Lipson v. Canada

Lipson v. Canada
Collection
Supreme Court Judgments
Date
2009-01-08
Neutral citation
2009 SCC 1
Report
[2009] 1 SCR 3
Case number
32041
Judges
Binnie, William Ian Corneil; LeBel, Louis; Deschamps, Marie; Fish, Morris J.; Abella, Rosalie Silberman; Charron, Louise; Rothstein, Marshall
On appeal from
Federal Court of Appeal
Subjects
Taxation
Notes
SCC Case Information: 32041
Decision Content
SUPREME COURT OF CANADA
Citation: Lipson v. Canada, 2009 SCC 1, [2009] 1 S.C.R. 3
Date: 20090108 Docket: 32041
Between:
Earl Lipson
Appellant
and
Her Majesty the Queen
Respondent
And Between:
Jordan B. Lipson
Appellant
and
Her Majesty the Queen
Respondent
Coram: Binnie, LeBel, Deschamps, Fish, Abella, Charron and Rothstein JJ.
Reasons for Judgment: (paras. 1 to 53)
Dissenting Reasons: (paras. 54 to 99)
Dissenting Reasons: (paras. 100 to 124)
LeBel J. (Fish, Abella and Charron JJ. concurring)
Binnie J. (Deschamps J. concurring)
Rothstein J.
______________________________
Lipson v. Canada, 2009 SCC 1, [2009] 1 S.C.R. 3
Earl Lipson Appellant
v.
Her Majesty the Queen Respondent
- and -
Jordan B. Lipson Appellant
v.
Her Majesty the Queen Respondent
Indexed as: Lipson v. Canada
Neutral citation: 2009 SCC 1.
File No.: 32041.
2008: April 23; 2009: January 8.
Present: Binnie, LeBel, Deschamps, Fish, Abella, Charron and Rothstein JJ.
on appeal from the federal court of appeal
Taxation — Income tax — Tax avoidance — Series of transactions — Series of transactions beginning with wife borrowing money to purchase shares in family corporation and leading to husband deducting interest on the couple’s home mortgage loan — Whether general anti-avoidance rule applicable to deny tax benefits — Whether series of transactions results in abuse and misuse of one or more provisions of Income Tax Act — Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .), s. 245(4).
The taxpayer E and his wife entered into an agreement of purchase and sale for a family residence. The wife borrowed $562,500 from a bank to finance the purchase of shares in a family corporation. She paid the borrowed money directly to the taxpayer who transferred the shares to her. The taxpayer and his wife obtained a mortgage from a bank for $562,500. That same day, they used the mortgage loan funds to repay the share loan in its entirety. On his 1994, 1995 and 1996 tax returns, the taxpayer deducted the interest on the mortgage loan and reported the taxable dividends on the shares as income when applicable. The brother of the taxpayer, J, conducted similar transactions. The Minister of National Revenue disallowed the deductions for those taxation years and reassessed the taxpayers accordingly. The Tax Court of Canada dismissed the taxpayers’ appeals, holding that the series of transactions constituted a misuse of ss. 20(1) (c), 20(3) , 73(1) and 74.1 of the Income Tax Act and the taxpayers’ appeals were dismissed. The Federal Court of Appeal upheld that decision.
Held (Binnie, Deschamps and Rothstein JJ. dissenting): The appeals should be dismissed.
