Canada Trustco Mortgage Company v. The Queen

Canada Trustco Mortgage Company v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2003-05-07
Neutral citation
2003 TCC 215
File numbers
2002-1155(IT)G
Judges and Taxing Officers
Campbell J. Miller
Subjects
Income Tax Act
Decision Content
Docket: 2002-1155(IT)G
BETWEEN:
CANADA TRUSTCO MORTGAGE COMPANY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeals heard on February 17, 18, 26 and 27, 2003, at Toronto, Ontario,
By: The Honourable Judge Campbell J. Miller
Appearances:
Counsel for the Appellant:
Al Meghji and Monica Bringer
Counsel for the Respondent:
Alexandra Brown and Michelle Farrell
____________________________________________________________________
JUDGMENT
The appeals from assessments of tax made under the Act for the 1996 and 1997 taxation year are allowed, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that (i) with respect to the 1996 taxation year the reassessment was conceded by the Respondent to be statute barred; and (ii) with respect to the 1997 taxation year section 245 does not apply to disallow the capital cost allowance claimed by the Appellant.
The Appellant is entitled to its costs.
Signed at Ottawa, Canada, this 7th day of May, 2003.
"Campbell J. Miller"
J.T.C.C.
Citation: 2003TCC215
Date: 20030507
Docket: 2002-1155(IT)G
BETWEEN:
CANADA TRUSTCO MORTGAGE COMPANY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Miller J.
[1] This is a general anti-avoidance rule (GAAR) case, in which I must determine whether a complex arrangement entered into by the Canada Trustco Mortgage Company ("Canada Trust") in 1996 crosses the line from good business planning to GAARable tax planning. There is no question this was a good deal from the Appellant's perspective - the question is: Was it an abusive deal from a Canadian tax perspective? Was it a legitimate commercial financing transaction planned to obtain the most effective tax treatment, or was it a contrived purchase of a tax benefit wrapped up in commercial trappings?
[2] With the help of the Royal Bank of Canada ("RBC"), Canada Trust bought $120 million worth of trailers from Transamerica Leasing Inc. ("TLI"). The trailers were circuitously leased back to TLI. Canada Trust claimed approximately $31 million of capital cost allowance ("CCA"). The Minister of National Revenue ("the Minister") applied the GAAR to deny the tax benefit arising from this CCA. I find the transaction does not run afoul of GAAR because there has been no misuse of the provisions of the Act or an abuse having regard to the provisions of the Act read as a whole.
[3] In analyzing this transaction, I will follow the process set forth in section 245 itself and the approach favoured by the Federal Court of Appeal.[1]
1. Does the deferral of tax constitute a tax benefit?
2. Can the arrangement which resulted in the deferral reasonably be considered to have been entered primarily for bona fide purposes, other than to obtain the tax benefit?
3. Was there a misuse of provisions of the Income Tax Act (the Act) or abuse of the Act as a whole? This can be broken down into the following questions:
(i) Does the GAAR legislation capture a misuse or abuse of regulations under the Act?
(ii) What is the clear and unambiguous policy underlying the capital cost allowance (CCA) treatment in the sale-leaseback arrangements of exempt property?
(iii) Has there been a misuse or abuse due to:
(a) there being no real cost against which there can be a claim for CCA; or
(b) the transaction not being in the context of a financing arrangement.
4. What are the reasonable tax consequences to the Appellant in the circumstances to deny the tax benefit?
Facts
[4] The parties provided an Agreed Statement of Facts (Partial) and an Agreed Statements of Facts Supplementary (Partial), along with supporting documents to those agreed facts. The Appellant called one witness, Mr. Michael Lough, the officer of the Appellant who recommended this transaction to the Appellant's Board. The Respondent called no witnesses but submitted, pursuant to section 30 of the Canada Evidence Act, a business records affidavit of John Tanter, a Vice-President of Royal Bank of Canada Europe Limited (RBCEL). I will describe the relevant agreed facts before dealing with the other evidence.
A. Introduction
1. The Appellant was at all material times a large diversified financial institution carrying on business in Canada and a large corporation within the meaning of the Income Tax Act (Canada) (the "Act").
2. The Appellant was at all material times a company subject to the Trusts and Loan Companies Act and regulated in Canada by the Office of the Superintendent of Financial Institutions ("OSFI").
3. At all material times, the Appellant carried on business in Canada under the name Canada Trust in combination with its subsidiaries, including The Canada Trust Company. In an extract from the annual report of the Appellant's parent corporation CT Financial Services the operations and business of the Appellant are described as follows:
... Canada Trust also holds a portfolio of loans and leases to government agencies and large companies. Canada Trust does not intend to make any significant increase in this class of investment and since 1995, it has gradually reduced the size of the existing portfolio. ...
B. Approval to enter into said transactions
4. The transactions that are the subject matter of this appeal resulted from negotiations that were carried out by the Appellant and the other parties over a period of several months leading to the execution of a Term Sheet (the "Final Term Sheet") by the Appellant and other parties.
5. The transactions that are the subject matter of this appeal were entered into by the Appellant after approval was granted first by the Appellant's "Senior Credit Committee" ("SCC") and then by the Executive Committee of the Appellant's Board of Directors ("Executive Committee").
