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Federal Tax - General Anti-avoidance Rule (GAAR) (2). Magren Holdings Ltd v. Canada
In Magren Holdings Ltd v. Canada (Fed CA, 2024) the Federal Court of Appeal dismissed a appeal, this from a dismissed Tax Court appeal, this from a Ministerial assessment "imposing tax on the basis that all of the capital dividends those corporations paid in 2006 were excess dividends", and "where a corporation pays a capital dividend in excess of the balance of its capital dividend account, the corporation is liable for tax":
Here the court considered the GAAR principle at length:[107] I agree with the Tax Court that GAAR applies. There were tax benefits and avoidance transactions, and the avoidance transactions abused the object, spirit and purpose of the capital gain and capital loss provisions and the capital dividend rules. Finally, I am satisfied that the resulting tax consequences are reasonable in the circumstances.
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D. Does GAAR Apply?
[174] I am satisfied GAAR applies.
[175] To sustain the assessments based on GAAR, three questions must be answered affirmatively:. Is there a tax benefit?
. If so, is one or more of the transactions giving rise to the tax benefit an avoidance transaction?
. If so, is the tax avoidance abusive? Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2 S.C.R. 601 at para. 66 [Canada Trustco]; Copthorne Holdings Ltd. v. Canada, 2011 SCC 63, [2011] 3 S.C.R. 721 at para. 33 [Copthorne]; Deans Knight Income Corp. v. Canada, 2023 SCC 16, [2023] 4 C.T.C. 25 at para. 51 [Deans Knight].
[176] While "“tax benefit”" and "“avoidance transaction”" are defined in the Income Tax Act, to determine whether the avoidance is abusive, a court must identify the rationale—the object, spirit and purpose—of the provisions relied on to obtain the tax benefit. Frustration of that object, spirit and purpose leads to a finding of abuse.
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[186] The Supreme Court teaches that where a series of transactions gives rise to more than one tax benefit, the legal analysis must focus on the individual tax benefits: Lipson v. Canada, 2009 SCC 1, [2009] 1 S.C.R. 3 at para. 22. The series of transactions at issue here undoubtedly involved many tax benefits, several of which may have been perfectly acceptable. GAAR’s focus is denial of one or more particular tax benefits.
[187] Although the existence of a tax benefit is a question of fact, given the Tax Court’s error, as in Lipson, this Court must identify the tax benefit.
[188] The definition of "“tax benefit”" includes "“a reduction, avoidance or deferral of tax”": s. 245(1). As the respondent points out, nothing precludes a corporation from paying a capital dividend despite the corporation’s CDA balance being nil. The consequence of doing so is liability for Part III tax. Conversely, paying a capital dividend while avoiding that tax is a tax benefit. There is no value judgment at the tax benefit stage—the only question is whether there was a reduction, avoidance or deferral of tax or other amount payable, or an increase in a refund of tax or other amount, under the Income Tax Act. Undoubtedly avoiding or reducing Part III tax is a perfectly acceptable tax benefit in many circumstances, but it nonetheless is a tax benefit.
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[192] The tax benefit the Minister seeks to deny by the assessments at issue here is clear — the appellants’ avoidance of Part III tax. To deny that tax benefit, the Minister issued assessments, not notices of determination of the appellants’ CDA. The Part I assessments reduced the appellants’ capital gains and capital losses to nil, thus eliminating their CDA, and the Minister assessed the appellants for the Part III tax avoided.
[193] It is true that Part III tax was not payable by the appellants until GAAR applied. However, where the tax benefit at issue is the avoidance of tax, it is no surprise that the consequence of GAAR applying is liability for the tax avoided. That does not mean the avoidance of that tax was not a tax benefit.
