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McIntyre: Not What You Bargained For?

When are the parties to a civil tax dispute bound by agreed facts from a criminal proceeding?

This was the question considered by the Tax Court of Canada on a Rule 58 motion made by the taxpayers in McIntrye et al v. The Queen (2014 TCC 111). Specifically, the taxpayers argued the principles of issue estoppel, res judicata, and abuse of process applied to prevent the Minister of National Revenue (the “Minister”) from assuming facts inconsistent with agreed facts from a prior criminal guilty plea.

In McIntyre, two individuals and their corporation were audited for the 2002 to 2007 tax years. The individuals and the corporation were charged with criminal income tax evasion. As part of a plea bargain, one individual and the corporation plead guilty based on certain agreed facts, and the court imposed sentences accordingly. The other individual was not convicted.

Subsequently, the Minister issued GST reassessments of the corporation, and further reassessments of the individuals for income tax. In issuing the reassessments, the Minister refused to be bound by the agreed facts from the criminal proceeding. In the Notices of Appeal in the Tax Court, the taxpayers argued the reassessments must be consistent with the agreed facts.

The taxpayers brought a motion under section 58 of the Tax Court Rules (General Procedure) for a determination of a question of law or mixed fact and law before the hearing of the appeals. Specifically, the taxpayers asked (i) whether the doctrines of issue estoppel, res judicata and abuse of process prevented the Minister from making assumptions inconsistent with the agreed facts, and (ii) whether the parties were bound by the agreed facts in respect of the calculation of certain capital gains, shareholder debts, losses and shareholder benefits.

The taxpayers argued that it was appropriate to deal with these issues before the hearing, whereas the Crown argued that these issues could not be determined on a Rule 58 motion because, in this case, the facts arose from a plea bargain rather than a determination by a court, the agreed facts did not address the GST liability of the corporation or the other individual’s income tax liability, and the facts (and tax liability) of a criminal proceeding would only prohibit the parties from alleging a lower tax liability in a civil proceeding.

The Tax Court dismissed the taxpayer’s motion. The Court considered the applicable test on a Rule 58 motion, namely that there must be a question of law or mixed fact and law, the question must be raised by a pleading, and the determination of the question must dispose of all or part of the proceeding (see HSBC Bank Canada v. The Queen, 2011 TCC 37).

The Court stated that, in this case, only the first two requirements were met:

[35] I agree with the Respondent’s analysis of the caselaw. It confirms that prior convictions in criminal proceedings resulting from plea bargains, although a factor that may go to weight in a civil tax proceeding, are not determinative of the relevant facts and issues in a subsequent tax appeal.

[38] In MacIver v The Queen, 2005 TCC 250, 2005 DTC 654, Justice Hershfield also concluded that a question is best left to the trial Judge where the motion is merely to estop a party from contesting certain facts that will not dismiss an entire appeal. As noted in his reasons, unless such a question can fully dispose of an appeal by finding that issue estoppel applies, a Rule 58 determination could do little more than split an appeal and tie the hands of the trial Judge.

The Court noted that the agreed facts did not address the corporate GST liability or the second individual’s income tax liability, dealt only with the 2004 to 2007 tax years, and did not address the imposition of gross negligence penalties. The Court concluded that issue estoppel would not apply because there was not a sufficient identity of issues between the criminal and civil proceedings. It would be unfair, the Tax Court stated, to prohibit the parties from adducing evidence in the civil tax appeals where there had been no introduction and weighing of evidence in the criminal proceeding.

McIntyre: Not What You Bargained For?

GAAR Did Not Apply In Respect of Capital Gains Allocated to Minor Beneficiaries of a Family Trust

On March 21, 2012 the Tax Court of Canada issued judgment in the decision of McClarty Family Trust et al v. The Queen. The Minister of National Revenue (the “Minister”) had applied the general anti-avoidance rule (the “GAAR”) in section 245 of the Income Tax Act (the “Act”) to re-characterize capital gains reported by the McClarty Family Trust (“MFT”) as taxable dividends. However, the Court agreed with the appellants’ submissions that the transactions in issue were undertaken primarily for the purpose of placing Darrell McClarty, the father of the minor beneficiaries of the MFT, beyond the reach of creditors and allowed the appeal.

The Minster’s argument was that pursuant to a series of transactions, Darrell McClarty was able to split business income with his minor children in a manner that avoided the tax on split income in section 120.4 of the Act (as it existed in 2003 and 2004).

