Deans Knight Income Corp. v. Canada

Deans Knight Income Corp. v. Canada
Collection
Supreme Court Judgments
Date
2023-05-26
Neutral citation
2023 SCC 16
Case number
39869
Judges
Wagner, Richard; Karakatsanis, Andromache; Côté, Suzanne; Brown, Russell; Rowe, Malcolm; Martin, Sheilah; Kasirer, Nicholas; Jamal, Mahmud; O’Bonsawin, Michelle
On appeal from
Federal Court of Appeal
Subjects
Taxation
Notes
Case in Brief SCC Case Information
Decision Content
SUPREME COURT OF CANADA
Citation: Deans Knight Income Corp. v. Canada, 2023 SCC 16
Appeal Heard: November 2, 2022 Judgment Rendered: May 26, 2023 Docket: 39869
Between:
Deans Knight Income Corporation Appellant
and
His Majesty The King Respondent
- and -
Attorney General of Ontario, Canadian Chamber of Commerce, Tax Executives Institute, Inc., and Agence du Revenu du Québec Interveners
Coram: Wagner C.J. and Karakatsanis, Côté, Brown,* Rowe, Martin, Kasirer, Jamal and O’Bonsawin JJ.
Reasons for Judgment: (paras. 1 to 141)
Rowe J. (Wagner C.J. and Karakatsanis, Martin, Kasirer, Jamal and O’Bonsawin JJ. concurring)
Dissenting Reasons: (paras. 142 to 197)
Côté J.
Note: This document is subject to editorial revision before its reproduction in final form in the Canada Supreme Court Reports.
* Brown J. did not participate in the final disposition of the judgment.
Deans Knight Income Corporation Appellant
v.
His Majesty The King Respondent
and
Attorney General of Ontario,
Canadian Chamber of Commerce,
Tax Executives Institute, Inc., and
Agence du Revenu du Québec Interveners
Indexed as: Deans Knight Income Corp. v. Canada
2023 SCC 16
File No.: 39869.
2022: November 2; 2023: May 26.
Present: Wagner C.J. and Karakatsanis, Côté, Brown,* Rowe, Martin, Kasirer, Jamal and O’Bonsawin JJ.
on appeal from the federal court of appeal
Taxation — Income tax — Tax avoidance — Application of general anti‑avoidance rule — Limitation on losses deductible from taxable income — Corporation lacking income sufficient to use non‑capital losses and other tax attributes from previous years to reduce corporate income tax — Corporation entering into transactions with other parties and deducting non‑capital losses from income earned in new investment venture — Deductions denied by Minister — Tax Court holding that transactions were tax avoidance but were not abusive under general anti‑avoidance rule — Court of Appeal concluding that transactions abusive — Whether general anti‑avoidance rule applicable to deny corporation’s deductions of non‑capital losses — Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .), ss. 111(5), 245.
Section 111(1) (a) of the Income Tax Act allows a taxpayer’s non‑capital losses to be carried back or forward to different taxation years to offset income in those years. However, s. 111(5) restricts non‑capital loss carryovers for a corporation if control of the corporation has been acquired by a person or group of persons, unless it continues the same or similar business that incurred the losses. Prior to the transactions in issue, Deans Knight Income Corporation (“Deans Knight”), then operating under the name Forbes Medi‑Tech Inc. (“Forbes”), had approximately $90 million of unused non‑capital losses, scientific research and development tax expenditures, and investment tax credits but given that it was in financial difficulty, it did not have income which its past losses could offset. It entered into an investment agreement with a venture capital company, Matco, and a complex arrangement was devised to take advantage of the loss carryover deduction in s. 111(1) (a) without triggering the restriction in s. 111(5) . First, Forbe’s assets and liabilities were moved into a new parent company, Newco. Second, pursuant to the investment agreement, Matco purchased a debenture convertible into some of the voting shares and all of the non‑voting shares that Newco held in Forbes. While Newco was not obliged to sell its shares to Matco, it was promised that it would receive at least a guaranteed amount if it sold the shares or if such an opportunity did not present itself. Third, Matco would find a new business venture for Forbes, which would be used to raise money through an initial public offering (“IPO”). The profits from this venture could be sheltered by the tax attributes Forbes originally could not utilize. Other than when acting pursuant to the investment agreement, Newco and Forbes could not engage in a variety of activities without the consent of Matco. The arrangement went according to plan. Matco found a mutual fund management company, Deans Knight Capital Management, that agreed to use Forbes for an IPO through which it would raise money to invest in high‑yield debt instruments. Forbes’ name was changed to Deans Knight. The IPO and subsequent investment business succeeded. Accordingly, for its 2009 to 2012 tax years, Deans Knight deducted a majority of its non‑capital losses to reduce its tax liability.