[194] Many cases illustrate this point. In Deans Knight the tax benefit was the reduction of Part I tax by deducting losses. Until GAAR applied, the losses were deductible and the reduced Part I tax was not payable. GAAR applied to deny that tax benefit by denying the losses so the Part I tax became payable. In Lipson, the deduction of interest resulted in a reduction of Part I tax and the reduced Part I tax was not payable until GAAR was applied.
[195] Copthorne might be viewed as more analogous to this case. There the tax benefit was the avoidance of withholding tax; that tax did not become payable until GAAR applied to reduce the paid-up capital of the Canadian corporation. By reducing the paid-up capital and assessing the Canadian payer corporation for withholding tax, the tax benefit — the avoidance of withholding tax—was denied. Here the tax benefit is avoidance of Part III tax. By applying GAAR to eliminate the appellants’ capital gains and capital losses, and thus their CDA, and assessing the Part III tax, the appellants’ tax benefit was denied.
[196] That is not to say that there were not other tax benefits from the series of transactions at issue in this appeal. There were. For example, the capital dividends Mr. Grenon received were a tax benefit. The Minister might have assessed Mr. Grenon on the basis his capital dividends were a tax benefit that should be denied. However, nothing in the record suggests the Minister did so and I am not persuaded that the Minister was obligated to assess Mr. Grenon to deny his tax benefit, rather than the appellants to deny theirs. GAAR does not dictate which tax benefit or tax benefits from avoidance transactions must be denied.
[197] The assessments at issue in this appeal address a particular tax benefit — avoidance of Part III tax. That tax benefit is the appellants’ tax benefit.
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[206] If a transaction results in a tax benefit, or is part of a series of transactions that would result in a tax benefit, the transaction is an avoidance transaction unless it may reasonably be considered to have been undertaken primarily for bona fide purposes other than to obtain the tax benefit: s. 245(3).
[207] However, "“a bona fide non-tax purpose for a series of transactions does not exclude the possibility that the primary purpose of one or more transactions within the series is to obtain a tax benefit”": Canada v. MacKay, 2008 FCA 105, [2008] 4 F.C.R. 616 at para. 25, leave to appeal to SCC refused, 32616 (15 January 2009) (emphasis in original). ....
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[214] I turn now to the final element of GAAR — abuse.
(3) Was there an abuse?
[215] The avoidance transactions that resulted in the tax benefits were abusive.
[216] Determining whether the tax avoidance — obtaining the tax benefits — was abusive involves two steps. First, a court must identify the object, spirit and purpose of the relevant provisions. Once it has done so, it must decide whether the result of the transactions frustrates that object, spirit and purpose: Deans Knight at para. 56, citing Canada Trustco at para. 44 and Copthorne at paras. 69-71.
[217] To identify the object, spirit and purpose of the provisions alleged to be abused, courts must have "“reference to the provisions themselves, the scheme of the [Income Tax Act] and permissible extrinsic aids”": Deans Knight at para. 58, citing Canada Trustco at para. 55.
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[222] .... Where "“a taxpayer does not satisfy the statutory requirements of a provision on which [it] relies, the Minister need not resort to GAAR”": Canada v. Imperial Oil Ltd., 2004 FCA 36, [2004] 2 C.T.C. 190 at para. 30; see also Copthorne at para. 66; Deans Knight at para. 62. And, "“there is no bar to applying the GAAR in situations where the [Income Tax Act] specifies precise conditions that must be met to achieve a particular result”": Deans Knight at para. 71.
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(4) Are the tax consequences reasonable in the circumstances?
[244] Where GAAR applies, the tax consequences to a person shall be determined as are reasonable in the circumstances in order to deny a tax benefit that would result, directly or indirectly, from a series of transactions that includes an avoidance transaction: s.245(2).
[245] As defined, "“tax consequences”" includes the tax or other amount payable under the Income Tax Act or any other amount that is relevant for purposes of computing that amount (i.e., the tax): s. 245(1). In determining the tax consequences as are reasonable in the circumstances to deny a tax benefit that would result from an avoidance transaction, the tax effects that would otherwise result from the application of other provisions of the Income Tax Act may be ignored: s. 245(5)(d).
