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 the face of it, the decisions of the Federal Court seemed to directly contradict section 87 of the Indian Act, which provided that the “personal property of an Indian …. situated on a reserve” was exempt from taxation. Since the 1998 case, Recalma v. R., the Federal Court had reasoned that savings in financial institutions located on reserve were taxable because the financial institutions generated their income from participating in the “commercial mainstream.”  The reasoning was related to a belief that the tax exemption under s.87 of the Indian Act should be related to preserving a traditional way of life or related to Indians qua Indians.

In Bastien Estate v. Canada, 2011 SCC 38 and Dubé v. Canada, 2011 SCC 39 the majority of the Supreme Court (per Cromwell J, McLachlin CJ and Binnie, Fish and Charron JJ concurring) was very clear in reformulating the purpose of section 87:

Section 87 protects the personal property of Indians that is situated on a reserve from taxation. In determining the location of personal property for the purpose of s. 87, there is no requirement that the personal property be integral to the life of the reserve, or that it, in order to be exempted from taxation, must benefit what the court takes to be the traditional Indian way of life. (at para. 30)

The two cases were held together, but the facts were slightly different.

Rolland Bastien had a moccasin making business on the Wendlake reserve. He deposited his savings from his business in the Caisse populaire Desjardins du Village Huron, which was located on his reserve. Bastien also lived on the reserve. Cromwell J. characterized the “property” in this case to be the contractual right to interest from the investment certificates. Whether the financial institution generated the funds to fulfill its obligation to pay from the “commercial mainstream” or not was not relevant.

Rather, Cromwell J. returned to the connecting factors test developed in Williams v. R. (1992) to determine whether the property was situated on the reserve.   First, he found that the “place of contracting, the place of performance and the residence of the debtor”  were all on reserve. Second, the residence of the payee was on reserve. And third, the “source of the capital which was invested to produce the interest income” was also on reserve.

Alexandre Dubé was born on the Obedjiwan Reserve in Quebec. He had a business transporting people from this reserve to the town of Roberval for medical treatment.  It appears that he did not live on the reserve itself. Because there was not financial institution situated on his reserve, he kept his savings in the  Caisse populaire Desjardins de Pointe-Bleue, which was located on a different reserve – the Mashteuiatsh Reserve.

The trial judge found that not all the savings came from his transportation business. The trial judge also found that the majority of the members of the caisse populaire were native and that 75 per cent of the income was lent to members of the caisse living on and off reserve. In the factual circumstances of this case, Cromwell J  found irrelevant or of little weight Dubé’s place of residence, the fact that not all the savings were generated from an activity connected to the reserve and the fact that he did not spend the interest income on reserve.

Deschamps J (Rothstein J concurring) criticized the majority judgment for placing too much emphasis on the residence of the debtor and raised the fear that the majority’s reasoning could lead to artificial tax avoidance schemes. She felt that if the income invested had been generated on the reserve, as was the case with Bastien, the interest on that income should not be taxed. However, Dubé had not generated his funds from activity on the reserve. Consequently, Deschamps concurred in the result in Bastien Estate but dissented in Dubé.

In my view, the majority decision accords with the spirit and intent of the provisions of the Indian Act, but I do not think that these cases open the way for a wholescale avoidance of tax by channelling investment vehicles through on-reserve financial institutions. Cromwell J. was careful to restrict his reasons to the fact that these cases dealt with guaranteed investment certificates.

Nonetheless, it is encouraging to see that all the judges reject the line of cases that put a cultural gloss on the Indian Act by tying tax exemptions to “traditional” activities. If economic development is to be important to reserve communities, they should be able to rely on the statutory framework that is provided in the Indian Act. Of course, this framework is riddled with problems and new self-government agreements have done away with the tax exemptions in favour of a more sophisticated set of economic development tools, including greater access to benefits from traditional lands.

For those communities still living under the Indian Act, however,  these decisions can be seen as a step in the right direction.