Per LeBel, Fish, Abella and Charron JJ.: It has long been a principle of tax law that taxpayers may order their affairs so as to minimize the amount of tax payable. However, this principle has never been absolute, and Parliament has enacted the general anti-avoidance rule (“GAAR”) to limit the scope of allowable avoidance transactions while maintaining certainty for taxpayers. The GAAR denies a tax benefit where three criteria are met: the benefit arises from a transaction (ss. 245(1) and 245(2)); the transaction is an avoidance transaction as defined in s. 245(3); and the transaction results in an abuse and misuse within the meaning of s. 245(4). The taxpayer bears the burden of proving that the first two of these criteria are not met, while the burden is on the Minister to prove, on the balance of probabilities, that the avoidance transaction results in abuse and misuse within the meaning of s. 245(4). Here, all the transactions were conceded to result in two tax benefits and to be avoidance transactions. [21-23]
A two-part inquiry must be followed to determine whether a transaction results in a misuse and an abuse for the purposes of s. 245(4) of the Act. First, a court must conduct a unified textual, contextual and purposive analysis of the provisions giving rise to the tax benefit in order to determine their essential object, spirit and purpose. It is important to identify which provision is associated with each tax benefit. Here, the tax benefit of interest deductibility is associated with ss. 20(1)(c) and 20(3) and the tax benefit arising out of the use of the attribution rules by the taxpayer to reduce his income is linked with ss. 73(1) and 74.1(1). Second, a court must determine whether the avoidance transaction frustrates the object, spirit or purpose of the relevant provisions. In assessing a series of transactions, the misuse and abuse must be related to the specific transactions forming part of the series. However, the entire series of transactions should be considered in order to determine whether the individual transactions within the series abuse one or more of the provisions of the Act. Individual transactions must be viewed in the context of the series. This approach is consistent with the wording of the GAAR provisions, in particular with ss. 245(2) and 245(3)(b), which contemplate the denial of a tax benefit resulting from a series of transactions. Further, the use of the words “directly or indirectly” in s. 245(4), indicates that Parliament intended the GAAR to apply even where abuse is an indirect result of a transaction and consequently, that regard may be had to the series of transactions when determining whether a transaction within the series is abusive. It is preferable to refer to the “overall result” of the transactions which more accurately reflects the wording of s. 245(4), and the jurisprudence of this Court rather than “overall purpose” which may incorrectly imply that the taxpayer’s motivation or the purpose of the transaction is determinative. An avoidance purpose is needed to establish a violation of the GAAR when s. 245(3) is in issue, but is not determinative in the s. 245(4) analysis. [25-28] [33-34] [36-38]
The Minister has failed to establish that the purpose of ss. 20(1)(c) and 20(3) have been misused and abused. The series of transactions did not become problematic until the taxpayer and his wife turned to ss. 73(1) and 74.1(1), in order to obtain the result contemplated in the design of the series of transactions which resulted in the taxpayer applying his wife’s interest deduction to his own income. The attribution by operation of s. 74.1(1) that allowed the taxpayer to deduct the interest in order to reduce the tax payable on the dividend income from the shares and other income, which he would not have been able to do were the wife dealing with him at arm’s length, qualifies as abusive tax avoidance. It does not matter that s. 74.1(1) was triggered automatically when the taxpayer did not elect to opt out of s. 73(1). To allow s. 74.1(1) to be used to reduce the taxpayer’s income tax from what it would have been without the transfer to his wife frustrates the purpose of the attribution rules. The GAAR was not at issue in Singleton, nor was s. 74.1 of the Act, and consequently Singleton is distinguishable. [20] [41-42]
Here, it is not open to the Court to consider the interpretation and application of the specific anti-avoidance rule in s. 74.5(11) as it was expressly disavowed by all parties throughout the proceedings. The GAAR’s application was the focus of the appeals and was the proper basis for the reassessments of the transactions. These transactions are caught by the GAAR. Courts should avoid extending the GAAR beyond its statutory purpose. But, bearing this purpose in mind, where the language of and principles flowing from the GAAR apply to a transaction, the court should not refuse to apply it on the ground that a more specific provision — one that both the Minister and the taxpayers considered to be inapplicable throughout the proceedings — might also apply to the transaction. [43-47]
Finally, in determining the tax consequences of the GAAR’s application under s. 245(5), courts must be satisfied that an avoidance transaction has been found under s. 245(4), that s. 245(5) provides for the tax consequences and that they deny the tax benefits that would flow from the abusive transactions. Courts must then determine whether these tax consequences are reasonable in the circumstances. In the present case, the disallowance of the interest expense in computing the income or loss attributed to the taxpayer and allocation of that interest deduction back to his wife is a reasonable outcome. [51]
Per Binnie and Deschamps JJ. (dissenting): The GAAR is a weapon that, unless contained by the jurisprudence, could have a widespread, serious and unpredictable effect on legitimate tax planning. At the same time, the GAAR must be given a meaningful role. That role is circumscribed by the requirement in s. 245(4) that the transactions not only be shown to be “avoidance transactions”, but in addition that the Minister demonstrate that the tax benefit results from a misuse/abuse of the provisions of the Income Tax Act relied upon to produce it. In the present case, the Minister has failed to make such a demonstration. When the series of transactions at issue is properly characterized, it is a tax avoidance scheme that should not have been found to be abusive under the GAAR. [55] [59] [64]