The Minister reassessed Deans Knight and denied the deductions. Deans Knight objected to the reassessments and appealed to the Tax Court. Among other arguments, the Minister adopted the position that the general anti‑avoidance rule in s. 245 of the Income Tax Act (“GAAR ”) applied to deny the deductions because the transactions constituted abusive tax avoidance. The Tax Court agreed the transactions were tax avoidance transactions that resulted in a tax benefit but held they were not abusive. On appeal, the Federal Court of Appeal held that the transactions were abusive and the GAAR applied to deny the tax benefits. It set aside the judgment of the Tax Court and dismissed Deans Knight’s appeal of the reassessments.
Held (Côté J. dissenting): The appeal should be dismissed.
Per Wagner C.J. and Karakatsanis, Rowe, Martin, Kasirer, Jamal and O’Bonsawin JJ.: The transactions were abusive and therefore the GAAR applies to deny the tax benefits. The object, spirit and purpose of s. 111(5) is to prevent corporations from being acquired by unrelated parties in order to deduct their unused losses against income from another business for the benefit of new shareholders. Through a complex series of transactions, Deans Knight underwent a fundamental transformation that achieved the outcome that Parliament sought to prevent, while narrowly circumventing the text of s. 111(5). Without triggering an “acquisition of control”, Matco gained the power of a majority voting shareholder and fundamentally changed Deans Knight’s assets, liabilities, shareholders and business. This severed the continuity that is at the heart of the object, spirit and purpose of s. 111(5). The result obtained by the transactions frustrated the rationale of s. 111(5) and therefore constituted abuse.
The GAAR was a choice by Parliament to complement its specific anti‑avoidance efforts with the enactment of a general rule. While abusive tax avoidance can involve unforeseen tax strategies, it is more broadly designed to capture situations that undermine the integrity of the tax system by frustrating the object, spirit and purpose of the provisions relied on by the taxpayer. Some uncertainty is unavoidable when a general rule is adopted, but a reasonable degree of certainty is achieved by the balance struck within the GAAR itself. A GAAR analysis involves a structured, three‑step test, and asks whether (1) there was a tax benefit; (2) the transaction giving rise to the tax benefit was an avoidance transaction; and (3) the avoidance transaction was abusive.
Analyzing whether the avoidance transactions are abusive involves determining the object, spirit and purpose of the relevant provisions, and determining whether the result of the transactions frustrated that object, spirit and purpose. The object, spirit and purpose represents the legislative rationale that underlies specific or interrelated provisions of the Act. It is critical to distinguish the rationale behind a provision from the means chosen to give that rationale effect within the provision. The object, spirit and purpose of a provision must be worded as a description of its rationale. A court is not repeating the test for the provision or crafting a new, secondary test; rather, the object, spirit and purpose is a concise description of the rationale underlying the provision, such as why relief is being provided, the conduct that Parliament sought to encourage, or the result or mischief that Parliament sought to prevent.
The use of a provision’s text, context and purpose to determine the rationale differs from traditional statutory interpretation. Since in a GAAR analysis, the search is for the rationale that underlies the words, considering the provision’s text, context and purpose ensures that the intrinsic and extrinsic evidence used to discern that rationale remains tied to the provision itself. Considering a provision’s text involves asking how it sheds light on what the provision was designed to achieve, since the language and structure of the provision can be evocative of Parliament’s underlying concerns. Courts must also consider the provision’s context, with a focus on the relationship between the provision alleged to have been abused and the particular scheme within which it operates. Understanding the provision’s purpose is central to the GAAR analysis, and legislative history and extrinsic evidence provide insight into the rationale for specific provisions.