Darrell McClarty was the owner of all of the issued and outstanding Class A voting shares of McClarty Professional Services Inc. (MPSI). The MFT owned all of the issued and outstanding Class B, non-voting common shares. MPSI, in turn, owned 31% of Projectline Solutions Inc., which earned business income from the provisions of geotechnical engineering services.

In 2003 and 2004, the MFT received stock dividends consisting of Class E common shares of MPSI. The Class E shares had low paid-up capital and a high redemption value. After the Class E shares were received by the MFT, the MFT sold them to Darrell McClarty for fair market value, realizing capital gains. The capital gains were then distributed to the minor beneficiaries of the MFT, and thereby not subject to tax under section 120.4 of the Act.

Through a series of loans between Darrell McClarty, MPSI and the MFT, Mr. McClarty ended up owing $104,400.37 in outstanding promissory notes to the MFT and the MFT had outstanding promissory notes in the amount of $96,000 owned to its minor beneficiaries. The Minister argued that the creditor protection objectives were essentially ineffective and that the circular flow of loans disguised the true intention of the plan, which was to distribute funds to minor beneficiaries in a manner that would not subject them to the tax on split income in section 120.4.

However, the Court accepted Mr. McClarty’s evidence that he was motivated to protect assets from his former employer, who was a potential judgment creditor in relation to allegations of improper use of software belonging to the former employer. The Court also agreed that because of the liabilities of Mr. McClarty and the MFT noted above, the creditor protection objectives were achieved.

It was also argued that the protection from creditors would have been achieved simply by paying dividends to the beneficiaries of the MFT and therefore the declarations of stock dividends amounted to avoidance transactions. However, the Court accepted the Appellants’ argument that the transfer of wealth from MPSI was undertaken to provide protection from creditors without attracting significant tax costs. The transactions were not avoidance transactions because it was acceptable to undertake creditor proofing transactions in a manner that attracted the least possible tax. Furthermore, the transaction would never have occurred in the absence of the need to protect MPSI’s assets.

The Court therefore concluded that because there were no avoidance transactions under subsection 245(3) of the Act, there was no need to continue the analysis to determine if there was abusive tax avoidance. However it did note that to the extent that there was a gap in the legislation, which allowed for the distribution of capital gains to minor beneficiaries of a trust in a manner that was not taxable under section 120.4 of the Act, it was inappropriate for the Minister to use the GAAR to fill in the gaps.

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GAAR Did Not Apply In Respect of Capital Gains Allocated to Minor Beneficiaries of a Family Trust

A General Anti-Avoidance Rule (GAAR) for the United Kingdom?

Plus ça change, plus c’est la même chose. The United Kingdom is now seriously considering the introduction of a form of GAAR after having relied for years on judicial doctrines of anti-avoidance as expounded in such cases as WT Ramsay Ltd v. IRC, [1981] STC 174 (HL); CIR v. Burmah Oil Co. Ltd., [1982] STC 30 (HL); Furniss v. Dawson, [1984] STC 153 (HL); Craven v. White, [1988] STC 476 (HL); Ensign Tankers (Leasing) v. Stokes (HMIT), [1992] STC 226 (HL).  The most recent report is dated November 11, 2011 and is entitled “GAAR Study: A study to consider whether a general anti-avoidance rule should be introduced into the UK tax system“.

The uncertain and indeed sometimes contradictory principles developed in the U.K. cases have impelled an Advisory Committee consisting of a distinguished group of practitioners, academics and judges led by Graham Aaronson, Q.C. to advocate a “moderate” rule that targeted “abusive” arrangements, but to reject a “broad spectrum” general anti-avoidance rule. It is difficult for Canadians who have lived for over 20 years with the GAAR in section 245 of the Income Tax Act and observed the Canadian courts in scores of cases grapple with concepts such as “abuse”, “misuse” or “avoidance transactions” not to view with a measure of smug satisfaction – indeed Schadenfreude – the spectacle of a high level panel wrestling with such philosophical conundrums as the distinctions between “contrived and artificial schemes”, “abnormal arrangements” and “responsible tax planning”. The problem in the United Kingdom of codifying an anti-avoidance rule is similar to that in the United States where the judicial anti-avoidance doctrines applied in different circuits have necessitated the enactment of an amendment to § 7701(o) of the Internal Revenue Code to include a complex codification of the economic substance doctrine, one of the principal pillars of United States anti-avoidance jurisprudence. The Advisory Panel has performed a creditable task by analyzing the very problems that Canadian courts have been struggling with since the inception of the Canadian version of GAAR. The philosophical predilection of the United Kingdom courts embodied in Ramsay and its progeny may well influence the interpretation of the English GAAR just as the Duke of Westminster‘s case has implicitly survived GAAR in Canadian jurisprudence and has influenced its interpretation and evolution.

