Deans Knight Income Corporation v. The Queen

Deans Knight Income Corporation v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2019-04-05
Neutral citation
2019 TCC 76
File numbers
2014-4148(IT)G
Judges and Taxing Officers
Brent Paris
Subjects
Income Tax Act
Decision Content
Docket: 2014-4148(IT)G
BETWEEN:
DEANS KNIGHT INCOME CORPORATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on February 13, 14, 15, 16, 19 and 20, 2018
at Vancouver, British Columbia
Before: The Honourable Justice B. Paris
Appearances:
Counsel for the Appellant:
J. Kelly Hannan
Heather DiGregorio
Darian Khan
Counsel for the Respondent:
Robert Carvalho
Perry Derksen
Shannon Currie
JUDGMENT
The appeals from the reassessments made under the Income Tax Act for the 2009, 2010, 2011 and 2012 taxation years are allowed, in accordance with the attached Reasons for Judgment.
The parties will have 30 days from the date of this judgment to arrive at an agreement on costs, failing which they are directed to file their written submissions on costs within 60 days of the date of this judgment. Such submissions shall not exceed 15 pages.
Signed at Vancouver, British Columbia, this 5th day of April 2019.
“B.Paris”
Paris J.
Citation: 2019 TCC 76
Date: 20190405
Docket: 2014-4148(IT)G
BETWEEN:
DEANS KNIGHT INCOME CORPORATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Paris J.
[1] This appeal involves the deduction by the Appellant of accumulated and unclaimed non-capital losses, scientific research and experimental development expenditures (“SRED”) and investment tax credits (“ITCs”) (together the “Tax Attributes”) subsequent to a series of transactions carried out in 2008 and 2009. The transactions were designed to move all of the Appellant’s assets and liabilities into a new corporation and to use the Appellant’s remaining corporate shell to raise money through an initial public offering (“IPO”) to fund a new business whose profits would be sheltered by the Tax Attributes. Tax practitioners refer to this type of arrangement as a “recapitalization and restart transaction”.
[2] The transactions in issue were set up by an intermediary, Matco Capital Ltd. (“Matco”), a venture capital company. Matco also made a significant investment in the Appellant with the expectation that it would earn a profit from its investment as a result of the transactions that were undertaken.
Issues
[3] The first issue to be decided is whether Matco, in the course of the transactions, obtained an option to purchase the majority of the voting shares of the Appellant, and thereby acquired control of the Appellant pursuant to subsection 256(8) and paragraph 251(5)(b) of the Income Tax Act. (the “Act”) [1] If an acquisition of control occurred, the Appellant would be precluded from deducting the Tax Attributes pursuant to subsections 111(5), 37(6.1) and 127(9.1) of the Act, which I will refer to collectively as the tax attribute streaming restrictions.
[4] In the alternative, the Respondent takes the position that the general anti-avoidance rule in section 245 of the Act (the “GAAR”) applies to deny the deduction of the Tax Attributes.
Facts
[5] The parties filed a Partial Statement of Agreed Facts at the hearing. In addition, the Appellant called five witnesses, including David Goold, CFO of the Appellant between 2004 and 2010, and Alan Ross, managing director of Matco and senior tax lawyer at Bennett Jones LLP in Calgary.
[6] The Appellant was incorporated in 1985 and originally carried on the business of mineral exploration. In 1992, it ceased that activity and began carrying on a drug research and nutritional food additive business.
[7] The Appellant’s shares were listed on the Toronto Stock Exchange in 1999 and on the NASDAQ Stock Market in 2000.
[8] In 2007, the Appellant began experiencing cash flow problems following disappointing results in a clinical trial of a drug it was developing. Its share price dropped and, as a result, it faced a possible NASDAQ delisting.
[9] In light of these difficulties, the Appellant, with the assistance of advisers at PricewaterhouseCooper (“PwC”), began investigating the possibility of realizing some value from its Tax Attributes. Given the problems it was facing, the Appellant considered it unlikely that it would be able to use the Tax Attributes at any future point. The amount of the Tax Attributes was approximately $90 million.
