Landrus v. The Queen

Landrus v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2007-05-02
Neutral citation
2008 TCC 274
File numbers
2004-3026(IT)G
Judges and Taxing Officers
Brent Paris
Subjects
Income Tax Act
Decision Content
Docket: 2004-3026(IT)G
BETWEEN:
GARY LANDRUS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeal heard on May 15, 2007, at Toronto, Ontario.
Before: The Honourable Justice B. Paris
Appearances:
Counsel for the Appellant:
Louise R. Summerhill
Counsel for the Respondent:
Franco Calabrese
____________________________________________________________________
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1994 taxation year is allowed with costs and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the Appellant is entitled to deduct a terminal loss of $29,130.
Signed at Ottawa, Canada, this 2nd day of May 2008.
“B.Paris”
Paris J.
Citation: 2008TCC274
Date: 20080502
Docket: 2004-3026(IT)G
BETWEEN:
GARY LANDRUS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Paris, J.
[1] The Appellant was a limited partner in the Roseland Park II Limited Partnership (“Roseland II”), which was formed in 1989 to acquire a newly built condominium building in London, Ontario. Another newly built condominium building, adjacent to the Roseland II property, was acquired by the Roseland Park I Limited Partnership (“Roseland I”). Due to a general downturn in the real estate market in Southern Ontario, the value of the Roseland I and II properties dropped substantially in the years following their acquisition.
[2] In a series of transactions undertaken in December 1994, Roseland I and Roseland II sold all of their assets to a new limited partnership, Roseland Park Master Limited Partnership (“RPM") and the limited partners of Roseland I and II received partnership interests in RPM.
[3] The dispositions triggered terminal losses to Roseland I and II under subsection 20(16) of the Income Tax Act [1] (the “Act”), since there was still a positive Undepreciated Capital Cost (“UCC”) balance after the disposition. These losses were allocated to the limited partners. The Appellant deducted $29,130 as his share of the terminal loss of Roseland II in computing his income for the 1994 taxation year.
[4] The Minister of National Revenue (“Minister”) used the general anti-avoidance rule (“GAAR”) in section 245 of the Act to deny the deduction of the terminal loss.
[5] In general terms, the GAAR applies in circumstances where a taxpayer obtains a tax benefit as a result of a transaction which is not arranged primarily for bona fide purposes other than to obtain the tax benefit and the transaction amounts to abusive tax avoidance.
[6] Since the Appellant has conceded that there was a tax benefit, the issues in this appeal are whether the assets of Roseland II were transferred to RPM primarily to obtain the tax benefit, and if so, whether this constituted abusive tax avoidance. If both conditions are met, the GAAR would apply, and the Appellant concedes that the Minister would be entitled to deny the terminal loss deduction pursuant to subsection 245(5) of the Act.
Facts
[7] A partial agreed statement of facts and joint book of documents were filed by the parties at the hearing. The Appellant also called four witnesses: Mr. Gary Landrus, the Appellant, Mr. Joseph Froio, a limited partner in Roseland I, Mr. Wayne Jacobs, an executive of Allied Canadian Corporation, the corporation (“Allied”) that became the general partner of Roseland II in 1993 and who devised the restructuring proposal, and Mr. Ralph Neville, a partner at BDO Dunwoody, who provided accounting advice on the transaction.
Background
[8] Roseland I was formed in 1988 to acquire and operate a 94 unit residential condominium building located at 858 Commissioners Road East, London, Ontario. A total of 94 partnership interests in the limited partnership were sold to the public. The general partner was Roseland Park (I) General Partner Limited.
[9] Roseland II was formed in 1989 to acquire and operate a 110 unit residential condominium building located at 860 Commissioners Road East, London, Ontario. A total of 110 partnership interests in Roseland II were sold to the public. The general partner was Roseland Park (II) General Partner Limited.
[10] Roseland I acquired the property at 858 Commissioners Road East on December 30, 1988 at the following cost:
(a) Land $476,000
(b) Building $5,495,845
(c) Furniture and Equipment $515,100
(d) Landscaping $27,137
(e) Paving $78,614
[11] Roseland II acquired the property at 860 Commissioners Road East on January 31, 1990 for the following cost:
(a) Land $555,200
(b) Building $6,632,492
(c) Furniture and Equipment $653,400
(d) Paving $102,995
[12] The buildings at 858 and 860 Commissioners Road East were part of a development that was to consist of four residential condominium towers and an amenities centre with two levels of parking, a swimming pool, clubhouse, community centre and tennis court. Due to the slowdown in the real estate market, only three towers (including the Roseland I and II properties) and the amenities centre were built. The development was located next to a hospital in what was said to be a good area of the city, and had views over the Grand River.