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VIII. Conclusion
[264] I am satisfied that GAAR applies. The avoidance transactions that led to the tax benefit—the appellants’ avoidance of Part III tax—frustrated the object, spirit and purpose of the capital gain and capital loss provisions of the Income Tax Act. I am satisfied that the elimination of the appellants’ capital gains and capital losses by the Part I assessments, with the commensurate elimination of the additions to their CDA and the resulting Part III assessments, are reasonable tax consequences to deny their tax benefit. . 3295940 Canada Inc. v. Canada
In 3295940 Canada Inc. v. Canada (Fed CA, 2024) the Federal Court of Appeal considered (and allowed) a corporation's appeal against a GAAR (referred to below as 'abuse') [ITA s.245] finding:[3] To borrow liberally from one author, what should then have been a “plain-vanilla tax‑planning opportunity” whereby Micsau used its high cost to be taxed on its true economic gain ended up being, for the Tax Court of Canada, an abusive avoidance transaction by 3295: Eric Hamelin, “GAAR Applicable to the Circular Payment of Capital Dividends” (2023) 71:3 Can Tax J 859 at 868 [Hamelin].
[4] In light of the true nature and overall result of the series of transactions, there was no abuse of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the Act). For the following reasons, I would allow the appeal.
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[28] The Minister of National Revenue (Minister) reassessed 3295 pursuant to the General Anti-Avoidance Rule (GAAR) in section 245 of the Act. The GAAR applies when a series of transactions meets three requirements. First, a tax benefit must arise from the series of transactions. Second, there must be avoidance, meaning the series was undertaken primarily for the purpose of obtaining a tax benefit. Third, the avoidance must be abusive. Abuse occurs when the result of the series frustrates the object, spirit, and purpose of a provision of the Act or of the Act as a whole.
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V. Analysis
[45] The Tax Court failed to consider the entire series of transactions and its overall result. This error of law led the Court to misconstrue the abuse analysis and improperly reject alternative transactions that would have confirmed that the series did not abuse subsection 55(2) or the scheme governing capital dividends.
A. The Tax Court Misconstrued the Abuse Analysis
[46] The Supreme Court and this Court have held that, to determine whether transactions forming part of a series are abusive, one must consider the “entire series of transactions” or its “overall result”: Lipson et al. v. The Queen, 2009 SCC 1 at para. 34; Copthorne Holdings Ltd. v. The Queen, 2011 SCC 63 at para. 71 [Copthorne]; Canada v. Landrus, 2009 FCA 113 at paras. 66–67; Birchcliff Energy Ltd. v. Canada, 2019 FCA 151 at paras. 27–28 [Birchcliff]; Oxford Properties at paras. 106–110, 118–119.
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B. The Tax Court Failed to Consider the Alternative Transactions
[55] By failing to consider the entire series and its overall result, the Tax Court not only misconstrued the abuse analysis but also improperly rejected alternative transactions, which would have confirmed that the series is not abusive.
[56] Alternative transactions that a taxpayer might have carried out are considered in the course of GAAR analyses.
[57] For instance, in some cases, the existence of a tax benefit can only be established by comparing the tax consequences of the transaction or series actually carried out with the tax consequences of an alternative transaction that might have been carried out: Canada Trustco at para. 20; Copthorne at para. 35. A perfect example is the case at bar, in which 3295 conceded the existence of a tax benefit because selling its 1.5M Holdings shares without the series would have resulted in a higher capital gain.