[10] In May 2007, Goold told the Appellant’s board of directors about the possibility of reorganizing the Appellant in order to realize a value of between 4 and 4.5 cents on the dollar for its Tax Attributes, for a total of between $3.5 million and $4 million. According to the minutes of that meeting, Goold advised the directors that the reorganization would involve the transfer of all existing assets and liabilities of the Appellant to a new corporation with the same shareholders as the Appellant, and the takeover of the Appellant itself – which at that point would essentially be a shell corporation with the Tax Attributes - by another taxable Canadian entity which would be able to use the Attributes.
[11] The Appellant’s financial problems continued to worsen and by November 2007 it had six months of cash left.
[12] On November 9, 2007, Goold reported to the board of directors that the Appellant had received two proposals regarding the possible tax reorganization of the Appellant, including one from Matco. The minutes of the November 9, 2007 Board meeting show that Matco intended “to roll the acquired company into an oil and gas venture which Matco has already targeted…and will take a fee plus an interest in the oil and gas company.”
[13] On November 13, 2007 Matco and the Appellant executed a letter of intent (the “November LOI”) which included the following terms:
- Matco would pay the Appellant $4 million by way of purchasing a $2.9 million convertible debenture in the Appellant and by payment of an additional $1.1 million (as described below) within a year.
- To the extent the Tax Attributes were over $92 million or under $90 million, there would be an adjustment to the price using a ratio of $0.0414 per dollar.
- The convertible debenture held by Matco would be convertible into 35% of the voting shares and all of the non-voting shares of the Appellant, which together would represent 77.78% of all of the issued and outstanding shares.
- The existing assets and liabilities of the Appellant would be transferred to a new company (“Newco”), the shares of which would be owned by the present shareholders of the Appellant. Newco would become the parent of the Appellant.
- Newco would be guaranteed an opportunity to sell its Remaining Shares of the Appellant for minimum proceeds of $1.1 million within one year.
[14] In December 2007, Matco advised Goold that it would not be proceeding with the proposal. Ross testified that the oil and gas transaction it was working on fell apart and the Tax Attributes were no longer required. Matco also advised the Appellant that it would be open to pursuing an alternative transaction in 2008.
[15] In early 2008, the Appellant carried out a plan of arrangement pursuant to which a new company, 0813361 B.C. Ltd. (“Newco”) was incorporated and all outstanding common shares, options and warrants of the Appellant were exchanged for common shares options and warrants of Newco on an eight to one basis.
[16] Newco was incorporated on January 10, 2008 and the plan of arrangement closed on February 27, 2008. As a result of the share exchange, the Appellant became a wholly owned subsidiary of Newco and the shares of Newco began trading on the TSX and NASDAQ in substitution for the common shares of the Appellant.
[17] According to a Management Information Circular of the Appellant dated January 14, 2008, the reorganization was being undertaken in part to facilitate the Appellant’s compliance with the NASDAQ minimum bid-price listing standards. The Circular also stated that:
Management of [the Appellant] believes that, in addition to achieving NASDAQ minimum bid-price listing standards, this structure will provide greater flexibility and enable Forbes to accommodate and capitalize on certain financing opportunities that may arise in the future.
[18] Both Ross and Goold testified that negotiations between Matco and the Appellant began again in January 2008, but that they had not reached any agreement when the plan of arrangement was carried out.
[19] On March 4, 2008, Matco and the Appellant entered into another letter of intent (the “March LOI”) which contained terms that were substantially similar to the November LOI. The March LOI provided that:
- Newco would receive $3.8 million from the purchase by Matco of a convertible debenture issued by the Appellant for $3 million (convertible into 35% of the voting shares and 100% of the non-voting shares of the Appellant, representing 79% of the equity shares of the Appellant) and an additional amount of $800,000 within one year. The amounts were subject to adjustment based on the amount of the Tax Attributes.
- All of the existing assets of the Appellant and the amount paid by Matco for the debenture would be transferred to Newco and Newco would assume all of the liabilities of the Appellant (the “Spinning Out Transaction”).
[20] The March LOI provided that the proceeds to be received by the Appellant would be adjusted upwards or downwards by 4.2 cents for every dollar that the Tax Attributes were more or less than $90.8 million.