[13] Each partnership interest in Roseland I and II had referenced to it a particular condominium unit in the respective buildings. Upon withdrawal from the partnerships, each partner became entitled to receive the referenced unit. The size of the unit and its location in the building determined the cost of the partnership interest and the partner’s percentage interest in the partnership. The limited partner selected the referenced unit at the time of acquiring his or her interest in the limited partnership.
[14] The rental income from all of the units was pooled for each building, respectively, and net profit was allocated to each limited partner based on his or her percentage interest in the partnership.
[15] Financing for the partnership units had been arranged by the promoter and was available in part by means of a mortgage from the Royal Bank registered against the referenced unit selected by the purchaser of the partnership interest.
[16] On May 10, 1989, the Appellant purchased his interest in Roseland II for $107,650 which he financed as follows:
(a) Cash: $6,630
(b) Royal Bank mortgage: $70,725
(c) Second mortgage: $30,295
[17] The Appellant chose Unit 1005A as the condominium unit available to him upon withdrawal from the partnership.
[18] Roseland I began rental operations in February 1989 and Roseland II in February, 1990. They faced a difficult rental market almost from the outset. According to a note sent to the investors in Roseland II by the General Partner in May 1991[2], London had the highest vacancy rate in Ontario due to the completion of almost 4,500 new rental apartments in the area between 1988 and 1990. The vacancy rate for apartment buildings in London, completed after 1985, was said to be 10.4% in October 1990. Also, unemployment in the region was increasing.
[19] It is clear from the evidence that the financial performance of Roseland I and II in the initial years was disappointing to the investors. Cash flow was less than anticipated and resale prices for condominium units in both buildings were well below the prices paid originally for the partnership interests to which the units were referenced.
[20] According to Mr. Froio, the value of the condominium units had “plummeted like a rock.” He also said that a number of units in Roseland I had been foreclosed by the Royal Bank in the first few years of operation and that the units had been resold for as little as half their original price.
[21] The Appellant said that he had the impression from one visit to the property in 1990 or 1991 that Roseland I and II were in competition with each other for rentals and resales, although he had thought that the two buildings were supposed to be part of a common enterprise. He also saw a “downward spiral” in the resale prices of units in the building.
[22] The Appellant felt that the management of Roseland II was inadequate. At first he talked a couple of times a year with a representative of the general partner and received regular mail outs about Roseland II, but he said that after 1991, mail outs were irregular and that he had difficulty keeping up with what was going on with the property. He also thought the general partner or property manager could be doing more to coordinate resales of the units.
[23] In early 1993, against this backdrop of investor dissatisfaction, Allied was approached about taking over as the general partner of Roseland II.
[24] Mr. Wayne Jacobs, an executive with Allied, testified that, during that period, the company was developing a niche in the property management market in Southern Ontario dealing with real estate owned by limited partnerships. He said:
The niche was the tumbling real estate market of the early '90s and there were a lot of limited partnerships in the marketplace where the general partner or property manager hadn't performed to the expectation of these investors and so these investors felt that that there was a need to try and do something about the value of their property and the asset that they owned.[3]
[25] Mr. Jacobs testified that Allied was first approached by certain limited partners in Roseland II, whereas the first reporting letter sent out to the limited partners in Roseland II by Allied in 1993 said that Mr. Tom Borromeo, who was the director and an officer of the general partner of Roseland II at the time, approached Allied. The report stated:
. . . Mr. Borromeo recently came to the conclusion that the Limited Partnership would be better served by an organization with comprehensive syndicate management and property management expertise. As a result, he approached Allied Canadian Corporation. . . [4]
[26] In June 1993, Allied acquired the one outstanding share of Roseland Park (II) General Partner Limited, and Allied personnel were elected as directors and appointed as officers of the general partner. In September 1993, Allied Canadian Management Corporation (a company related to Allied) took over as property manager of Roseland II.
