Canada v. Oxford Properties Group Inc.

Canada v. Oxford Properties Group Inc.
Court (s) Database
Federal Court of Appeal Decisions
Date
2018-02-01
Neutral citation
2018 FCA 30
File numbers
A-399-16
Notes
Reported Decision
Decision Content
Date: 20180201
Docket: A-399-16
Citation: 2018 FCA 30
CORAM:
NOËL C.J.
DAWSON J.A.
RENNIE J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
and
OXFORD PROPERTIES GROUP INC.
Respondent
Heard at Toronto, Ontario, on December 11, 2017.
Judgment delivered at Ottawa, Ontario, on February 1, 2018.
REASONS FOR JUDGMENT BY:
NOËL C.J.
CONCURRED IN BY:
DAWSON J.A.
RENNIE J.A.
Date: 20180201
Docket: A-399-16
Citation: 2018 FCA 30
CORAM:
NOËL C.J.
DAWSON J.A.
RENNIE J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
and
OXFORD PROPERTIES GROUP INC.
Respondent
REASONS FOR JUDGMENT
NOËL C.J.
[1] This is an appeal by Her Majesty the Queen (the Crown or the appellant) from a decision of the Tax Court of Canada in which D’Arcy J. (the Tax Court judge) allowed Oxford Properties Group Inc.’s (Oxford or the respondent) appeal from a reassessment issued by the Minister of National Revenue (the Minister) with respect to its 2006 taxation year. The reassessment was issued pursuant to the General Anti-Avoidance Rule (GAAR) found in section 245 of the Income Tax Act, R.S.C., 1985, c.1 (5th Supp.) (the Act).
[2] The Tax Court judge held that the series of transactions undertaken by Oxford, which involved rolling three real estate properties through a tiered partnership structure, increasing the adjusted cost base of the partnership interests and selling these interests to tax-exempt entities without tax being paid on the latent recapture and accrued gains in the property held by the partnerships, not to amount to abusive tax avoidance.
[3] In support of the appeal, the Crown contends that the Tax Court judge in coming to this conclusion misconstrued the provisions of the Act which were relied upon to obtain this beneficial tax treatment. The Crown invites us to construe these provisions with a focus on their object, spirit and purpose as the GAAR commands, and to come to the opposite conclusion.
[4] For the following reasons, I am of the view that a proper construction of the provisions in issue supports the Crown’s contention and that the Tax Court judge’s conclusion of non-abuse cannot stand. However, I also agree with the respondent’s alternative argument that the consequential adjustments made by the Minister pursuant to subsection 245(5) are not reasonable as they overshoot the abuse that was made of the provisions in issue. I therefore propose to allow the appeal in part only and refer the reassessment back to the Minister for reconsideration and reassessment in accordance with these reasons.
[5] The provisions of the Act that are relevant to the analysis which follows are set out in the annex to the reasons.
FACTS
[6] The series of transactions unfolded over some five years and are complex. The details are fully set out in the Statement of Agreed Facts which is reproduced at Appendix A of the judgment under appeal (Oxford Properties Group Inc. v. The Queen, 2016 TCC 204). The following is an outline of the transactions as they unfolded with a focus on the statutory provisions that were used to achieve the tax benefit.
[7] The respondent’s predecessor, Old Oxford, was a publicly traded Canadian corporation and one of the largest real estate firms in North America. In 2001, BPC Properties Inc. made a proposal to takeover a substantial portion of the common shares of Old Oxford. The parties agreed that, prior to the takeover, Old Oxford would undertake a pre-closing arrangement and divest itself of certain real estate properties. The properties in question, the Atria Complex, the Richmond Adelaide Center (RAC) and the Calgary Eaton Center (CEC) (collectively the real estate properties), had high fair market values and low adjusted cost bases (ACB) and undepreciated capital costs (UCC).
[8] In pursuance of this agreement, a first set of limited partnerships was created, namely OPGI Office LP and MRC Office LP (OPGI Office LP and MRC office LP are collectively referred to as the first tier partnerships). Using the rollover provided for under subsection 97(2), the RAC and CEC were transferred to OPGI Office LP whereas the Atria Complex was transferred to MRC Office LP. The elected amounts corresponded to the ACB and UCC of the properties. As such, the partnerships had high fair market values but the interests held by the partners in the partnerships had a low ACB. Pursuant to section 97, the properties held by the partnerships maintained their tax attributes, that is their low ACB and UCC.