Singleton illustrates the proposition that there is nothing abusive in principle for a taxpayer to rearrange his or her capital (borrowed or non-borrowed) in a tax efficient manner. The Minister is not asking the Court to revisit Singleton. He does not claim that GAAR would have applied in that case. The Minister acknowledges here that it is common ground that the interest was deductible. Thus, applying Singleton, the only question is whether the deduction becomes “abusive” when income or losses are attributed back to the transferor by the spousal attribution rules in ss. 73(1) and 74.1(1). [57-58] [60]
If the tax plan in Singleton is not abusive, the Minister has failed to establish that Singleton with a spousal twist is abusive tax avoidance either. There is nothing in the Act to discourage the transfer of property at fair market value between spouses. Indeed, by allowing a spouse to transfer property to the other spouse at the transferor’s adjusted cost base, Parliament intended to make such inter-spousal transfers attractive. The Minister has failed to identify a specific policy shown to be frustrated by the taxpayer’s plan as required by Canada Trustco and Kaulius. The approbation by the Court of the Minister’s resort to vague generalities or “overriding policy” will only increase the element of uncertainty in tax planning that Canada Trustco and Kaulius sought to avoid. [59] [67]
Canada Trustco requires the Minister to identify the misuse and abuse of an “object, spirit or purpose” that is “anchored in a textual, contextual and purposive interpretation of the specific provisions that are relied upon for the tax benefit”. By ignoring the initial sale of shares to the spouse and recharacterizing the interest payment in relation thereto as nothing more than interest on a house mortgage, and effectively arguing for a stand-alone prohibition on the deductibility of a house mortgage interest (despite Singleton), the Minister engages in the sort of vague appeal to “overriding policy” that Canada Trustco sought to eliminate from the GAAR analysis. [65]
In this case, as in Singleton, there was a change in the taxpayer’s position with real economic substance. The share sale must be accepted as an essential part of the “series of transactions”. Parliament must have contemplated that by giving taxpayers a choice under s. 73(1) in the context of an inter-spousal transfer of property, they would exercise it in a tax-minimizing manner. Far from offending the “object, spirit or purpose” of the spousal attribution rules, the taxpayer’s tax plan fulfilled them, or at a minimum did not abuse them. It cannot be right that whenever a lower income spouse borrows money to purchase shares from a higher income spouse there is an abuse of the spousal attribution rules unless the transferring spouse opts out of ss. 73(1) and 74.1(1), and thereby forfeits a tax benefit clearly available under the Act. While many spouses regard themselves as forming an economic unit, the rate at which spousal units implode serves as a reminder that the economic union of marriage is neither indissoluble nor free of risk. [87] [91-93] [96]
The “overall purpose” approach which the Tax Court judge adopted, and the Federal Court of Appeal accepted, was an error of law. The principal focus in s. 245(4) is on results not purpose. While the legal relationships actually created by the taxpayer do not control the application of the GAAR, they cannot be ignored. Here, the application of the GAAR would mean paying lip service to the principle that taxpayers are entitled to arrange their affairs to minimize the amount of tax payable, without taking seriously its role in promoting consistency, predictability and fairness in the tax system. [86] [90] [98]
Per Rothstein J. (dissenting): There was no abuse of ss. 20(1)(c) and 20(3) of the Act. There is no reason why a taxpayer may not arrange his or her affairs so as to finance personal assets out of equity and income earning assets out of debt. With respect to the taxpayer’s use of s. 74.1(1), ss. 245(2) and 245(4) require that all other relevant provisions of the Act be read before the Minister may have recourse to the GAAR. This Court held in Canada Trustco that the GAAR is a provision of last resort. If there is a specific anti-avoidance rule that precludes the use of an enabling rule to avoid or reduce tax, then the GAAR will not apply. The Minister did have other recourse in this case. Section 74.5(11) is a specific anti-avoidance rule that precludes the use of the attribution rules where one of the main reasons for the transfer of property was to reduce the amount of tax that would be payable on the income derived from the property. Here, one of the main reasons for the transfer of shares to the wife was to reduce or eliminate the dividend income on the shares. Therefore because s. 74.5(11) applied, s. 245 did not apply, and could not be relied upon by the Minister. The Minister should have resorted to s. 74.5(11) in order to reassess the taxpayer in respect of his use of s. 74.1(1). The Minister’s failure to invoke s. 74.5(11) is fatal to his reassessment in respect of s. 74.1(1). The Minister cannot preemptively rely on the GAAR to address the alleged abusive use of s. 74.1(1) as if s. 74.5(11) did not exist. The fact that the parties did not rely on s. 74.5(11) — either as the basis for reassessment or as the reason why the Minister’s claim should fail — does not change the fact that the section applies in law. If the Minister had reassessed the taxpayer by use of the relevant specific anti-avoidance provision, s. 74.5(11), then the tax benefit that resulted from the taxpayer’s use of the attribution rules would have been precluded. The Minister could not invoke the GAAR to reassess in respect of the taxpayer’s use of s. 74.1. [100] [102] [104-105] [108-110] [114-115] [118] [122] [124]
Cases Cited
Cited by LeBel J.