[27] Once Allied took over, Mr. Jacobs said that he felt the financial results could be improved by combining the operations of Roseland I and II in order to achieve “economies of scale”. He said the restructuring was necessary “in order to really make a difference” and “to bring everything under one management group so there would be no duplication of efforts by anyone.” He said that there would be a “tremendous savings of costs plus there wouldn’t be the same fight for the rental revenue.”[5]
[28] Mr. Jacobs said that Allied made the recommendation to bring the two partnerships together after Allied was approached by investors from Roseland I who were aware that Allied had taken over the management of Roseland II, although he did not give any specific date when this happened.
[29] Mr. Froio said that rumours began circulating among the partners of Roseland I in late 1993 or early 1994 that Allied had some idea of putting the partnerships together to save some costs, and the topic was discussed at a meeting of the Roseland I partners in April 1994. The Appellant said that he first became aware of the restructuring proposal after reading the quarterly reporting letter sent out by Allied to the limited partners in June 1994.
[30] The documents in evidence show that the matter of the restructuring was discussed at the annual meetings of both limited partnerships in the spring of 1994.[6] Also, according to a report to Roseland II partners dated June 1, 1994[7] the restructuring proposal had the support of both limited partnerships at that time.
[31] Mr. Jacobs said that after obtaining the support of the limited partners for the proposal, Allied retained the services of Ralph Neville, senior tax partner at BDO Dunwoody Ward Malette, as well as the law firm Aird & Berlis, in order to confirm the viability of the transaction. He said that Allied wanted to try and understand if the restructuring was possible and what the implications of it would be. He said that Allied did not want the restructuring to have a negative impact on the partners so it “approached BDO to try and understand what were the implications of bringing two different partnerships together as a single partnership.”
[32] Allied also obtained an appraisal of the assets of Roseland I and Roseland II. The appraisal report was dated August 31, 1994. On the basis of these appraisal values, an estimate of each partner’s terminal loss was calculated.
[33] Allied set up two meetings for September 8, 1994, one for the partners of Roseland I and the other for the partners of Roseland II, to discuss and vote on the proposal. The partners were provided in advance of the meetings with an information circular including the estimate of the potential terminal loss for each partner and a copy of an opinion letter from Mr. Neville. The proposal was described in the following terms in the information circular:
The proposed restructuring involves the sale of each Limited Partnership's property in its entirety to a new limited partnership, which will be owned directly or indirectly by the current limited partners of the Limited Partnerships. Each limited partnership interest will continue to be referenced to its current individual condominium unit and each limited partner of the new limited partnership will have the same rights and obligations as in their respective previous limited partnership.[8]
[34] Allied also sent a letter dated August 26, 1994 to the Roseland I partners setting out the following advantages of its proposal:
Short-Term Benefit: Average terminal loss per limited partnership interest of approximately $19,000, permitting reduction in income taxes payable in 1994 by approximately $10,106 (assuming top marginal rates of income tax).
Long-Term Benefit: Potential to benefit from evident recovery in real estate market by selling at a future date into an improved market.
Flexibility: Highly flexible, in that it does not preclude any course of action in the future, including outright liquidation.
Tax Effectiveness: Highly effective, in that it liberates a loss for income tax purposes in 1994 without crystallizing an economic loss.
Comprehensive Management: Allied Canadian has comprehensive asset management capability that can be brought to bear on the combined properties of both limited partnerships, resulting in diversification of risk and the achievement of economies of scale.
Overall Cost of Holding: The after-tax cost to limited partners of holding the investment throughout 1995 and 1996, taking account of the terminal loss, will be negligible. [9]
[35] The Appellant attended the special meeting of the partners of Roseland II on September 8, 1994 where presentations were made by representatives of Allied, BDO and Aird & Berlis. The Appellant said that the limited partners were told that the restructuring would create a larger rental pool and create efficiencies in operations such as common management, and only one management residence on site rather than two. The tax consequences of the proposal were also discussed, and were estimated to have taken up about half the time of the meetings. At his examination for discovery, the Appellant had said that the bulk of the discussion at the meeting was related to the tax aspect of the transaction.
[36] The limited partners of Roseland II then approved the proposal and the necessary special resolution was passed on or about September 8, 1994.