[9] Further restructuring resulted in the amalgamation of OPGI Amalco and MRC Amalco, the limited partners in each of the first tier partnerships. This newly formed entity was subsequently amalgamated with its sole shareholder. The result of the latter amalgamation was the formation of the respondent, Oxford. Following the amalgamations, the partnership interests in the first tier partnerships formerly held by OPGI Amalco and MRC Amalco were held by Oxford.
[10] Because Oxford was formed by way of a vertical amalgamation, it became eligible for a bump pursuant to subsection 88(1), which allows a parent corporation to increase the tax cost of the non-depreciable capital property held by its subsidiary at the time of the amalgamation. Oxford was therefore able to increase, or bump, the ACB of the partnership interests it held in the first tier partnerships formerly held by OPGI Amalco and MRC Amalco. As a result, the first tier partnerships now had high fair market values and the partnership interests held by the partners had a high ACB while the properties held by the partnerships retained their low ACB and UCC.
[11] The following step in the series was the formation of a second tier of partnerships in which the first tier partnerships became partners: MRC Office LP became a partner in Atria limited partnership (Atria LP) while OPGI Office LP became a partner in RAC limited partnership (RAC LP) as well as Calgary Eaton Center partnership (CEC LP). Oxford was therefore a partner in the first tier partnerships, which in turn held partnership interests in three newly formed partnerships (Atria LP, RAC LP and CEC LP are collectively referred to as the second tier partnerships).
[12] On February 1, 2004, the first tier partnerships transferred the real estate properties to the second tier partnerships by way of rollovers pursuant to subsection 97(2). In exchange for debt and further partnership interests, MRC Office LP transferred the Atria Complex to Atria LP and OPGI Office LP transferred the RAC to RAC LP and its interest in the CEC to CEC LP. The elected amounts again corresponded to the tax cost of the property transferred, that is their ACB and UCC subject to a slight variation with respect to the land portion of the CEC and the Atria Complex. As a result, the second tier partnerships had high fair market values and their partnership interests had low ACB. As was the case following the first rollovers, the real estate properties retained their low ACB and UCC.
[13] The first tier partnerships were then dissolved. The property of the first tier partnerships, including the partnership interests which they held in the second tier partnerships, were distributed to their partners. This resulted in Oxford acquiring partnership interests in the second tier partnerships. As well, an election was made pursuant to subsection 98(3). This allowed Oxford to avail itself of a second bump and increase the ACB of the partnership interests it held in the second tier partnerships. As a result, the partnership interests held by Oxford in the second tier partnerships had high fair market values and ACB while the real estate properties retained their low ACB and UCC. This was the situation when, between September 2005 and July 2006, Oxford disposed of its partnership interests in the second tier partnerships to the tax-exempt entities.
[14] Given the high ACB of the partnership interests sold by Oxford, little or no taxable capital gain was generated by the sale and, in one case, a capital loss resulted. The outcome is that even though the sale was made to tax-exempt entities, subsection 100(1) had no application. As a result, tax on the latent recapture and accrued gains inherent in the underlying real estate properties which had been deferred by reason of the rollovers was avoided altogether.
- The reassessment
[15] The Minister canvassed several assessing positions before ultimately deciding to rely on the GAAR (Appeal Book, Vol. 3, p. 342). The Minister came to the view that, although the series of transactions complied with the letter of the law, the overall result was abusive. Specifically, the rollovers and bumps were used to increase the ACB of the partnership interests in the first and second tier partnerships in a manner which allowed Oxford to circumvent the application of subsection 100(1).
[16] The reassessment denies the bumps in their entirety and applies subsection 100(1) on the resulting capital gain. This gives rise to a taxable capital gain of $148,187,562.00. It is common ground that this taxable capital gain reflects recapture in the amount of $116,591,744.00 and a taxable capital gain in the amount of $32,203,408.00; $21,285,500.00 being attributable to the depreciable property and $10,917,908.00 being attributable to the non-depreciable property (Summary of relevant income inclusions under alternative methods; GAAR consequences; Appeal Book, Vol. 2, pp. 206, 422, 426, 430).