Once the object, spirit and purpose has been ascertained, the abuse analysis focuses on whether the result of the transactions frustrates the provision’s object, spirit and purpose. Avoidance transactions will be abusive where their result: is an outcome that the provisions relied on seek to prevent; defeats the underlying rationale of the provisions; or circumvents provisions in a manner that frustrates their object, spirit and purpose. Courts must go beyond the legal form and technical compliance of the transactions; they must compare the result of the transactions to the underlying rationale of the provision and determine whether that rationale has been frustrated. In coming to such a conclusion, the abusive nature of the transaction must be clear. However, there is no bar to applying the GAAR in situations where the Act specifies precise conditions that must be met, as with a specific anti‑avoidance rule; even specific and carefully drafted provisions are not immune from abuse.
A review of s. 111(5)’s text, context and purpose reveals its underlying rationale. With respect to the text of the provision, s. 111(5) is a restriction on a taxpayer’s ability to make use of its non‑capital losses incurred in another taxation year. First, the text of s. 111(5) references “control”, which has been interpreted as referring to de jure control. The general test for de jure control is whether the controlling party enjoys, by virtue of its shareholdings, the ability to elect the majority of the board of directors. Second, control must be “acquired by a person or group of persons”. Third, s. 111(5) creates an exception that losses remain deductible if, after an acquisition of control, the corporation engages in the same or a similar business. Thus, the connection to past losses is severed only when control has been acquired and there is a break from the corporation’s past business. The text of s. 111(5) reflects a concern with denying loss carryovers when there is a lack of continuity within the corporation, as measured by both the identity of its controlling shareholders and its business activity.
A contextual analysis also sheds light on the rationale behind s. 111(5). First, s. 111(5) should be considered against the foundational principles of the Income Tax Act . Under the Act, every person, including a corporation, is a separate taxpayer, and it is a foundational principle that taxpayers are to be taxed on their own earnings. When there has been an acquisition of control and a corporation’s business ceases to operate, it can no longer be understood as the same taxpayer. Furthermore, s. 111(5) delineates the boundaries of the benefit‑conferring provision, s. 111(1)(a). Section 111(1)(a) modifies the general rule that each taxpayer is taxed based on their income and losses within a single taxation year to allow a taxpayer to deduct non‑capital losses against income in a future or prior taxation year, but only the taxpayer who suffered the loss is entitled to deduct the loss. Section 111(5) ensures that this principle is given effect for corporations. While a corporation is still the same legal person after an acquisition of control, the identity of those behind the corporation has changed. Section 111(5) functions so that the tax benefits associated with those losses will not benefit a new shareholder base carrying on a new business. This restriction is consistent with other provisions in the Act which also treat a corporation as, effectively, a new taxpayer following an acquisition of control. There are reasons why Parliament chose the de jure control test as the standard to be used on an application of s. 111(5): it is a clearer benchmark than de facto control, meaning greater certainty for the majority of transactions, which are not tax‑motivated. However, the provision’s rationale is not fully captured by the de jure test; rather, the rationale of s. 111(5) is illuminated by related provisions which both extend and restrict the circumstances in which an acquisition of control has occurred, including by looking beyond the standard documentation under the de jure control test. These provisions suggest that de jure control is not a perfect reflection or complete explanation of the mischief that Parliament sought to address.