6. Appendix 1 is an authentic copy of a schedule produced by the Appellant setting out its investment in the lease, the return on that investment and the tax and accounting consequences of the transactions that are the subject matter of this appeal.
C. The Purchase and Sale of the Equipment
7. The Appellant entered into an equipment purchase agreement (the "Equipment Purchase Agreement") dated December 17, 1996, in respect of the purchase of certain equipment (the "Equipment") from Transamerica Leasing Inc. ("TLI"), a corporation resident in the United States of America, for a price of $120 million (CDN).
8. The parties are agreed that the fair market value of the said Equipment was $120 million (CDN) at the material time.
9. The terms of the Equipment Purchase Agreement provide, inter alia, that TLI agrees to sell, transfer and assign to the Appellant, the Appellant agrees to purchase of the Equipment absolutely (subject to the Operating Leases as defined therein), and at closing (December 17, 1996), a certificate of delivery, title to, ownership of and risk of loss in and to the Equipment shall pass from TLI to the Appellant.
D. TLI to hold title documentation in trust for the Appellant
10. The Appellant entered into a trust agreement (The "Trust Agreement") dated December 17, 1996 with TLI.
11. The terms of the Trust Agreement provide, inter alia, that solely for administrative convenience the Appellant appoints TLI as trustee and agent of the Appellant to hold in TLI's name, for and on behalf of the Appellant each Certificate of Title, Certificate of Ownership, registration and like documentation in respect of the Equipment.
E. Loan to the Appellant
12. The total purchase price of the Equipment was $120 million (CDN). In addition, the Appellant incurred $2.34 (CDN) in related transaction costs.
13. Approximately $24.98 million (CDN) of the Appellant's own funds were used to purchase the Equipment.
14. The balance of the required funds, approximately $97.35 million (CDN), was borrowed by the Appellant from the Royal Bank of Canada ("RBC") pursuant to the terms of a loan agreement (the "Loan Agreement"), dated December 17, 1996 between the Appellant and RBC (the "Loan").
15. The terms of the Loan Agreement provide, inter alia, that:
(a) the interest rate on the Loan was 7.5%; and
(b) the Appellant is required to make semi-annual instalment payments of principal and interest on the Loan to RBC as set out in "Schedule 2" to the Loan Agreement (the "Loan Instalment Payments").
(c) The terms of the Loan Agreement also provide that the Bank's recourse against the Appellant is limited as described in Article 4.2.
F. Leasing of the Equipment to MAIL
16. The Appellant entered into a lease agreement (the "Lease"), dated December 17, 1996, to lease the Equipment to Maple Assets Investments Limited ('MAIL"), a limited liability company incorporated under the laws of England.
17. The terms of the Lease include the following:
(a) the term of the Lease is for an initial period ending December 1, 2014;
(b) the Rent Payments under the Lease are based upon an effective rate of 8.5%;
(c) MAIL, as lessee, is required to make semi-annual payments to the Appellant as lessor in the amounts set out in "Schedule C" attached to the Lease (the "Rent Payments"); and
(d) MAIL is provided with an option to purchase the Equipment (the "Option Price") CDN $84 million being the First Option Value on December 1, 2005 and another option exercisable at the fair market value on December 1, 2014.
G. Sub-Lease of the Equipment to TLI
18. MAIL entered into a sub-lease agreement (the "Sub-Lease") dated December 17, 1996, to sub-lease the Equipment to TLI.
19. Most of the terms of the Sub-Lease are similar to those found in the Lease. The Sub-Lease provided TLI, as sub-lessee, purchase options similar to those provided to MAIL under the Lease. One term in the Sub-Lease which differs from the terms of the Lease is that the Sub-Lessee was required to pre-pay to MAIL on the date of closing all amounts that are or may become due under the Sub-Lease.
H. Co-ordination Agreement
20. The Appellant entered into a co-ordination agreement (the "Co-ordination Agreement") dated December 17, 1996 with TLI and MAIL.
I. Non-Disturbance Undertaking
21. The Appellant gave a non-disturbance undertaking, dated 17 December, 1996, relating to the Lease, the Sub-Lease and the Co-ordination Agreement (the "Non-Disturbance Undertaking").
J. Security for the Lease and Loan
22. On or about December 17, 1996, TLI pre-paid its payment obligations under the Sub-Lease to MAIL, in the approximate amount of $116.4 million (CDN) (the "Pre-payment").
23. On or about December 17, 1996 MAIL applied the Pre-payment funds as follows:
(a) MAIL placed on deposit with the RBC an amount equal to the Loan (approximately $97.35 million (CDN) (the "Defeasance Payment"); and
(b) MAIL paid the balance of the Pre-payment (approximately $19 million) to Royal Bank of Canada Trust Company (Jersey) as trustee of the Maple Assets Charitable Trust ("RBC Jersey") on the condition that RBC Jersey use these funds to purchase a Government of Ontario bond (the "Bond"), maturing on the December 1, 2005.