The Tax Court of Canada considered two main issues: whether the trust was valid and if the General Anti-Avoidance Rule (“GARR”) was applicable to deny the transactions and related tax savings. Sona Dhawan discussed the Tax Court decision in an earlier post. This post will focus on the validity of the trust and the appeal court’s reversal of the lower court’s finding that the arrangement was not a sham.

Background and Facts

Mr. Antle transferred shares that had accumulated a capital gain to a spousal trust set up in Barbados. The trust then sold the property to his wife who then sold the property to an arm’s length third-party. The proceeds from the sale were put back into the trust and the wife received them as a beneficiary. Barbados has zero capital gains tax, therefore the wife’s beneficial interest from the ultimate disposition of securities was tax-free.

As a result, the taxpayer saved approximately $1,299,821. Normally, if he had sold his shares to a third-party in Canada he would have been liable for tax on the accumulated capital gain. The Minister of National Revenue (“Minister”) reassessed Mr. Antle and included these gains as taxable capital gains. (It is not uncommon in these types of transactions for the tax savings to be divided between the taxpayer and the legal professionals who implemented the strategy.)

The Three Certainties

The first problem for the taxpayer was the creation of the trust. For a trust to be valid it must exhibit the three certainties: certainty of intention, certainty of subject matter, and the certainty of objects. For example, regarding certainty of intention, Mr. Antle argued that determining intention was not a subjective process but merely an objective evaluation of the text of the trust agreement. In other words, if the trust document itself indicated an intention to create a trust, the surrounding circumstances did not matter. Hence, if from reading the trust document it was clear that the trust had been set up to hold property for the eventual beneficiary, Mrs. Antle, then the certainty of intention requirement was met.

However, C. Miller J. of the Tax Court agreed with the Minister, concluding that there was no certainty of intention to create a trust; rather it was merely “a conduit to avoid tax”. The Justice concluded that determining intention is not solely an exercise in interpreting the written words of the trust agreement. He agreed with the Minister’s contention that “the language of the [trust] is insufficient if it does not accord with Mr. Antle’s actions.” According to C. Miller J.: “the inevitable conclusion [is] that Mr. Antle did not truly intend to settle shares in trust with Mr. Truss. He simply signed documents on the advice of his professional advisers with the expectation the result would avoid tax in Canada.”

On appeal, Antle again argued that to look beyond the wording of the trust agreement to determine whether certainty of intention existed was an error in law. This argument was also rejected by the Federal Court of Appeal, which affirmed that contextual considerations are relevant, making it necessary to look at the actions that accord with the trust agreement.

The Trust was a Sham

One of the more interesting conclusions of the Tax Court judge in Antle 2009 was the ruling that the trust was not a sham. Even though this issue did not affect the outcome of the appeal, it is notable that the Court of Appeal felt it necessary to correct the error in law.

A sham trust is a trust, validly constituted or not, where the terms of the trust are meant to deceive. In Snook v. London West Riding Investments, [1967] 2 QB 786, Lord Diplock considered the term “sham”, stating:

it means acts done or documents executed by the parties to the “sham” which are intended by them, to give to third parties or the Court, the appearance of creating between the parties, legal rights and obligations different from the actual legal rights and obligations (if any), which the parties intend to create… [T]hat for acts or documents to be a “sham”, with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating. No unexpressed intentions of a “shammer” affect the rights of a party whom he deceived.

Canadian jurisprudence adds that in order for a trust to be a sham, the settlor and trustee must both be of the same intent—that is to deceive or misrepresent the actual transaction.

The Tax Court of Canada undertook a nuanced determination of whether the trust was a sham, looking for proof of the intentions of those involved. The Federal Court of Appeal was much more succinct, stating:

the Tax Court judge misconstrued the notion of intentional deception in the context of a sham. The required intent or state of mind is not equivalent to mens rea and need not go so far as to give rise to what is known at common law as the tort of deceit. It suffices that parties to a transaction present it as being different from what they know it to be…[B]oth the appellant and the trustee gave a false impression of the rights and obligations created between them. Nothing more was required in order to hold that the Trust was a sham.