It is also necessary to consider extrinsic evidence of Parliament’s purpose. The legislative history behind s. 111(5) illustrates that Parliament was concerned with addressing the trading of loss corporations, which was undermining the tax base and creating inequity among taxpayers. While the means Parliament has chosen to address these concerns have evolved over time, its rationale for including the non‑capital loss carryover restriction in the Act has been consistent. When a corporation changes hands, and the loss business ceases to operate, the corporation is effectively a new taxpayer that cannot avail itself of non‑capital losses accumulated by the old taxpayer. The business continuity exception was included to encourage the recovery of unprofitable enterprises that require new investment by new owners to strengthen the corporation’s business. Although the corporation may have changed hands, the link in continuity is preserved through a different marker and the justification for s. 111(1)(a) remains applicable. This reinforces that, at its core, s. 111(5) serves to delineate the circumstances in which the basis for the loss carryover rule in s. 111(1)(a) is non‑existent.
Taken together, the object, spirit and purpose of s. 111(5) is to prevent corporations from being acquired by unrelated parties in order to deduct their unused losses against income from another business for the benefit of new shareholders. Parliament sought to ensure that a lack of continuity in a corporation’s identity was accompanied by a corresponding break in its ability to carry over non‑capital losses. This is the rationale underlying the provision and properly explains why Parliament enacted s. 111(5).
An analysis of the transactions at issue demonstrates that their result served to frustrate the object, spirit and purpose of s. 111(5): they achieved the outcome that Parliament sought to prevent and provided Matco with the benefits of an acquisition of control, all while narrowly circumventing the application of s. 111(5). They resulted in Deans Knight’s near‑total transformation: it became a company with new assets and liabilities, new shareholders and a new business whose only link to its prior corporate life was the tax attributes. It was used as the vessel for an unrelated venture selected by Matco. Matco achieved the functional equivalent of an acquisition of control through the investment agreement, while circumventing s. 111(5), because the transactions dismembered the rights and benefits that would normally flow from being a controlling shareholder. First, it contracted for the ability to select Deans Knight’s directors. Second, the investment agreement placed severe restrictions on the powers of the board of directors which, but for a circuit‑breaker transaction that occurred in this case, would normally occur through a unanimous shareholders agreement and which would lead to an acquisition of de jure control. Third, the transactions allowed Matco to reap significant financial benefits, while depriving Newco, the majority voting shareholder on paper, of each of the core rights that it could ordinarily have exercised.
Any residual freedom that Deans Knight had was illusory and reinforces how the transactions frustrated the rationale of s. 111(5). Deans Knight’s acceptance of the corporate opportunity presented by Matco was a fait accompli because Deans Knight was prohibited from engaging in any activity other than studying and accepting the corporate opportunity, and because the consequences of refusing the opportunity were severe. As for Newco’s ability to sell its remaining shares to a party other than Matco or to opt not to sell at all, Deans Knight’s actions were already locked down by the investment agreement, and the benefits of share ownership were already negated by being subjected to Matco’s approval. The ability to receive the guaranteed amount without selling the remaining shares to Matco was important because in certain circumstances, Matco’s purchase of the shares might lead to an acquisition of de jure control. The complex series of transactions and the flexibility built into the investment agreement were necessary only because the contracting parties sought to achieve the very mischief that s. 111(5) was intended to prevent. Considering the circumstances as a whole, the result obtained by the transactions frustrated the rationale of s. 111(5).
Per Côté J. (dissenting): The appeal should be allowed and the Tax Court’s judgment restored. The avoidance transactions did not frustrate the rationale of s. 111(5), and therefore, do not amount to abuse. The GAAR requires a careful balance between the interest of the taxpayer in minimizing his or her taxes through technically legitimate means and the legislative interest in ensuring the integrity of the income tax system. Despite Parliament’s unambiguous adoption of the de jure control test in s. 111(5) of the Income Tax Act, the majority has opted for an ad hoc approach that expands the concept of control based on a wide array of operational factors. This approach invites the exercise of unbounded judicial discretion and will result in the loss‑trading restrictions in s. 111(5) being applied to transactions on a circumstantial basis.