24. The Appellant, MAIL and RBC Jersey entered into a support agreement (the "Support Agreement"), dated December 17, 1996. RBC Jersey, entered into the Support Agreement in its capacity as trustee of the Maple Assets Charitable Trust (the "Trust"). RBC Jersey is a wholly owned subsidiary of RBC. Pursuant to the terms of the Support Agreement, the Trust agreed to purchase the Bond and agreed to pledge it as security in support of MAIL's obligation to pay the Purchase Option Payments or the Termination Values.
25. The Appellant, and RBC Jersey, in its capacity as trustee of the Trust, entered into a pledge agreement (the "RBC Pledge Agreement") dated December 17, 1996. Pursuant to the terms of the RBC Pledge Agreement, the Bond was pledged to the Appellant as security for MAIL's obligations under the Lease.
26. The Appellant entered into a security assignment (the "Security Assignment"), dated December 17, 1996 with RBC.
27. Pursuant to the terms of the Security Assignment, the Appellant provided RBC with an assignment of the Rent Payments owed from MAIL, provided MAIL with an irrevocable instruction to pay the assigned Rent Payments to RBC and agreed that Rent Payments be applied by RBC to the Loan Instalment Payments.
K. Other Agreements
28. The Appellant entered into a pledge agreement (the "MAIL Pledge Agreement") dated December 17, 1996 with MAIL.
29. The Appellant entered into a custodial agreement (the "Custodial Agreement") dated December 17, 1996, with RBC Jersey, in its capacity as trustee of the Trust, and Scotia McLeod Inc. as Custodian. Under the terms of this agreement, the Custodian agrees to hold the Bond or Replacement Bonds until the Bonds mature or are disposed of.
30. A management agreement dated December 17, 1996 was entered into between MAIL, RBC Jersey and Royal Bank of Canada Trust Corporation Limited, a company incorporated under the laws of England (the "Management Agreement"). Under the terms of the Agreement, RBCTC undertook to manage and fulfil the affairs and obligations of MAIL under the Transaction Documents and to provide the directors and officers of MAIL.
31. A Guarantee dated December 18, 1996 was entered into between Transamerica Finance Corporation (TFC) the parent corporation of TLI and MAIL (the "TFC/MAIL Guarantee"), whereby Transamerica unconditionally and irrevocably guarantees to MAIL the performance of all of TLI's obligations under the Co-ordination Agreement and the Sub-Lease Agreement.
32. A Guarantee dated December 18, 1996 was entered into between TFC and the Appellant (the "TFC/Appellant Guarantee"). By the terms of this Guarantee, TFC unconditionally and irrevocably guarantees all the obligations owed by TLI to the Appellant under the Equipment Purchase Agreement, the Co-ordination Agreement and the Trust Agreement.
L. Tax Reporting and assessments
33. In computing its income for the 1996 and 1997 taxation years the Appellant reported leasing income in the amounts of $48,920,847 and $51,787,114, respectively.
34. In computing its income for the 1996 and 1997 taxation years the Appellant deducted capital cost allowance ("CCA") in respect of its leasing assets in the amount of $36,214,174 and $46,365,889, respectively. Pursuant to Regulation 1100(15) these capital cost allowance claims were made only against the leasing income realized by the Appellant in the particular years.
35. By way of a reassessment dated October 18, 2002 the Minister reassessed the Appellant in respect of its 1997 taxation year by denying it the class 10 CCA claim of $31,196,700. The Minister reassessed on the basis that the Appellant had failed to acquire title to the equipment and, in the alternative, that section 245 of the Income Tax Act ("the GAAR") applied to deny the Appellant a deduction for the said CCA. The Attorney General has since abandoned the argument that the Appellant failed to obtain title to the equipment and the sole ground on which Attorney General seeks to sustain the reassessment is the GAAR. In reassessing, the Minister did not assume as a fact, and the Attorney General does not assert that:
· any of the transactions in issue were a sham or were legally ineffective;
· that the fair market value of the equipment at the time of the purchase by the Appellant was not $120 million;
· that, with respect to the lease between the Appellant and MAIL, the rental rate on the equipment was not a market rate; or
· that, with respect to the loan from the Royal Bank, the rate of interest on the loan was not a market rate.
Mr. Lough's evidence
[5] Mr. Lough was actively involved in the negotiation and finalization of these transactions on behalf of the Appellant. He testified that he had given the arranger, Macquarie Corporate Finance (USA) Inc. ("Macquarie"), the idea that the Appellant wanted a leasing transaction for $100 million. He stated that he had specified the type of equipment (long-term assets easy to value, such as tractors or trailers), the length of the term and the strength of the counterparty sought. He did not stipulate that the Appellant had any need for financing. The structure of the deal was left to the arranger. Mr. Lough acknowledged the Appellant had engaged previously in a similar structure to the one ultimately implemented. He further acknowledged the type of assets sought was due to their good after-tax return.
[6] Macquarie eventually found the Transamerica Leasing Inc. deal, which did involve the financing piece for the Appellant. Mr. Lough described the benefit of the financial arrangement as improving the economics of the transaction, by allowing the netting of the non-recourse loan against the total value of the lease for purposes of financial reporting on the balance sheet, which reduced the amount of capital the Appellant was required by regulatory authorities to hold, and also by relying on leveraged lease accounting to draw income to the early part of the lease.