DECISION OF THE TAX COURT OF CANADA
[17] After dismissing Oxford’s contention that the tax benefit which it achieved did not result from a series of avoidance transactions (Reasons, para. 76), the Tax Court judge devoted the remainder of his analysis to the issue of abuse. He did so by focussing on each of the steps undertaken by Oxford in order to circumvent the application of subsection 100(1).
[18] With respect to the rollovers, the Tax Court judge concluded that subsection 97(2) permits tax to be “fully or partially avoided” upon the transfer of property to a partnership and that subsection 97(4) preserves recapture when the property so transferred is depreciable property (Reasons, paras. 107, 111). The Tax Court judge also found that when a partnership interest is purchased by a tax-exempt entity, subsection 97(2) must be considered in light of paragraph 69(11)(b) (Reasons, para. 121). Because the three year holding period set out in subsection 69(11) had been met in this case, the Tax Court judge concluded that subsection 97(2) had not been abused. He also found that, although the purpose of subsection 97(2) was to preserve the cost base and potential recapture in the real estate properties, the fact that little or no tax was paid on the sale of the partnership interests did not offend subsection 97(2) as its purpose is not to tax the partners when they dispose of their partnership interests on the accrued gain and latent recapture relating to property held by the partnership (Reasons, paras. 181, 186, 188).
[19] As to the object, spirit and purpose of the bump provisions, the Tax Court judge held that subsection 88(1) prevents double taxation by allowing the disappearing ACB of a parent’s shares in its subsidiary to be pushed down to other non-depreciable capital property while simultaneously preserving the tax attributes of depreciable property (Reasons, paras. 143-145). Subsection 98(3) functions in a similar manner and with a similar purpose, but with the view of preserving ACB in the disappearing partnership interests (Reasons, paras. 160-167).
[20] The Tax Court judge also found that amendments made to section 88 in 2012 were relevant in construing the object, spirit and purpose of the bump provisions (Reasons, para. 153). He then proceeded to conclude that the purpose of sections 88 and 98, as they read before the amendments, was not to prohibit an “indirect” bump, preserve recapture or deny a bump based on the nature of the assets held by the partnerships (Reasons, para. 205). The Tax Court judge also held that the addition of subparagraph 88(1)(d)(ii.1), which would have prevented the result achieved by Oxford, reflects a change in the law rather than a clarification (Reasons, para. 211). As a result, Oxford’s use of the bumps did not frustrate the object, spirit or purpose of the provisions which were relied upon.
[21] The Tax Court judge then turned to subsection 100(1). He observed that the purpose of that provision was straightforward: to tax at a rate of 50% the portion of the capital gain realized on the sale of a partnership interest attributable to an increase in the value of non-depreciable property and to tax at a rate of 100% any portion of the gain that is attributable to depreciable property (Reasons, paras. 172-173). Taxing the portion of the gain attributable to an increase in the value of depreciable property at the rate of 100% ensures that “recaptured depreciation” is taxed at the same rate as it would have been, had the property been sold to a tax-exempt entity directly (Reasons, para. 174).
[22] However, the operation of subsection 100(1) is based on the gain otherwise determined under the Act (Reasons, para. 217). Given that the ACB of the partnership interests and the resulting gain were properly computed when regard is had to the bumps, subsection 100(1) was not abused. Moreover, had Parliament intended subsection 100(1) to operate as a “look through”, it would have drafted subsection 100(1) in a manner similar to subparagraph 88(1)(d)(ii.1) (Reasons, para. 216).
[23] Having found that no abuse had been demonstrated, the Tax Court judge allowed the respondent’s appeal insisting that it had engaged in a proper exercise of tax minimization (Reasons, para. 219).
POSITION OF THE PARTIES
- The Crown
[24] The appellant argues that Oxford used subsection 97(2), paragraph 88(1)(d) and subsection 98(3) in order to avoid recapture that would normally arise pursuant to subsection 100(1) (Memorandum of the appellant, para. 43). In concluding that this did not give rise to an abuse, the Tax Court judge erred in his analysis of these provisions and failed to consider the overall result achieved by Oxford (Memorandum of the appellant, para. 36).