Conclusion

The Federal Court of Appeal may have been issuing a warning to those who structure tax avoidance transactions using trusts, and in particular offshore trusts. For one, they affirmed that determining certainty of intention required contextual considerations; the taxpayer is not able to rely solely on the wording of the trust agreement in order to prove that certainty of intention exists. If the property was, as according to the agreement, to be held in trust for the beneficiary, then that is what must occur.

Again, the intention referred to by Lord Diplock “is not equivalent to mens rea“. A trust is a sham if “parties to a transaction present it as being different from what they know it to be…” Nothing more is required. This effectively makes the Minister’s job much easier. A valid trust must be a valid trust, there may be no way around it.

The Federal Court of Appeal decision in Canada v. Merchant Law Group, 2010 FCA 206, is a more recent, albeit less controversial case involving the Merchant Law Group and the subject of legal fees. The appeal court ruled that the firm failed to meet the requisite onus to establish that it was acting as an agent for the client when certain disbursements were incurred. As a result, the firm was found responsible for collecting and remitting the requisite GST.

This case is notable for providing guidance on the level of evidence required to prove the existence of an agency relationship when a claim is made that certain disbursements were incurred during the provision of legal services.

Background and Law

The Merchant Group was reassessed by the Minister of Finance (“Minister”) over the possible inappropriate tax treatment of disbursements incurred during the provision of legal services. This included payments for items such as courier fees, travel expenses, expert reports and testimonies, etc. According to the Minister’s reassessment, the firm failed to collect and remit the applicable Goods and Services Tax (“GST”) pursuant to the relevant provisions of the Excise Tax Act, R.S.C. 1985, c. E-15 (“ETA”). The Tax Court of Canada disagreed with that assessment in Merchant Law Group v. The Queen, 2008 TCC 337.

Pursuant to s. 165(1) of the ETA, GST in the amount of 5% has to be remitted to the government by “every recipient of a taxable supply…on the value of the consideration of the supply…” A “supply” is defined as “the provision of property or a service in any manner, including sale, transfer, barter, exchange, licence, rental, lease, gift or disposition…” A “taxable supply” is defined under s. 123(1) of the ETA as a “supply that is made in the course of a commercial activity…” Finally, the ““recipient”” of a supply of property or a service means…where consideration for the supply is payable under an agreement for the supply, the person who is liable under the agreement to pay that consideration…”

The Presumption of an Agency Relationship between the Lawyer and Client Will Not Do

The issue in the present case was whether or not the evidence presented by the Merchant Group was sufficient to establish the existence of an agency relationship. When incurring disbursements in the course of providing legal services, a lawyer who can sufficiently prove that she acted as the agent for the client is not, as mandated by the ETA, the “recipient of that taxable supply” because “the person who is liable under the agreement to pay…consideration” is the client. Therefore, the lawyer is not responsible to charge and remit the GST.

In contrast, the evidence may suggest that the lawyer herself incurred the disbursement during the provision of legal services. In this case, under the law the recipient of the supply is the lawyer and she is responsible for the GST because it was her, and not the client, who was obligated under an agreement to reimburse the third-party. (Note, in such an instance the GST can be claimed under a tax credit and the client is charged the amount minus the GST.)

In making its case, the Minister relied on GST/HST Policy Statement P-209R entitled “Lawyers and Disbursements” (“Policy”), which lists certain expenditures that are eligible to be considered as incurred within an agency relationship. This includes, for example, fees to commence a legal proceeding, filing fees (e.g. notice of intent to defend), or subpoena fees.

The impugned disbursements in the present case (including courier costs, transcript production, and travel expenses) did not fall within the range of those acceptable under the aforementioned Policy. Nevertheless, the Tax Court ruled in favour of the Merchant Group by relying primarily on the general nature of the solicitor-client relationship, in addition to the guidance set by GST/HST Policy Statement P-182R Agency.

According to Justice E. P. Rossiter of the Tax Court, “[i]t is trite to say that the relationship that exists between a solicitor and his client is one of principal and agent.” Furthermore, the key factors establishing an agency relationship set out in the P-182R were met. Nonetheless, the Federal Court of Appeal ruled that the lack of a written agreement was determinative.