Distinguished: Singleton v. Canada, 2001 SCC 61, [2001] 2 S.C.R. 1046, aff’g [1999] 4 F.C. 484; referred to: Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2 S.C.R. 601; Mathew v. Canada, 2005 SCC 55, [2005] 2 S.C.R. 643; Commissioners of Inland Revenue v. Duke of Westminster, [1936] A.C. 1; Placer Dome Canada Ltd. v. Ontario (Minister of Finance), 2006 SCC 20, [2006] 1 S.C.R. 715; Ludco Enterprises Ltd. v. Canada, 2001 SCC 62, [2001] 2 S.C.R. 1082; Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622; Thibaudeau v. Canada, [1995] 2 S.C.R. 627.
Cited by Binnie J. (dissenting)
Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2 S.C.R. 601; Commissioners of Inland Revenue v. Duke of Westminster, [1936] A.C. 1; Singleton v. Canada, 2001 SCC 61, [2001] 2 S.C.R. 1046; Jabs Construction Ltd. v. The Queen, 99 D.T.C. 729; Mathew v. Canada, 2005 SCC 55, [2005] 2 S.C.R. 643.
Cited by Rothstein J. (dissenting)
Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2 S.C.R. 601.
Statutes and Regulations Cited
Income Tax Act , R.S.C. 1985, c. 1 (5th Supp .), ss. 18(1)(a), (h), 20, 73(1), 74.1 to 74.5, 245.
Authors Cited
Ahmed, Firoz, and Cassandra Priede. “Case Comment — Lipson v. Canada” (2007), 17 Can. Curr. Tax 77.
Krishna, Vern. The Fundamentals of Canadian Income Tax, 9th ed. Toronto: Thomson/Carswell, 2006.
McDonnell, Thomas E. “The Relevance of ‘Overall Purpose’ in a GAAR Analysis” (2007), 55 Can. Tax J. 720.
Thivierge, Manon. “GAAR Redux: After Canada Trustco”, in Report of Proceedings of the Fifty-Eighth Tax Conference. Toronto: Canadian Tax Foundation, 2007, 4:1.
APPEALS from a judgment of the Federal Court of Appeal (Décary, Noël and Sexton JJ.A.), 2007 FCA 113, [2007] 4 F.C.R. 641, 280 D.L.R. (4th) 714, 361 N.R. 191, [2007] 3 C.T.C. 110, 2007 D.T.C. 5172, [2007] F.C.J. No. 402 (QL), 2007 CarswellNat 640, affirming a decision of Bowman C.J.T.C., 2006 TCC 148, [2006] 3 C.T.C. 2494, 2006 D.T.C. 2687, [2006] T.C.J. No. 174 (QL), 2006 CarswellNat 982. Appeals dismissed, Binnie, Deschamps and Rothstein JJ. dissenting.
Edwin G. Kroft and Rosemarie Wertschek, Q.C., for the appellants.
Wendy Burnham and Daniel Bourgeois, for the respondent.
The judgment of LeBel, Fish, Abella and Charron JJ. was delivered by
LeBel J. —
I. Introduction
[1] These consolidated appeals raise the issue of what constitutes abusive tax avoidance for the purposes of the general anti-avoidance rule (“GAAR”) provided for in the Income Tax Act , R.S.C. 1985, c. 1 (5th Supp .) (“ITA ” or “Act ”). More specifically at issue is whether a series of transactions beginning with a wife borrowing money to purchase shares in a family corporation and leading to the husband deducting the interest on the couple’s home mortgage loan results in an abuse and misuse of one or more provisions of the Act ,* as contemplated in s. 245(4) of the ITA .
[2] The framework for identifying abusive tax avoidance was set out in the cases of Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2 S.C.R. 601, and Mathew v. Canada, 2005 SCC 55, [2005] 2 S.C.R. 643 (“Kaulius”). In those companion cases, the Court held that, for the purposes of s. 245(4), abusive tax avoidance occurs where the impugned transaction frustrates the object, spirit or purpose of one or more of the provisions relied on by the taxpayer.
