Nortel was once an industry leader in optical networking technology. Now, it may be at the centre of one of the biggest financial scandals in Canada – possibly in the world. Frank Dunn took the reigns of Nortel in 2001 following a period in which its stock price plunged and profits dwindled. Essentially, the RCMP charge him with ‘cooking the books,’ so as to make the situation seem less dire and ultimately to assuage the fears of investors. Specifically, they allege that in 2003 and 2006 Nortel egregiously misstated its early earnings. Not only did it force Nortel to ultimately seek creditor protection, but it also cost Canadians billions of dollars.

In terms of the law, this case is remarkable because it underlines how the Canadian legal system really struggles to persecute commercial crime. The RCMP first laid charges against Dunn in 2009; it has taken four years for the case to reach court. One reason for the delay is the nightmarish evidentiary load. For example, in 2009, the RCMP delivered four million documents to the defense as part of its disclosure. Not only is this amount of documents difficult to handle by the courts, but it also makes it difficult for the prosecution to build a case and to come out on top. As a result of these evidentiary issues surrounding the investigation and prosecution of serious Criminal Code of Canada capital market fraud offences, the RCMP, in collaboration with other government parties (e.g. securities regulators), have formed the Integrated Market Enforcement Teams (IMET). IMET is essentially a handful of elite groups tasked to tackle cases of this nature. Since its inception, ten operational IMETs in Canada have charged 42 individuals, of which 10 were ultimately convicted. They have all been on the smaller scale, such as Norbourg Financial Group, a former mutual fund. Nortel is without a doubt IMET’s biggest case.

In our post-Enron and WorldCom world, these low numbers are surprising. Enron and WorldCom were back-to-back scandals in the early 2000s that led to the largest corporate bankruptcy in US history (WorldCom). Further, its highest-ranked employees were swiftly charged, tried, convicted and sentenced to lengthy prison terms. The equivalent of IMET in the US is the United States’ Corporate Fraud Task Force, which was established in 2002. (This group was replaced by another group that carries on the same operations in 2009.) In the last ten years or so, it has convicted nearly 1,300 corporate fraudsters, including 200 CEOs. The legal structure set up in the US to investigate corporate fraud is not without criticism; it has been criticized for its slow, or lack of, response to the meltdown of the financial markets in 2007. Regardless, one could argue that the US has a much more robust system for punishing commercial crimes than Canada. The question of how Canada would have responded to a Enron-esque scandal was posed to Craig Hannaford, who led a former IMET operation, by Canadian Business magazine: “If we had a similar corporate scandal in Canada, would the RCMP have the capability to investigate effectively?” wondered Hannaford out loud. His answer was simple: no.

Hannaford is not alone in his view of the Canadian system. Al Rosen, a respected forensic accountant, offered a grim prediction: “I suspect it’s going to get screwed up.” There are a number of factors at play. First, the sheer size of the files would overwhelm the operation. There are some 23 million pages of evidence involved in this case. Critics have also pointed to the internal structure of the IMET. It takes years and years of training to meet the demands of the job. Because promotion is often slower and the salaries are lower than those in the private sector, IMET suffers from a low retention rate. There are also complaints that the IMET has poor leadership. What is most interesting, however, is public perception of corporate crime. One of the IMET’s earlier cases was Royal Group. The judge who heard the case agreed that the executives were to blame. However, Judge Blouin added a further statement: “To view events in [Royal Group’s] life in 1996, for example, through a corporate governance lens 10 years later, distorts the historical record.” Indeed, much has changed between 1996 and 2006 – Enron, WorldCom and the passage of the Sarbanes-Oxley Act in the United States. The growing cynicism toward corporate leadership does not seem like a compelling enough reason to exonerate these fraudsters, though.

Canada has yet to bear witness to a debacle on same scale as Enron or WorldCom. (And one hopes we never do!) This case also comes many years after Nortel’s heyday. Nortel may no longer be part of our national psyche in 2012. Yet Justice Frank Marrocco of the Ontario Superior Court of Justice, who will start hearing the case today, should aim to set the right tone and ultimately send the right message. This may not entail severe punishment for these three executives involved. (The maximum sentence for fraud affecting markets is 14 years imprisonment while falsifying accounts and filing a false prospectus carries a max sentence of 5 and 10 years, respectively). Rather, it may force our lawmakers to confront this problem and propose a solution. Canada could follow the path blazed by the US: the Sarbanes-Oxley Act of 2002 set new and enhanced standards for publicly traded companies and accounting firms in the wake of Enron’s collapse. As we witnessed with fall of the financial sector in 2007, commercial crime remains a pervasive problem. The case with Nortel provides ample opportunity to address the issue in a meaningful way.

What is clear in the caselaw is that the Duke of Westminster principle still holds in Canadian tax law (see: Canada Trustco Mortgage Company v. Her Majesty the Queen, 2005 SCC 54). What is unclear, however, is how, when, and to what degree the GAAR attenuates this principle. Recently, the Supreme Court of Canada (SCC) explored this tension in Copthorne Holdings Ltd. v. Canada, 2011 SCC 63, refining the interpretive approach to GAAR but at the same time affirming the inescapable truth that “it is relatively straightforward to set out the GAAR scheme. It is much more difficult to apply it.”

The case involved a group of Canadian and non-resident companies controlled by Li Ka-Shing and his son, Victor Li. Through a series of transactions, two Canadian corporations within this group that had previously been parent and subsidiary became “sister” corporations, or corporations owned directly by the same non-resident shareholder. The nature of the amalgamation becomes relevant because of the tax treatment of paid-up capital (PUC), the capital invested in a class of shares of a corporation by its shareholders. When that class of shares is redeemed by the corporation, the amount paid to shareholders includes an amount which is simply the return of capital (i.e. after-tax dollars invested in a corporation). This amount is not included in income as it has already been taxed. If the amount paid to shareholders exceeds the PUC (i.e. the amount invested), the excess amount is included in income as a dividend. It is in the interest of taxpayers, therefore, to structure their affairs so as to maximize the proportion of the payment which is attributable to PUC and thereby minimize the amount that is deemed to be a taxable dividend. This is exactly what Li Ka-Shing tried to do.

When corporations amalgamate, the general rule is that the PUC of the shares of both amalgamating corporations are aggregated to form the PUC of the new corporation. This does not apply, however, to an amalgamation involving a parent and subsidiary company (i.e. a vertical amalgamation). Upon amalgamation, the PUC of the shares of the subsidiary corporation owned by the parent company are cancelled to prevent the artificial inflation of PUC for tax purposes. Had the two Li companies remained as parent and subsidiary, the PUC of the shares of the subsidiary would have been cancelled on amalgamation. Since the two corporations had become sister corporations, the PUC was not cancelled and the amalgamated corporation proceeded to redeem a large portion of its shares to the non-resident shareholder.

