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CRA Update: Aggressive Tax Planning

At the Toronto Centre Canada Revenue Agency & Tax Professionals Breakfast Seminar on June 10, 2014, the Canada Revenue Agency (“CRA”) provided an update on selected CRA Compliance Measures in the Aggressive Tax Planning Division. The update was provided by Len Lubbers, Manager, GAAR and Technical Support, Aggressive Tax Planning Division of the Compliance Programs Branch.

Mr. Lubbers displayed and referred to a collection of powerpoint slides (some of which contained detailed statistics), but unlike previous seminars the CRA did not distribute copies of the slides during or after the presentation.

The CRA provided updates on (i) reportable tax avoidance transactions, (ii) the CRA’s related party initiative, (iii) the T1135 foreign income verification statement, (iv) gifting tax shelters, and (v) third party penalties. Here is a brief recap of some of the highlights from the presentation:

Reportable Tax Avoidance Transactions

  • New subsection 237.3 of the Income Tax Act, which addresses reportable transactions, became effective as of June 26, 2013, with retroactive effect to January 1, 2011;
  • Taxpayers who must report a transaction under subsection 237.3 must file form RC312 “Reportable Transaction Information Return“;
  • The deadline for 2012 and earlier years was October 23, 2013, and for subsequent years the RC312 information return is due by June 30 of the year following the transaction;
  • The CRA is currently reviewing the forms filed as of October 2013. The CRA did not disclose the number of RC312 forms that have been filed.

Related Party Initiative/High Net Worth Individual Program

  • The related party initiative program was piloted in 2005 and fully adopted in 2009;
  • The CRA considers that the title “Related Party Initiative” was “not particularly descriptive” of the program;
  • Initially, the program was targeted at individuals with a net worth of $50 million or more and where a taxpayer had 30 or more entities in a corporate group;
  • Several recent changes have expanded the scope of this initiative – namely, the CRA eliminated the requirement that the taxpayer’s wealth be held in 30 or more corporate entities;
  • Additionally, the $50 million threshold for individuals will be relaxed to include corporate groups where there are significant assets held by a group of individuals. For example, consider three individuals that own companies valued at $100 million. Separately, these individuals would not meet the $50 million threshold, but under the new parameters these individuals will be included in the audit program if there is sufficient “economic interdependence”;
  • Further, the long-form “questionnaire” issued by the CRA to taxpayers under audit in the program will now be used by the CRA to gather information from high-net worth individuals who are not under audit;
  • The CRA has formed audit teams in the Aggressive Tax Planning Division to handle these files (previously, these files were handled by audit teams in the Large Business Audit Division).

T1135 Foreign Income Verification Statement

  • The T1135 Foreign Income Verification Statement was introduced in 1995 as a response to concerns about the growing popularity of the use of international tax havens;
  • A revised T1135 form was issued in June 2013;
  • Given the severity of penalties which result from failure to file the T1135 information form, the CRA recommends a voluntary disclosure be made by taxpayers.

Gifting Tax Shelters

  • The CRA continues to monitor and reassess gifting tax shelters;
  • As of 2014, the CRA has reassessed 189,000 taxpayers and denied more than $3 billion of donation tax credit claims;
  • The CRA has revoked the registration of charities that were involved in gifting tax shelters, and the CRA has imposed $162 million of third-party penalties;
  • The CRA noted that the number of participants in tax shelters has been decreasing (i.e., 2012: 8,410 participants vs. 2013: 2,517 participants). The total donations to gifting tax shelters has also decreased (i.e., 2012: $266,675,953 vs. 2013: $7,518,712);
  • The CRA noted the new rule in subsection 225.1(7) that requires a taxpayer to pay 50% of the amount assessed (or the amount in dispute);
  • As of 2013, for taxpayers who participate in a tax shelter, the CRA will not assess a taxpayer’s return until the CRA has audited the tax shelter. In such cases, the CRA will assess a taxpayer’s return if he/she agrees to have the tax shelter credit claim removed from the return.

Third-Party Civil Penalties

  • Section 163.2 was introduced in 2000 (section 285.1 of the Excise Tax Act contains a similar penalty);
  • The CRA’s views on third party penalties is found in Information Circular IC-01-1 “Third Party Civil Penalties” (September 18, 2001);
  • Under section 163.2 there are two types of penalties: a tax planner penalty (under subsection 163.2(2)) and a tax preparer penalty (under subsection 163.2(4)). The CRA noted that both could apply to a taxpayer, but the maximum amount of the penalty in such a case would be the greater of the two amounts (i.e., the penalties are not combined (see subsection 163.2(14));
  • The process for the (potential) application of a penalty under section 163.2 is as follows: The local CRA auditor will gather facts of the taxpayer’s activities and circumstances. If a third party penalty may be applied, the auditor will refer the file to his/her senior manager in the local office. If the senior manager agrees that a penalty may be applied, the file will be referred to the CRA’s Third Party Penalty Review Committee at the CRA’s Ottawa headquarters. A third party penalty will only be applied upon the approval of the Third Party Penalty Review Committee;
  • 195 files have been referred to the Third Party Penalty Review Committee. Of these files, the CRA has applied a penalty in 92 files (for penalties totalling $181 million), has declined to apply a penalty in 87 files, and 16 files remain on-going;
  • The CRA awaits the Supreme Court of Canada’s decision in Guindon v. The Queen (Docket # 35519), which is tentatively scheduled to be heard on December 5, 2014. See our earlier blog posts on the Guindon case here and here.

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CRA Update: Aggressive Tax Planning

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?