[25] The Crown argues that the Tax Court judge’s analysis of subsection 100(1) was confined to the words or the text (Memorandum of the appellant, para. 51). The Tax Court judge further ignored that subsection 100(1) is located in Subdivision j, which deals with partnerships, and contemplates the tax consequences of the sale of a partnership interest (ibidem). Equally ignored was the reason why subsection 100(1) modifies the computation of the capital gain in the way that it does (Memorandum of the appellant, para. 52). According to the Crown, subsection 100(1) ensures that recapture is realized and taxed on the sale of a partnership interest to a tax-exempt entity as otherwise it will escape taxation altogether (Memorandum of the appellant, para. 56).
[26] The Crown further argues that the Tax Court judge committed two errors in his analysis of subsection 97(2). First, he conflated the deferral and avoidance of tax. While subsection 97(2) allows for the deferral of capital gains which would otherwise arise because there has been no change in the transferor’s economic position, it was not designed to avoid the taxation of the deferred gain (Memorandum of the appellant, para. 63). Second, the Tax Court judge’s understanding of this provision was clouded by his misunderstanding of subsection 69(11). The reason why subsection 69(11) did not apply was not because the three year holding period was respected, but because there was no subsequent sale of the real estate properties. Even if the partnership interests qualified as “substituted property”, no exemption was available because Oxford, the vendor, was a taxable corporation (Memorandum of the appellant, para. 71). The Crown also submits that subsection 69(11) deals with a different factual situation and has its own rationale; the Tax Court judge ought to have focused his analysis on subsection 100(1) (Memorandum of the appellant, para. 72).
[27] The Crown further argues that the purpose of the bump under section 88 is to preserve a tax basis embedded in non-depreciable capital property which would otherwise disappear. The bump allows this tax basis to be transferred to other non-depreciable capital property with similar tax attributes. Depreciable property is ineligible for the bump as it is taxed differently. Subsection 98(3) also excludes depreciable property again because it is “an asset of a different nature” (Memorandum of the appellant, paras.73-80).
[28] Nothing under the legislative scheme as it stood at the time suggests that the bump in the value of depreciable property through the interposition of a partnership was permissible. The 2012 amendments therefore merely confirm that one cannot do indirectly what is not permitted to be done directly. Indeed, the Budgetary Supplementary Information released at the time of its enactment indicates that this amendment was intended to “clarify” the law rather than modify it (Memorandum of the appellant, para. 85).
[29] The Crown also argues that the Tax Court judge erred in considering the Minister’s treatment of the Dufferin Mall and the René Lévesque transactions in order to determine whether paragraphs 88(1)(c) and (d) and subsection 98(3) were abused. A GAAR analysis is not a comparative analysis and the Minister’s treatment of these properties is irrelevant. In any event, the reason why the Minister did not invoke the GAAR on the Dufferin Mall transaction is because the partnership interests were sold to a taxable entity so that the deferred taxes will eventually be paid whereas the transfer of the property to the partnerships in the René Lévesque transaction was not part of the series of transactions (Memorandum of the appellant, paras. 99-103).
[30] The overall result of the series was the circumvention of subsection 100(1). A reasonable consequence would therefore be the denial of the bumps in order for subsection 100(1) to have its intended effect. Subsection 100(1) “exacts a price” to the extent that capital gains realized on depreciable property are taxed at a rate of 100%. However, this is the price that Parliament has imposed for trying to avoid recapture (Memorandum of the appellant, para. 106).
- Oxford
[31] The respondent supports the conclusion reached by the Tax Court judge and essentially adopts the reasons that he gave. It adds that he purposively construed the provisions in issue and considered the overall result of the series of transactions (Memorandum of the respondent, para. 70). In the event that the GAAR applies, Oxford argues that the tax adjustments brought about by the reassessment overshoot the abuse which they seek to correct and are as such unreasonable (Memorandum of the respondent, para. 122).