The payment was treated by the taxpayer as a return of capital and thus not taxable income. Despite the fact that there is no specific provision in the Act requiring inclusion of the payment in income, the Minister of National Revenue deemed the transactions abusive within the meaning of GAAR and concluded that a deemed dividend arose on the redemption of the shares amounting to $58,325,223. The re-assessment was upheld by the Tax Court and the Federal Court of Appeal.

At the SCC, Rothstein J. affirmed the analytic framework for applying the GAAR set out in Canada Trustco Mortgage. Courts must ask three questions: (1) was there a tax benefit? (2) was the transaction giving rise to the tax benefit an avoidance transaction? (3) was the avoidance transactions giving rise to the tax benefit abusive? What is unusual about the GAAR is that while a taxpayer’s transactions will be in compliance with the text of the relevant provisions of the Act, they may contravene their object, spirit, or purpose. Thus, unlike traditional statutory interpretation which draws on the spirit of legislative provisions in order to make clear the meaning of the text, the GAAR interpretive approach requires courts to enforce not only the text of the Act but also the underlying rationale as it may extend beyond the text.

In other words, the GAAR, by definition, constitutes a legislative override of a canon of statutory interpretation often invoked by courts in deciding tax cases: if the legislature had intended to include something in a statutory provision, it would have done so and it is not for courts to judicially supplement the legislative process. In the context of GAAR, the starting premise of judicial analysis is that the rationale of a provision will not always be exhausted by the precise words of a statute.

In applying the three-part test outlined above, the SCC found that the transactions resulted in a tax benefit. While Rothstein J. accepted that the transactions were necessary to achieve a number of beneficial outcomes sought (e.g. simplification of the corporate structure and the ability to shelter anticipated gains with losses within the amalgamating corporations), the decision to opt for a horizontal instead of a vertical amalgamation produced a discernable benefit to the taxpayer.

Second, the SCC found that the transaction giving rise to the tax benefit was an avoidance transaction since it was part of the same series of transactions as the prior amalgamation and a vertical amalgamation would have resulted in the same non-tax benefits as the horizontal amalgamation undertaken by the taxpayers.

Finally, the transaction giving rise to the tax benefit was abusive. Generally, the SCC held that the case for abusive tax avoidance will be made out where: (1) the transaction achieves an outcome the statutory provision was intended to prevent; (2) the transaction defeats the underlying rationale of the provision; or (3) the transaction circumvents the provision in a manner that frustrates or defeats its object, spirit, or purpose. Rothstein J. found that the purpose of the provision was to preclude corporations from preserving PUC of the shares of a subsidiary corporation on amalgamation with the parent corporation as that PUC reflects the investment of the same tax-paid dollars in the subsidiary as in the parent corporation. Copthorne’s transactions, therefore, contravened this purpose.

Implications: Certainty, Flexibility, and the “Damoclesian Menace of the GAAR”?

A corollary of vesting courts with the power to enforce not only the statutory text of the Act but also its underlying rationale is a requirement that courts look deeper into corporate transactions and assess their economic realities. Traditionally, the common law approach of the courts has been to accept the legal characterization of transactions despite their economic realities if there is no “sham” or “window dressing.” Thus, what is most significant about GAAR is not so much the requirement that courts elucidate the spirit, object, or purpose of statutory provisions and give them concrete weight, but the corresponding obligation on courts to depart from their usual hesitancy to inquire into the economic realities of transactions. Through the GAAR, the legislature recalibrates the traditional judicial balance struck between individual liberty and equity.

The outcome of the decision is consistent with several underlying principles of the tax regime, particularly the need to tax people on their ability to pay and the use of the tax system to achieve horizontal and vertical equity. One of Copthorne’s arguments was that the current approach to the GAAR, in affording a great deal of leeway and flexibility for reassessments in light of the rationale of provisions, undermines another important goal of the tax system: certainty and predictability. Copthorne argued that upholding the Tax Court’s decision amounts to subjecting taxpayers to the “Damoclesian menace of the GAAR.”

The SCC was satisfied that there are adequate safeguards embedded in the analytic framework set out for GAAR to manage effectively the inevitably greater uncertainty. The Court pointed out that GAAR should only be turned to as a last resort and that in order for it to be triggered, there must be an avoidance transaction resulting in a tax benefit. It also highlighted the fact that if a transaction had a secondary tax benefit purpose, it would not engage the GAAR. Furthermore, the imposition of the burden on the Minister “who wishes to overcome the countervailing obligations of consistency and predictability to demonstrate clearly the abuse he alleges” protects taxpayers from the ‘menace’ of the GAAR.

Despite these safeguards, however, in the end the inescapable truth remains: it is relatively straightforward to set out the GAAR scheme. It is much more difficult to apply it.

On July 12, 2011, Molson-Coors Canada (Molson) won the right to spend $375 million over the next seven years on NHL sponsorship across North America. The Ontario Court of Appeal dismissed the claims of the NHL’s former sponsor, Labatt Brewing Company (Labatt). Essentially, the justices on the highest court of Ontario set aside the decision by Justice Newbould at the trial level based on the legal principle that judges should not independently determine a case based on theories that were not advanced in the proceedings. That would be contrary to the adversarial process, and patently unfair.

Facts

In Labatt Brewing Company Limited et al vs. NHL Enterprises Canada, L.P. et al, Labatt brought an application to the Ontario Superior Court of Justice against the NHL, Molson-Coors Canada, and related companies regarding beer sponsorship rights. Labatt’s sponsorship deal with the NHL terminated as of June 30, 2011. Subsequently, the NHL and Labatt entered into an exclusive negotiation period; Labatt sought to renew their deal for three years. At around the time that Labatt and NHL were drafting the final documents, Molson entered into the picture. After successful negotiations between Molson and the NHL, they signed a seven-year contract during which Molson would have exclusive sponsorship rights in the North American market.

An Exclusive Negotiation Period?

In the first proceeding, Labatt argued that the NHL had extended the exclusive negotiation period indefinitely. Albeit unsigned, an agreement on the terms of the renewal had been reached. The NHL denied that the exclusive negotiation period was indefinite. Further, the renewability provision was unenforceable, they argued. It was merely an agreement to agree.

Justice Newbould of the Ontario Superior Court of Justice took the position of Labatt. He found that the NHL did in fact extend the exclusive negotiation period indefinitely and that the parties arrived at a binding and exclusive agreement. That would have precluded the NHL from entering into any further talks with Molson.

Not Advanced by Counsel

The Ontario Court of Appeal overturned the decision by Justice Newbould for the reason that his decision was based on a theory and legal principle that had not been advanced by counsel. Specifically, the way in which Justice Newbould interpreted the renewal provision, from which he drew his final conclusion, was not grounded in the pleadings, evidence, positions or submissions of either of the parties. Justice Newbould himself interpreted the renewal provision in such a way that a binding sponsorship agreement had been reached.