[58] Similarly, courts consider alternative transactions’ tax consequences when determining whether tax avoidance is abusive: Shawn D. Porter, “The Misuse and Abuse Exception: The Role of Alternative Transactions” in Brian J. Arnold, ed., The General Anti-Avoidance Rule: Past, Present, and Future (Toronto: Canadian Tax Foundation, 2021) at 275–286 [Porter], citing Lehigh Cement Limited v. Canada, 2010 FCA 124 at paras. 40–41; Birchcliff at paras. 31, 48; Mathew v. Canada, 2005 SCC 55 at para. 58. Alternative transactions are helpful in determining the object, spirit and purpose of the relevant provisions and, correspondingly, what the Act seeks to allow and prevent. As stated by Webb J.A. of this Court: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 [Income Tax Act]. 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.
(…) [T]he alternative means by which the same result could have been realized is a relevant consideration in determining whether or not the avoidance transaction was abusive.
(Univar Holdco Canada ULC v. Canada, 2017 FCA 207 at paras. 19–20 [Univar]) ....
[61] More fundamentally, in deciding not to consider the alternative transactions, the Tax Court failed to take into account the series’ overall result: Micsau used its high ACB, and a capital gain was realized, which was roughly equal to the capital gain Micsau would have realized from selling 3295 directly. In my opinion, the alternative transactions 3295 submitted are relevant because:a)They are available under the Act. The fact that they were not presented to Novartis or that Novartis may have refused to proceed with them does not detract from the fact that the Act allowed for these transactions;
b)They are not so remote as to be practically infeasible. The alternative transactions 3295 submitted could realistically have been carried out. Had Novartis or RoundTable agreed, carrying out these alternatives would have been relatively easy;
c)They have a high degree of commercial and economic similarity to the series at issue: Porter at 270. The alternative transactions would have resulted in Novartis acquiring shares of a corporation whose underlying asset would be the generic drug business—exactly what Novartis in fact acquired;
d)They generate tax consequences approximately as favourable as the series at issue: The proposed alternatives would have enabled Micsau to use its ACB in the 3295 shares. This would have generated a capital gain of $53.7M—roughly the same gain that 3295 realized in our case; and
e)They are not abusive of the GAAR: Univar at para. 20; Porter at 277–279. The various alternative transactions would have enabled Micsau to realize its high ACB without attracting the application of the GAAR. . Canada v. MMV Capital Partners Inc.
In Canada v. MMV Capital Partners Inc. (Fed CA, 2023) the Federal Court of Appeal considered (and allowed) a Crown income tax appeal, here on 'general anti-avoidance rule' (GAAR) principles guided by the recent Deans Knight SCC case:[1] In Deans Knight Income Corp. v. Canada, 2023 SCC 16 (Deans Knight), the Supreme Court of Canada was faced with deciding whether a series of transactions undertaken to monetize a corporation’s non-capital losses was subject to the general anti-avoidance rule (GAAR) in section 245 of the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.). The Supreme Court concluded that the transactions achieved a result that frustrated the object, spirit and purpose of subsection 111(5) of the Income Tax Act and thus GAAR applied. (In these reasons, references to statutory provisions refer to provisions in the Income Tax Act.)
[2] In this appeal, we face the same question, but with respect to a different series of transactions undertaken by a different corporation. The Tax Court of Canada (2020 TCC 82, per Bocock J.) concluded that GAAR did not apply. The Crown appeals that decision, submitting that the transactions at issue here, like those in Deans Knight, abused subsection 111(5) and so GAAR similarly applies.
[3] The respondent disagrees. It submits that its circumstances are significantly different from those in Deans Knight such that GAAR does not apply.
[4] While there are factual differences between the two cases, when we apply the teachings from Deans Knight, the inescapable conclusion is that GAAR applies. Accordingly, I would allow the appeal.
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IV. Object, spirit and purpose does not focus on control
[23] Following Deans Knight, there can be no debate that the object, spirit and purpose of subsection 111(5) is “to prevent corporations from being acquired by unrelated parties in order to deduct their unused losses against income from another business for the benefit of new shareholders”. The Supreme Court tells us this no less than five times in the course of its decision: Deans Knight at paras. 6, 78, 113, 124, 140.