The majority’s approach to determining the object, spirit and purpose of s. 111(5) fails to account for the central principle that the GAAR does not and cannot override Parliament’s specific intent regarding particular provisions of the Act. The GAAR analysis rests on the same interpretive approach employed by the Court in all questions of statutory interpretation, and is little more than a specialized form of statutory interpretation to determine Parliament’s intent. It should not be assumed that the GAAR plays a role in every transaction and in every context. There is agreement with the majority that there is no bar to applying the GAAR in situations where the Act specifies precise conditions that must be met to achieve a particular result, as with a specific anti‑avoidance rule; however, a provision’s text can sometimes be conclusive and fully explain its underlying rationale. The key question is whether Parliament specifically intended to prevent or permit a certain type of transaction. Where an anti‑avoidance provision has been carefully crafted to include some situations and exclude others, it is reasonable to infer that Parliament chose to limit its scope accordingly. The GAAR was intended to catch unforeseen tax strategies, but if Parliament drafts a specific anti‑avoidance provision in a way that keeps a highly foreseeable gap open, the gap is more likely to be intentional, and relying on it should not be considered abusive.
Section 111(5) is a specific anti‑avoidance rule that limits what would otherwise be permissible deductions under s. 111(1)(a), which allows taxpayers to deduct non‑capital losses for the purpose of computing taxable income for a taxation year. Upon an acquisition of control, s. 111(5) prevents a corporation from carrying over losses unless the business, carried on by the corporation subject to the change of control, is continued for profit or with a reasonable expectation of profit. It bars corporate acquisitions for the singular purpose of accessing tax attributes by restricting the use of those attributes if accessed through the exercise of control. Courts have determined that “control” for the purposes of the Act means de jure control. De jure control refers to the ownership of a sufficient number of shares to have a majority of votes in the election of the corporation’s board of directors. A corporation’s constating documents create de jure control because they restrain the ability of shareholders to exercise their voting power freely. In contrast, external agreements give rise to obligations that are contractual and not legal or constitutional in nature. Consequently, the distinction between de jure and de facto control lies in the breadth of factors that can be considered in determining who has control over the corporation.
The object, spirit and purpose of s. 111(5) is to restrict the use of tax attributes if accessed through an acquisition of de jure control. A textual, contextual and purposive analysis of s. 111(5) of the Act reveals that Parliament never intended courts to consider factors other than those related to share ownership in determining who has control over a corporation. The majority introduces the notion of functional equivalence, which treats the investment agreement as a constating document for the purposes of control. This ignores that constating documents and external agreements are enforced in radically different ways: an ordinary contract can never be functionally equivalent to a constating document. The GAAR cannot be invoked to override Parliament’s clear intent, and the majority’s approach departs from Parliament’s clear articulation of a de jure control test for restricting losses under s. 111(5).
Whether an avoidance transaction is abusive is a fact‑intensive inquiry that raises a question of mixed fact and law. Absent an extricable error of law, the application of the law to the facts is subject to the standard of palpable and overriding error. No such error exists in the instant case. As de jure control is an essential element of the object, spirit and purpose of s. 111(5), the key question is whether Matco acquired de jure control of Deans Knight and the relationship between Matco and Deans Knight is the proper focus of the abuse analysis. The Tax Court’s decision was based on a combination of findings of fact and an interpretation of the investment agreement that is supported by the evidence. There is no reviewable error in the Tax Court’s conclusion that Matco did not acquire “effective” control of Deans Knight. At no point did Matco own or have a right to own enough shares to reach a majority shareholder position. The investment agreement is of no relevance as to whether Matco acquired de jure control. It did not give Matco control over Newco’s sale of the shares remaining after Matco converted the debenture or require that Matco present a sale opportunity for those shares. Parliament’s test for control is squarely focused on voting rights arising from ownership. The right to dividends is irrelevant. The only relevant incidence of ownership is voting power, something that the investment agreement did not take away. The Tax Court made a specific credibility finding on the point that Deans Knight remained a free actor throughout the transactions. Mischaracterization of s. 111(5) did not taint this important credibility finding. Matco did not acquire Deans Knight in any practical sense. Matco was only a facilitator of the transactions and did not use Deans Knight’s non‑capital losses for its own benefit. The existence of abusive tax avoidance is, at best, unclear and the benefit of the doubt should go to the taxpayer.