First, the Ontario Court of Appeals found that Labatt did not plead that the parties had reached a binding sponsorship agreement. Labatt did not make this claim at any point during the hearing either.  Furthermore, the application judge never raised the issue of whether a sponsorship agreement had been reached with the NHL or Molson during the parties’ oral submissions. In summary, the appeal ruling stated: “[A]t no time during the application hearing did Labatt assert that a binding sponsorship agreement existed between the parties” and “the application judge did not raise this issue with the NHL or Molson during their submissions.”

If the defendants were aware of the fact that the issue for determination was the binding sponsorship agreement, then they would have conducted its defense in a different manner. As a result of these findings, the Ontario Court of Appeal struck down the lower court’s decision.

Prejudicial and Inherently Unreliable

At the end of the day, this case was decided on procedural fairness. It is a well known that judges cannot impose legal liability where legal liability was not advanced by a claimant. In paragraphs 61 to 63 of the 2002 case of Rodario v. Royal Bank of Canada, Justice Doherty held that it was fundamentally unfair and inherently unreliable for a trial judge to make findings against a defendant on the basis of a theory of legal liability not advanced by the claimant.

The judicial system in Canada pivots around the adversarial process, whereby truth can only be attained after contestation and competition between two opposing parties. If the parties are denied the chance to examine and cross-examine a legal principle or theory, then the court would not have confidence in that legal principle or theory. So, if the theory of liability first appears in the reasons for judgment, and is not tested by the adversarial process, then it must be dismissed.

Conclusion

For most Canadians, the ruling in July is important insofar as Molson beer advertisements will flood our television and computer screens — from Tampa Bay Lightening games to Twitter feeds. For parties entering into negotiations, however, this case may carry even more weight. Parties need to more cognizant of where they are in the negotiations and understand the status of their discussions at all times.

Flowing from a spate of privacy cases at SCOTUS (most notably, Snyder v. Phelps covered by fellow Contributing Editor, Alysia Lau here and our Amici Curiae here and NASA v. Nelson that I covered here and here) as well as contributing to a general trend of ruling for “no constitutional right to privacy,” FCC v. AT&T Inc. (2011) No. 90-1279, 582 F. 3d 490 decided on March 1, 2011 continued a line of rulings that corporations as separate legal persons are not entitled to the personal right to privacy.

The telecommunications company, AT&T, was under investigation by the Federal Communications Commission (FCC). This independent agency of the U.S government had, in the words of the Third Circuit decision (pdf link) “ordered the production of invoices, internal emails and billing information, responses to interrogatories, names of employees involved in alleged overbilling, and AT&T’s assessment of the extent to which its employees’ actions violated its internal code of conduct.”

SCOTUS held that corporations do not have a right of personal privacy for purposes of Exemption 7(C) of the Freedom of Information Act that requires corporations to disclose law enforcement records to a federal agency unless disclosure “could reasonably be expected to constitute an unwarranted invasion of personal privacy.”

AT&T’s argument against disclosing its “embarrassing” record of overcharging the U.S government for its E-Rate services was that these records fell under the exemption mentioned above due to the corporation’s alleged right to personal privacy for its internal information.

A Lesson in Using the Dictionary

In a unanimous 8-0 decision, Roberts wrote what has been identified by the media as a “teacher-like” “grammar lesson” in corporate privacy rights:

Adjectives typically reflect the meaning of corresponding nouns, but not always. Sometimes they acquire distinct meanings of their own. The noun “crab” refers variously to a crustacean and a type of apple, while the related adjective “crabbed” can refer to handwriting that is “difficult to read”… “corny” can mean “using familiar and stereotyped formulas believed to appeal to the unsophisticated,” which has little to do with “corn” (“the seeds of any of the cereal grasses used for food”); and while “crank” is “a part of anaxis bent at right angles,” “cranky” can mean “given to fretful fussiness…

All of this to explain that:

“Person” is a defined term in the statute; “personal” is not. When a statute does not define a term, we typically “give the phrase its ordinary meaning”…“Personal” ordinarily refers to individuals. We do not usually speak of personal characteristics, personal effects, personal correspondence, personal influence, or personal tragedy as referring to corporations or other artificial entities. This is not to say that corporations do not have correspondence, influence, or tragedies of their own, only that we do not use the word “personal” to describe them.

The decision turned on a strict interpretation of the language of the statute and utilized several dictionary definitions to show that “ordinary usage of a noun and its adjective form may have different meanings as disparate as any two unrelated words.” SCOTUS ruled on this reasoning that artificial entities are not “personal” despite being separate legal “persons” and are therefore not subject to the statutory exemption for the disclosure of “personal” information.

Bring-On the Adjective-laden Legal Reasoning

I often enjoy reading decisions by SCOTUS and rarely hesitate to applaud colourful commentary and generous use of non-legalese descriptions and catchy phrases to lay down the law (particularly by Justice Scalia) — a method rarely used by Canadian Supreme Court justices, except Justice Binnie’s clever dissent in R. v. Sinclair.

This U.S. judgement is certainly one of these brisk, informative reads as it decided the case in 15-pages, a rather dry subject matter of corporate “personhood” by making it more approachably human (excuse the pun). Why else did the judge choose to compare a random choice of words such as “corn” vs. “corny,” “crab” vs. “crabbed,” and “crank” vs. “cranky” in a case about corporate personality, except for reasons of style and plain language emphasis that spells it out for the layperson without cloaking the answer in convoluted legalese. (This style is particularly intriguing for someone like myself with an interest in journalism, as it provides my legal coverage with plenty of quotable material). The bottom-line message in this case is clear: “personal privacy” is not a statutory right, not for corporations, but for living, breathing human beings.

On December 21, 2010, the Supreme Court of the State of New York, County of New York, filed a 32 page civil complaint against Ernst & Young LLP (pdf link)(“E&Y”) for its role in the demise of Lehman Brothers Holdings (“Lehman”) (“NY v. E&Y”). The complaint followed the demise of Lehman on September 15, 2008 after it filed for protection under Chapter 11 of the U.S. Bankruptcy Code with a record-setting $US613 billion in total debt.

According to the complaint, Lehman’s auditor, E&Y, helped “facilitate fraud” within Lehman. The allegations centre on the use of so-called “Repo 105 transactions” that are said to have begun early in the 2000’s. These transactions were in essence the bank parking “tens of billions of dollars of highly liquid fixed income securities” in European banks in order to reduce their balance sheet leverage. The allegations suggest these transactions had “no independent business purpose,” and that they painted a false picture of an important financial metric for investors, stock analysts, lenders, and others involved with Lehman.

Andrew Cuomo, then the Attorney General of the State of New York, handed down an incisively worded complaint. It opened with harsh allegations that:

E&Y substantially assisted Lehman Brothers Holdings Inc….now bankrupt,to engage in a massive accounting fraud, involving the surreptitious removal of tens of billions of dollars of securities from Lehman’s balance sheet in order to create a false impression of Lehman’s liquidity, thereby defrauding the investing public.