A  Written Agreement Establishing the Client’s Consent to Disbursements Incurred on her Behalf is Recommended

Unfortunately for the Merchant Group, a presumption that an agency relationship existed between the client and the lawyer was not sufficient for the Federal Court of Appeal. In his written reasons for judgment Chief Justice Blais stated:

The [Tax Court] Judge erred in law by relying upon the general nature of the solicitor-client relationship. As a matter of law it does not follow that, because the solicitor-client relationship is generally one of agency, all financial obligations incurred by a lawyer while providing legal services are incurred as agent of its clients…

According to the appeal court, to “establish the lawyer was not the recipient of a taxable supply at least some evidence must be led with respect to the particular transaction and the extent of the lawyer’s ability to bind his or her client to the transaction…” Most importantly, a written agreement demonstrating that the client consented to the lawyer making certain disbursements on her behalf is recommended. Furthermore, Chief Justice Blaise suggested that a written agreement may even “constitute sufficient evidence” to have disbursements not within the range of those allowed by the Policy treated in the desired way.

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 Tax Court of Canada recently ruled in Goar, Allison & Associates Inc. v. The Queen, 2009 TCC 174, that the penalty only applied if tax was owed, the opposite of the Tax Court’s latest determination in Exida I. Furthermore, both Goar and Exida I were conducted according to the rules of “informal procedure”, outlined in section 18 of the Tax Court of Canada Act, R.S.C. 1985, c. T-2. Per subsection 18.28, proceedings conducted by informal procedure lack “precedential value.” Hence, it was up to the Federal Court of Appeal to clarify the discrepancy between Goar and Exida I.

Legal Framework

According to ss. 162(1) & (2) of the ITA, failure to file an income tax return (as required by s. 150(1)) will result in a financial penalty, which is normally calculated as a percentage of the tax owed. Under s. 162(2) the penalty is increased for repeated late or missed filings. Subsection 162(2.1) applies specifically to non-resident corporations. A non-resident corporation that does not file an income tax return is subject to specific financial penalties, the greater of $100 or a maximum amount of $2500 ($25 per day to a maximum of 100 days). Finally, s. 162(7) provides additional sanctions for failure to comply with the ITA, except in instances where the ITA already provides a penalty for the impugned behaviour. It operates as a catch-all provision.

Before the Tax Court of Canada

Exida.com, a US corporation carrying on business in Canada, was penalized under s. 162(2.1) for its failure to submit an income tax return for 2003, 2004, and 2005. The company did not owe tax for those years.

Before the Tax Court, the primary issue was the interaction between ss. 162(1), 162(2.1), and 162(7) of the ITA. Again, s. 162(2.1) refers specifically to penalties for late or missed income tax filings of non-resident corporations. However, this provision only applies if a non-resident corporation is “liable to a penalty under” under ss. 162(1) & (2). The relevant subsections are as follows:

162(1) Every person who fails to file a return of income for a taxation year as and when required by subsection 150(1) is liable to a penalty equal to the total of…

162(2.1) … if a non-resident corporation is liable to a penalty under subsection (1) or (2) for failure to file a return of income for a taxation year, the amount of the penalty is the greater of…[emphasis added].

The key phrase is “liable to a penalty under subsection (1) or (2).” The penalty is a product of the tax owed and a predetermined percentage. According to ss. 162(1) & (2), if the tax owed is nil then the penalty is nil. Per a strict interpretation of the provision, advanced by Exida, s. 162(2.1) only applied if the non-resident corporation was “liable to a penalty” under ss. 162(1) or (2); in other words, only if they owed tax for the years in question.

Exida’s reasoning was in line with the Goar decision in which Justice Miller of the Tax Court ruled that s. 162(1) was not triggered unless tax was owed. In the present case, the Minister argued that the taxpayer was “liable to a penalty” as long as an income tax return had not been filed on time. According to the government’s submission, it did not matter that the penalty was nil. Furthermore, the catch-all provision in s. 162(7) could be applied if s. 162(2.1) was not.