[7] Mr. Lough agreed that the non-recourse financing modestly reduced the risk, although the Appellant was comfortable with the financial strength of TLI's parent. He testified that the non-recourse financing had no effect on the equipment purchase or the lease.
[8] Mr. Lough was made aware of the prepayment aspect of the transaction when Macquarie first made the TLI proposal to the Appellant. He viewed this element as more TLI's business than the Appellant's, as he stated it had no impact on the economics of the deal to the Appellant. Mr. Lough ran the deal through the Appellant's usual credit approval process, including having the trailers appraised. This led to the submission of a credit application to the Internal Credit Committee, which in turn led to the production of the Final Term Sheet. It was clear all steps in the transaction were contemplated to be concluded and were concluded on one day in December 1996.
[9] From a review of the Final Term Sheet, Mr. Lough confirmed that:
(i) there were no ongoing lease obligations from TLI after the prepayment, though there were obligations with respect to indemnities, early terminations and that sort of thing;
(ii) the deal could be unwound if there were adverse changes affecting the Appellant;
(iii) the RBC recourse for the loan payments was from the stream of lease payments due to the Appellant and that those loan payments were equal to the lease payments; and
(iv) the difference between the price received by TLI for the trailers from the Appellant and the prepayment of rent paid to Maple Assets Investments Limited (MAIL) was 3.35 per cent of the trailer cost, which Mr. Lough referred to as the net present value benefit.
[10] From a review of the credit application, Mr. Lough confirmed that:
(i) subject to indemnities there was no ongoing financial obligation of TLI;
(ii) risk of the inability of MAIL to make the first option payment was mitigated by MAIL's acquisition of a province of Ontario bond and the provision to the Appellant of a security interest in the bond;
(iii) the net investment was initially intended to be $24,985,541 which reduced over the first 2½ years and then went into a negative position; the projected $8.5 million income was accounted for over the initial 2½ year-period based on the leverage of the lease accounting approach;
(iv) the lease payments and a portion of the first option price would go to pay off the RBC loan;[2] the remainder of the purchase option price would be covered by the bond and would yield the $8.5 million before tax return on the Appellant's approximate $25 million investment;[3]
(v) there were no ongoing schedule payment obligations of TLI due to the prepayment it made and therefore there were no credit risk to the lessee;
(vi) ownership of the trailers would provide CCA of 30 per cent on a declining balance basis on the purchase of the $120 million worth of equipment to shelter lease income;
(vii) the transaction provided a shareholder value added to tax capacity ratio of 25 per cent, which Mr. Lough explained to mean the economic value added; basically it was an effective transaction;
(viii) the Appellant would obtain an opinion that it would be entitled to the CCA and that the lease investment met all current Canadian tax regulations; and
(ix) the transaction should be recommended as tax effective in utilizing the tax benefits to offset unsheltered taxable lease income.
Mr. Lough's recommendation went to the Board of the Appellant on similar terms.
[11] Mr. Lough briefly went over the financial projection of the deal which is attached as Appendix "A". In addressing the purpose of the transaction Mr. Lough's evidence was as follows:
Q. Mr. Lough, why did Canada Trust, or why did the appellant do the transactions that are the subject matter of this litigation?
A. We did these transactions as an investment to earn income for the Canada Trust. It was, you know, we, as I had mentioned earlier, we had, you know, a number of alternatives that my department looked at. The lease portfolio had run off in recent years so we were looking to do a lease in order to, you know, to maintain the diversification between the various portfolios.
Q. Mr. Lough, how did - did tax considerations enter into the decision to do this transaction? And if they did, how?
A. You know, certainly we looked at the after tax returns on this transaction as we would on any sort of transaction.
[Transcript page 66 line 10 to page 67 line 1]
Other evidence
[12] Apart from the documentation of the transaction itself introduced as evidence, the Appellant also entered several follow-up correspondences between Alan Wheable, Vice-President, Taxation, TD Bank Financial Group and the CCRA representative Guy Alden. The gist of these communications is that Canada Trust clarified with CCRA the role played by regulatory capital requirements.[4] What is apparent from this evidence is that the way the financing was structured, that is by the use of non-recourse debt, significantly improved Canada Trust's management of these requirements, though was of no economic import to Canada Trust. This advantage to Canada Trust was as a result of the net investment balance actively going negative (see Appendix A, Column 11) - this was triggered by the substantial CCA claimed.
[13] Finally, the Respondent produced a Business Records Affidavit from John Tanter,[5] which attached the Transaction Request - Structured Finance, created in the Structured Finance Division of RBC London. This document refers to the facility sought by the Appellant as a "Limited Recourse Cash Backed Term Loan Facility as part of a Canadian Cross-Border Leveraged Tax Lease". It was diagrammed as set out in Appendix "B".[6] The Transaction Request described the purpose of the facility as follows:[7]
Purpose
TL is currently leasing Trailers to several End Users (location not relevant since we are not taking risk on them) through operating leases. To lower the financing costs TL will sell the Trailers to CTM who depreciate the assets and claim the Capital Allowances. CTM will finance the purchase using a combination of debt and equity, with the interest on the debt being tax deductible. CTM will lease the Trailers to a UK SPC, who will on-lease it to TL. The benefit arising from the allowances and deductibility of interest will be shared with TL via the lease rentals. Since TL is the Seller as well as the Sublessee, it can enhance the benefit even further by using the money received from the sale of the Trailers to prepay its lease rentals (ie it pays the present Value of the lease rentals). Part of the prepayment of the lease rentals will be used as cash collateral for the loan to CTM, thus eliminating the risk for the lending bank but CTM will still be able to deduct the interest costs.