[24] Moreover, the Supreme Court expressly criticized the Tax Court’s focus on “effective control” in Deans Knight TCC. It explained that “[t]o define the object, spirit and purpose of s. 111(5) based on Parliament’s choice of test or substitute it for another test would…result in prioritizing the means (the how) over the rationale (the why)”: Deans Knight at para. 115 (emphasis in original).
[25] As it did in Deans Knight TCC, the Tax Court here erred in identifying the object, spirit and purpose of subsection 111(5). We must accept the Supreme Court’s determination of the object, spirit and purpose. Therefore, the only question before us is whether the transactions at issue here were abusive (i.e., frustrated that object, spirit and purpose).
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V. The transactions abused subsection 111(5)
[26] Determining whether a transaction or series of transactions abused the relevant provisions is “necessarily fact-intensive”: Deans Knight at para. 121, citing Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54 at para. 44 and Canada v. Oxford Properties Group Inc., 2018 FCA 30 at para. 39.
[27] In this case, there is little dispute about the facts; the dispute centres on whether those facts support a finding of abuse.
[28] The respondent submits that there are two “major distinctions” between the transactions in Deans Knight and those here, which largely explain why the transactions in Deans Knight abusively circumvented subsection 111(5), and why the transactions at issue here do not.
[29] The first is “the artificial manner in which the transactions in Deans Knight circumvented de jure control, as compared with this case where MMV simply acquired fewer votes than would have conferred de jure control”: respondent’s further supplementary submissions at para. 4. The second is “the complete transformation of the shareholder base in Deans Knight, as compared with this case where the [five original shareholders] continued to hold a majority of the votes before and after the transactions”: respondent’s further supplementary submissions at para. 4.
[30] The Crown submits those distinctions are irrelevant because the Court’s task is not to compare the respondent’s circumstances to those in Deans Knight. Rather, to determine whether subsection 111(5) was abused, the Court must compare the result of the transactions to the provision’s underlying rationale. Once that comparison is made in this case, says the Crown, the abuse is clear.
[31] I agree with the Crown.
[32] Deans Knight sets out the framework to be applied at the second stage of the abuse analysis at paragraph 69 of the reasons. There it tells us that to determine whether the underlying rationale of the provisions has been frustrated, we must compare the result of the transactions to that underlying rationale. The Supreme Court provides three examples from prior decisions that illustrate how the object, spirit and purpose of different types of tax provisions can be frustrated: Deans Knight at para 70.
[33] Citing paragraphs 124-127 of Copthorne Holdings Ltd. v. Canada, 2011 SCC 63, the Supreme Court states that abuse may be found “where a series of transactions ‘achieved a result the section was intended to prevent’ while narrowly avoiding application of the provision”: Deans Knight at para. 70. That example applied in Deans Knight (paras. 6, 122, 140). It applies in this case as well.
[34] The object, spirit and purpose of subsection 111(5) – its rationale – is “to prevent corporations from being acquired by unrelated parties in order to deduct their unused losses against income from another business for the benefit of new shareholders”.
[35] As in Deans Knight, what happened here is exactly what subsection 111(5) seeks to prevent.
[36] MMV, unrelated parties not previously shareholders, acquired well in excess of 99 percent of the respondent’s equity (more than 98 percent of its common share equity for $1,000 and 100 percent of its preferred share equity for US$23 million). MMV also became the respondent’s only secured creditor and the only source of the respondent’s funding. By any measure, MMV acquired the respondent. That the five original shareholders remained with an infinitesimal equity interest, but de jure control, does not change this.
[37] More than 18 months after the respondent ceased to carry on the VOIP business in which it incurred its losses, MMV sold a business to the respondent. That business was of an entirely different nature than the business in which the respondent incurred its losses.
[38] The respondent deducted its losses against the income earned from that new business. MMV, the new shareholder with more than 99.99 percent of the respondent’s equity, is the only shareholder that benefitted from those losses.