[3] For the reasons that follow, I agree with the courts below that the respondent has established abusive tax avoidance. The GAAR applies to one of the transactions within the series and can accordingly be used to deny one of the tax benefits sought by the appellants. As a result, the appeals should be dismissed.
II. Facts
[4] These appeals were heard on the basis of a statement of agreed facts and conclusion, on which I will rely in reviewing the relevant facts. The appellant Earl Lipson (“Mr. Lipson”) conducted a series of transactions whose purpose, he concedes, was to minimize his income tax. He also concedes that his transactions were avoidance transactions within the meaning of s. 245(3) of the ITA . First, in April 1994, Mr. Lipson and his wife, Jordanna Lipson (“Mrs. Lipson”), entered into an agreement of purchase and sale for a family residence in Toronto. The purchase price was $750,000. On August 31, 1994, Mrs. Lipson borrowed $562,500 from the Bank of Montreal to finance the purchase at fair market value of 20 and 5/6 shares in Lipson Family Investments Limited, a family corporation. Mrs. Lipson did not earn enough income to pay the interest on this loan (the “share loan”) and the bank would not have lent it to her on an unsecured basis but for the fact that Mr. Lipson had agreed to repay the loan in its entirety the following day. Mrs. Lipson paid the borrowed money directly to her husband, who transferred the shares to her. It should be noted that the brother of Earl Lipson, the appellant Jordan B. Lipson, conducted similar transactions. It was agreed in the courts below that the outcome in Earl Lipson’s appeal would be dispositive of his brother’s appeal. In this Court, the two appeals were consolidated and continued as one appeal in file No. 32041.
[5] Mr. and Mrs. Lipson obtained a mortgage from the Bank of Montreal for $562,500 (the “mortgage loan”), which was advanced on the closing date of September 1, 1994. They were joint chargers under the mortgage. That same day, they used the mortgage loan funds to repay the share loan in its entirety.
[6] Mr. Lipson relied on four provisions of the ITA to claim a deduction of the mortgage loan interest on his 1994, 1995 and 1996 tax returns. The first was s. 73(1), pursuant to which a taxpayer may defer tax on interspousal transfers of property. Mr. Lipson did not elect out of this provision, as he was entitled to do. As a result, the transfer of shares from him to his wife was deemed to have occurred at his adjusted cost base rather than at fair market value, such that he neither sustained a loss nor realized a gain on the sale.
[7] Second, s. 74.1 attributes any income or loss from property transferred from one spouse to another back to the transferring spouse for tax purposes. Thus, although Mrs. Lipson owned the shares acquired from her husband, the dividend income and losses were attributed to Mr. Lipson.
[8] The third provision, although the shares were paid for with the proceeds of the share loan rather than the mortgage loan, was s. 20(3), which allows a deduction for interest on money borrowed to repay previously borrowed money if the interest on the original loan is deductible. As the Tax Court judge noted, the purpose of this provision is to facilitate refinancing (2006 TCC 148, [2006] 3 C.T.C. 2494, at para. 20). The mortgage loan was therefore treated as having funded the share purchase.
[9] Finally, Mr. Lipson deducted the interest on the mortgage loan pursuant to s. 20(1)(c), which permits the deduction of interest on money borrowed “for the purpose of earning income from a business or property”. It is not in dispute that the shares in Lipson Family Investments Limited were income-producing assets for Mrs. Lipson and that, were it not for the attribution rule of s. 74.1, she would be entitled, under s. 20(1)(c), to deduct the interest on the money borrowed to purchase the shares. As a result of that attribution rule, however, the dividend income and the interest expense were attributed to Mr. Lipson.
[10] On his 1994, 1995 and 1996 tax returns, Mr. Lipson deducted the interest on the mortgage loan and reported the taxable dividends on the shares as income where applicable. The Minister of National Revenue (“Minister”) disallowed the interest expenses of $12,948.19, $47,370.55 and $44,572.95, respectively, for those years and reassessed Mr. Lipson accordingly. The Minister originally disallowed the deductions on the basis that the true economic purpose for which the borrowed money was used was not to earn income and that the interest was therefore not deductible under s. 20(1) (c) of the ITA . However, by the time the case reached the Tax Court of Canada, this Court had rejected the “true economic purpose” approach in Singleton v. Canada, 2001 SCC 61, [2001] 2 S.C.R. 1046, aff’g [1999] 4 F.C. 484. The Minister therefore argued the case on the basis of the GAAR set out in s. 245 of the ITA and submitted that the series of transactions amounted to abusive tax avoidance.