[21] On March 19, 2008 Matco, the Appellant and Newco entered into an agreement (the “Investment Agreement”) as outlined in the March LOI. Matco agreed to purchase a debenture for $3 million, later adjusted to $2.96 million, convertible into 35% of the voting common shares and 100% of the non-voting common shares of the Appellant (the “Convertible Debenture”), and the Appellant agreed to complete the Spinning Out Transaction and not to do anything that would destroy the value of its Tax Attributes.
[22] Under the Investment Agreement, Matco guaranteed that Newco could sell its remaining shares (“the “Remaining Shares”) of the Appellant for a minimum of $800,000 (the “Guaranteed Amount”). However, the Agreement provided that Newco would not be obliged to sell its shares of the Appellant to Matco at any time. The Remaining Shares made up 65% of the voting shares of the Appellant.
[23] According to the Investment Agreement, Matco would have one year to present a “Corporate Opportunity” to the Appellant and Newco. Ross described a Corporate Opportunity as a business opportunity that would be suitable for the Appellant to commence, involving a new business and management team. This was to be the business that would generate profits against which the Tax Attributes would be deducted. If Newco rejected a Corporate Opportunity presented to it by Matco, Matco would be relieved from the payment of the Guaranteed Amount.
[24] In the event that Newco or the Appellant took any steps that gave rise to an acquisition of control of the Appellant or Newco, Matco would no longer be required to pay the Guaranteed Amount and Newco would be required to re purchase the Convertible Debenture from Matco and pay an additional $1 million to Matco.
[25] The Investment Agreement also stated that, other than as contemplated by the Agreement, Newco and the Appellant could not, without the consent of Matco take any of the following actions:
- issue any shares, options, warrants, calls, conversion privileges or rights of any kind to acquire any shares of the Appellant
- sell, transfer, pledge, encumber or dispose of or agree to sell, transfer, pledge, encumber or dispose of any shares of, or any options, warrants, calls, conversion privileges or rights of any kind to acquire any shares of the Appellant,
- change or amend the Appellant’s constating documents or by-laws,
- split, combine or reclassify any outstanding shares of the Appellant;
- redeem or purchase any shares of the Appellant,
- reorganize, amalgamate or merge the Appellant,
- take any action or make any commitment with respect to, or in contemplation of, any complete or partial liquidation, dissolution or other winding-up of the Appellant,
- declare and/or pay dividends or reduce the capital of the Appellant,
- take any action that would or may give rise to a change of control of Newco or the Appellant,
- enter into, assign, terminate or amend any contract or agreement in respect of the Appellant,
- create any encumbrance on any of the assets of the Appellant,
- in respect of the Appellant, create, incur, guarantee, or assume any indebtedness for borrowed money or otherwise become liable or responsible for the obligations of any other person,
- in respect of the Appellant, make any loans, advances, or capital contributions to, or investments in, any other person,
- change in any respect any of the accounting principles or practices used by Newco or the Appellant, except for any change required by reason of a concurrent change in GAAP; and
- engage in any activity other than examining and pursuing opportunities relating to the further $800,000 commitment made by Matco.
[26] Immediately prior to the execution of the Investment Agreement, 1250280 Alberta Ltd. (“125”), a holding company wholly-owned by Ross, purchased 100 shares of the Appellant from Newco for $10. One of the purposes of having 125 acquire the shares of the Appellant was to ensure that the Investment Agreement would not constitute a unanimous shareholder agreement, since 125 was not a party to the Investment Agreement.
[27] On May 9, 2008:
- Newco purchased the Appellant’s assets in exchange for a promissory note to the Appellant and the assumption of the Appellant’s liabilities.
- Matco subscribed for the Convertible Debenture in the principal amount of $2,960,000.
- The Appellant transferred the $2,960,000 and assigned the promissory note to a subsidiary of Newco.
- All but one of the directors of the Appellant resigned, and Goold and Ross were elected directors.
[28] During the summer and fall of 2009, Matco took steps to find a business that could use the Appellant’s Tax Attributes.
[29] In December 2008, Matco learned that Deans Knight Capital Management (“DKCM”), a mutual fund management company, was interested in starting a business investing in high-yield debt instruments. DKCM saw an opportunity in high-yield bonds, which were selling at low prices because of the financial crisis. DKCM determined that it would be more suitable for its purposes to set up the investment through a corporation rather than as a mutual fund, in order to ensure that the investors’ capital would be locked up for a sufficient period of time.