The complaint went on to allege that E&Y “failed to meet” Generally Acceptable Auditing Standards (GAAS) by playing a key role in artificially inflating its client’s year-end balance sheet:

E&Y permitted Lehman to engage in an accounting fraud, while reaping over $150 million in fees. E&Y, as a purported independent auditor, was obligated instead to ensure that Lehman’s financial statements disclosed the Repo 105 transactions. The financial statements said not a word about Repo 105, falsely represented that Lehman was treating all repo transactions as financings, and E&Y accordingly must be held accountable for the consequences of this fraud.

If successful, subsequent litigation could result in E&Y losing its accounting license (among other sanctions) that, in turn, could reduce the major international “Big Four” accounting firms to a mere three. Judicial attention has already seen demise of another large accounting firm, Arthur Anderson LLP, when it voluntarily surrendered its license after being criminally convicted for destroying documents relating to the Enron fraud investigation in 2002.

What about Canada?

In R. v. Drabinsky (2009) CanLII 12802 (ON S.C.), Garth Drabinsky, former CEO and his business partner, Myron Gottlieb, of Livent Inc., a live theatre company based in Toronto, were found guilty last year by the Ontario Superior Court of Justice of the fraud and forgery in financial statements presented to their investors.

Over a decade ago, one of the other then “Big Five” accounting firms, KPMG, responsible for auditing Livent’s financial statements, lost a civil lawsuit launched by Drabinsky for a conflict of interest by alerting to “financial irregularities” in due diligence reports on behalf of Michael Ovitz, a prominent Hollywood talent agent, who was buying control in the company. Only after the deal that resulted in new management was suspicion raised about Livent’s deliberate act of “cooking the books;” however, neither KPMG nor Deloitte & Touche, another one of Livent’s auditing firms effectively silenced by their clients, was prosecuted as a part of a white collar crime that convicted Drabinsky and Gottlieb for fraud and forgery.

As for the convicted parties in R. v. Drabinsky, they were released in Ontario upon serving notice of appeal with an extension granted to file necessary court papers. Their appeal to the ONCA is speculated to be heard this year with some predicting that it will be appealed up to the SCC if the Court does not reduce their respective six and seven year sentences.

Meanwhile, NY v. E&Y has shown that U.S. authorities have taken a hard-lined stance on accounting fraud compared to its Canadian counterparts. While accounting firms may argue that their services can only audit financial statements with information given to them by their clients, some journalists and critics have argued that, in comparison, Canada’s more lenient approach has made this country a “safe haven” for white-collar crime. The ultimate result of these two cases may change the role of auditors in addressing accounting fraud during the GFC in Canada and the United States in the future. It may also affect whether enforcement for the sake of investor protection ought to spell the demise of large accounting firms.

As noted by S. Dhawan in  “What is next for antitrust class actions suits after DRAM?”, class actions in Canada have infrequently proceeded to a contested certification motion since they often fail to meet the requirements of the Competition Act (R.S.C., 1985, c. C-34). The particularly onerous requirement for would-be class action parties is the stipulation to put forward expert evidence to prove there is a workable methodology for establishing harm or loss on a class-wide basis. Without this, our courts have ruled that it would be too difficult to discern the appropriate loss and therefore could not definitely rule on the extent of liability (see, for instance, Chadha v. Bayer Inc.).

In this case, the court found several issues with sufficient common elements beyond the damages claims to provide the basis for certification. Importantly, it also ruled that damages could be determined on an aggregate basis at trial rather than before the certification motion has been granted. This ruling will help ease the certification standard, which in turn should increase the availability of class action suits.

Background – We All Want a Well-Priced Submarine

This case was an appeal from an order conditionally certifying an action commenced by two former Quizno’s franchisees, in Oakville and Windsor, Ontario, as a class proceeding.

The former franchiesees seek to represent all Quizno’s franchises in their claim that Quizno’s corporate headquarters charged them exorbitant food and supply prices through an affiliated company (Gordon Food Services). They allege that this overcharging constituted price maintenance, contrary to s. 61 of the Competition Act, R.S.C. 1985, c. 19 (2nd Supp.), a breach of contract, and a breach of the statutory duty of fair dealing. They also alleged that the defendants were liable for the tort of conspiracy. Pursuant to these allegations, the plaintiffs brought a motion to certify the action as a class proceeding.

The defendants responded by denying all wrongdoing, and alleging that the plaintiffs did not meet four out of the five requirements for certification of a class proceeding.

The motions judge who first heard the plaintiff’s certification motion concluded that the plaintiffs had not established a methodology for calculating what the prices for the franchisees would have been if there had been no conspiracy or price maintenance.

The only issue on appeal was whether or not the plaintiffs met the following criterion for certification for a class action, per Ontario’s Class Proceedings Act 1992, S.O. 1992, c. 6 s. 5(1):

(a) the pleadings or the notice of application discloses a cause of action;

(b) there is an identifiable class of two or more persons that would be represented by the representative plaintiff or defendant;

(c) the claims or defences of the class members raise common issues;

(d) a class proceeding would be the preferable procedure for the resolution of the common issues; and

(e) there is a representative plaintiff or defendant who,

(i) would fairly and adequately represent the interests of the class,

(ii) has produced a plan for the proceeding that sets out a workable method of advancing the proceeding on behalf of the class and of notifying class members of the proceeding, and

(iii) does not have, on the common issues for the class, an interest in conflict with the interests of other class members. 1992, c. 6, s. 5 (1). [Bolded issues are the most usually contentious ones].

In certifying the action as a class proceeding, the Divisional Court judge reversed the motions judge by finding the statement of claim disclosed causes of action for breaches of competition and contract law, as well as the tort of civil conspiracy. He found the two representative plaintiffs satisfactory, and ruled that there was a discernible class. The main issue was whether or not damages were a common issue amongst class members. The motions judge found that the refusal to certify the damages portion of the franchisees’ claim meant that all other aspects of the claim had to fail on the basis that common issues were not identified. The Divisional Court found that that fact that damages could not be ascribed to individual franchisees was not fatal to the class certification.

The Court of Appeal judge agreed with the Divisional Court’s decision, affirming the certification of the class action. They found that although a civil claim for damages under the Competition Act requires proof of harm or damage, proving the existence of price maintenance under s. 61 does not require evidence of damage, and can be determined on a class-wide basis.

A Warning to the Sandwich Cartel – The Importance of this Decision

The importance of this decision rests with the idea that the allegation of a competition, contract and tort breach are considered common issues that can proceed through certification without a damages assessment.

The implications of this are far-reaching. First, the Court of Appeal seems to have embraced a lower threshold for class action certification, especially with respect to claims that require proof of harm as an integral part of liability. Now, class action suits involving indirect or direct purchasers in Ontario are more likely to pass the certification stage and get to argue their cases on the merits. This could well lead to a significant increase in the quantity of Canadian class action suits brought and that proceed through to the lengthy and expensive trial process. Some may well see this as a clogging up of our courts, or a decision that helps pave the way for a more litigious Canada. On the other hand, this decision will improve access to justice for plaintiffs and reduce multiplicity of proceedings issues.