III. Judicial History
[11] The appellants appealed the Minister’s reassessments to the Tax Court of Canada. The only issue at trial was whether the transactions, which the parties agreed were avoidance transactions resulting in a tax benefit, constituted abusive tax avoidance and were prohibited by the GAAR. Bowman C.J.T.C. relied on the approach to the GAAR set out by this Court in Canada Trustco and Kaulius. He held that “[t]he overall purpose as well as the use to which each individual provision was put was to make interest on money used to buy a personal residence deductible” (para. 23). He emphasized this overall purpose in relation to the purposes of each of the provisions in question and found that the series of transactions resulted in a misuse of ss. 20(1) (c), 20(3) , 73(1) and 74.1 of the ITA (para. 23). He therefore dismissed the appeals.
[12] On appeal to the Federal Court of Appeal, the appellants claimed that Bowman C.J.T.C. had erred by relying on the overall purpose of the series of transactions in concluding that the transactions resulted in a misuse of specific ITA provisions. They added that Bowman C.J.T.C. had relied on the economic purpose and substance of the transactions, which is not the test for interest deductibility under s. 20(1)(c). The proper approach, according to the appellants, would have been to assess each transaction, and the resulting legal relationships, separately, in which case the court could find no abuse and misuse of the provisions. They argued that this approach was consistent with the Supreme Court’s rulings in Canada Trustco and Kaulius.
[13] Noël J.A. agreed that, viewed separately and without regard to the overall purpose of the scheme, no single one of the transactions appeared abusive (2007 FCA 113, [2007] 4 F.C.R. 641, at para. 33). However, he concluded that Bowman C.J.T.C. was entitled to consider the transactions as a series. Indeed, both ss. 245(2) and 245(3)(b) contemplate the denial of a tax benefit resulting from a “series of transactions”. Further, Noël J.A. quoted para. 46 of Kaulius, in which this Court spoke of assessing the “object, spirit or purpose” of the provision “in light of the series of transactions”. He concluded that “the series cannot be ignored in conducting the abuse analysis” for the purposes of the GAAR (para. 45). He held that it had been open to Bowman C.J.T.C. to find, as he did, that the transactions resulted in a misuse of several provisions of the ITA . He dismissed the appeals.
IV. Analysis
A. Issues and Positions of the Parties
[14] The appellants submit that the Minister has not established that abusive tax avoidance had occurred. They point out that it is not disputed that the share purchase transaction was a bona fide, legal transaction in which Mrs. Lipson acquired shares in Lipson Family Investments Limited. She earned income on those shares and, were it not for s. 74.1 of the ITA , would have been required to report that income for tax purposes but would, pursuant to s. 20(1)(c), have been entitled to deduct the interest paid on the money borrowed to purchase those shares. The purpose of s. 20(1)(c) is to encourage the accumulation of income-producing assets. The fact that the applicability of this provision depends on tracing (i.e., of the actual use of the borrowed funds) rather than on apportionment or ordering (based on assumptions about use) means that the provision is concerned with legal relationships rather than with the true economic purpose of the transaction or series of transactions (Appellants’ Factum, at paras. 72-76). This principle was confirmed in Singleton, where a taxpayer was effectively permitted to deduct his home mortgage interest under s. 20(1)(c) because the direct use of the funds in issue was to acquire an income-producing asset, not to purchase a house. Therefore, the transactions in that case did not frustrate the purpose of s. 20(1)(c).
[15] Similarly, according to the appellants, the purposes of the other three provisions on which they rely are not frustrated. Section 20(3) contemplates the refinancing of a loan, and that was what the Lipsons did in using the mortgage loan to pay off the share loan. Section 73(1) applies automatically unless the taxpayer opts out, and s. 74.1 also applies automatically if the taxpayer does not elect out of s. 73(1). The provisions operated as intended. It would have been a misuse had they not applied.
[16] The appellants argue that the courts below erred in their analysis of the GAAR by relying on the “overall purpose” of the transactions, since an “overall purpose” test is not part of the inquiry under s. 245(4). Further, to the extent that “overall purpose” is synonymous with “true economic purpose”, this Court rejected the application of such a test under s. 20(1)(c) in Singleton and stated in Canada Trustco that “economic substance” is not determinative in the inquiry under s. 245(4) (Canada Trustco, at paras. 57 and 59). The effect of adopting an “overall purpose” test under s. 245(4) would be to cause uncertainty and inconsistency for taxpayers.