CRA Rocks the Boat: Garber et al. v. The Queen

“Now then, Pooh,” said Christopher Robin, “where’s your boat?”
“I ought to say” explained Pooh as they walked down to the shore of the island “that it isn’t just an ordinary sort of boat. Sometimes it’s a Boat and sometimes it’s more of an Accident. It all depends”.
“Depends on what?”
“On whether I am on the top of it or underneath it”
A. A. Milne, Winnie-the-Pooh

Readers who were tax practitioners in the mid-80s will well remember the luxury yacht tax shelters, which were sold in 1984, 1985 and 1986 and which were one of the most popular tax shelters of that period. Many of us had clients who invested in this tax shelter and are aware that the CRA was very upset with this tax shelter and reassessed all of the investors. Tax practitioners from that period will also remember that the promoter of the tax shelter and several of his associates were prosecuted and convicted in connection with the luxury yacht tax shelter.

Approximately thirty years later, Associate Chief Justice Eugene Rossiter of the Tax Court of Canada released his decision in Garber et al. v. The Queen on January 7, 2014. The three appeals involved investors in limited partnerships which were established in 1984, 1985 and 1986 to acquire and charter luxury yachts and the deductions claimed by the Appellants in their 1984 to 1988 taxation years. The Appellants, as limited partners, claimed losses relating to the operation of the partnerships, interest deductions on promissory notes which were used to pay for the limited partnership units and professional fees paid in the year the Appellants subscribed for partnership units. The reasons for judgment note that 600 investors were reassessed and approximately 300 investors settled with the CRA.

The hearing opened on January 11, 2012 and in total over 62 days of evidence was given by 34 witnesses and there were 23 agreed statements of fact. The decision of Associate Chief Justice Rossiter is over 150 pages long and may rank as one of the longest Tax Court decisions (we previously commented on the length of the decision by Justice Boyle in McKesson Canada Corporation v. The Queen which was released in December 2013 – for those of you who keep track of such matters, this decision is fifty percent longer that the decision in McKesson.)

In basic terms, each of the Appellants invested in a limited partnership which was created to purchase a luxury yacht from the promoter. The promoter, as general partner, was committed to providing the yachts and to market and manage a luxury yacht chartering business for each limited partnership. The projections provided to the Appellants showed significant deductible start-up costs and the Appellants also expected to benefit from the tax depreciation (capital cost allowance) on the yachts. The Appellants’ investments were heavily leveraged with financing organized by the promoter and, therefore, a taxpayer who acquired a limited partnership unit would benefit from an attractive tax deduction in excess of his or her cash investment.

Associate Chief Justice Rossiter carefully reviewed the background facts relating to the limited partnerships (almost 100 pages are devoted to recounting the evidence). He noted that the promoter of the tax shelter and several of his associates were convicted of fraud in connection with the arrangement and found that the scheme was a fraud because virtually no yachts were acquired and the money paid by investors was used to promote future partnerships and not used in a yacht chartering business.

The CRA had offered numerous reasons why the expenses claimed by the Appellants should be disallowed:

  1. The limited partnerships did not constitute an income source under sections 3 and 4 of the Act because there was no genuine yacht charter business. The limited partnerships were not true partnerships because no actual business was carried out in common.
  2. The transactions were “mere” shams.
  3. Limited partnerships never actually incurred expenses for the purpose of gaining or producing business or property income.
  4. In the alternative, under subsections 9(1) and 18(9) of the Act, certain expenses incurred were not deductible in the years claimed because services were to be rendered after the end of the taxation year.
  5. In respect of interest payments, the CRA alleged that the promissory notes did not constitute actual loans and that no money was lent or advanced to the investors and, therefore there was no interest deductibility.
  6. To the extent any yacht was acquired by the 1984 partnership, capital cost allowance was restricted by the leasing property rules in subsections 1100(15), (17) (17.2) and (17.3) of the Income Tax Regulations.
  7. In the alternative, if interest was deductible, it would be limited by the half year rule in subsection 1100(2) of the Income Tax Regulations.
  8. For partnerships marketed in 1986, the partnership losses are restricted by the “at–risk” rules introduced on February 26, 1986.
  9. Subsection 245(1) of the Act is applicable because the expenses and disbursements claimed by an Appellant would unduly or artificially reduce the taxpayer’s income.
  10. The expenses are not deductible under section 67 of the Act because they were not reasonable and were not incurred to earn income.

After his extensive review of the evidence, Associate Chief Justice Rossiter analysed the legal issues. He found that there was no source of income for purposes of the Act under section 9 because the transactions were a fraud (similar to Hammill v. Canada, a 2005 decision of the Federal Court of Appeal) and because the scheme was a fraud, there was no source of income. It was noted that it is possible to have a fraud and a business (several cases are cited in this regard); however, based on the facts, in this situation, there was no business whatsoever. Therefore, there was no source of income.

One of the arguments made by the Appellants is that the significant amount of money received from investors was spent by the promoter and this indicates that there was a business. However, the facts were clear that money was not spent on acquiring yachts or a yacht charter business. Some of the funds were spent on unrelated endeavours and most of the funds were spent by the promoter on marketing and promoting future limited partnerships.

Associate Chief Justice Rossiter also noted that the Appellants commented during the trial on the “aggressive or inappropriate behaviour by members of the CRA”. He stated that his task “is not to assess the conduct of the CRA, but rather to determine whether or not the expenses claimed in these appeals are legitimate”. He also noted that the tax shelters were a Ponzi-like scheme which were set to collapse eventually and the conduct of the CRA did not turn the Ponzi-like scheme, which was a fraud from beginning to end, into a genuine business. In effect, all the CRA did was “lift the veil” to reveal the pervasive nature of the fraud.