Cases Cited
By Rowe J.
Distinguished: Canada v. Alta Energy Luxembourg S.A.R.L., 2021 SCC 49; applied: Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2 S.C.R. 601; Copthorne Holdings Ltd. v. Canada, 2011 SCC 63, [2011] 3 S.C.R. 721; referred to: Duha Printers (Western) Ltd. v. Canada, [1998] 1 S.C.R. 795; Mathew v. Canada, 2005 SCC 55, [2005] 2 S.C.R. 643; Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536; Triad Gestco Ltd. v. Canada, 2012 FCA 258, [2014] 2 F.C.R. 199; Lipson v. Canada, 2009 SCC 1, [2009] 1 S.C.R. 3; The Gladwin Realty Corporation v. The Queen, 2020 FCA 142, [2020] 6 C.T.C. 185; Commissioners of Inland Revenue v. Duke of Westminster, [1936] A.C. 1; Craven v. White, [1989] A.C. 398; Canada v. Oxford Properties Group Inc., 2018 FCA 30, [2018] 4 F.C.R. 3; Fiducie Financière Satoma v. The Queen, 2018 FCA 74, 2018 D.T.C. 5052; Housen v. Nikolaisen, 2002 SCC 33, [2002] 2 S.C.R. 235; Buckerfield’s Ltd. v. Minister of National Revenue, [1965] 1 Ex. C.R. 299; Silicon Graphics Ltd. v. Canada, 2002 FCA 260, [2003] 1 F.C. 447; Canada v. 594710 British Columbia Ltd., 2018 FCA 166, [2019] 5 C.T.C. 1; OSFC Holdings Ltd. v. Canada, 2001 FCA 260, [2002] 2 F.C. 288.
By Côté J. (dissenting)
Lipson v. Canada, 2009 SCC 1, [2009] 1 S.C.R. 3; 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; Canada v. Alta Energy Luxembourg S.A.R.L., 2021 SCC 49; Copthorne Holdings Ltd. v. Canada, 2011 SCC 63, [2011] 3 S.C.R. 721; Minister of National Revenue v. Landrus, 2009 FCA 113, 392 N.R. 54; Buckerfield’s Ltd. v. Minister of National Revenue, [1965] 1 Ex. C.R. 299; Duha Printers (Western) Ltd. v. Canada, [1998] 1 S.C.R. 795; Minister of National Revenue v. Consolidated Holding Co., [1974] S.C.R. 419; Silicon Graphics Ltd. v. Canada, 2002 FCA 260, [2003] 1 F.C. 447; Lyrtech RD Inc. v. The Queen, 2014 FCA 267, 2015 D.T.C. 5054; Housen v. Nikolaisen, 2002 SCC 33, [2002] 2 S.C.R. 235; Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53, [2014] 2 S.C.R. 633.
Statutes and Regulations Cited
Business Corporations Act, CQLR, c. S‑31.1, ss. 2 “to control”, 112.
Business Corporations Act, R.S.O. 1990, c. B.16, ss. 1(5), 115(1).
Canada Business Corporations Act , R.S.C. 1985, c. C-44, ss. 2(3) , 24(3) , 102(1) , 115(3) .
Civil Code of Québec, arts. 310, 335, 336.
Income Tax Act, R.S.C. 1952, c. 148, s. 27(1)(e) [rep. & sub. 1958, c. 32, s. 12(1)], (5) [ad. idem, s. 12(2); rep. & sub. 1963, c. 21, s. 6(1); rep. & sub. 1970-72, c. 63, s. 1], (5a) [ad. 1963, c. 21, s. 6(2)].
Income Tax Act , R.S.C. 1985, c. 1 (5th Supp .), ss. 2 to 4, 111(1)(a), (5), (5.4), 245, (1) “tax benefit”, 248(10), 249(4), 251(5)(b), 256(5.1) [ad. 1988, c. 55, s. 192], (7), (8), 256.1 [ad. 2013, c. 40, s. 94].