[14] Later, in detailing the structure of the transaction the Transaction Request states:[8]
To reduce the cost of funds for TL, TL wish to defease their debt and to hedge its "equity" obligations to CTM by way of buying a gov't of Ontario bond. In order to do this, TL prepays its obligations to MAIL under the sub-lease, which on day one is C$120MM less lease benefit of approx. C$3.5 MM. MAIL, in turn, upon receiving the TL prepayment, makes payment to RBC London of C$97.4MM to cover the debt defeasance - and that obligation is then taken on by RBC - and it also makes payment of C$19MM to MAIL for the equity hedging.
Appellant's Position
(1) Tax Benefit
[15] The Appellant contends the concept of tax benefit is comparative; that is, tax benefit compared to what? In the Appellant's view, compared to a standard sale-leaseback, which would have yielded the identical CCA treatment. Therefore, there is no tax benefit.
(2) Purpose other than to obtain a tax benefit
[16] Mr. Meghji's starting point in this argument is that an ordinary sale-leaseback is not an avoidance transaction. The differences between the ordinary sale-leaseback and this transaction are the elements of the TLI prepayment, the defeasance by MAIL and the RBC Limited recourse financing. None of which, according to the Appellant, impact on the tax treatment of this transaction versus the ordinary sale-leaseback.
[17] The Appellant was in the business of providing financing through lease transactions. This is evident from the significant leasing income against which the Appellant could use the CCA. The investment was analyzed as any other investment, and was entered into for the purpose of earning income. Indeed, the 8.5 per cent rate of return compared favourably to returns on other types of investments. The limited recourse feature of the debt had commercial benefits, which were acknowledged by CCRA's representative. This was clear from the communications between Mr. Alden, the CCRA representative and Mr. Wheable, Vice-President. These communications do not prove the tax motive, as the Respondent suggests, but a commercial purpose derived in part from the tax treatment.
(3) Misuse or Abuse
(i) Applicability of GAAR to Regulations
[18] As subsection 245(4) refers specifically to a misuse of "the provisions of this Act" it should not be interpreted to capture Regulations. This view is supported by both the Fredette v. The Queen[9] and Rousseau-Houle v. The Queen[10] decisions. The alleged misuse in this case is of the Regulations, not the legislation.
(ii) What is the clear and unambiguous policy?
[19] The policy behind the leasing property rules clearly sanctions the application of a loss generated by claiming CCA in respect of one leased property against rental income from another leased property. The specified leasing property rules limit the amount of CCA available to a lessor of property other than "exempt property". The policy behind the "exempt property" list is that it applies to certain types of property based on the attributes of the property itself. By their very nature of being trailers, the equipment qualifies as exempt property in the context of a leasing arrangement. The leasing property and specified leasing property rules provide a clear framework limiting a lessor's claim to CCA.
[20] The Appellant provided a history of the leasing property rules to assist with the identification of the clear policy. In 1976, the leasing property rules (Regulation 1100) were introduced to restrict CCA on leasing property to be applied against leasing income. This legislation was introduced in the following manner by the 1976 Budget Papers:[11]
While there is much leasing which is entered into for bona fide commercial reasons, nevertheless there is need for a tax rule to prevent unwarranted use of capital cost allowances. The most direct approach would be to look through the form of leases and distinguish between those which are in substance financing arrangements designed to transfer the deductibility of capital cost allowances, and those which are true leases in a more conventional sense. However, past experience and further study indicates that this approach is highly impractical, and that there is need for a more general rule of a workable nature.
It is therefore proposed that with respect to all leases of moveable property, the capital cost allowances thereon cannot be used to create a loss to shelter non-leasing income. This rule would apply to individuals and corporations. It would not affect those taxpayers such as equipment dealers or manufacturers who are allowed for tax purposes to treat moveable property held for both sale or lease as inventory.
[21] The application of CCA from one leasing property against rental income of another leasing property is clearly sanctioned by the Regulations. This is exactly what the Appellant did.
[22] The specified leasing property rules were introduced in 1989, further restricting the amount of CCA available in respect of "specified leasing property". Leases of such property were recharacterized as a loan. Certain properties were exempt from the specified leasing property rules. Trailers designed for hauling freight were on the exempt list. The 1989 Budget Supplementary Information stated:[12]
The new regime will not apply to assets which are commonly leased for operational purposes and for which CCA reasonably approximates actual depreciation. Based upon these considerations, leases of computers, office equipment and furniture having a value of up to $1 million each, residential furniture and appliances, buildings, automobiles and light trucks will be exempt from these rules. The rules will not, of course, apply in respect of the licensing of films, video tapes, patents, and other intangible properties.
The trailers in issue have the necessary attributes of "exempt property".