Secondly, it looks like this decision will have less-than-obvious implications for franchisors in Ontario. As the June 24 2010 Osler Update speculates, this decision implies that courts hearing franchise class actions are willing, when appropriate, to certify as a common issue whether there has been a breach by the franchisor of a specific provision of a franchise agreement. The Court of Appeal noted that a dispute between a franchisor and their franchisees is exactly the type of case for a class proceeding.

If, in a few years, you notice you’re getting more bang for your buck at Quizno’s, thanks should be directed to the Ontario Court of Appeal for allowing more class proceedings to be certified for trial. This could do wonders to avoid price-gouging franchisors and could pave the way for more class action certifications.

In this latest case, Heron Bay Investments Ltd. v. Her Majesty the Queen, 2010 FCA 203, the Federal Court of Appeal (reasons for judgment by Sharlow J.A.) ruled that the actions of Hogan J. in Heron Bay Investments Ltd. v. The Queen, 2009 TCC 337 gave rise to a reasonable apprehension of bias and breached “the rules of procedural fairness.” The case was sent back to the Tax Court for retrial by another judge.

Background and Facts

The Heron Bay Corporation is a member of the Conservancy Group of corporations, which includes Rosehue Downs Developments Inc., Burlmarie Developments Inc., Shellfran Investments Ltd., Marlo Developments Inc., and Viewmark Homes Ltd. The Rosehue and Burlmarie corporations entered into an agreement to purchase property from Runnymede Development Corporation Ltd., an arm’s length corporation. Marlo, along with Shelfran and Viewmark, entered into an agreement to purchase the property from Rosehue and Burlmarie. Viewmark borrowed from Heron Bay for the purchase.

For the 1995 tax year, Heron Bay deducted the amount of the loan to Viewmark. According to Heron Bay, the loan was doubtful because the value of the property interest bought by Viewmark was less than the purchase price, thus there was a reasonable doubt that it would be repaid.

For tax purposes, a doubtful loan is one that stands the chance of not being reimbursed in full. The deducted amount must be included as income in the following year. But, if  the loan is still doubtful at the end of the year a new deduction is allowed. This can be repeated until the debt is recovered or is no longer doubtful. At that point the deduction is included as income. (If the loan becomes bad or uncollectible it can be deducted per s. 20(1)(p)(ii) of the ITA).

Pursuant to s. 20(1)(l)(ii) of the ITA, the amount of a doubtful loan can only be deducted from income if certain conditions are realized. The criteria in the present case were as follows:

(1) in the year in which the deduction is claimed, the taxpayer’s ordinary business must include the lending of money;

(2) the loan in respect of which the deduction is claimed must be made in the ordinary course of the taxpayer’s money lending business; and

(3) the loan must be doubtful at the end of the year in which the deduction is claimed, meaning that there must be a reasonable doubt that it would be collected.

The Tax Court of Canada ruled that the first criterion under s. 20(1)(l)(ii) was met; the year in which the deduction was claimed the taxpayer’s ordinary course of business included the lending of money. However, criterion two and three were not fulfilled—the loan was not “made in the ordinary course of the taxpayer’s money lending business” and there was not a reasonable doubt that at the end of the relevant taxation year the loan would be repaid. Hence, the deduction was disallowed.

The Federal Court of Appeal

Before the Federal Court of Appeal, Heron Bay argued that Hogan J. of the Tax Court was “wrong in law” by finding that criterion 2 and 3 were not met. Also, Heron Bay maintained:

the judge deprived Heron Bay of procedural fairness by considering authorities not cited by either party without giving the parties an opportunity to make submissions on those authorities, considering issues not pleaded by either party without giving the parties an opportunity to make submissions on those issues, and intervening excessively in the examination of witnesses, giving rise to a reasonable apprehension of bias.

At trial, Hogan J. referenced authorities not referred to by Heron Bay or the Minister. For example, Canada Trustco Mortgage Co. v. Canada, [2005] 2 S.C.R. 601 was not cited in the reasons of Hogan J., but referred to in his deliberations. As well, Hogan J. considered journal articles and additional secondary sources not cited or referred to by Heron Bay or the Minister. Nevertheless, according to the Court of Appeal, this alone did not indicate a breach of procedural fairness:

The judge cannot be precluded from referring in his deliberations to cases that are not cited by a party and are not referred to in his reasons…Nor can the judge, when addressing a legal issue raised by a party, be precluded from referring to a case he considers relevant to that issue merely because the case was not cited by a party… As to the judge’s reliance on articles by learned authors, it seems to me that he has simply adopted from those articles excerpts (including case references) stating principles that the authors have derived from jurisprudence relevant to the issues raised in the appeal…

According to the Court of Appeal, a “breach of procedural fairness” might have occurred if Hogan. J had relied on the impugned authorities to introduce “a principle of law that was not raised by either party expressly or by necessary implication, or had taken the case on a substantially new and different analytical path.”

It was Hogan J.’s application of s. 69 of the ITA, without allowing Heron Bay to make relevant submissions, that the Court of Appeal ruled a breach of procedural fairness. Section 69(1)(a) states that the acquisition of anything from someone at non-arm’s length, at greater than the fair market value, is deemed for tax purposes to have been acquired at fair market value. The Federal Court of Appeal ruled that even though this reference to s. 69 was a breach of procedural fairness, it was obiter and did “not justify a retrial.”

In the end, a retrial was ordered due to concerns regarding the Tax Court judge’s excessive intervention in examinations and cross-examinations. Excessive intervention by a judge can warrant a new trial (see James v. Canada (2000), [2001] 1 C.T.C. 227 (F.C.A.); R. v. Brouillard, [1985] 1 S.C.R. 39).

According to the Court of Appeal, the Tax Court judge “seemed to fall into the habit of taking over the questioning.” Moreover, Hogan J., during the examination of one witness, “adopted a position in opposition to Heron Bay on a critical issue in the case, giving rise to a reasonable apprehension that the judge was not a fair and impartial arbiter.”

In the case of GlaxoSmithKline Inc. v. The Queen, 2008 TCC 324 [Glaxo I], the “reasonable in the circumstances” standard was applied to payments for a pharmaceutical product purchased by Glaxo Canada (“Glaxo”) from a non-arm’s length non-resident person, Adechsa SA (“Adechsa”), both members of the Glaxo Group of companies (“Glaxo Group”). The Minister and Tax Court of Canada agreed that the reasonable amount was the fair-market value of the pharmaceutical product.

However, according to the Federal Court of Appeal decision in Glaxosmithkline Inc. v. Canada, 2010 FCA 201 [Glaxo II], (reasons for judgement by Nadon J.A.) the failure of the Tax Court of Canada to “consider all relevant circumstances which an arm’s length purchaser would have had to consider…”, including a related licensing and purchasing agreement, was a legal error. Essentially, determining the price that is “reasonable in the circumstances” is a contextual process and not merely an exercise in determining the fair market value.