Associate Chief Justice Rossiter also made clear that because the investment by limited partners was heavily leveraged, there was a lack of capital and this was a significant indication that there was no business being carried on.

Accordingly, there was no genuine business and the Appellants did not have a source of income from which they could deduct expenses or losses.

Furthermore, there were no genuine partnerships. For a partnership to exist, the parties must be a) carrying on a business b) in common and c) with a view to profit. Here, there was no business carried on; merely a fraud perpetuated by the promoter. Business was not carried on “in common” despite the existence of a partnership agreement because the promoter was perpetrating a fraud even though the limited partners were ignorant of the fraud perpetrated on them. As to a “view to profit”, there was no “view to profit”; the promoter had the intention to profit at the expense of the limited partnerships and the activities were so underfunded and so limited that there was no intention to profit.

Associate Chief Justice Rossiter went on to state that if there was a business carried on, the expenses claimed were not incurred for the purpose of operating the limited partnerships’ yacht chartering business and therefore were not deductible pursuant to subsection 18(1) of the Act.

Associate Chief Justice Rossiter also reviewed the requirement under subsection 18(9) of the Act that a taxpayer match any prepaid expense for services, interest, taxes, rent, royalty or insurance to the year in which those expenses relate. Based on the facts, the deductions claimed had little relation to actual expenses incurred and therefore deductibility is precluded under this provision.

Associate Chief Justice Rossiter also stated that in respect of one yacht which the taxpayers argued had been acquired by one of the 1984 partnerships, no evidence was presented that ownership of the boat was acquired by the limited partnership and therefore capital cost allowance was not deductible pursuant to paragraph 1102(1)(c) of the Income Tax Regulations. In any event, a boat was never acquired for income gaining or earning purposes and was only used by the promoter as window dressing to perpetrate the fraud.

In respect of the interest expenses claimed, the test under sub-paragraph 20(1)(c)(ii) was not met, because there was never a legal obligation to pay interest. The taxpayers entered into promissory notes based on fraudulent misrepresentations and any contractual obligation to pay interest would have been vitiated by the fraud.

In addition, in respect of the 1986 partnerships, the “at-risk” rules applied. It had been argued by the Appellants that the partnerships were grandfathered under the legislation but the statutory test for grandfathering had not been met.

Finally, any expense would have been denied under section 67 of the Act as the expenses were not reasonable in the circumstances if one considers the entire scheme. The Appellants had offered no evidence to show that expenses were legitimate or reasonable in light of services rendered or if any services were rendered at all.

Associate Chief Justice Rossiter concluded by stating that because of the lack of a source of income, the non-existence of genuine limited partnerships, the fact that the expenses were not incurred for business purposes, as well as the alternative arguments he addressed in his decision, it was not necessary to deal with all of the CRA’s arguments (e.g. sham and section 245). Accordingly, the appeals were dismissed with costs.

Given the amounts involved, and the number of taxpayers who were awaiting these decisions, it is likely that this case will “sail” into the Federal Court of Appeal.

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CRA Rocks the Boat: Garber et al. v. The Queen

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

Argument concludes in Supreme Court of Canada in trust residence appeal (Garron)

Earlier today, the Supreme Court of Canada heard arguments in the Garron appeal.  The reasons for judgment of the Tax Court of Canada and the Federal Court of Appeal, as well as the factum of each party, may be found at our earlier post.

Appellants’ Oral Argument

Counsel for the Appellants argued that the Income Tax Act contemplates that the residence of a trust is to be determined by the residence of the trustee.  It does so through a combination of subsections 104(1) and 104(2).  As a trust itself has no legal personality, Parliament has created a “deemed individual” character for trusts in the form of the trustee under subsection 104(2).  In the Appellants’ view, subsection 104(1) is critical as it provides the “linkage” between the trust and the trustee.

Justice Abella wondered whether the phrase “ownership or control” in subsection 104(1) suggests that Parliament intended that the “control” test apply in the context of determining the residence of a trust, as the Crown contends.

Justices LeBel and Karakatsanis wondered why one would look to the residence of the trustee when, under subsection 104(2), the trust is considered a separate person.

Justice Rothstein wondered why a trust should be treated differently than a corporation in the sense that both are created in similar ways and both have similar “locational attributes”.  In other words, why can’t we locate the trust outside the place the trustee resides?

Justice Moldaver wondered whether the phrase “unless the context otherwise requires” in subsection 104(1) suggests that Parliament did not want trustees to be set up as straw men outside Canada simply to avoid tax.  Counsel for the Appellants responded that the phrase “unless the context otherwise requires” means that in a provision where it makes no sense for “trust” to mean “trustee” it does not mean “trustee” (e.g. subsection 108(6)).  He also responded that Parliament addresses avoidance concerns elsewhere in the Income Tax Act, including section 94.  He submitted that the rule for the determination of residence of a trust is not the answer to tax avoidance.

Counsel for the Appellants drew to the Court’s attention the (a) affiliated persons rule and (b) qualified environmental trusts rule as both deal with the residence of trustees (as opposed to the residence of trusts).  This makes it clear that the residence of the trustees is what really matters and confirms the “linkage” between trust and trustee.

Counsel for the Appellants also noted that the plan undertaken in this case would not work today in light of the amendments to section 94 of the Income Tax Act and the provisions of the Income Tax Conventions Interpretation Act.

Justice Abella asked whether, in light of the fact that both corporations and trusts manage property, the test ought to be the same for each (i.e. the central management and control test) and where they manage the property should be determined in the same way for both.  Counsel for the Appellants characterized such an approach as “superficial”.