[23] In 1991, the Government of Canada added railway cars to the exempt list. Once added, it is implicit that the Minister of Finance is of the view that the CCA rate approximates economic depreciation.
[24] While the clear and unambiguous policy behind the specified leasing property rules is to restrict the CCA which a lessor may claim, the clear and unambiguous policy is also that specified leasing property rules not apply to exempt property. The policy behind the exempt property list is that it applies to certain types of property based on the attributes of the property itself.
(iii) Has the policy been misused or abused?
(a) On the basis there is a zero cost
[25] The Appellant rejects the Respondent's position that there is a misuse or abuse because the transaction resulted in the Appellant having no "real cost" in respect of the trailers. The Appellant did have a "real cost" of approximately $120 million. It is not open to the Respondent to recharacterize a transaction and then allege misuse or abuse based on the recharacterized transactions. The question of misuse or abuse applies to the legal rights and obligations that exist, not to a recharacterization of such rights. Only after a misuse has been found can the transaction then be recharacterized to determine the appropriate tax consequences. The Appellant cites The Queen v. Canadian Pacific Limited[13] in support of this proposition.
[26] In Canadian Pacific and in Consumers' Gas Company Ltd. v. The Queen,[14] it is established that cost in property, "real" or otherwise, does not turn on economic burden, but upon what outlay was made for the property. The Appellant also relies also on the comments of Le Dain J. in Gelber v. The Queen:[15]
... In my opinion, the fact that a purchaser of property provides, as a condition of the purchase, for a leaseback under which he is assured of a revenue that will cover the amount of his investment and some return on it does not make the purchase price any less the true capital cost of the property. The degree to which an investment is at risk is not, in the absence of a provision in the Act or the regulations to that effect, a valid criterion as to what is capital cost.
Similarly in Signum Communications Inc. v. The Queen[16] the Court applied the decisions in Reed (H.M. Inspector of Taxes) v. Young[17] and Gelber to hold that a limited partner could claim a loss beyond his at-risk amount where no statutory at-risk rules were applicable.
[27] The Appellant argues that Parliament reacted to the case law, rejecting the premise that cost is determined by extent of economic burden by introducing a number of specific provisions to override the case law: limited partnership-at-risk rules, tax shelter rules, limited recourse debt rules, and computer software tax shelter rules. These do not apply here.
(b) On the basis there is no financing provided to the lessee
[28] The Appellant rejects the Respondent's no-financing argument on the basis that the policy identified by the Appellant is not couched in terms of financing being an essential requirement of such a policy. Even if financing were necessary to be in compliance with the policy, financing was in this case provided to TLI. The Respondent's position ignores the Appellant's perspective. What TLI proceeds to do is just not relevant to the finding of whether financing was provided. No policy requires that the vendor under a sale-leaseback arrangement must use the proceeds in any particular manner.
[29] The alleged misuse is directed at, in this case, the lessor, so surely it is the lessor's perspective which must be considered. But, even in considering the lessee's viewpoint, the Appellant's position is that the Appellant obtained financing. The factors that might suggest no financing was provided, do not involve the lessor (for example, the prepayment by the lessee), and consequently cannot affect the CCA claim.
(4) Reasonable consequences
[30] There is no dispute that the reassessment in issue arose because of the fact of the prepayment, defeasance and the limited-recourse financing. The Respondent has admitted that the purchase of the equipment and the lease with MAIL are not objectionable per se. The Appellant says that in order for the tax consequences to be considered reasonable in the circumstances, there should be some reasonable nexus between the abusive transactions and the resulting tax consequences. The entitlement to the CCA claim arose from the purchase of the equipment and the lease with MAIL and not the purportedly abusive transactions. As such the Appellant says that even if one were to accept the Minister's theory of the misuse and/or abuse, the denial of the CCA or the cost is not reasonable in the circumstances.
Respondent's Position
(1) Tax benefit
[31] The Respondent suggests that no comparable is required to find that there is a tax benefit, in this case, the benefit being the deferral of tax that arises by nature of the deduction of CCA in the amount of $31,196,700 for 1997. And even if a comparable were required to determine the tax benefit, the only comparable in this case would be no investment at all; that is, the Appellant would not have bought trailers without concurrently entering into the whole arrangement, which provided the tax benefit without any ongoing risk.
(2) Purpose other than to obtain a tax benefit
[32] Firstly, the Respondent maintains that the whole arrangement, not just the acquisition of the trailers, is an avoidance transaction. It is not appropriate to parse out the separate elements of the arrangement. Neither the acquisition nor the arrangement as a whole was undertaken primarily for a bona fide reason other than to obtain the tax benefit. There was nothing to this deal except the tax benefit. Relying on an objective determination, by examining contemporaneous events, this pre-ordained series of transactions was entered into primarily for the purpose of obtaining the tax benefit and sheltering other income.
[33] The Respondent relies on Mr. Lough's report to the Credit Committee in which he refers to the tax benefits generated by the transaction. This was further supported by the summary for presentation to the Board, which talked in terms of the sheltering of other taxable lease income. This, the Respondent suggests, was in the context of a company winding down its leasing operations, as stated in the company's 1996 annual return. The Respondent also relies on the RBC analysis which refers to a "tax lease".
