In Spruce Credit Union v. The Queen (2014 FCA 143) the Federal Court of Appeal upheld the lower court’s interpretation and application of the inter-corporate dividend deduction under subsection 112(1) of the Income Tax Act (Canada) (the “Act”). The Court of Appeal also considered the interpretation of “avoidance transaction” for purposes of the general anti-avoidance rule (“GAAR”) in section 245 of the Act.
Spruce Credit Union (“Spruce”) was a member of a network of credit unions providing financial services to individuals in British Columbia. Two separate provincially-owned entities were responsible for insuring the deposits of B.C. credit unions during the relevant period: the Credit Union Deposit Insurance Corporation (“CUDIC”) and the Stabilization Central Credit Union of British Columbia (“STAB”).
Certain regulatory changes required that funds held by STAB were to be transferred to CUDIC. After considering alternatives, it was decided that CUDIC would assess the member credit unions the amount in aggregate necessary to meet the fund requirement, and STAB would pay a dividend on its Class A shares to the credit unions, roughly equal to the assessment. In fact, two dividends were declared and paid: (a) “Dividend A”, from STAB’s “aggregate cumulative investment income”, and (b) Dividend B, from STAB’s “aggregate cumulative assessment income”.
The Canada Revenue Agency (the “CRA”) reassessed Spruce, denying the inter-corporate dividend deduction (under subsection 112(1) of the Act) in respect of Dividend B (Dividend A was not reassessed). The CRA assessed Spruce on two grounds: (a) the dividend was not deductible under ordinary rules, but rather was governed by specific rules in the Act pertaining to credit unions, and (b) the GAAR applied.
The Tax Court (2012 TCC 357) held the deduction under subsection 112(1) was available to Spruce in respect of Dividend B. Further, there was no “avoidance transaction” and therefore the GAAR could not apply. (Note: The Tax Court’s costs award in Spruce Credit (2014 TCC 42) was not considered in the present case. That decision is the subject of a separate appeal before the Federal Court of Appeal (Court File No. A-96-14).)
On appeal, the Crown argued that the Tax Court erred because it was “inappropriate to consider whether the taxpayer chose the particular transaction among alternatives primarily based on tax considerations”. In the Crown’s view, the Federal Court of Appeal’s decision in MacKay v. The Queen (2008 FCA 105) required the Court to consider whether the non-tax objective could have been obtained without the particular impugned transaction or through an alternative transaction.
In the present appeal, the Federal Court of Appeal held the lower court had made no error in respect of its findings regarding the availability of the deduction under subsection 112(1). Further, the Court of Appeal rejected the Crown’s arguments regarding the GAAR.
The Court held that when determining whether a particular transaction is an avoidance transaction, the existence of an alternative transaction that may have attracted additional tax is only one factor to consider. The very existence of such alternative transaction is not, in and of itself, determinative of whether there has been an avoidance transaction. The fact that this alternative transaction exists is only one consideration in determining whether any transaction in a series in an avoidance transaction.
The Federal Court of Appeal noted that the Crown’s suggested interpretation would undermine the long-standing Duke of Westminster principle in Canadian tax law that taxpayers are free to organize their affairs in a manner to pay the least amount of tax within the bounds of the law. The Supreme Court of Canada has affirmed the validity of the Duke of Westminster principle in numerous GAAR decisions.
It is not entirely clear what distinction may be made between the facts and reasoning in the present case and those in MacKay. In Spruce Credit, there was a regulatory regime that required compliance and which necessitated the transfer of funds from STAB to CUDIC. The taxpayers chose a tax-efficient manner in which to achieve the regulatory compliance. In MacKay, the taxpayers choose a course of tax-efficient planning based on a voluntary acquisition of certain real property. That said, in neither case is this distinction particularly clear.
Perhaps future court decisions may provide some guidance on this point and on the interpretation of “avoidance transaction” generally. At the time of publication of this article, the Crown had not yet sought leave to appeal the decision to the Supreme Court of Canada.
A longer version of this article will appear in an upcoming edition of CCH’s Tax Topics.