Legal Framework

Section 69(2) of the ITA states:

69. (2) Where a taxpayer has paid or agreed to pay to a non-resident person with whom the taxpayer was not dealing at arm’s length as price, rental, royalty or other payment for or for the use or reproduction of any property, or as consideration for the carriage of goods or passengers or for other services, an amount greater than the amount (in this subsection referred to as “the reasonable amount”) that would have been reasonable in the circumstances if the non-resident person and the taxpayer had been dealing at arm’s length, the reasonable amount shall, for the purpose of computing the taxpayer’s income under this Part, be deemed to have been the amount that was paid or is payable therefor.

Pursuant to this section, a payment to a non-arm’s length non-resident person has to be an amount not greater than what would be “reasonable in the circumstances” if the payment was made to an arm’s length person.

Background and Facts

For the four years at issue (1990-1993), Glaxo purchased the pharmaceutical ingredient ranitidine, which is marketed as Zantac, from Adechsa SA (“Adechsa”), a related non-resident company, for the price of between $1512 and $1651 per kilogram. In the same period, two generic Canadian pharmaceutical companies purchased the same product for much less—between $194 and $304 per kilogram.

The Minister reassessed Glaxo for the years 1990-1993 for overpaying for the drug randitine and as a result its income was increased to account for the difference between the price paid and what the Minister considered to be the amount “reasonable in the circumstances.”

In Glaxo I, Rip A.C.J. (now C.J.) of the TCC deemed the reasonable amount to be the fair market value of ranitidine, as substantiated by the prices paid by the generic companies. The excess amounts paid to Adechsa were deemed to be benefits, and pursuant to s. 56(2) of the ITA, subject to non-resident withholding tax.

When Determining the “Reasonable Amount” Under s. 69(2) Business Circumstances Must be Taken Into Account

The main issue in the present case was what considerations were to be taken in order to determine what was a “reasonable amount” pursuant to s. 69(2) of the ITA. According to the Court of Appeal, for s. 69(2) to take effect the following criteria must be met:

1. There must be a taxpayer (as defined in subsection 248(1);

2. who paid or agreed to pay;

3. to a non-resident;

4. with whom the taxpayer was not dealing at arm’s length;

5. an amount and as a price, rental, royalty or other payment for or for the use or reproduction of any property, or as consideration for the carriage of goods or passengers or for other services;

6. the amount must be “greater than the amount that would have been reasonable in the circumstances if the non-resident person and the taxpayer had been dealing at arm’s length”.

The Federal Court of Appeal was primarily concerned with criterion 6. Glaxo contended that the business circumstances surrounding the transactions should have been taken into account when determining the price that would have been “reasonable in the circumstances.” The company argued that s. 69(2) should not apply if it could be determined that any reasonable business person, in the same situation, yet dealing at arm’s length, would have paid the amount.

To buttress this argument, the company contended that related license and supply agreements, which in part required that Glaxo purchase the product from Adechsa, should be taken into consideration; to do otherwise would be “ignoring a crucial business circumstance.” In part, the agreements provided the Glaxo subsidiary with select intellectual property rights, including the use of the ranitidine patent and associated trademark, along with “other patented and trademarked products.”

Conclusion

In Glaxo I, the Tax Court rejected the impact of the agreements. In Glaxo II, the supply and license agreements were together held to potentially validate the price difference at issue. According to the Federal Court of Appeal, the Tax Court of Canada erred by misunderstanding the test for s. 69(2). Real world conditions must be taken into consideration, “including all relevant circumstances which an arm’s length purchaser would have had to consider…” As a result, the issue was returned to Rip C.J. of the Tax Court for a rehearing.

The Minister made this assessment pursuant to section 43 of the Retail Sales Tax Act (RSTA), R.S.O. 1990, c. R-31. Section 43 of the RSTA provides that when a bankrupt corporation has failed to remit taxes, the directors of the corporation are jointly and severally liable with the corporation to pay the tax. Furthermore, section 43(3) of the RSTA recognizes a due diligence defence for directors where they are not subjected to any liability if they exercise the degree of care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances.

The application judge held that Ms. Danso-Coffey could not be lawfully assessed as a director under section 43 of the RSTA. A person’s consent is required in order for the appointment of the person as a director to be valid. Because she never gave her consent and was named director without her knowledge, she was never a director. The judge further held that the RSTA is not a sufficiently comprehensive code. Thus, it does not oust the court’s jurisdiction to grant declaratory relief. Nothing in the RSTA would prevent the court from exercising its inherent and statutory jurisdiction to grant declaratory relief. The application granted Ms. Danso-Coffey relief from payment of tax arrears, stating that it would be “unfair not to do so”. The Minister appealed this decision.

The Ontario Court of Appeal allowed the Minister’s appeal for declaratory relief, and in doing so, reinforced a number of corporate and tax law principles that an individual may want to keep in mind when deciding whether to act as a director of a corporation.

(a) There is a presumption of accuracy for any information provided on a tax return as deemed by statute

Section 2(1) of the Corporation Information Act (CIA), R.S.O. 1990, c. C.39, requires corporations to file an initial return, which includes the names and addresses of directors. The Minister is authorized to certify that “that a person named in the certificate on the date or during the period specified in the certificate is shown on the records of the Ministry as a director, officer, manager or attorney for service of the corporation named in the certificate” (section 19(c) of the CIA). There is a presumption that any information contained in any return or notice filed under the CIA is accurate. Due to unnecessary administrative expenses involved in checking the information in each return, it is reasonable to presume that the information provided is accurate and error-free. However, the Minister has the discretion to issue an assessment of the tax return as a regulating mechanism to monitor any transgressions.

(b) Minister has the discretion to issue assessment notwithstanding the presumption of accuracy

The Minister claimed to have relied upon this presumption of accuracy. The return filed by the corporation stated that Ms. Danso-Coffey was the director of the corporation. Ms. Danso-Coffey provided explanations for this error in the return. Nonetheless, as per section 18(7) of the RSTA, the Minister was not bound by the information provided by Ms. Danso-Coffey and had the discretion to issue an assessment. This discretion must be exercised reasonably and not arbitrarily or capriciously. In this case, the Ontario Court of appeal disagreed with the application judge and held that the assessment was within the mandate and authority of the Minister, and thus, was lawful.

(c) Limitation to Superior Court’s Inherent Jurisdiction

The Ontario Court of Appeal held that although the Superior Court retains jurisdiction to grant declaratory relief, “this was not an appropriate case for the court to exercise its jurisdiction.” The Ontario Court of Appeal looked at the purpose and wording of the RSTA, which was held to be a “revenue raising mechanism” and an “important policy tool”.

Additionally, it held that the Superior Court’s inherent jurisdiction is not to be exercised in a vacuum. It is “not limitless. If the legislative body has not left a functional gap or vacuum, then inherent jurisdiction should not be brought into play.” The court further stated that the RSTA was a complete code with no functional gap, so the Superior Court should not have exercised its jurisdiction.