[30] DKCM intended to raise money for the investments by means of an initial public offering (“IPO”) and to pay returns to investors as the debt instruments paid returns or were redeemed.
[31] In December 2008, Matco proposed that DKCM use the Appellant as the corporate vehicle for the intended IPO and DKCM decided to use the Appellant rather than a newly incorporated company because of the availability of the Tax Attributes. In submissions to the B.C. Securities Commission, DKCM stated that it expected that the Tax Attributes would shelter the majority of the portfolio income and capital gains for the entire five years the Appellant was projected to operate.
[32] Matco presented the DKCM proposal to the Appellant as the “Corporate Opportunity” pursuant to the Investment Agreement. Both Goold and Ross testified that the board of directors of the Appellant discussed the proposal, did some investigation into DKCM’s background, and then approved the proposal.
[33] On December 19, 2008, DKCM and the Appellant entered into a letter of intent to have the Appellant undergo a recapitalization and reorganization to become a dividend paying investment company to capitalize on the availability of the Tax Attributes. The letter of intent included the following conditions:
- The Appellant would have at least $95 million in deductible amounts (for income tax purposes) available to be used against income earned by the corporation in Canada;
- DKCM would be appointed to manage the Appellant;
- Four of the five directors of the Appellant would be appointed by DKCM;
- The Appellant would agree to be used in a $100 million minimum public offering (the “IPO”), the proceeds of which would be used to purchase corporate debt securities that would generate income and gains that could be sheltered by the Tax Attributes.
- The pricing of the IPO would be done in a manner to attribute a net asset value of $5 million to the existing common shares of the Appellant.
[34] In early 2009, the Appellant engaged investment dealers to prepare the IPO.
[35] On February 5, 2009, the President of DKCM became a director of the Appellant, and the Appellant’s name was changed to its current name, Deans Knight Income Corporation.
[36] On March 18, 2009, immediately prior to the IPO, Matco converted its debenture into 35% of the voting shares and 100% of the non-voting shares of the Appellant. It also obtained an exception to the six month post-IPO lock-up period to enable it to purchase the Remaining Shares from Newco prior to the expiry of the one year Guarantee Period on April 30, 2009.
[37] Also on March 18, 2009, Ross and four nominees of DKCM were appointed as the directors of the Appellant, and three officers of DKCM were appointed as officers of the Appellant.
[38] The IPO closed on March 18, 2009 and 10,036,890 common shares were issued at $10 per share for proceeds of $100,368,900. As a result, Matco’s shares of the Appellant were valued at $4,148,000.
[39] On April 16, 2009, Matco, through a related corporation, made an offer to Newco to purchase the Remaining Shares at the Guaranteed Amount. Newco accepted the offer on April 20, 2009.
[40] Goold testified that Newco accepted the offer despite the discount to the IPO price because it needed the money for its own operations and because Newco’s board believed that the share price might go down before the end of the lock-up period.
[41] The Appellant’s high-yield bond investment business proved successful and over the first four years it paid regular dividends to its shareholders. In the fifth year of the business, the Appellant began to wind up operations, as initially contemplated.
[42] In filing its income tax return for the taxation year ending December 31, 2009, the Appellant claimed a terminal loss in the amount of $1,961,758 from its taxation years ending December 31, 2007 and preceding years.
[43] In filing its income tax returns for the taxation years ending December 31, 2009 to December 31, 2012 and in computing its income, the Appellant claimed non-capital losses and SRED expenditures from its taxation years ending December 31, 2007 and preceding years as follows:
Non-capital loss
SRED
December 31, 2009
$26,968,031
Nil
December 31, 2010
$21,491,406
$937,370
December 31, 2011
Nil
$5,943,668
December 31, 2012
Nil
$9,382,189
[44] By notices dated July 16, 2014, the Minister of National Revenue (the “Minister”) reassessed the 2009 to 2012 taxation years of the Appellant to disallow the claimed Tax Attributes and Terminal Loss.
Did the Appellant obtain a right to acquire the majority of the voting shares of
the Appellant?