[37] The Appellant stated that he voted for the proposal because he felt that a larger unit with more effective rental policies would stop or decrease the “rush to the door selling” and that there would be “a larger pool on which to develop the investment.” He also thought that the restructuring would eliminate competition between the two buildings. He said that he was skeptical about the tax benefit because in other limited partnerships in which he had been involved, cash flow and tax projections had not always proved reliable.
[38] In cross-examination he agreed that at the time he was desperate to get something out of his investment, although he still wanted to continue with it.
[39] The Appellant said that from his point of view the primary purpose of the reorganization was “to salvage our investments, to have a larger rental pool with proper management to be a more effective sufficient rental organization.”
[40] A special meeting of the partners Roseland I was also held on September 8, 1994 to vote on the proposal. Mr. Froio said that he understood before the meeting that “there was going to be a good cost potential savings to put it together” and a better payout to the partners. He voted in favour of the restructuring “mainly for the business purposes and a possibility of the tax thing”, although he thought the tax benefit was too good to be true. He also added that, from his perspective, the transaction was undertaken for cost savings and to create synergies with regard to getting the tenants that both buildings were competing for.
[41] The special resolution approving the sale of the assets of the partnership to a new limited partnership was subsequently passed by the Roseland I limited partners on September 22, 1994.
[42] The sale of the assets of Roseland II to RPM took place as follows:
- RPM was formed and registered on December 21, 1994.
- on December 23, 1994, Roseland II subscribed for 4,448 interests in RPM. The subscription price of $4,448,000, being equal to the fair market value of the net assets of Roseland II net assets (as determined by the appraisal referred to above), was paid by promissory note.
- on December 23, 1994, Roseland II directed RPM to issue the limited partnership interests subscribed for in RPM, to the limited partners of Roseland II in proportion to their existing interests in Roseland II. The Appellant received a 1.002% interest in RPM.
- on December 28, 1994, Roseland II sold all of its assets to RPM for fair market value consideration paid by cancellation of the promissory note given by Roseland II for the subscription price of the partnership interests in RPM.
[43] The sale of the assets of Roseland I to RPM was done in a similar manner, except that an additional step was added to ensure that Ontario land transfer tax would not have to be paid.
[44] The sale of the assets by Roseland I and Roseland II resulted in terminal losses of $1,709,454 and $2,916,612 respectively, which were allocated to the limited partners.
[45] Roseland I and Roseland II were dissolved on June 3, 1998.
[46] The Appellant said that after the reorganization of the partnerships, he recalled that there was some increase in cash flow. Wayne Jacobs said that the two properties had better operating results but gave no details in this regard.
[47] No reference was made by any of the witnesses to a document[10] included in the joint book of documents which set out the income and expenses for Roseland I and II for 1993 and 1994, and for RPM for 1995, which on its face does not appear to show any significant change in income or expenses after 1994 when the partnerships were combined.
[48] The Appellant withdrew from RPM in 2000, and exercised his option to take title to Unit 1005A. He then sold that unit to an unrelated party for $63,500. He reported the difference between the sale price and his share of the cost at which RPM purchased the Roseland II assets in 1994 on income account. At the time of the hearing, Mr. Froio was still a member of RPM.
[49] Mr. Ralph Neville gave evidence concerning the accounting advice he provided on Allied’s proposal to combine the two limited partnerships. He stated that the “traditional” way of effecting a merger of two partnerships was to dissolve the existing partnerships and distribute the assets of the partnerships into the hands of the existing partners, and then have the existing partners contribute those assets into a new partnership in return for a partnership interest.
[50] In this case, he felt that there were certain business reasons for not using this method to merge the partnerships. The first related to the fact that, upon distribution of partnership property to the limited partners, each limited partner would hold an undivided interest in the entire property. In order to transfer that property into the new limited partnership, it would be necessary for all of them to agree to the transfer. Without the unanimous agreement of the limited partners, the transfer could not proceed, thus giving each limited partner the power to block the transfer of the property to the new limited partnership by withholding his or her agreement. Mr. Neville said that it was not certain in this case whether all of the limited partners in Roseland I and II would have consented to such a transfer. The second reason for not using the traditional method was that the transfer of the partnership property would have attracted Ontario land transfer tax.
[51] He therefore recommended the method that was used here, which involved the sale of the partnership property to RPM, and the issuance of partnership interests in RPM that were subsequently distributed to the limited partners of Roseland I and II.