We can expect to see substantial refinement in the development of the “moderate” (or “targeted”) anti-avoidance rule (“TAAR” as opposed to “GAAR”) to ensure that it conforms to the stated objectives of the rule in that it

(a) deters or counteracts contrived, artificial and abusive schemes;

(b) does not undermine or discourage competitiveness that arises from “responsible” tax planning;

(c) eliminates uncertainty in predicting the tax consequences of arrangements that results from, inter alia

(i) “notoriously long and complex” tax legislation;

(ii) differing interpretations of arrangements by courts and tribunals; and

(iii) a battery of specific anti-avoidance rules.

Graham Aaronson and the Advisory Committee are to be commended for producing a competent and commonsensical report that responds realistically to a serious issue. The legislative implementation of the proposals is not certain. The possibility of GAAR was explored in the United Kingdom in 1998 and came to nothing. It may be assumed that if the proposals are enacted, it will take many years for the United Kingdom courts to develop principles that will clarify the application of the rule, in the same way in which the Supreme Court of Canada has reduced the Canadian version of GAAR to manageable proportions in Canada Trustco.

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A General Anti-Avoidance Rule (GAAR) for the United Kingdom?

Tax Court of Canada: The GAAR Does Not Apply to Disallow Deduction of a $5.6 Million Business Loss

On October 28, 2011 the Tax Court of Canada released Judgment and Reasons for Judgment of the Honourable Justice Judith Woods in Global Equity Fund Ltd. v. Her Majesty The Queen, 2011 TCC 507.  Global Equity Fund Ltd. (“Global”) had appealed the application of the General Anti-Avoidance Rule (the “GAAR”) by the Minister of National Revenue (the “Minister”) to disallow the deduction of a $5,600,250 business loss incurred on the sale of shares in a private corporation.

The Court found that the loss was produced after Global subscribed for shares of a new subsidiary corporation, which then issued preferred shares to Global which were redeemable and retractable for $5,600,250 but had a paid up capital of $56 and which resulted in an income inclusion of $56.  The stock dividend had the effect of reducing the fair market value of the shares of the new subsidiary to a nominal amount but did not affect Global’s adjusted cost base in those shares.  Global then disposed of the common shares to a newly settled family trust at a loss in the amount of $5,600,250.

The Court did not accept Global’s argument that the transactions leading up to the loss were implemented for creditor protection purposes.  Accordingly the Court held that a number of transactions in issue were avoidance transactions within the meaning of subsection 245(3) of the Income Tax Act (the “Act”).

The Court also noted that this case was similar to two recent decisions of the Tax Court of Canada where similar strategies were used by other taxpayers to create capital losses. In both cases (Triad Gestco Ltd. v. The Queen, 2011 TCC 259 and 1207192 Ontario Ltd. v. The Queen, 2011 TCC 383) the Tax Court upheld the application of the GAAR to deny the losses.  The Court noted that both of these decisions are under appeal to the Federal Court of Appeal.

However, in Global’s case the Court was not prepared to accept the Crown’s argument that the object and spirit of the provisions of the Act identified by the Crown evidenced a policy to disallow losses realized within an economic unit to real losses.  The Court held that Parliament did not intend that the object and spirit of provisions identified by the Crown which targeted capital losses were intended to inform as to the object and spirit of the provisions relied upon by Global in the facts of this case.

Relying on the Supreme Court of Canada decision in Canada Trustco Mortgage Co. v. The Queen (2005 SCC 54), Justice Woods held that the provisions in the Act relied upon by Global to produce the losses had not been misused and she was also unable to discern a general policy from these provisions that restricted business losses in the manner suggested by the Crown.  The Tax Court rejected the Crown’s argument that there was a general restriction against the deduction of artificially-created business losses.  For all of these reasons the Tax Court held that the Minister had not met the onus of establishing abusive tax avoidance under subsection 245(4) of the Act and allowed the appeal.

[Note: The author, along with Jehad Haymour of Fraser Milner Casgrain LLP, acted as counsel for Global – Ed.]

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Tax Court of Canada: The GAAR Does Not Apply to Disallow Deduction of a $5.6 Million Business Loss