[45] The first issue to be decided is whether Matco obtained a right under the Investment Agreement to acquire the majority of the voting shares of the Appellant, thereby acquiring control of the Appellant pursuant to subsection 256(8) and paragraph 251(5)(b) of the Act.
[46] Subsection 256(8) provides that where a person acquires a right referred to in paragraph 251(5)(b) (a “251 Right”), and it can reasonably be considered that a main purpose of acquiring that right was to avoid the limitations on the deduction of certain Tax Attributes, including those at issue in this case, the taxpayer will be deemed to be in the same position in relation to the control of the corporation as if the right had been exercised when it was acquired, including for the purposes of determining whether there has been an acquisition of control. If an acquisition of control results, the taxpayer is prevented from claiming those tax attributes subject to any exception provided for in the Tax Attributes streaming rules.
[47] During the years in issue subsection 256(8) read as follows:
Where at any time a taxpayer acquires a right referred to in paragraph 251(5)(b) in respect of a share and it can reasonably be concluded that one of the main purposes of the acquisition is
(a) to avoid any limitation on the deductibility of any non-capital loss, net capital loss, farm loss or any expense or other amount referred to in subsection 66(11), 66.5(3) or 66.7(10) or (11),
(b) to avoid the application of subsection 10(10) or 13(24), paragraph 37(1)(h) or subsection 55(2) or 66(11.4) or (11.5), paragraph 88(1)(c.3) or subsection 111(4), (5.1), (5.2) or (5.3), 181.1(7) or 190.1(6),
(c) to avoid the application of paragraph (j) or (k) of the definition “investment tax credit” in subsection 127(9),
(d) to avoid the application of section 251.1, or
(e) to affect the application of section 80,
the taxpayer is deemed to be in the same position in relation to the control of the corporation as if the right were immediate and absolute and as if the taxpayer had exercised the right at that time for the purpose of determining whether control of a corporation has been acquired for the purposes of subsections 10(10) and 13(24), section 37, subsections 55(2), 66(11), (11.4) and (11.5), 66.5(3), 66.7(10) and (11), section 80, paragraph 80.04(4)(h), subparagraph 88(1)(c)(vi), paragraph 88(1)(c.3), sections 111 and 127 and subsections 181.1(7), 190.1(6) and 249(4), and in determining for the purpose of section 251.1 whether a corporation is controlled by any person or group of persons.
[48] The material portions of paragraph 251(5)(b) for the purposes of this argument read as follows:
(b) … a right under a contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently,
(i) to, or to acquire, shares of the capital stock of a corporation …
[49] The Respondent submits that under the Investment Agreement Matco obtained the right to acquire all of voting shares of the Appellant from Newco minus the 100 shares owned by 125. Since a right to acquire shares is a right that falls within paragraph 251(5)(b) of the Act, and since, according to the Respondent, Matco acquired the right for the purpose of circumventing the tax attribute streaming restrictions, subsection 256(8) would apply to deem Matco to have exercised the right, resulting in an acquisition of control of the Appellant. As a result, the Appellant would be precluded from deducting the Tax Attributes.
[50] Under the Convertible Debenture provided for in the Investment Agreement, Matco had the option to acquire 35% of the voting shares and 100% of the non-voting shares of the Appellant, through the exercise of its conversion right.
[51] In addition, the Respondent says that the Investment Agreement gave Matco the right (which the Respondent refers to as the “Residual Right”) to acquire the Remaining Shares in exchange for the Guaranteed Amount.
[52] In the Respondent’s submission, one of Matco’s main purposes in acquiring the Convertible Debenture and the Residual Right was to avoid the limitations on the deduction of the Tax Attributes.
[53] Since the Appellant does not dispute that the Convertible Debenture gave Matco the right to acquire shares of the Appellant, I will only deal with the Respondent’s argument concerning the so called Residual Right.
[54] The Respondent says that, it was fundamental to the deal between Matco, Newco and the Appellant and that it was clearly intended by all that Matco would acquire the Remaining Shares pursuant to the Residual Right. Counsel says that the true nature, purpose or effect of the Residual Right was a right to acquire shares of the Appellant and that any terms of the Investment Agreement that would suggest otherwise were mere “window dressing”. Counsel also says that Matco needed to secure a right to the Remaining Shares of the Appellant in order for it to receive the increase in value of the Appellant occasioned by Matco finding a third party to utilize the Tax Attributes.