Subsection 162(7) is relevant only in instances where another provision in the ITA does not provide a penalty for the impugned behaviour. According to Justice Woods s. 162(2.1) provided a penalty, and it was “not relevant that the penalty could be nil.” Therefore, s. 162(7) had no application. Refusing to follow the decision in Goar, Woods held the issue should be resolved by applying a textual, contextual and purposive approach.

First, the meaning of “liable” is broad and is defined in part as “responsible at law” or “[b]ound or obliged by law or equity.” Furthermore, the history of the legislation, including a technical note released in conjunction with s. 162(2.1), is evidence that the failure to submit the return is the conduct Parliament intended to penalize, regardless of whether there was unpaid tax. The relevant portion of the technical note is as follows:

New subsection 162(2.1) is a special rule for the computation of penalties under subsections 162(1) (failure to file return) and 162(2) (repeated failure to file). The rule, which applies to all non-resident corporations, provides that a penalty under either of those subsections is to be computed as the greater of two amounts. The first amount is the amount determined under subsection 162(1) or 162(2). The second amount is the greater of $100 and $25 for each day, up to 100, that the failure to file continues. New subsection 162(2.1) thus operates to subject non-resident corporations to the effect of the “regular” penalties under subsections 162(1) and (2) in respect of a failure to file an income tax return and, consistent with the role of that tax return as an information return for those corporations that claim an exception from Canadian tax as a result of the application of a tax treaty, to the alternative penalties that would apply under subsection 162(7) of the Act if a separate information return had been required in respect of those corporations.

The Federal Court of Appeal

Justice Noel provided the written reasons for judgement, with Justices Trudel and Dawson concurring. Referring to the legislative history of s. 162(2.1), the Court of Appeal determined that the provision was implemented to specify the obligations related to non-resident corporate income tax filings. Prior to this, s. 150(1) only referred to “corporations”. Addressing the technical note, the Court of Appeal ruled that it was evidence of intent to subject a non-resident corporation to alternative penalties, but it did not demonstrate intent related to circumstances when no tax was owed. Furthermore:

[t]he reasoning of the Tax Court Judge results in a penalty being levied under subsection 162(2.1) even though the stated condition precedent for its application—“if a non-resident corporation is liable to a penalty under subsection 162(1) or (2)”—is not met. No textual or purposive analysis can justify such a result…”

According to Justice Noel, “it is equally clear that those charged with implementing this past aspect of the legislative plan failed in their task.” The alternative penalties in s. 162(2.1) are only triggered if the non-resident corporation is “liable” under ss. 162(1) & (2). The Federal Court referred to this as a “fundamental drafting error.” And, as a result of that error the ITA does not provide a specific penalty for the failure of a non-resident corporation to file a tax return. Therefore, the Court of Appeal held, the catch-all penalty provision found in s. 162(7) was triggered and Evida was liable for the respective penalty as a result.

Conclusion

Ultimately, a non-resident corporation is only liable for penalties under s. 162(2.1) if they are liable under ss. 162(1) & (2). And they are only liable per ss. 162(1) & (2) if taxed is owed. However, the Federal Court of Appeal ruled that under the circumstances s. 162(7) is applicable if tax is not owed. The maximum penalty under s. 162(7) is $2500 for each contravention or failure to file a return.

In my opinion, the Federal Court of Appeal was reasonable in its decision. The definition of “penalty”, outside of the monetary penalty referenced in the relevant provisions, was not explicitly examined in conjunction with the word “liable” in Exida I or Exida II. The Oxford Dictionary defines a “penalty” as a “punishment imposed for breaking a law” or a “disadvantaged suffered as a result of an action or situation.” Again, “liable” was defined by the Tax Court as “responsible at law” and other analogous phrases. In the end, “liable to a penalty” suggests being “responsible at law” for a “punishment imposed for breaking a law.” Here, the “penalty” was nil under ss. 162(1) & (2). A “penalty” of nil is not a punishment or disadvantage suffered. Therefore, Exida was not “liable to a penalty” and s. 162(2.1) was not triggered.