[17] The respondent, on the other hand, submits that the appellants’ approach effectively reads the GAAR out of the ITA . The very purpose of the GAAR is to negate arrangements that would result in a tax benefit “but for this section” (s. 245(2)). In other words, even if the provision being relied on allows a tax benefit, this does not preclude the transaction from being abusive under s. 245(4) of the Act .
[18] A contextual and purposive approach to the GAAR, as is mandated by Canada Trustco and Kaulius, requires a court to consider the purpose of each provision relied on and whether that purpose was defeated by the transaction or series of transactions. According to the respondent, such an analysis leads inevitably to the conclusion that to allow the interest to be deducted in the case at bar would frustrate the purpose of the provisions being relied on. Specifically, the deduction of mortgage interest frustrates the purpose of s. 20(1)(c) because personal expenses such as home mortgage interest are not deductible under s. 20(1)(c), as is clear from ss. 18(1) (a) and 18(1) (h) of the ITA . Such a deduction also frustrates s. 74.1, because that provision is aimed at preventing income splitting. Section 74.1 is an anti-avoidance provision, but it was used here precisely to avoid tax. It cannot be consistent with the object, spirit or purpose of s. 20(1)(c), s. 73(1) or s. 74.1 to permit one spouse to deduct interest on money borrowed to fund a personal expense for the benefit of both spouses. The respondent therefore submits that the courts below were correct in finding that the transactions were prohibited by the GAAR.
B. Applicability of the Singleton Case to the Present Situation
[19] As I mentioned above, the appellants consider this Court’s decision in Singleton to weigh in their favour because of its focus on legal relationships. The Minister concedes that, were it not for the GAAR, Mr. Lipson could properly deduct the interest expense under s. 20(1)(c) (Statement of Agreed Facts and Conclusion, at para. 15). If, as in Singleton, the issue in the instant case were whether the deduction was properly available under s. 20(1)(c), the Minister’s concession would be fatal.
[20] However, neither the GAAR nor s. 74.1 of the ITA was at issue in Singleton, so the present case is distinguishable. By treating Singleton as dispositive of the present appeals, the appellants in effect read the GAAR out of the ITA .
C. Interpretation of Tax Statutes and the Principle of Minimizing Tax Liability
[21] It has long been a principle of tax law that taxpayers may order their affairs so as to minimize the amount of tax payable (Commissioners of Inland Revenue v. Duke of Westminster, [1936] A.C. 1 (H.L.)). This remains the case. However, the Duke of Westminster principle has never been absolute, and Parliament enacted s. 245 of the ITA , known as the GAAR, to limit the scope of allowable avoidance transactions while maintaining certainty for taxpayers (Canada Trustco, at para. 15). In brief, the GAAR denies a tax benefit where three criteria are met: the benefit arises from a transaction (ss. 245(1) and 245(2)); the transaction is an avoidance transaction as defined in s. 245(3); and the transaction results in an abuse and misuse within the meaning of s. 245(4). The taxpayer bears the burden of proving that the first two of these criteria are not met, while the burden is on the Minister to prove, on the balance of probabilities, that the avoidance transaction results in abuse and misuse within the meaning of s. 245(4).
[22] The appellants argue that the courts below erred by disregarding the existence of two tax benefits stemming from the series of transactions. They contend and concede that the series of transactions involves two tax benefits: Mrs. Lipson’s entitlement to the interest deduction and the actual deduction of that interest from Mr. Lipson’s income by application of the attribution rules (see Transcript, at pp. 9, 10 and 17). I would add that, as specified in Canada Trustco, at para. 19, the existence of a tax benefit is a factual determination best left to the Tax Court judge. However, in the case at bar, the Tax Court judge did not clearly decide whether the series of transactions created more than one tax benefit. This Court must therefore make that determination. I agree that the GAAR analysis should be conducted in respect of each of those tax benefits. The appellants sought an overall result, that is, the deduction of the interest payments on the mortgage from their income. Nevertheless, the legal analysis required by the GAAR cannot stop at this level. Its focus must be on the individual benefits — which may in combination have led to the overall result — in the context of the series of transactions.
[23] Mr. Lipson concedes that all the transactions were avoidance transactions (see Statement of Agreed Facts and Conclusion, at para. 16). Therefore, the issue before us is whether any of the transactions result in a misuse and an abuse having regard to the provisions the taxpayers have relied on.