[32] The Tax Court judge correctly understood that subsection 97(2) must be construed in light of subsection 69(11). This latter provision indicates that Parliament made the conscious decision that latent recapture and accrued capital gains could go unpaid in the context of transactions involving a tax-exempt purchaser, where the three year holding period is met (Memorandum of the respondent, para. 96). Oxford argues that paragraph 69(11)(b) deals “exclusively with tax-deferred transfers to partnerships under 97(2)” and prescribes the limited circumstances in which the benefit of a rollover can be denied (Memorandum of the respondent, para. 56).
[33] The Tax Court judge also correctly concluded that any rule against “indirect bumping” would have to be based on a broad policy that is not grounded in the Act (Memorandum of the respondent, para. 107). He also correctly discerned that the 2012 amendments implement a change in this policy (Memorandum of the respondent, para. 119). Oxford argues that section 88 sets out explicitly and exhaustively the circumstances in which a bump can be denied. Nowhere do these rules deny the bump where property is pre-packaged and sold to a tax-exempt entity (Memorandum of the respondent, para. 51).
[34] Oxford further argues that, as the Tax Court judge correctly concluded, the purpose of subsection 100(1) is not to tax accrued gains on the property held by a partnership. The starting point is the actual gain calculated under the usual rules (Memorandum of the respondent, paras. 115-116).
[35] In the event that the GAAR applies, Oxford argues that the Crown’s assessment is punitive because the disallowance of the bumps affects the computation of the entire capital gain, not just recapture (Memorandum of the respondent, para. 124). The adjustment should be limited to the latent recapture which, based on the Crown’s own theory, reflects the only income which was avoided. It adds that in any event the adjustment should be corrected so as not to tax 100 percent of the capital gain portion of the adjustment pertaining to the depreciable property (Memorandum of the respondent, paras. 121-126).
ANALYSIS AND DISPOSITION
[36] In a GAAR analysis, three questions must be addressed: was there a tax benefit? If so, were the transactions which gave rise to this benefit avoidance transactions? If so, were the avoidance transactions abusive? (Copthorne Holdings Ltd. v. Canada, [2011] 3 S.C.R. 721 [Copthorne] at para. 33, citing Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2 S.C.R. 601 at paras. 18, 21, 36).
[37] In the present case, the respondent conceded that: the deferred tax on the accrued gains and recapture pursuant to subsection 97(2); the bumps in the ACB of the partnership interests in the first and second tier partnerships by virtue of subsections 88(1) and 98(3); and the reduction of tax payable on the sale of the partnership interests to the exempt entities, all give rise to a tax benefit (Reasons, para. 58). As to the second question, the Tax Court judge found that the sale of the partnership interests to the exempt entities was part of a series of transactions that contained one or more avoidance transactions (Reasons, para. 76). The respondent does not challenge this finding in this appeal.
[38] The only question which arises in this appeal turns on the abuse analysis. Specifically, does the elimination of the capital gain on the sale of the partnership interests to the exempt entities by the use of the bumps and the consequential avoidance of recapture under subsection 100(1) frustrate this provision and the other provisions relied upon in order to achieve this result?
- Standard of review
[39] The inquiry as to whether there has been an abuse gives rise to a question of mixed fact and law and is therefore subject to the standard of palpable and overriding error (Trustco at para. 44; Housen v. Nikolaisen, 2002 SCC 33, [2002] 2 S.C.R. 235 at para. 37 [Housen]). However, the abuse analysis proceeds in two stages. The first stage requires the determination of the object, spirit and purpose of the provisions giving rise to the tax benefit while the second turns on whether the provisions, so construed, were frustrated by the tax benefit achieved (Trustco at para. 44). The object, spirit and purpose of a provision is discerned by way of statutory interpretation (Copthorne at para. 70). This gives rise to a question of law and is an extricable part of the analysis. It is therefore subject to the standard of correctness (Trustco at para. 44; Housen at paras. 8, 37).
- Construction under the GAAR
[40] In order to situate the discussion which follows, it is useful to first consider the approach to statutory construction called for under the GAAR at the abuse stage of the analysis.