[55] The Respondent submits that there was no possibility of Matco not acquiring the Remaining Shares, given that it would be liable to pay the Guaranteed Amount whether or not it purchased the shares. Likewise, the Appellant would have to agree to sell the shares in order to receive the Guaranteed Amount and since Matco had to approve any sale by the Appellant of its shares to a third party, Matco had complete control over any sale.
[56] Furthermore, the Respondent says that the subsequent conduct of the parties demonstrated that the Residual Right was treated by them as an option, since Newco sold the Remaining Shares to Matco for less than it would have been able to obtain if it had waited until the end of the post-IPO lock-up period to sell them. Also, Newco did not seek to obtain an exemption for its shares from the lock-up period, and took no part in the negotiations with DKCM over the amount at which the existing shares of the Appellant would be valued.
[57] For the reasons that follow, I find that on a proper construction of the Investment Agreement, Matco did not have a right to acquire the Remaining Shares.
[58] Under the terms of the Investment Agreement, Matco was obliged to present a “Sale Opportunity” in respect of the Remaining Shares of the Appellant to Newco within the year following the closing of the Investment Agreement, and Matco guaranteed a minimum price to the Appellant of $800,000 for those shares (subject to certain adjustments). In the event that Matco did not present a Sale Opportunity or Partial Sale Opportunity as required, it would still be liable to pay the Guaranteed Amount. If Newco did not accept a Sale Opportunity, Matco’s liability to pay the Guaranteed Amount terminated.
[59] The Investment Agreement specifically provided that Newco was not required to sell any of the Remaining Shares prior to or during the Guarantee Period or at any other time. Section 5.8 of the Investment Agreement reads as follows:
5.8 [Newco] shall not be required to sell any of the Remaining Shares prior to or during the Guarantee Period or at any other time.
[60] The Respondent has not shown that this term was a sham or inconsistent with any other rights in the Agreement or with the Agreement read as a whole.
[61] First, the Investment Agreement did not give Matco complete control over the sale of the Remaining Shares and Newco was not required to obtain Matco’s consent for a sale, as alleged by the Respondent. The relevant part of paragraph 6.1(b) of the Investment Agreement sets out that:
Other than as contemplated by this Agreement (including pursuant to the Reorganization, a Sale Opportunity, a Partial Sale Opportunity or a Corporate Opportunity), [Newco] shall not, and to the extent applicable shall cause [the Appellant] not to, without the prior written consent of Matco acting reasonably,
…
… sell, transfer, pledge, encumber or dispose of or agree to sell, transfer, pledge, encumber or dispose of any shares of, or any options, warrants, calls, conversion privileges or rights of any kind to acquire any shares of [the Appellant.]
[62] A “Sale Opportunity” is defined in the Investment Agreement generally as a transaction that would result in the sale of the Remaining Shares to one or more arm’s-length third parties. Nothing in the Investment Agreement requires that Matco be the party presenting a Sale Opportunity. The Investment Agreement also appears to contemplate the possibility of a sale of the Remaining Shares (or some of those shares) to a third party, without the need for Matco’s consent, since according to paragraph 6.1(b) of the Agreement, the requirement to obtain Matco’s consent does not apply to situations contemplated by the Agreement, including a Sale Opportunity. It is inaccurate, then, to say that any sale of the Appellant’s shares would require Matco’s consent and it cannot be said that Matco had complete control over any sale by Newco of the Remaining Shares.
[63] I find that the Respondent’s reliance on what it called the “economics of the transaction” is in effect an attempt to recharacterize the legal relationships of the parties based on what it views as the substance of the Investment Agreement. This is not permitted. This principle is set out by the Supreme Court of Canada in Shell Canada Ltd. v. Canada.
