the taxpayer has abused the provisions of the ITA. In my view, these alternative transactions are a relevant factor in determining whether or not there has been an abuse of the provisions of the ITA. If the taxpayer can illustrate that there are other transactions that could have achieved the same result without triggering any tax, then, in my view, this would be a relevant consideration in determining whether or not the avoidance transaction is abusive.8
In 3295, the Court refused to consider the sale of the parent corporation (which would have triggered less tax) as a relevant alternative to the sale of its subsidiary for the purposes of the abuse analysis: the object of the sale, the price and the commercial consequences would all have been different.9 It is worth specifying that in Univar, the alternative transaction accepted by the Court involved the transfer of the same corporate entities.10
In the case at hand, the Court did however confirm that the fact that the purchaser did not want to acquire the parent corporation because of its contingent liabilities was not relevant in and of itself to the abuse analysis.11 As such, an alternative transaction should not be disregarded solely based on the fact that the parties could not agree to it during their negotiations.12
In conclusion, alternative transactions should remain relevant to the GAAR analysis, even when merely theoretical. Taxpayers should ensure that the alternatives relied on are equivalent commercially, and that they provide further illustration as to the reasonable tax consequences applicable to them.
1. 3295940 Canada Inc. v. Her Majesty the Queen, 2022 TCC 68 ("3295").
2. 3295, para. 131, 136 and 143.
3. 3295, para. 12 and 13.
4. 3295, para. 120 and 121.
5. 3295, para. 144.
6. When the existence of a tax benefit is not clear, the fact that a taxpayer reduced, avoided or deferred tax payable has to be established by comparison with an alternative arrangement. See Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, para. 20.
7. Univar Holdco Canada ULC v. The Queen, 2017 FCA 207 ("Univar"), which overturned Univar Holdco Canada ULC v. R., 2016 TCC 159 ("Univar TCC"). See also more recently Fiducie Financière Satoma v. Canada, 2018 FCA 74, para. 59 and 60.
8. Ibid., para. 19.
9. 3295, para. 159, 160 and 161.
10. For the relevant facts, see Univar TCC, para. 17, 52, 53, 104 and 105.
11. 3295, para. 113. This was precisely the case in Univar.
12. 3295, para. 156 and 157.
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