[41] The distinction between a word-based construction and an object, spirit and purpose interpretation in a GAAR context was carefully delineated by the Supreme Court in Copthorne:
[66] The GAAR is a legal mechanism whereby Parliament has conferred on the court the unusual duty of going behind the words of the legislation to determine the object, spirit or purpose of the provision or provisions relied upon by the taxpayer. While the taxpayer’s transactions will be in strict compliance with the text of the relevant provisions relied upon, they may not necessarily be in accord with their object, spirit or purpose. […]
[42] The Court went on to explain:
[70] The object, spirit or purpose can be identified by applying the same interpretive approach employed by this court in all questions of statutory interpretation — a “unified textual, contextual and purposive approach” (Trustco, at para. 47; Lipson v. Canada, 2009 SCC 1 (CanLII), [2009] 1 S.C.R. 3, at para. 26). While the approach is the same as in all statutory interpretation, the analysis seeks to determine a different aspect of the statute than in other cases. In a traditional statutory interpretation approach the court applies the textual, contextual and purposive analysis to determine what the words of the statute mean. In a GAAR analysis the textual, contextual and purposive analysis is employed to determine the object, spirit or purpose of a provision. Here the meaning of the words of the statute may be clear enough. The search is for the rationale that underlies the words that may not be captured by the bare meaning of the words themselves. However, determining the rationale of the relevant provisions of the Act should not be conflated with a value judgment of what is right or wrong nor with theories about what tax law ought to be or ought to do.
(My emphasis)
A GAAR analysis can therefore lead to a result that is different from that obtained by a traditional, textual, contextual and purposive interpretation focused on the meaning of the words of the relevant provisions.
[43] The Supreme Court further explained that by invoking the GAAR, the Minister necessarily concedes that based on a traditional approach, the tax benefit is properly attained:
[109] […] When the Minister invokes the GAAR, he is conceding that the words of the statute do not cover the series of transactions at issue. Rather, he argues that although he cannot rely on the text of the statute, he may rely on the underlying rationale or object, spirit and purpose of the legislation to support his position.
[44] Although the GAAR is based on the premise that the construction which it commands will lead to a different result than that obtained on the basis of a word-based analysis, the Court was quick to point out that this will not always be the case:
[110] I do not rule out the possibility that in some cases the underlying rationale of a provision would be no broader than the text itself. Provisions that may be so construed, having regard to their context and purpose, may support the argument that the text is conclusive because the text is consistent with and fully explains its underlying rationale.
[111] However, the implied exclusion argument is misplaced where it relies exclusively on the text of the PUC provisions without regard to their underlying rationale. If such an approach were accepted, it would be a full response in all GAAR cases, because the actions of a taxpayer will always be permitted by the text of the Act. As noted in OSFC, if the Court is confined to a consideration of the language of the provisions in question, without regard to their underlying rationale, it would seem inevitable that the GAAR would be rendered meaningless (para. 63).
(My emphasis)
[45] It is clear from the above that in all cases, the GAAR requires the Court to look into the underlying rationale of the provisions relied upon in order to obtain the tax benefit. This goes to the heart of the Crown’s contention that rather than giving the relevant provisions a meaning which accords with their object, spirit and purpose, the Tax Court judge confined the effect of these provisions to their wording. According to the Crown, this narrow construction of the relevant provisions cannot stand as it is based on an erroneous assessment of the impact of subsequent amendments brought to the Act in 2012, many years after the series of transactions unfolded.
[46] I will come back to this later but I note for now that subsequent amendments cannot be assumed to alter or confirm the prior state of the law (see subsections 45(2) and (3) of the Interpretation Act, R.S.C., 1985, c. I-21 (the Interpretation Act)). The recent decision of this Court in Univar Holdco Canada ULC v. Canada, 2017 FCA 207 at paragraphs 23 to 27 illustrates the point that in a GAAR context, the provisions used to obtain the tax benefit must first be construed on their own. Only then can one say whether a subsequent amendment that touches upon the same subject matter confirms or alters the prior state of the law.
- Statutory context
[47] Before turning to the analysis, it is useful to say a few words about the tax treatment of partnerships, the distinction between capital property and depreciable capital property and the context in which subsection 100(1) was enacted in 1972.
[48] Partnerships have a hybrid status under the Act. Although partnership income is allocated to the partners, it is computed “as if the partnership were a separate person” (paragraph 96(1)(a)). Because partnerships are distinct from the partners at the income computation stage – Division B – computation of income – they, much like corporations, can hold assets, in which case the interest of the partners in those assets is reflected by their partnership interests. Partnership interests are distinct from the underlying property held by the partnership and can be subject to a different treatment under the Act.