Authors Cited
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APPEAL from a judgment of the Federal Court of Appeal (Stratas, Woods and Laskin JJ.A.), 2021 FCA 160, 460 D.L.R. (4th) 731, [2021] 5 C.T.C. 39, 2021 D.T.C. 5095, [2021] F.C.J. No. 825 (QL), 2021 CarswellNat 2893 (WL), setting aside a decision of Paris J., 2019 TCC 76, [2019] 4 C.T.C. 2001, 2019 D.T.C. 1059, [2019] T.C.J. No. 58 (QL), 2019 CarswellNat 1133 (WL). Appeal dismissed, Côté J. dissenting.
Barry R. Crump, Heather DiGregorio, Robert Martz and Jennie Han, for the appellant.
Michael Taylor and Perry Derksen, for the respondent.
Alexandra Clark, Dona Salmon and Jennifer Boyczuk, for the intervener the Attorney General of Ontario.
Steve Suarez, Laurie A. Goldbach and Elizabeth Egberts, for the intervener the Canadian Chamber of Commerce.
Al Meghji, Edward Rowe and Joanne Vandale, for the intervener the Tax Executives Institute, Inc.
Pierre Zemaitis and Josée Fournier, for the intervener Agence du Revenu du Québec.
The judgment of Wagner C.J. and Karakatsanis, Rowe, Martin, Kasirer, Jamal and O’Bonsawin JJ. was delivered by
Rowe J. —
TABLE OF CONTENTS
Paragraph
I. Overview
1
II. Facts
7
III. Judicial History
26
A. Tax Court of Canada, 2019 TCC 76, [2019] 4 C.T.C. 2001
26
B. Federal Court of Appeal, 2021 FCA 160, 460 D.L.R. (4th) 731
34
IV. Issues
39
V. Analysis
40
A. Background to the General Anti-Avoidance Rule
40
B. The Relationship Between the GAAR, the Duke of Westminster Principle and Uncertainty
46
C. Applying the GAAR
51
(1) Tax Benefit
53
(2) Avoidance Transaction
54
(3) Abusive Tax Avoidance
56
(a) The Object, Spirit and Purpose Reflects the Rationale of the Provision
58
(b) The Provision’s Text, Context and Purpose Are Used to Determine Its Rationale
62
(c) The Abuse Analysis Focuses on Whether the Result of the Transactions Frustrates the Provision’s Object, Spirit and Purpose
69
(d) Summary
73
VI. Application
75
A. Which Provisions Are at Issue?
75
B. What Is the Object, Spirit and Purpose of Section 111(5)?
78
(1) The Text of the Provision
79
(2) The Context of the Provision
84
(a) Section 111(5) Should Be Considered Against the Foundational Principles of the Act
85
(b) Section 111(5) Delineates the Boundaries of the Benefit-Conferring Provision, Section 111(1)(a)
86
(c) Parliament’s Selection of Control Tests Differs Across the Act
91
(d) The Control Test in Section 111(5) Is Expanded and Restricted by Other “Deeming” Provisions
96
(3) The Purpose of the Provision
100
(4) Conclusion on Object, Spirit and Purpose
113
C. Was There an Abuse of Section 111(5)?
121
VII. Conclusion
141
Appendix
I. Overview
[1] This tax appeal raises the issue of the application of the general anti-avoidance rule (the “GAAR ”) to transactions undertaken by the appellant, Deans Knight Income Corporation, to monetize non-capital losses and other deductions.
[2] Under the Income Tax Act , R.S.C. 1985, c. 1 (5th Supp .) (the “Act ”), a taxpayer’s tax burden is normally calculated based on the income and losses from that taxation year (s. 2). However, the Act allows non-capital losses to be carried back 3 years or carried forward 20 years in order to offset income in those years (s. 111(1)(a)). This ability to carry over losses is limited: one such limit is that, if control of the corporation has been acquired, non-capital losses from before the acquisition cannot be carried over, unless the corporation continues the same or similar business that incurred the losses (s. 111(5)). An acquisition of control occurs where a person or group of persons acquires de jure control, which generally involves acquiring sufficient share ownership to elect a majority of the board of directors (Duha Printers (Western) Ltd. v. Canada, [1998] 1 S.C.R. 795). It is also deemed to occur when a taxpayer acquires a right to acquire such shares if the purpose is to avoid the application of the loss carryover restriction (ss. 256(8) and 251(5)(b); see Appendix).