In essence, the Court of Appeal held that any disputes concerning the validity of a tax assessment has to be resolved within the RSTA, without resorting to a declaration by the Superior Court. The court allowed the appeal with respect to the application judge’s declaration that the respondent is not liable for the company’s retail sales tax arrears, reinstating the Minister’s decision.

(d) Directors in name have to bear in mind that they may be held personally liable for payment of tax arrears if the company goes bankrupt

As stated earlier, the statute requires a corporation to file an initial return setting out the names and addresses of the directors of the corporation. The Minister has the authority to assume that any information provided on the tax return is accurate. Furthermore, section 262(3) of the Ontario Business Corporations Act (OBCA), R.S.O. 1990, c. B. 16, provides that a director named (i) in the articles, (ii) in the most recent return or (iii) in the notice filed under the CIA is presumed to be the director of the corporation. The latter two are most relevant to our current discussion. These presumptions validate the common sense rule of verifying all information provided in the return and the notices to keep them error-free and accurate. Acting as a “figurehead” director for a relative or a friend can have negative repercussions, upon insolvency or bankruptcy of the corporation, leaving an unwitting and innocent individual personally liable for someone else’s mistakes and errors in judgment. Serious thought and consideration must be given with respect to the feasibility and validity of the corporation in the long term before accepting a position as a director of a corporation.

(e) Directors have a due diligence defence to avoid liability under the Act

But, all is not lost for directors. Section 43(3) of the RSTA places a duty to exercise a degree of care, diligence and skill to prevent the failure to collect and remit taxes. The courts concluded that a director can raise a due diligence defence to avoid liability. Contrary to the application judge’s decision, the Ontario Court of Appeal concluded that the due diligence defense is not limited to proving that the directors took all reasonable steps, but further includes a reasonable mistaken belief in the facts. The courts cited R. v. London Excavators & Trucking Ltd., (1998) 40 O.R. (3d) 32, which laid out the defense of due diligence as having one of two forms: “(1) holding a reasonable belief in a mistaken set of facts, and (2) taking all reasonable steps to avoid the offending event.” In this case, Ms. Danso-Coffey was reasonably mistaken in her belief. This extension of the due diligence defence to mistaken belief in tax remittance cases dealing with director’s liability has various implications for the Minister and the directors. It seems like a logical extension of the test, especially in this situation, because it favors those individuals who become liable for huge sums of money due to a mistake or an error.

(f) Other defences available

The court also laid out other defences available to defendants in this position, including:
(1) If the name of a person has been wrongly entered or retained in the registers or other records of a corporation, any aggrieved person may apply to rectify the records under section 250(1) of the OBCA.

(2) The person may also obtain recourse under section 248 of the OBCA, which is the oppression remedy.

(3) As a last resort, any individual can seek an exemption pursuant to s. 9(1) of the RSTA which provides:

If, owing to special circumstances, it is deemed inequitable that the whole amount of tax imposed by this Act be paid, the Minister may, with the approval of the Lieutenant Governor in Council, exempt a purchaser from payment of the whole or any part of such tax.

However, the court was quick to emphasize that this is a last resort remedy and should only be used when all other avenues have been exhausted.

Noted tax law scholar Vern Krishna related the gist of general anti-avoidance legislation at a recent lecture competition:

The law allows you to do something. You do it according to the law, and take advantage of the law, and then somebody says, “No… that was not very nice. You went too far.” And you say, “How far is ‘too far’?” And [they] say, “Well, we’ll tell you when we find out.” (Laughter.) But you say, “I need to know, because I need to plan in advance!” And they say, “No, you’ll find out in the fullness of time.” (Laughter.)

Thus, general fairness concerns of uncertainty, unpredictability, and retroactivity arise. Furthermore, having to do with but a property interest, general anti-avoidance legislation is not subject to Charter scrutiny under s. 7. As expected, the courts are left to divine the meaning of “misuse” and “abuse” under s. 245(4), demarcating the line between valid and non-valid arrangements of financial affairs.

This brings us to Copthorne Holdings Ltd. v. Canada, 2009 FCA 163, the latest tax avoidance case that the Supreme Court of Canada is set to hear. Granted leave to appeal on January 28, Copthorne Holdings concerns a series of avoidance transactions in the corporate context. Involved in a dizzying corporate web is a group of interrelated companies owned by the family of Hong Kong businessman Li Ka-Shing (“the Li group”). Unravelling this web, the pertinent facts, as best as I can understand, are as follows:

• 1991: The Li group invests $96.7m in its corporation, VHHC Investments Inc. (“VHHC Investments”). VHHC Investments invests $67.4m of that amount in a subsidiary, VHHC Holdings Ltd. (“VHHC Holdings”). At the end of the year, the issued shares of VHHC Investments and VHHC Holdings thus have paid-up capital (“PUC”) amounts of $96.7m and $67.4m respectively.

• 1992: VHHC Holdings is transferred from VHHC Investments to another Li group company, Copthorne Holdings Ltd. (“Copthorne I”). VHHC Holdings realizes a capital loss.

• 1993: The decision is made to amalgamate VHHC Holdings and Copthorne I. Since VHHC Holdings is Copthorne I’s subsidiary, such a vertical amalgamation would result in the intercorporate elimination of VHHC Holding’s PUC. VHHC Holdings is instead transferred to Copthorne I’s parent corporation for its nominal fair market value (“the 1993 Share Sale”), making VHHC Holdings and Copthorne I sister corporations prior to amalgamating to form Copthorne Holdings Ltd. (“Copthorne II”), thereby preserving VHHC Holdings’ $67.4m as part of Copthorne II’s aggregate PUC.

• 1994: In response to the announcement of proposals to amend foreign accrual property income (“FAPI”) provisions of the Income Tax Act, the Li group decides to undertake a corporate reorganization. Copthorne II as well as VHHC Investments are transferred to L.F. Investments (Barbados) Ltd. (“L.F. Investments”).

• 1995: Copthorne II and VHHC Investments are amalgamated to form Copthorne Holdings Ltd. (“Copthorne III”). Copthorne III’s PUC is roughly $164.1m, consisting of the $96.7m PUC of VHHC Investments and the preserved $67.4m of VHHC Holdings, the PUC of all other parties to these successive amalgamations being nominal. Following this amalgamation, Copthorne III redeems a number of shares from its parent, LF Investments (“the 1995 Redemption”). Since the redemption price of each share was equal to its PUC, the redemption did not give rise to taxable income in the form of a deemed dividend pursuant to s. 84(3) of the ITA. Accordingly, Copthorne III did not withhold or remit tax on behalf of L.F. Investments in respect of the redemption proceeds.