[49] Depreciable property is by definition capital property (section 54) and the disposition of capital property for proceeds which exceed its ACB – essentially the capital cost in the case of depreciable capital property – gives rise to a capital gain, 50% of which is taxable. To this extent, the tax treatment of depreciable and non-depreciable capital property is identical.
[50] However, only capital property that comes within the definition of “depreciable property” in subsection 13(21) – essentially capital property that is used in the income making process and with respect to which capital cost allowance (CCA) may be claimed – can give rise to recapture. In simplified terms, CCA allows for a 100% deduction of the annual rate of depreciation authorized by regulation and recapture essentially brings back into income the excess CCA claimed, as revealed by the difference between the selling price of a depreciable property and its UCC as it stood when sold. In contrast with a capital gain derived from the disposition of depreciable property, recapture gives rise to a 100% inclusion given that it recuperates a 100% deduction (For a more detailed explanation of the workings of the capital cost allowance system see Water’s Edge Village Estates (Phase II) Ltd. v. Canada, 2002 FCA 291, [2003] 2 F.C.R. 25 [Water’s Edge] at paragraphs 37 to 41).
[51] Subsection 100(1) was enacted at the time when the capital gains system was introduced in 1972. The concern which it addresses is the sale of partnership interests to tax-exempt entities in circumstances where the underlying assets comprise property, the disposition of which can give rise to a 100% rate of inclusion – i.e.: depreciable capital property, resource property and other types of property that are subject to a 100% rate of inclusion. A partnership interest, being capital property, will be subject to capital gain treatment when sold – unless held on a trading account – and the purchaser will eventually be subject to tax on any latent recapture in the underlying depreciable property when it is disposed of.
[52] However, where the purchaser of the partnership interest is a non-taxable entity, the recapture of excessive depreciation will never take place. Subsection 100(1) prevents this potential revenue loss by making the disposing partners liable for tax on 100% of any portion of the gain resulting from the sale of their partnership interests which can be attributed to depreciable capital property held by the partnership based on its pro-rated value.
[53] I now turn to the object, spirit and purpose analysis of the provisions that were used in order to avoid the application of subsection 100(1).
- Subsection 97(2)
[54] In implementing the first step of the series, Old Oxford used the subsection 97(2) rollover on the transfer of the real estate properties to the first tier partnerships. Subsection 97(2) was also used when these properties were later transferred to the second tier partnerships.
[55] Subsection 97(2) allows for the transfer of property – including non-depreciable capital property, depreciable capital property and inventory – to a partnership on a tax deferred basis subject to a joint election being filed by the partners. In this case, where the ACB was elected with respect to the land portion of the property – i.e.: the non-depreciable capital property – and the UCC was elected with respect to the buildings erected thereon – i.e.: the depreciable capital property – the accrued capital gain and the recapture which would otherwise have resulted from the transfer by virtue of subsection 97(1) were deferred. This last provision provides that the partners, upon contributing property to a partnership, are deemed to receive proceeds equal to the fair market value of the transferred property.
[56] Rollovers, including the one provided for in subsection 97(2), defer the tax consequences of transfers which take place amongst selected groups such as shareholders and their corporations (subsection 85(1)) and partners and their partnerships (subsection 97(2)), the premise being that no tax consequences should be recognized given that there is no fundamental change in ownership – i.e.: rather than holding the transferred property, the transferor holds a partnership interest or shares having the same value (Vern Krishna, The Fundamentals of Canadian Income Tax, 9th ed. (Toronto: Thomson/Carswell, 2006) at p. 1112).
[57] The logic behind rollovers as revealed by the mechanism used to give effect to them – i.e.: the fact that a transferor’s deemed proceeds become the transferee’s deemed cost – ACB or UCC as the case may be – makes it clear that any tax thereby deferred will be paid on a subsequent disposition giving rise to a change in the transferor’s economic position. As was said in direct reference to subsection 97(2): “tax is not avoided; it is deferred […]” (Continental Bank of Canada et al. v. the Queen, 94 D.T.C. 1858 at 1872 (T.C.C.), aff’d 96 D.T.C. 6355 (F.C.A.). This flows from both the wording and the object, spirit and purpose of subsection 97(2).