Finally, counsel for the Appellants argued that adoption of the “formalistic” central management and control test will not eliminate the possibility of manipulation.  One could arrange that all meetings at which substantive decisions are made occur outside Canada.  Accordingly, there is no reason to prefer that test over the traditional residence of the trustee test.

Crown’s Oral Argument

Counsel for the Crown argued that the central management and control test is the proper test for determining the residence of a trust for income tax purposes.  She argued that such a test is consistent with the legislative scheme.  She also argued that the rationale for the application of the test in the trust context is the same as the rationale for the application of the test in the corporate context.

Justice Moldaver asked, if Parliament intended the same rule to apply to trusts as to corporations, why the Income Tax Act did not provide that a trust is deemed to be a  corporation rather than an individual.  Crown counsel responded that someone has to be assigned responsibility for administrative functions, as noted by the Federal Court of Appeal, and that is the trustee under subsection 104(1).  Such administrative functions include filing returns, receiving assessments, filing objections and appeals and paying tax debts of the trust.

Citing De Beers Consolidated Mines, Justice Rothstein asked what the result would be if those who actually controlled the trusts met in Barbados and that is where they made all the substantive decisions (i.e. the key decisions affecting the trust property).  After noting that you can’t just leave Canada in order to “paper” such decisions if they were actually made in Canada, Crown counsel admitted that such a trust would be resident in the Barbados if indeed all substantive decisions were made in Barbados.

Justice LeBel asked whether one would have to perform a complete factual enquiry in order to make such a determination.  Crown counsel said yes, just as one would do in the case of a corporation in order to determine the place of central management and control.

Crown counsel listed a number of similarities between corporations and trusts particularly with respect to the managment of property as a function of each.  The question then becomes: where is that management exercised?

Justice Deschamps asked Crown counsel about the two statutory examples cited by counsel for the Appellants, namely, the affiliated persons rule and the qualified environmental trust rule.  She argued that those rules simply dictate where the trustees must reside and nothing else.

Counsel concluded by noting that the central management and control test has been applied for one hundred years and that test should now be adopted to determine where a trust is resident.

The Crown’s Alternative Arguments: Section 94 and GAAR

Junior counsel for the Appellants and the Crown spent approximately ten minutes each arguing the section 94 and GAAR points.  There were no questions directed to the Appellants on these points, but several questions were directed to the Crown.

The Crown contends that even if the trusts were resident in Canada (under either test), the trusts should be deemed not to have been resident in Canada under paragraph 94(1)(b) (the “contribution test”), as the Federal Court of Appeal concluded, on the basis that the trusts “acquired” property without actually “owning” it.  Junior counsel for the Crown was challenged on this point by Justice Rothstein.  He was also challenged when he argued that the GAAR applied.  Justice LeBel admitted that he had “some problems at this stage” with the application of the GAAR under the circumstances.  In addition, Justice Rothstein questioned whether there could be a GAAR case if all substantive decisions had actually made in the Barbados and, therefore, the trusts had satisfied the Crown’s central management and control test.  Junior counsel for the Crown responded by contending that there would be a GAAR case as such trusts, in light of the fact that they have no function to serve, would be artificial entities and devoid of economic substance.

After a very brief reply by counsel for the Appellants, judgment was reserved.

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Argument concludes in Supreme Court of Canada in trust residence appeal (Garron)

Panel of Tax Experts Debates Impact of Copthorne Decision at Canadian Tax Foundation Seminar

On Thursday, January 26, 2012, in the ballroom of the historic Fairmont Royal York Hotel in downtown Toronto, the Canadian Tax Foundation hosted a lively panel discussion on the recent Supreme Court of Canada (“SCC”) decision in Copthorne Holdings Ltd. v. The Queen. The event was also webcast, with an audience from coast to coast in Canada, and internationally as far away as France and New Zealand.

The decision in Copthorne centred on whether a “doubling-up” of paid-up capital (“PUC”) amounted to abusive tax avoidance that should be subject to the application of the general anti-avoidance rule (“GAAR”). For more on the Copthorne decision, see our previous post here.

The esteemed panel included a diverse group of tax experts. Madame Justice Karen Sharlow of the Federal Court of Appeal and Mr. Justice Wyman W. Webb of the Tax Court of Canada provided judicial insights into the potential ramifications of the SCC’s decision in Copthorne. Noted tax litigators Al Meghji of the private bar and Elizabeth Chasson of the Department of Justice considered the impact that the decision may have on the tax dispute resolution process, particularly in instances where the Canada Revenue Agency (“CRA”) is seeking to impose the GAAR. Tim Wach, a tax planner in private practice who was previously seconded to the Department of Finance, and Wayne Adams, former Director General, Income Tax Rulings at CRA rounded out the panel.

The discussion, moderated by Justin Kutyan, Pooja Samtani and Timothy Fitzsimmons of the CTF’s Young Practitioner’s group in Toronto, began with several panel members expressing their opinions on whether the decision in Copthorne changed their understanding of the application of the GAAR. Mr. Adams indicated that the SCC seems to have affirmed the CRA’s application of the GAAR where taxpayers have “created” tax attributes or have otherwise engaged in “sleight of hand”. Madame Justice Sharlow noted that the impact of Copthorne cannot be fairly assessed separate and apart from particular fact situations which will be presented to the courts in due course. Mr. Meghji said that, in his opinion, the approach taken by the Supreme Court is notably distinct from the approach taken in other international GAAR cases, particularly those coming from Australia and New Zealand.