[34] As the transaction presents no risk to the Appellant, the Respondent maintains it lacks commerciality. Also, the Respondent suggests a further lack of commerciality due to the ability for the deal to be unwound if tax laws change to adversely affect the Appellant.
[35] Further, the fact TLI could, after closing the transaction, claim depreciation for accounting and US tax purposes is significant.
(3) Misuse or Abuse
(i) Applicability of GAAR to Regulations
[36] The Rousseau-Houle decision upon which the Appellant relies is under appeal. The Respondent simply disagrees with that decision. Many of the details of the CCA scheme, while found in the Regulations are rooted in the Act. Specifically, paragraph 18(1)(b) provides no deduction shall be allowed for an amount on capital account "except as expressly permitted by this Part." Also, subsection 20(1) provides that:
20(1) Notwithstanding paragraphs 18(1)(a), (b) ... there may be deducted ...
(a) such part of the capital cost to the taxpayer of property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by regulation;
[37] GAAR specifically refers to an analysis of the abuse "having regard to the provisions of this Act ... read as a whole". The Regulations are inextricably connected to the Act.
[38] Finally, relying upon the Supreme Court of Canada decisions in Attorney General of Québec v. Blaikie[18] and Leaf v. Governor General in Council[19] the Respondent argues the Supreme Court of Canada, outside the criminal context, has endorsed the proposition that "Act" includes subordinate legislation such as Regulations.
(ii) What is the clear and unambiguous policy?
[39] The clear and unambiguous policy behind CCA is to recognize the capital cost of assets consumed in a taxpayer's business.
[40] Recognizing that leasing arrangements afforded lower financing costs to lessees by transferring CCA entitlement to a lessor, the government introduced the leasing property rules to limit CCA to lessors to application against their leasing income. As these arrangements continued to proliferate the specified leasing property rules were introduced, with the effect of treating payments under a lease as if they were loan payments of principal and interest. Exceptions in the form of exempt property were identified: these were assets commonly leased for operational purposes and for which CCA reasonably approximated depreciation.
[41] The Respondent cites the Department of Finance Technical Notes of March 14, 1991, quoting the Regulatory Impact Analysis Statement:[20]
In many cases, leasing constitutes a financing alternative to conventional purchasing and borrowing. For taxpayers who are not currently taxable, leasing may provide a form of after-tax financing ... the tax advantages of leasing arise because the capital cost allowance (CCA) for leased property may exceed actual depreciation. In this situation, leasing allows a non-taxpaying lessee to trade accelerated CCA which the lessee cannot use to a taxpaying lessor in return for reduced rental payments. For the lessor, the accelerated write-offs defer taxes payable on other income - a benefit that can extend indefinitely if the asset base of the lessor is expanding. While a lower cost of financing can be achieved by leasing in these circumstances, the savings are generated at the expense of government tax revenues.
[42] Further, the April 27, 1989, Budget Papers state:[21]
The government has made a number of changes to the Income Tax Act over the last five years to curtail opportunities for after-tax financing ... Consistent with these changes, the budget proposes to alter the tax treatment of certain leases for the purposes of the CCA provisions. These changes reduce the tax advantages of leasing for taxpayers who are tax-exempt or who are currently not taxable. The changes do not, however, alter the relative treatment of leased assets and purchased assets where there is no benefit from transferring deductions. In particular, special rules are provided to ensure that the full benefit of capital cost allowance remains available to taxpayers using the leased property in the course of their businesses.
(iii) Has the policy been misused or abused?
(a) On the basis there is a zero cost
[43] The Respondent's position is that the true economic substance in this case is that the Appellant incurred no cost, and Parliament did not intend that a taxpayer with no true cost be allowed to claim CCA. The prepayments in the context of the non-recourse loan insured the Appellant had no economic risk. Borrowed funds from RBC were returned the same day, not used to acquire capital assets in an income-earning process. Even the Appellant's equity funding was ultimately covered by a province of Ontario bond.
[44] The Respondent relies on comments in the Tax Court of Canada decisions of McNichol v. The Queen[22] and RMM Canadian Enterprises Inc. et al v. The Queen[23] for the proposition that the Court must look at "the effect of the transaction viewed realistically".
(b) On the basis there was no financing
[45] The policy underlying the specified leasing property rules is to allow leasing to persist as an alternative method of financing while limiting tax advantages of doing so. The Respondent submits that the object and spirit of the specified leasing property rules is to reduce the tax advantage of leasing while continuing to allow lease financing to acquire assets for operational purposes. No such financing was provided in this case to bring the Appellant within this context.
(4) Reasonable tax consequences
[46] The Respondent proposes that the reasonable tax consequences are as follows: Where the misuse and abuse arise: (a) because the Appellant did not incur any real cost, the Appellant should be taxed as if its cost for CCA purposes is nil; or, alternatively, (b) because there was no financing provided, the Appellant should be taxed as if the specified leasing property rules apply with the result that no CCA is available.
Analysis
[47] Section 245 of the Income Tax Act reads in part as follows:
245(1) In this section,
"tax benefit" means a reduction, avoidance or deferral of tax or other amount payable under this Act or an increase in a refund of tax or other amount under this Act;
"tax consequences" to a person means the amount of income, taxable income, or taxable income earned in Canada of, tax or other amount payable by or refundable to the person under this Act, or any other amount that is relevant for the purposes of computing that amount;
"transaction" includes an arrangement or event.