[58] Indeed, subsection 97(4) ensures this result in express terms with respect to recapture by providing that where depreciable property is transferred to a partnership for proceeds which exceed the transferor’s capital cost, this cost becomes the partnership capital cost and the difference is deemed to have been taken as CCA by the partnership.
[59] Against this background, it must be acknowledged that the object, spirit and purpose of subsections 97(2) and 97(4) is to track the tax attributes of depreciable property in order to ensure that deferred recapture and gains are subsequently taxed.
[60] The respondent argues that this treatment does not apply to all situations where a tax-exempt entity is involved. It points to the fact that a tax-exempt entity is permitted to be a member of a partnership. As such, a partnership could sell property that was rolled into it at its tax cost pursuant to subsection 97(2) with the result that any excess recapture shown to have been claimed on the subsequent sale of the property would go untaxed to the extent that it is allocated to the tax-exempt partner.
[61] That is so. Parliament has not provided for every situation where the interposition of a tax-exempt entity can give rise to revenue losses but it can be seen, when regard is had to subsection 100(1), that when partnership interests are sold to exempt entities, latent recapture was not intended to go untaxed. This treatment is consistent with the object, spirit and purpose of subsection 97(2).
[62] The Tax Court judge did not construe subsection 97(2) this way. He focussed his attention on the three year holding period set out in subsection 69(11) of the Act, and concluded that subsection 97(2) is not frustrated when deferred recapture goes untaxed, so long as this holding period is met.
[63] All are agreed that subsection 69(11) can have no application in this case because even if it were otherwise applicable, the three year holding period was respected. This provision, specifically paragraph 69(11)(b), envisages an initial disposition of property for an amount below its fair market value in circumstances where planning steps have been taken in order to allow the taxpayer to “benefit” (“profiter” in the French text) from a tax exemption available to any person on “any income arising on a subsequent disposition” of the property. Where this can be shown, the provision deems the initial disposition to have taken place at fair market value. However, subsection 69(11) ceases to apply if the property originally transferred is kept by the transferee for a minimum period of three years and no arrangements can be shown to have been made for a subsequent distribution within this period.
[64] The Tax Court judge’s reasoning for holding that this three year limitation is part of the object, spirit and purpose of subsection 97(2) is as follows (Reasons, para. 193):
I agree with counsel for the [respondent] that Parliament is presumed to know the law and to take the law into account when making amendments.[Footnote omitted] Parliament was aware of the three-year limitation at the time it extended the application of subsection 69(11) to tax-exempt entities. Thus, when it amended subsection 69(11) it made the positive decision to limit the application of subsection 69(11) to transfers to tax-exempt entities that occur within the three-year period. In my view, it is reasonable to conclude that Parliament was of the view that transfers after this three-year period did not abuse subsection 97(2). Such a conclusion must be drawn in order to, in the words of the Supreme Court of Canada, preserve some “certainty, predictability and fairness in tax law so that taxpayers may manage their affairs accordingly.”[55] [Canada Trustco, para. 61]
[65] I first note that subsection 69(11) is found in subdivision f, “Rules Relating to Computation of Income” whereas 97(2) is found in subdivision j which deals with “Partnerships and Their Members”. This shows that the application of subsection 69(11) is not restricted to partnerships. It therefore cannot be said that subsection 69(11) was introduced in order to target subsection 97(2) rollovers (Reasons, para. 189). It has a much broader application. Although it could apply to a series of transactions initiated by a subsection 97(2) rollover, subsection 69(11) applies to any series where the initial disposition takes place below fair market value, whether a rollover under subsection 97(2) or any other provision is involved or not. As such, there is no “plausible and coherent plan” which could justify reading the three year time limitation set out in subsection 69(11) into subsection 97(2) (Copthorne at para. 91).
[66] I note as well that it is not unusual for Parliament to place a time limit on anti-avoidance provisions whose application depends on a transaction which may take place sometime in the future (Compare paragraph 6204(1)(b) of the Income Tax Regulations, C.R.C., c. 945 as construed by this Court in Montminy v. the Queen, 2017 FCA 156 at para. 59;