Use of Income Tax Act’s General Anti-Avoidance Rule No Clearer after Lipson

Yesterday, the SCC released their first decision of the new year – a decision which may have broad implications on the tax planning of many Canadians. The case, Lipson v Canada, 2009 SCC 1, deals with the legality of a set of transactions which culminated in the deduction of mortgage loan interest payments for personal income tax purposes. Although each transaction was legal, the question before the court was whether the series of transactions as a whole violated the Income Tax Act, RSC 1985, c 1 (5th Supp) [ITA]’s General Anti-Avoidance Rule.

This case has been eagerly anticipated by tax professionals and lawyers. We culled some of these opinions back during the time of the hearing. Some further reports have sprouted up after yesterday’s release of the decision. They can be found here and here.


Earl and Jordanna Lipson was a married couple with plans to purchase a home. They structured their transactions as follows:

  1. Jordanna borrowed $562,000 from a bank to purchase shares in a family corporation from Earl.
  2. Earl and Jordanna took out a mortgage for the same amount and used this money to repay Jordanna’s loan.
  3. On his 1994, 1995, and 1996 tax returns, Earl is attributed Jordanna’s dividend income from the shares. He is also attributed the mortgage loan interest deductions which were treated as having financed the share purchase.

The Decision

The decision is broken up into 3 parts: a 4-member majority penned by Lebel J., and two separate dissenting opinions penned by Binnie J. and Rothstein J. respectively.

The Majority Opinion

Lebel J. concludes that the transactions executed by Mr. Lipson constituted abusive tax avoidance. In doing so, he followed the analytical approach laid out in Canada Trustco Mortgage Co v Canada, [2005] 2 SCR 601 [Canada Trustco]. Canada Trustco specifies that the three requirements for denying a tax benefit under the GAAR are: (1) the benefit arises from a transaction, (2) the transaction is an avoidance transaction as defined in s. 245(3), and (3) the transaction results in an abuse and misuse within the meaning of s. 245(4).

The contentious part of the test was the third step. Canada Trustco specifies that transactions will be found to be abusive “when a taxpayer relies on specific provisions of the ITA in order to achieve an outcome that those provisions seek to prevent.” The first step in this analysis is to determine the object, spirit, and purpose of a given provision. The second step is to determine whether the transaction falls within or frustrates the purpose (Canada Trustco, paras 44-45).

Lebel J. does not have any problem with the first two steps of the transaction as outlined above. Rather, it is the attribution to Mr. Lipson of the deductions from the mortgage loan interest payments which is problematic. At paras 32-33, Lebel J. notes that the attribution rules (ss. 74.1 to 74.5) on which Earl relies “are anti-avoidance provisions whose purpose is to prevent spouses (and other related persons) from reducing tax by taking advantage of their non-arm’s length status when transferring property between themselves.” At para 42, Lebel J. reasons that Mr. Lipson’s use of s. 74.1 to avoid tax ran counter to the section’s anti-avoidance purpose:

[T]he attribution to Mr. Lipson of the net income or loss derived from the shares would enable him to reduce the dividend income attributed to him by the amount of the interest on the loan that financed his wife’s purchase of those shares. However, before the transfer, when the dividend income was in Mr. Lipson’s hands, no interest expense could have been deducted from it. It seems strange that the operation of s. 74.1(1) can result in the reduction of the total amount of tax payable by Mr. Lipson on the income from the transferred property. The only way the Lipsons could have produced the result in this case was by taking advantage of their non-arm’s length relationship. Therefore, the attribution by operation of s. 74.1(1) that allowed Mr. Lipson to deduct the interest in order to reduce the tax payable on the dividend income from the shares and other income, which he would not have been able to do were Mrs. Lipson dealing with him at arm’s length, qualifies as abusive tax avoidance. … [T]o allow s. 74.1(1) to be used to reduce Mr. Lipson’s income tax from what it would have been without the transfer to his spouse would frustrate the purpose of the attribution rules. Indeed, a specific anti-avoidance rule is being used to facilitate abusive tax avoidance. [emphasis added]

Lebel J. summarizes:

[T]he tax benefit of the interest deduction resulting from the refinancing of the shares of the family corporation by Mrs. Lipson is not abusive viewed in isolation, but the ensuing tax benefit of the attribution of Mrs. Lipson’s interest deduction to Mr. Lipson is. It follows that this latter tax benefit can be denied under s. 245(2), which is triggered because the transactions in the series include the attribution of the interest deduction under s. 74.1(1) and this attribution frustrates the object, spirit and purpose of that provision. (para 48)