The fact that s. 162(2.1) provides a minimum penalty applicable to non-resident corporations makes it reasonable that such a penalty was implemented to account for situations where tax was not owed and the resulting calculation would be nil. However, as noted by Justice Noel, “[w]hile a contextual and purposive analysis is useful…it cannot be used to give the legislative language a meaning which it cannot bear…”

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.

Race tracks offer a prize, known as purse money, to each of the top five finishes in a horse race. Under an agreement with the race track, the horse owner typically gets 90% of the purse money, while the driver and trainer each get a 5% share. (Unlike jockeys, who sit on the horse itself, horse drivers mount a two-wheel cart pulled by a horse; this is called “harness racing.”) The respondent, a firm representing horse drivers and trainers in Ontario, argued that the payments that they receive constitute prize money, which is not subject to GST. It relied on section 188(2) of the Excise Tax Act, R.S. 1985, c. E-15, which exempts from GST liability any “prize” given to a “competitor” in a “competitive event.” Revenue Canada argued that the 5% share that a horse driver or trainer gets after a successful race is not a prize, but a remuneration for services rendered to the horse owner.

While the Tax Court of Canada found that the horse driver and trainer were “competitors” and that their share in the winnings constituted a “prize,” Stratas J.A. of the Federal Court of Appeal reversed that decision and found in favour of Revenue Canada. He wrote that Tax Court had erred in writing that the horse owner, driver, and trainer were joint winners in the purse money; indeed, “the only evidence on this point supported a finding that the purse money belonged only to the horse’s owner.” The mere fact that the driver and trainer of a horse get paid only if they win the race does not, in itself, make these payments “prizes.” They may still be remuneration for services rendered, under a compensation scheme based on performance or result.

Stratas J.A. wrote that, to determine whether a payment is a “prize” under section 188(2),

…it is necessary to determine the true nature of the payments and … what property or services are being sold, transferred, bartered, exchanged, licenced, rented, leased, given or disposed for the payments. … Some useful circumstances to examine include the purpose behind the payments, the true relationships among the parties, and any agreements, laws and regulatory provisions that apply.

Both the regulatory framework and the wording of the contracts between the race tracks and horse racing participants suggested that the 5% payments to drivers and trainers were better characterized “as fees, contingent on success, that are intended to remunerate … for services rendered to owners” than as prize money. Rule 18.11 of the Ontario Racing Commission’s Rules of Standardbred Racing states that purse money is payable to owners, and that the driver and/or trainer’s “fees” are deducted from that amount:

18.11 Where an agreement exists between a recognized harness participants’ association and a racing association, drivers’ and/or trainers’ fees may be deducted from the purses payable to owners and paid to the drivers and/or trainers within 30 days. A copy of such agreement must be filed with the Commission.

The race track does not therefore reward “purse money” to drivers and trainers, but merely deducts their fees from the purse money and remits it to them on behalf of the horse owner. The contract between the respondent and the race tracks also use the term “drivers’ fees” and refers to purse money “won by horses,” not by drivers, suggesting that the payments that drivers receive are not prizes, but payments for services. Having found that the drivers’ and trainers’ respective shares in purse money constitute fees for services, the court concludes that they do not enjoy GST exemption under section 188(2) of the Excise Tax Act.

While the court’s reasoning is sound, it does seem rather strange that horse owners get a competition “prize” while the horse driver and trainer, the individuals who actually put in the effort to win the competition, get a “payment for services rendered” that is subject to GST. This is incongruent to other professional racing sports like auto racing. Since Stratas J.A. bases his decision on a somewhat literal reading of the Rules of Standardbred Racing and the contract between the race tracks and race participants, horse owners (who, as recipients of the drivers’ and trainers’ services, are the ones responsible for paying the GST) may want to reword their agreements with race tracks and lobby the Ontario Racing Commission to change the wording of the rules, so that compensation to drivers and trainers can be characterized better as divvying up prize money.

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.