[3] The appellant sought to take advantage of the loss carryover rule in s. 111(1)(a) without triggering the restriction in s. 111(5). Although the transactions in this appeal will be explained in detail in the following section, a brief summary is warranted. Prior to the transactions at issue, the appellant was a struggling Canadian corporation that had approximately $90 million of unused non-capital losses, scientific research and development tax expenditures (“SR&ED” expenditures), and investment tax credits (“ITCs”) (collectively, the “Tax Attributes”). Given that it was in financial difficulty, it did not have income which its past losses could offset. It sought to monetize their value and entered into an agreement with a venture capital company, Matco Capital Ltd. (“Matco”), in order to do so. A complex arrangement was devised involving the following key transactions. First, all of the appellant’s assets and liabilities would be moved into its newly created parent company. Second, Matco would obtain a debenture which could be converted into shares of the appellant, and the appellant’s parent company was promised that it would receive at least a guaranteed amount for the sale of its remaining shares. Third, Matco would find a new business venture for the appellant, which would be used to raise money through an initial public offering (“IPO”). The profits from this venture could be sheltered by the Tax Attributes the appellant originally could not utilize. The arrangement went according to plan. For the 2009 to 2012 tax years, the appellant deducted a majority of its Tax Attributes to reduce its tax liability. However, the Minister of National Revenue reassessed and denied these deductions.
[4] Before this Court, the parties accept that the appellant complied with the text of the Act . In other words, the parties agree that there was no “acquisition of control” and that, therefore, the loss carryover restriction in s. 111(5) did not apply. The central issue in this appeal is whether s. 245 of the Act , known as the general anti-avoidance rule or the GAAR , applies to deny the deductions. The GAAR operates to deny tax benefits flowing from transactions that comply with the literal text of the Act but nevertheless constitute abusive tax avoidance. For the GAAR to apply to a transaction, three elements found in s. 245 must be met: (1) there must be a “tax benefit”; (2) the transaction must be an “avoidance transaction”, meaning one that is not undertaken primarily for a bona fide non-tax purpose; and (3) the avoidance transaction giving rise to the tax benefit must be an “abuse” of the provisions of the Act (or associated enactments).
[5] The Tax Court found that the transactions were tax avoidance transactions that resulted in a tax benefit, but concluded that they were not abusive. On appeal, the Federal Court of Appeal held that the transactions were abusive, such that the GAAR applied to deny the tax benefits. I note that the parties and the lower courts focused on the non-capital loss deductions since the SR&ED and ITC provisions function similarly. As was the case in the Federal Court of Appeal, the only issue on appeal is whether the appellant’s series of transactions resulted in abusive tax avoidance.
[6] For the reasons that follow, I would dismiss the appeal. The transactions were abusive. The object, spirit and purpose of s. 111(5) of the Act is to prevent corporations from being acquired by unrelated parties in order to deduct their unused losses against income from another business for the benefit of new shareholders. Through a complex series of transactions, the appellant underwent a fundamental transformation that achieved the outcome that Parliament sought to prevent, while narrowly circumventing the text of s. 111(5). The result of the transactions thereby frustrated the provision’s rationale. Since the GAAR applies to deny the tax benefits, the Minister’s reassessments must be restored.
II. Facts
[7] Before the transactions at issue in this appeal, the appellant carried on a drug research and nutritional food additive business under the name Forbes Medi-Tech Inc. Its shares were publicly listed on the NASDAQ and TSX. In 2007, the appellant’s business was struggling and it faced a potential delisting of its shares from the NASDAQ because the bid price for its common stock had fallen below the minimum price required by the exchange. At a meeting of the appellant’s board of director