The panel was also asked for their views on the impact of the Copthorne decision on the meaning of “series of transactions” as it is used in Canadian tax law generally. Mr. Wach expressed the view that he did not think that the decision required the Department of Finance to revise the extended meaning of “series of transactions” in subsection 248(10) of the Income Tax Act (Canada). Mr. Adams noted that, in his view, the Court validated the CRA’s approach to the concept of a “series of transactions” as it has been applied for the last 15 years (in contrast, he noted, to earlier cases in the which the SCC emphatically rejected CRA’s approach in other areas). The panel session also included a rather animated debate among the panel members on the role of the GAAR Committee in light of Copthorne and whether the positions taken by individual members of the GAAR Committee would be relevant to a Court in deciding a GAAR case.

The panel engaged in a lively discussion touching on many aspects of the Copthorne decision, the meaning of “series of transactions” and the GAAR more generally. While there was agreement among certain panel members on some issues, there was also respectful disagreement on many others with each member of the panel expressing his or her views with considerable passion and conviction.

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Panel of Tax Experts Debates Impact of Copthorne Decision at Canadian Tax Foundation Seminar

Conference on the Copthorne decision at U of T Faculty of Law – January 6, 2012

On December 16, 2011, the Supreme Court of Canada released its much-anticipated decision in Copthorne Holdings Ltd. v. Canada (go here for our blog post on the decision).  Next Friday afternoon, January 6, 2012, the Faculty of Law at the University of Toronto will be hosting an extraordinary event exploring the implications of the decision for the future of the GAAR.  An outstanding array of speakers has been lined up (including FMC’s own Don Bowman).  Spending that Friday afternoon at the Faculty of Law is sure to be one of the best ways to efficiently get up to speed on all the implications of the decision.

For details, please see the attached flyer, or go directly to http://www.copthorne.ca for registration information.

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Conference on the Copthorne decision at U of T Faculty of Law – January 6, 2012

Crown Wins GAAR Case in the Supreme Court of Canada: Copthorne Holdings Ltd. v. The Queen

On December 16, 2011, the Supreme Court of Canada released its latest General Anti-Avoidance Rule (GAAR) decision in Copthorne Holdings Ltd. v. Canada.  The appeal was heard on January 21, 2011 by all nine of the Justices (Chief Justice McLachlin, Justice Binnie, Justice LeBel, Justice Deschamps, Justice Fish, Justice Abella, Justice Charron, Justice Rothstein and Justice Cromwell).  Since the date of the hearing, Justices Binnie and Charron have retired.  This was the fourth GAAR appeal heard by the Supreme Court (the earlier cases were Canada Trustco Mortgage Co. v. Canada, Mathew v. Canada and Lipson v. Canada).

With Justice Rothstein writing for a unanimous Court, the taxpayer’s appeal was dismissed.  In so doing, the Court arrived at the same result as the Tax Court of Canada and the Federal Court of Appeal while, at the same time, providing important guidance for corporate Canada on the interpretation and application of the GAAR particularly in the context of reorganizations and distributions.  The clarity and precision of Justice Rothstein’s reasons should be welcomed by the business community, though the result in this particular case was unfavourable to the taxpayer.

If $96 million was contributed as capital, how can a taxpayer withdraw more than that amount as a tax-free return of capital?  Does the GAAR preclude such a result?  That the Court’s answer to the latter question was “yes” should not be regarded as a general defeat for tax planners.  The encouraging news for tax planners appears most clearly in two paragraphs of the reasons (note the deliberate use of the word “and” in paragraph 121):

[121] Copthorne also argues that the Act does not contain a policy that parent and subsidiary corporations must always remain as parent and subsidiary.  I agree. There is no general principle against corporate reorganization.  Where corporate reorganization takes place, the GAAR does not apply unless there is an avoidance transaction that is found to constitute an abuse.  Even where corporate reorganization takes place for a tax reason, the GAAR may still not apply.  It is only when a reorganization is primarily for a tax purpose and is done in a manner found to circumvent a provision of the Income Tax Act that it may be found to abuse that provision.  And it is only where there is a finding of abuse that the corporate reorganization may be caught by the GAAR.

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[123] While Parliament’s intent is to seek consistency, predictability and fairness in tax law, in enacting the GAAR, it must be acknowledged that it has created an unavoidable degree of uncertainty for taxpayers.  This uncertainty underlines the obligation of the Minister who wishes to overcome the countervailing obligations of consistency and predictability to demonstrate clearly the abuse he alleges.


In a nutshell, a non-resident invested $96 million in a Canadian holding company.  Those funds were then used to purchase Canadian portfolio investments and Canadian real property.  There were a number of subsidiaries and other affiliated corporations through which those investments were made.  About $67 million of that $96 million was, in turn, contributed to a subsidiary.  Following a 1993/1994 series of transactions, that $67 million of PUC was preserved which resulted in aggregate paid-up capital (“PUC”) as between the two companies of $163 million ($96 million plus $67 million).  That amount of PUC was later utilized, in another transaction, to permit the non-resident to withdraw $142 million from Canada free of withholding tax.

It was a set of 1994 proposals by the Department of Finance relating to the foreign accrual property income (“FAPI”) rules which caused the non-resident to monetize certain of his holdings.   This was done by redeeming $142 million of shares without payment of Canadian withholding tax.  What troubled the Minister of National Revenue was that the original investment was $96 million – any amount withdrawn in excess of the original capital contribution ought to have been considered a deemed dividend subject to Canadian withholding tax.

Having made the decision to divest those holdings, the taxpayer’s choice was whether to organize such a divestiture by way of a horizontal amalgamation or a vertical amalgamation.  If divestiture was to be accomplished by way of a horizontal amalgamation, the taxpayer believed that the total amount that could be removed free of Canadian withholding tax was $163 million ($96 million plus $67 million) as subsection 87(3) of the Income Tax Act does not provide for horizontally amalgamated corporations to lose their PUC as would have been the case on a vertical amalgamation (in the latter case, the PUC of the subsidiary would disappear on the amalgamation as the shares in the subsidiaries would necessarily have been cancelled).