The Minister of Finance, applying the GAAR, determined that a deemed dividend had in fact arisen on the 1995 Redemption, for which withholding tax was due on the part of Copthorne III. The 1993 Share Sale was determined to be the avoidance transaction, though the tax benefit of it was not realized until the later 1995 Redemption. Since the GAAR applies not only to a “transaction” pursuant to s. 245(3)(a) but also to a “series of transactions” pursuant to s. 245(3)(b), the tax benefit that arose from 1993 Share Sale and 1995 Redemption was open to be denied if the two transactions were found to constitute a series thereof and furthermore were found to be abusive per the statute and related case law. The Tax Court of Canada, agreeing with the Minister’s tax assessment, explained the abusiveness of the transactions and the deemed dividend that should have otherwise arisen:

25     … [T]he calculation of PUC resulted in the very blatant advantage of a “double counting” in the amount of $67[.4m]. None of the provisions in the Act ever intended that an artificial inflation of PUC be preserved for a subsequent return of such an increase to shareholders on a tax-free basis. I am dealing with a total PUC of $164[.1m] belonging to Copthorne III … The origin of this amount is made up of $96[.7m] PUC originally belonging to VHHC Investments and $67[.4m] PUC belonging to Copthorne II. However the $67[.4m] is easily traced to the initial investment made by VHHC Investments in VHHC Holdings. This PUC was preserved by the 1993 Share Sale and maintained throughout the First and Second Amalgamations. This means that the $67[.4m] PUC is part and parcel of or is derived from the $96[.7m] PUC. To permit transactions that produce an aggregate of these two amounts creates a double counting of PUC in the amount of $67[.4m]. …

74     … When VHHC Investments is later amalgamated with Copthorne II, the underlying principles respecting the calculation of PUC are offended because approximately $67 million of PUC is essentially double counted in the PUC of the newly amalgamated corporation. It is this double counting that circumvents the proper application of the relevant provisions in a manner that frustrates and defeats the object, spirit and purpose of those provisions, which individually, together and when read in conjunction with other provisions in the Act, are meant to operate to prevent the artificial increase of PUC on amalgamation and its subsequent return to shareholders on a tax-free basis.

At issue on appeal to the Federal Court of Appeal was the precise definition of a “series of transactions”. Where s. 245(3)(b) makes “series['] of transactions” subject to the GAAR, s. 248(10) helps to set out and broaden the definition of a “series” beyond the common law definition: a “series [of transactions or events] shall be deemed to include any related transactions or events completed in contemplation of the series.”

The proper interpretation of s. 248(10), specifically the words “completed in contemplation of the series”, was the question of law on appeal. Justice Ryer, for the unanimous Federal Court of Appeal, reviewed the case law on which the Tax Court of Canada based its decision:

40     Subsection 248(10) was interpreted by Rothstein J.A. in [OSFC Holdings Ltd. v. Her Majesty the Queen, 2001 FCA 260 ("OSFC")] (at paragraph 36). There, he stated:

… Subsection 248(10) does not require that the related transaction be pre-ordained. Nor does it say when the related transaction must be completed. As long as the transaction has some connection with the common law series, it will, if it was completed in contemplation of the common law series, be included in the series by reason of the deeming effect of subsection 248(10). Whether the related transaction is completed in contemplation of the common law series requires an assessment of whether the parties to the transaction knew of the common law series, such that it could be said that they took it into account when deciding to complete the transaction. If so, the transaction can be said to be completed in contemplation of the common law series. [Emphasis added]

41     The Supreme Court of Canada approved and elaborated upon Justice Rothstein’s interpretation of subsection 248(10). At paragraph 26 of [Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54 ("Canada Trustco")], McLachlin C.J. and Major J. stated:

26     Section 248(10) extends the meaning of “series of transactions” to include “related transactions or events completed in contemplation of the series”. The Federal Court of Appeal held, at para. 36 of OSFC, that this occurs where the parties to the transaction “knew of the … series, such that it could be said that they took it into account when deciding to complete the transaction”. We would elaborate that “in contemplation” is read not in the sense of actual knowledge but in the broader sense of “because of” or “in relation to” the series. {…}

Copthorne Holding’s objection to the Tax Court’s ruling and argument before the Federal Court of Appeal:

43     The appellant contends that a close [causal] connection is required. … [T]he appellant argues that there is no causal connection between the [1993 Share Sale] and the 1995 Redemption, in the sense that the latter event was caused by the Proposed FAPI Amendments and therefore could not have been caused by the [1993 Share Sale] in which the PUC preservation transaction occurred. … [A]ny causal connection that might otherwise have existed between the [1993 Share Sale] and the 1995 Redemption was … broken by the Proposed FAPI Amendments.

44     In support of this … the appellant cites a passage from the decision of the Tax Court of Canada in MIL (Investments) S.A. v. The Queen, [2006] 5 C.T.C. 2552 (affirmed on other grounds, 2007 FCA 236). At paragraph 65 … Bell J. stated:

There must be a strong nexus between transactions in order for them to be included in a series of transactions. In broadening the word “contemplation” to be read in the sense of “because of” or “in relation to the series”, the Supreme Court cannot have meant mere possibility, which would include an extreme degree of remoteness. {…} [Emphasis added]

While agreeing that the Supreme Court of Canada’s broadening in Canada Trustco of “in contemplation” did not go so far as to mean “mere possibility”, Ryer J.A. rejected Bell J.’s stricter wording of “strong nexus”. This makes sense, as it would “require an even closer connection between the transaction and the series than was required under the interpretation offered Rothstein J.A. in OFSC.”

Following OFSC and Canada Trustco, and thus affirming the Tax Court in this regard, Ryer J.A. introduced the phrase “motivating factor”:

In my view, if a series is a motivating factor with respect to the completion of a subsequent transaction, the transaction can be said to have been completed “in contemplation of the series” and a direct causal relationship between the series and the transaction, as argued by the appellant, need not be established. In my opinion, this standard is reconcilable with the test as stated in OSFC and as broadened in Canada Trustco. [My underlining.]

Ryer J.A. affirmed the Tax Court’s application of OFSC and Canada Trustco to the facts and conclusion that “the 1995 Redemption formed part of [a s]eries [containing the 1993 Share Sale]“: “the conclusion that the PUC preservation that occurred in the [1993 Share Sale] was … a motivating factor in relation to the completion of the 1995 Redemption, is unassailable.”

In dismissing this appeal, the Federal Court of Appeal also affirmed the Tax Court of Canada’s finding of mixed law and fact that avoidance transactions of corporate PUC preservation, such as conducted here, are abusive within the meaning of the Act and the related case law, offending the principles respecting the calculation of PUC.

In closing, the Court will, having granted leave to appeal in Copthorne, at the very least have to abate whatever uncertainty there is in respect of the corporate tax consequences relating to amalgamations and paid-up capital. More importantly, the Court will have to settle any conflicting trends in the case law arising from a misinterpretation of its jurisprudence (i.e. Canada Trustco) with respect to the concept of a “series of transactions” as set out in the Income Tax Act. Furthermore, when the Court ultimately settles on an appropriate standard (whether familiar or novel), as part of defining that standard it will have to demonstrate and elaborate on what exactly qualifies that standard. Fairness concerns aside, such jurisprudential wrangling seems an inescapable part of the administrative and judicial burden imposed by general anti-avoidance legislation such as our s. 245.