[52] Mr. Neville also gave evidence that he understood that using the traditional method would have enabled the limited partners in Roseland I and II to claim terminal losses to the same extent as using the method he recommended. He explained that upon dissolution of a partnership the distribution of the partnership assets to the partners is done at the fair market value of the assets (in the absence of any election by the partners under subsection 98(3)). This would have triggered a terminal loss in the same way that the disposition of the assets at fair market value to RPM did.
Reassessments
[53] The Minister assessed the limited partners of Roseland I and II and denied the deduction of the terminal losses. The Minister initially took the position that there was no change in beneficial ownership of the Roseland I and II assets upon the sale to RPM, that the “stop‑loss” provisions of section 85(5.1) of the Act applied to deny to the terminal losses resulting from the transfer of the property, and, finally, in the alternative, that the GAAR applied to deny the terminal losses.
[54] Subsequent to the Appellant’s notice of objection, the Minister confirmed the reassessment, relying only on the GAAR.
Relevant legislation
[55] Section 245 reads as follows for the year in issue:
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, and includes a reduction, avoidance or deferral of tax or other amount that would be payable under this Act but for a tax treaty or an increase in a refund of tax or other amount under this Act as a result of a tax treaty;
"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) Subsection (2) applies to a transaction only if it may reasonably be considered that the transaction
(a) would, if this Act were read without reference to this section, result directly or indirectly in a misuse of the provisions of any one or more of
(i) this Act,
(ii) the Income Tax Regulations,
(iii) the Income Tax Application Rules,
(iv) a tax treaty, or
(v) any other enactment that is relevant in computing tax or any other amount payable by or refundable to a person under this Act or in determining any amount that is relevant for the purposes of that computation; or
(b) would result directly or indirectly in an abuse having regard to those provisions, other than this section, read as a whole.
(5) Without restricting the generality of subsection (2), and notwithstanding any other enactment,
(a) any deduction, exemption or exclusion 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, exemption or exclusion, 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.
[56] The terminal loss provision, subsection 20(16) read as follows for the year in issue:
Notwithstanding paragraphs 18(1)(a), 18(1)(b) and 18(1)(h), where at the end of a taxation year,
(a) the total of all amounts used to determine A to D in the definition “undepreciated capital cost” in subsection 13(21) in respect of a taxpayer’s depreciable property of a particular class exceeds the total of all amounts used to determine E to J in that definition in respect of that property, and
(b) the taxpayer no longer owns any property of that class,
in computing the taxpayer’s income for the year
(c) there shall be deducted the amount of the excess determined under paragraph 20(16)(a), and
(d) no amount shall be deducted for the year under paragraph 20(1)(a) in respect of property of that class.
Appellant’s position
[57] The Appellant concedes that the terminal loss allocated to him by Roseland II is a tax benefit within the meaning of subsection 245(1). However, he takes issue with the Minister’s conclusions that the transaction giving rise to the terminal losses, i.e. the disposition of the property by Roseland II to RPM, was not done for bona fide purposes other than to obtain the tax benefit, and that the transactions result in a misuse of the provisions of the Act or an abuse of the Act read as a whole.
[58] The Appellant argued that there was no avoidance transaction in this case because the primary purpose of the transactions was to bring two competing buildings into a common pool, streamlining costs and management.
[59] The Appellant submitted that the fact that information was received on the tax savings resulting from the reorganization must be considered in the context of all the evidence and does not prove the sale was tax motivated. Mr. Jacobs indicated that the business purpose was identified before tax advice was sought and that lawyers and accountants were only contacted in order to determine the best way to effect the sale and ensure that there were no adverse consequences to the partners.
[60] The Appellant also referred to his testimony that his decision to vote for the reorganization had nothing to do with the proposed tax benefits.
[61] Based on the foregoing the Appellant concluded that the sale of the building was done primarily for business reasons other than to obtain the terminal losses.
[62] The Appellant further submitted that the disposition of the partnership assets to RPM did not involve any misuse of the terminal loss provision, subsection 20(16), or any abuse of the Act as a whole.
[63] The Appellant submits that there is nothing in the object, spirit or purpose of subsection 20(16) that would prevent partners from claiming a terminal loss on the disposition of depreciable property by the partnership such as was done in this case.