There were two sets of transactions which the Crown had to connect in order to succeed under the extended definition of “series” in subsection 248(10) of the Income Tax Act.  There was a series of transactions in 1993/1994 (the sale of VHHC Holdings to Big City, and the subsequent amalgamation of VHHC Holdings with Copthorne I to form Copthorne II) which achieved the result of preserving $67 million of PUC in the subsidiary.  Then there was a transaction in 1995 (Copthorne III redeemed its shares without its shareholder incurring an immediate tax liability) which actually utilized the $67 million of PUC which had been preserved under the 1993/1994 series of transactions.

Was There a Tax Benefit?

In paragraph 37, Justice Rothstein explains why there was clearly a tax benefit:

[37] . . . . The only question was whether the amalgamation would be horizontal or vertical.  As the Tax Court judge pointed out, the vertical amalgamation would have been the simpler course of action.  It was only the cancellation of PUC that would arise upon a vertical amalgamation that led to the sale by Copthorne I of its shares in VHHC Holdings to Big City.  To use the words of Professor Duff, “but for” the difference in how PUC was treated, a vertical amalgamation was reasonable.

Was the Transaction Giving Rise to the Tax Benefit an Avoidance Transaction?

As there was no question about the tax benefit, the first issue was whether there was an “avoidance transaction”.  According to the Crown, the avoidance transaction was the 1993/1994 series of transactions which preserved the $67 million of PUC in the subsidiary as that series of transactions resulted in a tax benefit as part of a larger series (including the 1995 redemption transaction) in which the $67 million of PUC was actually utilized.

One of the Supreme Court’s concerns during oral argument was whether the 1993 series of transactions preserving $67 million of PUC was undertaken primarily for bona fide (i.e non-tax) purposes.  The taxpayer argued that it would have been imprudent, from a business perspective, to have squandered (or failed to preserve) all of the available PUC.  There is no relevant nexus, the taxpayer argued, between the 1993/1994 series of transactions and the 1995 redemption transaction.

During oral argument, considerable time was spent on the question of whether the extended meaning of “series of transactions” in subsection 248(10) of the Income Tax Act could be used to connect transactions where the first series was not undertaken specifically in order to facilitate the second transaction.  The taxpayer argued that the 1995 series could not have been undertaken “in contemplation of” the 1993/1994 series as the 1995 series was prompted by an intervening event (i.e., the proposed change to the FAPI rules).

Justice Rothstein held as follows:

[48] The Tax Court judge was aware both of the intervening introduction of the FAPI rule changes, as well as the time interval between the sale and amalgamation in 1993 and 1994 and the redemption in 1995 (para. 38).  Copthorne argued that these intervening events broke the purported series.  The Tax Court judge agreed that the test should not catch “transactions that are only remotely connected to the common law series” (para. 39).  Nonetheless, she found that there was a “strong nexus” between the series and the subsequent redemption, because “the Redemption   . . . was exactly the type of transaction necessary to make a tax benefit a reality based on the preservation of the PUC” (para. 40).  The Federal Court of Appeal upheld this conclusion, finding that there was no palpable and overriding error of fact. I would also uphold the Tax Court judge’s conclusion for the same reason.

At paragraph 56, Justice Rothstein concluded that, as stated by the Court in Canada Trustco, “the language of s. 248(10) allows either prospective or retrospective connection of a related transaction to a common law series and that such an interpretation accords with the Parliamentary purpose.”  He therefore agreed with the Tax Court and Federal Court of Appeal that “the redemption transaction was part of the same series as the prior sale and amalgamation, and that the series, including the redemption transaction, resulted in the tax benefit.” [paragraph 58]

Justice Rothstein’s observations here should be of considerable comfort to tax planners who will look to paragraph 47 in particular:

[47] Although the “because of” or “in relation to” test does not require a “strong nexus”, it does require more than a “mere possibility” or a connection with “an extreme degree of remoteness” (see MIL (Investments) S.A. v. R., 2006 TCC 460, [2006] 5 C.T.C. 2552, at para. 62, aff’d 2007 FCA 236, 2007 D.T.C. 5437).  Each case will be decided on its own facts.  For example, the length of time between the series and the related transaction may be a relevant consideration in some cases; as would intervening events taking place between the series and the completion of the related transaction.  In the end, it will be the “because of” or “in relation to” test that will determine, on a balance of probabilities, whether a related transaction was completed in contemplation of a series of transactions.

Tax planners now know that a transaction will not fall within a series of transactions unless it was undertaken “because of” or “in relation to” the series.  Such a test is far superior to the “mere possibility” standard.

On the “avoidance transaction” issue as a whole, Justice Rothstein concluded that:

[60] The Tax Court judge found that the 1993 sale of VHHC Holdings shares from Copthorne I to Big City was an avoidance transaction.  The Federal Court of Appeal agreed.

[61] The sale preserved the PUC of the VHHC Holdings shares when VHHC Holdings and Copthorne I were amalgamated to form Copthorne II, which allowed for the subsequent redemption of Copthorne III shares without liability for tax.  This is a tax purpose.

[62] Copthorne argues that the transactions were undertaken for the purposes of simplifying the Li Group companies and using the losses within the four amalgamated companies to shelter gains also within the four amalgamated companies.  While simplification and sheltering gains may apply to the other transactions, they do not explain the sale of VHHC Holdings shares to Big City.  As the Tax Court judge found, the share sale introduced an additional step into a process of simplification and consolidation.  A vertical amalgamation would have resulted in the same simplification and consolidation.  Moreover, Copthorne has not shown why sheltering gains using losses within the four companies would not have been possible if the companies were amalgamated vertically.