…absent a specific provision of the Act to the contrary or a finding that they are a sham, the taxpayer’s legal relationships must be respected in tax cases. Recharacterization is only permissible if the label attached by the taxpayer to the particular transaction does not properly reflect its actual legal effect (citations omitted.) [2]
[64] Also, the Respondent’s position that it was the intention of all parties to the Investment Agreement that Matco would acquire the Remaining Shares was not consistent with the testimony of both Ross and Goold. In particular, Goold said that there was no understanding by Newco or the Appellant that Matco would always purchase the shares. Furthermore he said that it was Newco’s choice to sell the Remaining Shares to Matco, and that, although the board of Newco understood that it could choose to wait until the lock-up period expired to sell its shares, the decision was made to accept Matco’s offer in April 2009 because Newco needed the money for its operations and was concerned about the possibility of a decline in value of those shares if held until the end of the lock-up period. I accept Goold’s testimony on this point. He has no interest in the outcome of these proceedings and his recollection of the events surrounding Matco’s offer to purchase the shares and the board’s decision to sell was clear and uncontradicted. I therefore find him to be a credible witness. It is also plausible that Newco preferred to sell its shares sooner rather than later, given the shaky state of the financial markets in 2009.
[65] Furthermore, I find nothing to support the contention that Matco could only profit from the monetization of the Appellant’s Tax Attributes if it acquired the Remaining Shares. After the conversion of the Convertible Debenture for which it paid $2.96 million, Matco held 35% of the voting shares and 100% of the non-voting shares, and those shares were given a value of over $4 million in the IPO. Clearly Matco earned a significant profit without acquiring the Remaining Shares. I would also note that the additional profit it stood to make by acquiring the Remaining Shares was only approximately $200,000. In my view, Matco was careful to structure the transactions to not create any right to acquire the Remaining Shares in order to avoid an acquisition of control under the Act. It is more likely than not that it preferred to give up some of the upside in order to achieve this goal.
[66] I therefore find that Matco did not acquire a 251 Right in respect of the Remaining Shares and therefore did not acquire control of the Appellant.
GAAR
[67] In a GAAR analysis, three questions must be addressed. Was there a tax benefit? If so, were the transactions that gave rise to that benefit avoidance transactions, and if so, were those transactions abusive? [3]
[68] The following transactions were assumed by the Minister to be avoidance transactions (the “Avoidance Transactions”) within the meaning of subsection 245(3) of the Act:
- The Appellant’s adoption of a strategy related to the “Realization of Tax Loss Value,” in order to sell its Tax Attributes.
- Matco’s offer to issue a Convertible Debenture to the Appellant.
- The Investment Agreement between Matco and the Appellant to restructure the Appellant.
- The incorporation of Newco.
- The distribution of Newco shares to the existing shareholders of the Appellant.
- The sale of the Appellant’s assets (at a loss) to Newco.
- The issuance of the Convertible Debenture between Matco and the Appellant.
- The conversion of the Convertible Debenture by Matco.
- Matco’s purchase of all of the shares of the Appellant held by Newco after the IPO closed.
- The application of the non-capital losses and terminal losses and the deduction of the SRED expenditures incurred by the Appellant in the years 2009 to 2012.
[69] The term “tax benefit” is defined in subsection 245(1) of the Act as:
…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;
[70] The Appellant submitted that none of the transactions alleged by the Respondent to give rise to the tax benefit resulted in the Appellant claiming the Tax Attributes, and that the tax benefit in this case only arose by virtue of the Appellant carrying on business after the close of the IPO. It was argued that, had the Appellant not had any income from its post-IPO business, it would not have been able to claim the Tax Attributes. The Appellant said that the income earning activities could not be considered as part of the series of transactions, and that, while the Tax Attributes were preserved by the series of transactions, their preservation does not constitute a reduction, deferral or avoidance of tax. The Appellant relies on the following excerpt from Copthorne:
In the agreed statement of facts, the parties agreed that the sale of VHHC Holdings to Big City, and the subsequent amalgamation of VHHC Holdings with Copthorne I to form Copthorne II were part of a series of transactions. However, these transactions themselves did not result in a tax benefit. The tax benefit was only realized when Copthorne III redeemed its shares without its shareholder incurring an immediate tax liability. Thus, it is necessary to decide whether the redemption transaction is part of the series of transactions which included the sale of VHHC Holdings to Big City and the subsequent amalgamation of Copthorne I and VHHC Holdings. [4]
[71] In the Appellant’s view, the preservation of the Tax Attributes in this case, like the preservation of PUC by the first series of transactions in Copthorne, did not result in the Appellant realizing a tax benefit.