[64] The Appellant referred to the understanding expressed by Mr. Neville that terminal losses are generally available in a traditional merger of partnerships where the conditions of subsection 20(16) are otherwise met: see Interpretation Bulletin IT‑ 471R dealing with the merger of partnership.
[65] The Appellant also referred to an opinion letter written by the Rulings Directorate of Revenue Canada in 1994 that states that if there is a dissolution of a limited partnership and a distribution of the partnership assets to the partners, the partnership will be deemed to have disposed of the assets and any terminal loss arising from that disposition can be allocated to the partners and claimed by them.[11]
[66] In the Appellant’s view, this shows that the Canada Revenue Agency (“CRA”) accepts that the object, spirit and purpose of subsection 20(16) is not offended by these transactions.
[67] The Appellant underlined the fact that this case does not involve a scheme whereby the Appellant is trying to claim a loss incurred by some other taxpayer. The Appellant in this case suffered a real economic loss on his investment in Roseland II when the property was sold for fair market value in 1994 because the property was worth less than when it was purchased in 1989. The fair market value of the property was therefore substantially less than its undepreciated capital cost and this resulted in a terminal loss under subsection 20(16) of the Act.
[68] The Appellant said that none of the stop‑loss rules to which the Respondent referred in argument were applicable in this case and that the object spirit and purpose of the stop-loss rules is therefore irrelevant to the issue to be decided. The only issue is the object, spirit and purpose of subsection 20(16).
[69] The Appellant also contended that the Respondent is attempting to characterize the transaction in suggesting that there was no disposition of an economic interest. There was a real change of ownership of the assets from Roseland Park II to RPM which resulted in the receipt of proceeds of disposition.
[70] In the event that the GAAR is found to apply, the Appellant does not challenge the Minister’s determination of the appropriate tax consequences pursuant to subsection 245(5) of the Act.
Respondent’s position
[71] The Respondent takes the position that the primary purpose of the dispositions of the assets by Roseland I and II was to obtain a tax benefit for the limited partners by crystallizing the terminal losses on the properties, without disposing of their investment in the underlying assets, and that the dispositions would result in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act as a whole.
[72] The Respondent acknowledged that, once it has been established that an avoidance transaction occurred, GAAR will apply only if the Respondent is able to show that the transaction was abusive within the meaning of subsection 245(4) of the Act. This involves a two step process. The provision that gave rise to the tax benefit must be interpreted to ascertain its object, spirit or purpose and then the Respondent must demonstrate that the avoidance transaction frustrates the object spirit or purpose of that provision.[12]
[73] The Respondent identified the provisions which gave rise to the tax benefit to the Appellant in this case, as subsection 20(16) and section 96 of the Act. He said that “the scheme of the Act within which these provisions operate seeks to prevent deductions in respect of the disposition of capital property in circumstances in which there is not a true economic disposition of the property between parties within the same economic unit such that the taxpayer either directly or indirectly continues to participate with the same or an identical property even after the disposition.”[13]
[74] The Respondent explained that subsection 20(16) is part of the Capital Cost Allowance (“CCA”) system in the Act which allows the taxpayer to deduct the actual cost of depreciable assets over a period of time at a rate prescribed by the Act. Citing the Federal Court of Appeal decision in Water’s Edge Village Estates (Phase II) v. Canada,[14] he stated that the object and spirit of the CCA provisions in the Act was to provide for the recognition of money spent to acquire qualifying assets to the extent that they are consumed in income earning processes under the Act.
[75] The Respondent said that the terminal loss under subsection 20(16) is premised on the taxpayer no longer owning any property of a prescribed class at the end of a taxation year, and there being “unused” UCC in respect of that prescribed class. Therefore, the terminal loss provision acts as a final adjustment to CCA “when an arm’s length sale demonstrates the property has been under-depreciated” under the CCA system.
[76] According to the Respondent, the policy of the Act is to recognize a disposition only in situations in which there has been a “real economic disposition” of a taxpayer’s interest in property.
[77] The Respondent argued that further evidence of this policy is found in the following provisions in the Act (as it read for the year in issue), commonly referred to as “stop-loss” provisions:
Subparagraph 40(2)(g)(i), which provided that a superficial loss from the disposition of a capital property is nil. “Superficial loss” is defined in subsection 54(1) as the loss arising from a disposition of property by a taxpayer where the same or identical property was acquired by the taxpayer, the taxpayer’s spouse or a corporation controlled by the taxpayer directly or indirectly in any manner whatever within a period beginning 30 days before the disposition and ending 30 days after the disposition.