[63] I see no error in the finding of the Tax Court judge that the sale of the VHHC Holdings shares from Copthorne I to Big City was not primarily undertaken for a bona fide non-tax purpose.  The burden was upon Copthorne to prove the existence of a bona fide non-tax purpose (Trustco at para. 66), which it failed to do.  Thus, I would affirm her finding that the sale of the VHHC Holdings shares to Big City was an avoidance transaction.

[64] Because there was a series of transactions which resulted in a tax benefit, the finding that one transaction in the series was an avoidance transaction satisfies the requirements of s. 245(3).

Was the Avoidance Transaction Giving Rise to the Tax Benefit Abusive?

The Crown argued that the role of PUC in the Income Tax Act is to “benchmark” the total amount that may be repaid to shareholders tax free.  It argued that the taxpayer abused, among other provisions, subsection 87(3) of the Income Tax Act by undertaking a horizontal amalgamation as it did.  The purpose of that provision, the Crown argued, is to prescribe how a taxpayer is to compute PUC on all amalgamations – it instructs taxpayers that they may not amalgamate a parent and a subsidiary without eliminating the PUC of the subsidiary.  The Crown contended that this was, at the end of the day, an amalgamation of a parent and subsidiary to which subsection 87(3) was intended to apply.  The Crown argued that the “result” was a vertical amalgamation and that the GAAR is a “results-based” test.  The result was a vertical amalgamation “by another name” and that is how subsection 87(3) was abused.  The taxpayer “inserted” an avoidance transaction (the 1993 series) which resulted in a vertical amalgamation being done horizontally.  In the final analysis, a subsidiary (with $67 million of PUC) had been amalgamated with the parent (with $96 million of PUC).  As subsection 87(3) is intended to prevent the duplication of PUC, a transaction that avoids the effect of subsection 87(3), but which nevertheless achieves PUC duplication, is abusive and, therefore, properly subject to the GAAR.

Justice Rothstein reviewed the purpose of subsection 87(3) and held as follows:

[88] In any GAAR case the text of the provisions at issue will not literally preclude a tax benefit the taxpayer seeks by entering into the transaction or series.  This is not surprising.  If the tax benefit of the transaction or series was prohibited by the text, on reassessing the taxpayer, the Minister would only have to rely on the text and not resort to the GAAR.  However, this does not mean that the text is irrelevant. In a GAAR assessment the text is considered to see if it sheds light on what the provision was intended to do.

[89] The text of s. 87(3) ensures that in a horizontal amalgamation the PUC of the shares of the amalgamated corporation does not exceed the total of the PUC of the shares of the amalgamating corporations.  The question is why s. 87(3) is concerned with limiting PUC in this way.  Since PUC may be withdrawn from a corporation without inclusion in the income of the shareholder, it seems evident that the intent is that PUC be limited such that it is not inappropriately increased merely through the device of an amalgamation.

[90] Section 87(3) also provides, in its parenthetical clause, that the PUC of the shares of an amalgamating corporation held by another amalgamating corporation is cancelled.  In other words, in a vertical amalgamation, the PUC of inter-corporate shareholdings, such as exists in the case of a parent-subsidiary relationship, is not to be aggregated.  Again, having regard to the fact that PUC may be withdrawn from a corporation not as a dividend subject to tax but as a non-taxable return of capital, the indication is that the parenthetical clause is intended to limit PUC of the shares of the amalgamated corporation to the PUC of the shares of the amalgamating parent corporation.  While the creation of PUC in the shares of downstream corporations is valid, its preservation on amalgamation may be seen as a means of enabling the withdrawal of funds in excess of the capital invested as a return of capital rather than as a deemed dividend to the shareholder subject to tax.

In arguing why such a result was not abusive, the taxpayer had asked the Court to bear in mind the entire scheme of the Income Tax Act, including capital gains tax.  The taxpayer noted that a capital gain of some $150 million was realized under the Income Tax Act on the disposition of the taxpayer’s Canadian investment portfolio.  It was argued that the fact that there was no Canadian tax on that gain by virtue of the Canada-Netherlands Tax Convention was irrelevant – it was Canada’s decision not to tax such gains in the context of the Treaty.

Justice Rothstein responded to this argument as follows:

[100] Copthorne argues that the provisions of the Act relating to capital gains and PUC are part of a single integrated scheme that “provides a complete solution to this situation” and ensures that tax eventually is applied to shareholder returns, either as a deemed dividend or as a capital gain (A.F., at para. 69).

[101] On the basis of the arguments made, I have not been convinced to accept Copthorne’s position.  Capital gains or losses are calculated in relation to the adjusted cost base (“ACB”) of a share, not its PUC.  While PUC relates to shares, ACB relates to a specific taxpayer. PUC depends on the amount initially invested as capital, whereas the ACB reflects the amount the current shareholder paid for the shares.  In some cases the ACB and PUC may be the same, but in others they may not be.  In the case of shares acquired from a prior shareholder it will be unlikely that the ACB will be equal to the PUC.

[102] I would hesitate to conclude that the Act contains a “complete solution” whereby any withdrawal that would not be caught under the PUC-deemed dividend scheme would be caught instead by the capital gains scheme.  An amount returned to a shareholder on a share redemption may be considered a return of capital  rather than a deemed dividend under s. 84(3).  However, the return of capital may reflect either a capital gain or a capital loss, which would be determined in relation to the ACB of the shareholder.