[24] The GAAR is set out in s. 245 of the ITA . The provision at issue in the present case, s. 245(4), reads as follows:
Subsection (2) [i.e. the denial of a tax benefit] 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.
[25] In other words, a taxpayer will not be denied a tax benefit resulting from an avoidance transaction unless that transaction directly or indirectly results in the abuse and misuse of provisions of the Act (or regulations, etc.). The approach to determining whether a transaction results in a misuse and an abuse for the purposes of s. 245(4) was set out in Canada Trustco, at paras. 44-62, the key portion of which reads as follows:
The heart of the analysis under s. 245(4) lies in a contextual and purposive interpretation of the provisions of the Act that are relied on by the taxpayer, and the application of the properly interpreted provisions to the facts of a given case. The first task is to interpret the provisions giving rise to the tax benefit to determine their object, spirit and purpose. The next task is to determine whether the transaction falls within or frustrates that purpose. The overall inquiry thus involves a mixed question of fact and law. The textual, contextual and purposive interpretation of specific provisions of the Income Tax Act is essentially a question of law but the application of these provisions to the facts of a case is necessarily fact-intensive.
This analysis will lead to a finding of abusive tax avoidance when a taxpayer relies on specific provisions of the Income Tax Act in order to achieve an outcome that those provisions seek to prevent. As well, abusive tax avoidance will occur when a transaction defeats the underlying rationale of the provisions that are relied upon. An abuse may also result from an arrangement that circumvents the application of certain provisions, such as specific anti-avoidance rules, in a manner that frustrates or defeats the object, spirit or purpose of those provisions. By contrast, abuse is not established where it is reasonable to conclude that an avoidance transaction under s. 245(3) was within the object, spirit or purpose of the provisions that confer the tax benefit. [paras. 44-45]
[26] In determining the purpose of the relevant provision(s) of the Act , a court must take a unified textual, contextual and purposive approach to statutory interpretation (Canada Trustco, at para. 47). This approach is, of course, not unique to the GAAR. As this Court confirmed in Kaulius, the approach to statutory interpretation is the same for provisions of the ITA as for those of any other statute: it is necessary “to determine the intention of the legislator by considering the text, context and purpose of the provisions at issue” (para. 42; see also Placer Dome Canada Ltd. v. Ontario (Minister of Finance), 2006 SCC 20, [2006] 1 S.C.R. 715, at paras. 21-23).
[27] Thus, the first analytical step is to interpret the four provisions at issue in the present case to determine their essential object, spirit and purpose. The parties do not generally dispute Bowman C.J.T.C.’s analysis in this regard, although they emphasize different aspects of the provisions’ object, spirit and purpose. For example, the Minister highlights the link between certain provisions and Parliament’s goal of regulating taxation within the spousal unit (Respondent’s Factum, at para. 47). The appellants, on the other hand, submit that the Tax Court judge erred in his analysis of the purpose of s. 20(1)(c) by failing to appreciate the importance of “tracing” (Appellants’ Factum, at para. 33(c)).
[28] At this step, it is important to identify which provisions are associated with each tax benefit. Here, it is clear that the tax benefit of deductibility of interest relates to ss. 20(1)(c) and 20(3). On the other hand, the tax benefit arising out of Mr. Lipson’s use of the attribution rules, namely the possibility of deducting the interest to reduce his income, is linked with ss. 73(1) and 74.1(1). By virtue of these provisions, Mr. Lipson retains, for tax purposes, the stream of income from the shares sold to his wife but is able to deduct the interest payments on the mortgage from his income.
[29] Section 20(1)(c) allows taxpayers to deduct interest on borrowed money used for a commercial purpose. The purpose of this provision is to “create an incentive to accumulate capital with the potential to produce income” (Ludco Enterprises Ltd. v. Canada, 2001 SCC 62, [2001] 2 S.C.R. 1082, at para. 63), or to “encourage the accumulation of capital which would produce taxable income” (Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622, at para. 57).
[30] Section 20(3) was enacted “[f]or greater certainty” in order to make it clear that interest that is deductible under s. 20(1)(c) does not cease to be deductible because the original loan was refinanced. It serves “a practical function in the commercial world of facilitating refinancing” (Tax Court judgment, at para. 20).
[31] The effect of s. 73(1) is to facilitate interspousal transfers of property without triggering immediate tax consequences (Tax Court judgment, at para. 21). This is an exception to the general rule that capital gains and losses are recognized when property is disposed of. According to Professor Vern Krishna:
The