Paragraph 40(2)(e), which denied a corporation’s loss from the disposition of any capital property by it to a person by whom it was controlled or to a corporation that was controlled by a person who controlled the corporation;
Subsection 85(4), which denied a loss that would otherwise arise on the disposition of capital property (except depreciable capital property) or eligible capital property by a taxpayer to a corporation controlled, directly or indirectly in any matter what ever, by the taxpayer, by the spouse of the taxpayer or by a person or group of persons by whom the taxpayer is controlled, directly or indirectly in any matter what ever; or where an amount would otherwise be deductible under paragraph 24(1)(a),
Subsection 85(5.1) which denied or reduced a terminal loss which would otherwise have resulted from the disposition of depreciable property by a person or partnership to:
- a corporation that was controlled, directly or indirectly in any manner whatever immediately after the disposition by the transferor, the transferor's spouse, or a person, group of persons or partnership by whom the transferor was so controlled; or
- a person, spouse of a person, member of a group of persons or partnership who controlled the transferor; or
- a partnership in which the transferor’s interest, as a member, was as a majority interest partner as described in paragraphs 97(3.1)(a) or (b) of the Act.
[78] The stop-loss rule in subsection 85(5.1) was repealed and replaced in 1998 by subsection 13(21.2) which was made applicable to transactions occurring after April 26, 1995. One of the changes brought about by the enactment of subsection 13(21.2) was to expand the scope of former subsection 85(5.1) to include a broader range of transferees, and to cover transfers made indirectly to those transferees.
[79] The definition of superficial loss was also amended at the same time to apply to a reacquisition of the subject property (or acquisitions of identical property) by a wider group of persons related to the taxpayer.
[80] The Respondent submitted that the Court could look to the policy behind subsection 13(21.2) and the amendments to the superficial loss definition even though those provisions were not yet in effect in the year in issue in this appeal. He said that in Water’s Edge Village Estates (Phase II) v. Canada, the Federal Court of Appeal accepted that subsequent amendments to the Act could be taken as demonstrating a desire by Parliament to close loopholes that previously existed in the Act in which permitted an anomalous result having regard to the object and spirit of the relevant provisions of the Act.
[81] The Respondent argued that in each of these stop‑loss provisions, the Act specifically provides that a legal disposition in and of itself is not sufficient to permit a deduction of a loss where the taxpayer has simply transferred the interest to either a related party or a member of an “economic unit” of which the taxpayer is a part. Any recognition of the losses for tax purposes would be premature, since the taxpayer has not truly disposed of his or her economic interest in the property. In the Respondent’s words, there was no “disposition of economic substance.”
[82] According to counsel this is indicative of a policy under the Act to prevent recognition of losses where no disposition of the taxpayer’s economic interest in the property has occurred, or where the taxpayer continues to have a direct or indirect interest in the property after the disposition.
[83] The Respondent submitted, therefore, that the transaction carried out by Roseland II in this case frustrated the object, spirit or purpose of subsection 20(16) because it was simply a transfer of property by a group of partners from one partnership to another, and was not a true disposition of property as intended by Parliament. He said that, in the end, the Appellant and the other investors were able to access the terminal losses while at the same time continuing their investment in the same property or a similar property through different partnerships. There was no change to their investment after the transfer since they continued to have the right to acquire the same referenced condominium units after the restructuring as they did before. The realization of terminal loss was premature because the investors had not stopped using the partnership assets in the income earning process. It was therefore only a paper loss occasioned by the decrease in the value of the partnerships’ assets by 1994. In the Respondent’s view, accessing the terminal losses before the sale of the partnership assets to third parties constituted abusive tax avoidance.
Analysis
Purpose of the transaction
[84] Subsection 245(3) provides that the GAAR will not apply to a transaction that "may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit." In determining purpose, regard must be had to all of the circumstances surrounding the transaction. In OSFC Holdings Ltd. v. R.,[15] Rothstein J. said:
The words "may reasonably be considered to have been undertaken or arranged" in subsection 245(3) indicate that the primary purpose test is an objective one. Therefore the focus will be on the relevant facts and circumstances a