Comments on GAAR Generally

Lebel J. notes that while the GAAR is a residual provision,

it is [nevertheless] designed to address the complexity of transactions which fall outside the scope of specific anti-avoidance provisions. … [I]t relates specifically to the impact of complex series of transactions which often depend on the interplay of discrete provisions of the ITA. The Minister could properly use the GAAR in respect of a series of transactions that had an impact on more than just one stream of income. (para 47)

With regards to the concerns that the application of GAAR would create uncertainty, Lebel J. writes:

To the extent that it may not always be obvious whether the purpose of a provision is frustrated by an avoidance transaction, the GAAR may introduce a degree of uncertainty into tax planning, but such uncertainty is inherent in all situations in which the law must be applied to unique facts. The GAAR is neither a penal provision nor a hammer to pound taxpayers into submission. It is designed, in the complex context of the ITA, to restrain abusive tax avoidance and to make sure that the fairness of the tax system is preserved. A desire to avoid uncertainty cannot justify ignoring a provision of the ITA that is clearly intended to apply to transactions that would otherwise be valid on their face. (para 52)

Binnie J.’s Opinion

Writing for himself and Deschamps J., Binnie J. at para. 76 challenges the assertion of the majority opinion that “the purpose of [the attribution rules in] s. 74.1(1) is to prevent spouses from reducing tax by taking advantage of their non-arm’s length relationship when transferring property between themselves” (para. 42 of the decision). He writes the following,

This concept of an abuse of s. 74.1(1) [as envisioned by the majority] is so broad that it would include interspousal transfers of assets at fair market value for bona fide economic reasons. It offers, I think, too large a field of operation for the GAAR. The reality is that such a reduction in the total amount of tax is the likely result of any interspousal rollover from a higher income spouse to a lower income spouse, a result that s. 74.1 plainly contemplates.

Binnie J. further continues,

[78] When Parliament used the words “income or loss” in s. 74.1(1), it expressly contemplated that regardless of the relative income of the spouses, interest expenses incurred by the transferee (here the wife) will in the circumstances dictated by Parliament be attributed to the transferor (here the appellant). Section 74.1(1) does not change the ownership of the property. It simply attributes the net income or loss arising from the transferred property to the transferor in circumstances where the transferor has decided not to opt for a deemed disposition and thereby risk capital gains tax.

[80] In an effort to identify the “object, spirit or purpose” of s. 74.1(1) abused by the appellant’s plan, my colleague LeBel J. states, as mentioned, that “the attribution rules in ss. 74.1 to 74.5 are anti-avoidance provisions whose purpose is to prevent spouses (and other related persons) from reducing tax by taking advantage of their non-arm’s length status when transferring property between themselves” (para. 32). In my respectful view, what LeBel J. believes s. 74.1(1) is designed to prevent is actually a reasonable statement of what s. 74.1(1) seeks to permit. … The taxpayer’s evident purpose was to postpone capital gains tax on the transfer of property to the wife while in the meantime allowing any “income or loss[es]” to be attributed to himself.

As such, Binnie J. concludes that “far from offending the ‘object, spirit or purpose’ of the spousal attribution rules, the appellant’s tax plan fulfilled them, or at a minimum did not abuse them” (para. 93).

Statements Regarding the GAAR

With respect to the GAAR, Binnie J. was on the side of limiting the reach of the provision. This can be seen through his emphasis on the onus of the Minister to establish that the ‘object, spirit or purpose’ of a given provision has been frustrated. (para. 94) Additionally, Binnie J. also pointed out the “GAAR is a weapon that, unless contained by the jurisprudence, could have a widespread, serious and unpredictable effect on legitimate tax planning.” (para. 55)

Rothstein J.’s Opinion

Rothstein J. disagreed with both the majority opinion and Binnie J.’s dissent with regards to how they approached the attribution rules. Instead, he felt that s. 74.5(11) was a more specific anti-avoidance provision concerning the attribution rules which should be applicable. Since Canada Trustco indicated that the GAAR was a provision of last resort, he reasoned that the availability of an alternative provision for the Minister to argue under precluded the applicability of the GAAR. As such, since the Minister failed to invoke s. 74.5(11), there was nothing standing in the way of Mr. Lipson validly deducting the mortgage loan interest payments.

Looking Forward

While the exact consequences of this case will be borne out over the next months and years, the observation that “the line between legitimate tax minimization and abusive tax avoidance is ‘far from bright’” (para 63) nevertheless seems to remain. While this case may provide another example of when the GAAR is applicable, it also illustrates the difficulties with identifying the “object, spirit or purpose” of a given provision. Moreover, this case indicates the insufficiency of ensuring the legality of all constituent transactions. In light of this, it may very well be the case that greater uncertainty will creep into tax planning in the future.

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