(2) Where a transaction is an avoidance transaction, the tax consequences to a person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that, but for this section, would result, directly or indirectly, from that transaction or from a series of transactions that includes that transaction.
(3) An avoidance transaction means any transaction
(a) that, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit; or
(b) that is part of a series of transactions, which series, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.
(4) For greater certainty, subsection (2) does not apply to a transaction where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of this Act or an abuse having regard to the provisions of this Act, other than this section, read as a whole.
(5) Without restricting the generality of subsection (2),
(a) any deduction in computing income, taxable income, taxable income earned in Canada or tax payable or any part thereof may be allowed or disallowed in whole or in part,
(b) any such deduction, any income, loss or other amount or part thereof may be allocated to any person,
(c) the nature of any payment or other amount may be recharacterized, and
(d) the tax effects that would otherwise result from the application of other provisions of this Act may be ignored,
in determining the tax consequences to a person as is reasonable in the circumstances in order to deny a tax benefit that would, but for this section, result, directly or indirectly, from an avoidance transaction.
[48] There has been ample written about this most unique piece of legislation that no explanatory preamble is required before heading down the analytical path recommended by the Federal Court of Appeal in OSFC and Water's Edge.
1. Does the deferral of tax constitute a tax benefit?
[49] The legislation defines a tax benefit as "a deferral of tax under the Act". It seems clear that on the simplest construction of these words the approximate $31 million CCA claimed by the Appellant in 1997 results in a tax deferral which would therefore be a tax benefit. Yet, in tax laws nothing is apparently as simple as it appears. One must read these words in a comparative sense argues Mr. Meghji, relying on Judge Bonner's comments in the McNichol and Canadian Pacific cases, and on editorial comment of Mr. Harry Erlichman.[24]
[50] There may be cases which lend themselves to a comparative analysis for purposes of clearly identifying the tax benefit. But some transactions do not lend themselves to such an approach. This is one of them. This is not a case of a commercial venture whose very essence is readily separable from any tax implications, which can be compared to a like venture with tax implications then overlaid. The difficulty with this transaction is that the tax is integral to the very commerciality of the deal - there is no simple tax-untainted transaction to compare to.
[51] I am not satisfied that the comparative requirement is even a necessary part of the analysis of tax benefit. In this case, it is acknowledged that the benefit, if any, is a tax deferral. When you read the term "tax deferral" (or even tax reduction) in the context in which it is used (being subsection 245(3) of the Act), that section then reads as follows: "An avoidance transaction means any transaction ... that, but for this section, would result, ...in a tax deferral".
[52] I suggest the logical interpretation of this would be that the deferral (or reduction even) arises not in comparison to some hard-to-establish normative transaction, but in comparison to the taxpayer's position before the purported avoidance transaction. Indeed, many reductions, deferrals or avoidances will be tax benefits, but certainly not all are avoidance transactions. The definition of tax benefit should not be determined in a vacuum, but should be determined in the context of the question of whether there is an avoidance transaction. In this case, after the Appellant's transaction, there has been a deferral of tax compared to prior to the transaction. This leads to the question of the purpose behind the transaction to determine whether it is indeed an avoidance transaction.
2. Can the arrangement which resulted in a deferral reasonably be considered to have been entered primarily for bona fide purposes other than to obtain the tax benefit?
[53] The distinction between the sort of arrangement before me, and other arrangements that have been subjected to GAAR, is that in a form of sale-leaseback transaction, the CCA treatment is not extraneous to the commercial venture, but intrinsic to it. A financial institution which provides lease financing is aware of the specified leasing property rules, and the ability to continue to receive generous CCA treatment with respect to exempt property. This fact came through loud and clear in Mr. Lough's recommendations to the Credit Committee, and in the Final Term Sheet itself. This is not a situation of tax treatment being applied, after the fact, to a commercial transaction, but being inextricably caught up in the commercial venture. It becomes difficult therefore to disassociate the bona fide purpose of "other than to obtain the tax benefit" from the purpose of obtaining the tax benefit, in trying to determine which is the primary purpose.
[54] The Respondent argues that this is not difficult at all, because there are no competing purposes - there is only one purpose - to obtain the tax benefit. Obviously it will therefore be the primary purpose. The Appellant takes the position that, while there may be a tax-motivated purpose, it was incidental to the commercial purpose of engaging in the Appellant's profitable business of lease financing, and more specifically, to maintain some sort of diversification amongst its investments. While I do not accept the Respondent's contention that there was only one purpose, the tax purpose, I do find that, on balance, these transactions cannot be viewed as having been undertaken primarily for bona fide purposes other than to obtain the tax benefit.
[55] In arguing this aspect of the case, Mr. Meghji makes much of the contention that, had this been an ordinary sale-leaseback, it would not have been offside. That may be so, but not necessarily because it would not be viewed as an avoidance transaction, but more, I would suggest, because it would not be viewed as an abuse or misuse of provisions of the Act. I am prepared to deal with the