[39] How did MMV benefit?
[40] But for MMV selling the assets to the respondent, the income generated by those assets would have been earned by MMV, but without the benefit of the respondent’s losses to reduce taxable income. In 2012 and 2013, the respondent paid dividends to MMV, entirely to the exclusion of the five original shareholders. Those dividends exceeded the respondent’s aggregate income in 2011, 2012 and 2013 by nearly $14 million. This was possible both because the losses meant the respondent paid no taxes on its income and because the respondent used principal repayments received on its loan portfolio to fund the dividends paid to MMV.
[41] Thus, MMV received all of the business income free of corporate tax. Moreover, MMV received significant capital that previously had been deployed in the business it sold to the respondent, albeit as dividends rather than as a reduction of its invested capital in the respondent (i.e., the advances under the credit facility or the preferred shares). The obvious inference is that this enabled MMV to retain its 99.99 percent equity interest and maintain its priority debt claim against the respondent while reducing the respondent’s asset base.
[42] The respondent argues that when examining shareholder continuity, the focus should be on de jure control. Here, it says, the five original shareholders with the majority of the common shares remained constant; in contrast, in Deans Knight, the original shareholder “was completely taken out of the picture” and the company “ended up with a completely new shareholder base”: respondent’s further supplementary submissions at para. 10.
[43] While those are the facts in Deans Knight, nothing in that decision suggests a completely new shareholder base is required to find abuse of subsection 111(5). Rather, the question Deans Knight posed was whether a new shareholder base benefitted from the losses. Here, for reasons explained above, only the new shareholder benefitted.
[44] The respondent also submits that the five original shareholders could have acted to elect a new board that would pay them dividends, and no contract precluded them from doing so. That may be true. But that they did not, when doing so would appear to have been in their economic interests, is not at all surprising because of the practical constraints they faced.
[45] All five original shareholders would have had to agree to a new slate of directors to outvote MMV. Moreover, MMV’s interest in the respondent (more than 99.99 percent of the equity that cost more than US$23 million) was of an entirely different scale and import than that of the five original shareholders (less than 0.01 percent of the equity valued at pennies when MMV became a shareholder). The power imbalance is self-evident. MMV had the right to demand immediate repayment of the credit facility and to demand redemption of the preferred shares within 30 days. Had it done so, the respondent would have been unable to pay dividends and, once those demands had been met, would have had little, if any, assets of value. Given this, and their collective infinitesimal interest in the respondent, the prospect of the five original shareholders electing directors and paying themselves dividends was illusory.
[46] Put another way, while their common shares provided the five original shareholders with de jure control, they had no effective way to use that control to benefit from the respondent’s losses. Their de jure control was meaningful only because it prevented MMV from acquiring de jure control. Doing so would have been fatal to MMV being able to benefit from the respondent’s losses.
[47] The transactions at issue “achieved an outcome that Parliament sought to prevent” and “all while narrowly circumventing the application of s. 111(5)”: Deans Knight at para. 122.
[48] Drawing from Deans Knight (at paragraphs 124-127), “the reorganization transactions resulted in the [respondent’s] near-total transformation: its assets and liabilities were shifted”. Here, the respondent’s assets were sold in 2009 and 18 months later its remaining liabilities had been settled or purchased by MMV for a small fraction of the amount owing. MMV became the respondent’s only creditor. As a result, like in Deans Knight, all that remained of the respondent were its non-capital losses. The respondent was “gutted of any vestiges from its prior corporate ‘life’ and became an empty vessel with Tax Attributes” that “were preserved to benefit another party”, MMV. The respondent “was, in practice, a company with new assets and liabilities, [a new shareholder/owner] and a new business”. Thus, “the transactions resulted in a fundamental change in the [respondent’s] identity”.
[49] Accordingly, the transactions frustrated the object, spirit and purpose of subsection 111(5) and were abusive.
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