[103] Further, the tax rates applicable to dividends and capital gains are not identical.  With respect to non-resident shareholders, tax treaties may exempt capital gains from tax but not dividends.  This suggests that the capital gains scheme is not an automatic proxy for the PUC-deemed dividend scheme, whereby a taxpayer will always be liable for the same tax under one tax scheme or the other on a redemption.  Copthorne did not cite any sources directly on point.  The capital gains issue was not addressed by either the Tax Court judge or the Federal Court of Appeal.  In the circumstances, Copthorne has not substantiated this argument sufficiently that it can be accepted in this case.

The taxpayer contended that no one would squander a valuable “corporate attribute” such as PUC by undertaking a vertical amalgamation in which the $67 million of PUC would have vanished.  There was no abuse here as Parliament specifically described in subsection 87(3) a set of circumstances in which PUC would be reduced (i.e., on a vertical amalgamation) but provided no reduction of PUC on a horizontal amalgamation.

On the overall “abuse” analysis, Justice Rothstein concluded as follows:

[124] Copthorne agrees that s. 87(3) would have led to a cancellation of the PUC of the VHHC Holdings shares if it had been vertically amalgamated with Copthorne I.  Instead of amalgamating the two companies, Copthorne I sold its VHHC Holdings shares to Big City, in order to avoid the vertical amalgamation and cancellation of the PUC of the shares of VHHC Holdings.  The transaction obviously circumvented application of the parenthetical words of s. 87(3) upon the later amalgamation of Copthorne I and VHHC Holdings.

[125] The question is whether this was done in a way that “frustrates or defeats the object, spirit or purpose” of the parenthetical words of s. 87(3) (Trustco, at para. 45).  In oral argument, Copthorne argued that by leaving VHHC Holdings and Copthorne in a vertical structure would be “throwing away” the PUC upon amalgamation.  It argued that the purpose of s. 87(3) cannot require shareholders to throw away valuable assets.  However, it must be remembered that there has been a finding of tax benefit (protecting the PUC of the shares of VHHC Holdings of $67,401,279 from withholding tax upon Copthorne III redeeming a large portion of its shares) and an avoidance transaction (the sale of VHHC Holdings from Copthorne I to Big City).  The GAAR analysis looks to determine whether the avoidance of a vertical amalgamation and preservation of the VHHC Holdings’ PUC of $67,401,279 circumvented s. 87(3), achieves an outcome s. 87(3) was intended to prevent or defeats the underlying rationale of s. 87(3).  If such a finding is made, the taxpayer is not “throwing away” a valuable asset.  It is the application of the GAAR that applies to deny the benefit of that “asset” to the taxpayer.

[126] It is true that the text of s. 87(3) recognizes two options, the horizontal and vertical forms of amalgamations.  It is also true that the text does not expressly preclude a taxpayer from selecting one or the other option.  However, I have concluded that the object, spirit and purpose of s. 87(3) is to preclude the preservation of PUC, upon amalgamation, where such preservation would allow a shareholder, on a redemption of shares by the amalgamated corporation, to be paid amounts without liability for tax in excess of the investment of tax-paid funds.

[127] I am of the opinion that the sale by Copthorne I of its VHHC Holdings shares to Big City, which was undertaken to protect $67,401,279 of PUC from cancellation, while not contrary to the text of s. 87(3), does frustrate and defeat its purpose.  The tax-paid investment here was in total $96,736,845.  To allow the aggregation of an additional $67,401,279 to this amount would enable payment, without liability for tax by the shareholders, of amounts well in excess of the investment of tax-paid funds, contrary to the object, spirit and purpose or the underlying rationale of s. 87(3).  While a series of transactions that results in the “double counting” of PUC is not in itself evidence of abuse, this outcome may not be foreclosed in some circumstances.  I agree with the Tax Court’s finding that the taxpayer’s “double counting” of PUC was abusive in this case, where the taxpayer structured the transactions so as to “artificially” preserve the PUC in a way that frustrated the purpose of s. 87(3) governing the treatment of PUC upon vertical amalgamation.  The sale of VHHC Holdings shares to Big City circumvented the parenthetical words of s. 87(3) and in the context of the series of which it was a part, achieved a result the section was intended to prevent and thus defeated its underlying rationale.  The transaction was therefore abusive and the assessment based on application of the GAAR was appropriate.

Although the decision is a defeat for a taxpayer on the facts of the case, the approach used by the Court (particularly the cautionary notes struck in paragraphs 121 and 123) along with the clarity and precision of the reasons written by Justice Rothstein (as adopted by the entire Court) should be generally reassuring to the business community.  Corporate Canada will still be able to engage in tax planning to advance business objectives if the transactions contemplated are adequately supported by non-tax purposes and if the results of those transactions do not circumvent any provisions of the Income Tax Act that are clearly aimed at precluding those results.

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Crown Wins GAAR Case in the Supreme Court of Canada: Copthorne Holdings Ltd. v. The Queen

Copthorne Decision to be Released by Supreme Court of Canada on Friday, December 16, 2011 at 9:45 a.m.

The Supreme Court of Canada announced today that its long-awaited General Anti-Avoidance Rule (GAAR) decision in Copthorne Holdings Limited v. The Queen will be released on Friday, December 16, 2011 at 9:45 a.m.

In preparation for Friday, it will be useful to re-read the decision of the Federal Court of Appeal dismissing Copthorne’s appeal as well as the decision of the Tax Court of Canada dismissing Copthorne’s appeal.

In addition, the written submissions of each party are available at the Supreme Court of Canada’s website and the archived webcast of the hearing may be viewed from the Court’s website as well.  The appeal was heard on January 21, 2011.

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Copthorne Decision to be Released by Supreme Court of Canada on Friday, December 16, 2011 at 9:45 a.m.

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?