[72] Finally, the Appellant stresses that the Tax Attributes arose as a result of carrying on its own business in years prior to the IPO and that no new Tax Attributes were created by the alleged avoidance transactions.
[73] I find no merit in the Appellant’s submissions regarding the tax benefit. It is clear that the transactions in issue resulted in a reduction of tax to the Appellant through the claiming of the Tax Attributes in the years in issue. As the Supreme Court noted in Canada Trustco, “[i]f a deduction against taxable income is claimed, the existence of a tax benefit is clear, since a deduction results in a reduction of tax.” [5]
[74] It is not necessary for the avoidance transactions to include the claiming of the tax benefit, as suggested by the Appellant. The tax benefit must simply result directly or indirectly from the avoidance transaction or transactions.
[75] The argument that the tax benefit resulted from the income earned after the IPO rather than from the alleged avoidance transactions fails to recognize that without the existence of those transactions, none of the Tax Attributes would have been available to claim against the post-IPO income. Therefore, it follows that the Tax Attribute deductions resulted from the alleged avoidance transactions.
[76] One way to establish that a tax benefit exists is by comparison with an alternative arrangement that could reasonably have been undertaken. This is set out by the Supreme Court in Copthorne:
As found in Trustco, the existence of a tax benefit can be established by comparison of the taxpayer’s situation with an alternative arrangement (para. 20). If a comparison approach is used, the alternative arrangement must be one that “might reasonably have been carried out but for the existence of the tax benefit” (D. G. Duff, et al., Canadian Income Tax Law (3rd ed. 2009), at p. 187). By considering what a corporation would have done if it did not stand to gain from the tax benefit, this test attempts to isolate the effect of the tax benefit from the non-tax purpose of the taxpayer. [6]
[77] In this case, an appropriate comparator would be the use of a new corporation by DKCM to carry on the investment business. This was contemplated by DKCM but rejected in favour of using the Appellant only because of existence of the Tax Attributes. This shows clearly that there was a tax benefit as a result of the transactions in issue.
[78] Turning to the issue of whether the transactions relied upon by the Respondent were avoidance transactions, the Appellant takes the position that all of the impugned transactions were carried out primarily for a bona fide business purpose.
[79] The Appellant points to the evidence showing that from late 2006 into 2007 it was attempting to raise new financing and to pursue new business opportunities and that the plan to raise money from its Tax Attributes must be considered in this context. It entered into the Investment Agreement and DKCM LOI and took all necessary steps to reorganize and recapitalize itself in furtherance of its intention to start a new business.
[80] The Respondent argues that the Appellant did not raise the argument that the transactions were carried out primarily for a non-tax purpose in its Notice of Appeal and pleaded no facts to support it and therefore is precluded from raising it.
[81] I agree with the Respondent. The record shows that the Appellant brought an application shortly before the hearing of the appeal for leave to amend its Notice of Appeal to add the argument and plead additional facts in support, but the application was dismissed. That decision was not appealed. Therefore, given the Appellant’s failure to plead this argument and any necessary material facts, it is not now open to the Appellant to take the position that the alleged avoidance transactions were entered into primarily for a non-tax purpose.
[82] However, if it had been necessary to decide the question, I would have found that the Appellant did not rebut the assumptions made by the Respondent concerning the Appellant’s purpose in entering into the transactions.
[83] The evidence shows beyond a doubt that the Appellant’s primary purpose in entering into the Investment Agreement and restructuring itself and all related transactions was to carry out a “monetization” of the Tax Attributes. Goold’s testimony in this regard was clear and was fully supported by the contemporaneous documentation. While the Appellant argued that the purpose of raising funds was a non-tax purpose, it is clear that those transactions would not have been undertaken but for the tax purpose. The means by which the Appellant raised funds was through the “monetization” of its Tax Attributes, and it is obvious that the reduction of tax was the primary reason for carrying out the transactions.
[84] The next question to be determined is whether the Avoidance Transactions amounted to abusive tax avoidance under subsection 245(4) of the Act.
[85] Under subsection 245(4), the Court must apply a two stage analysis. First, it must undertake a textual and purposive analysis of the provisions giving rise to the tax benefit in order to determine the object, spirit and purpose of those provisions. Second, it must decide whether the impugned transaction or transactions frustrate or defeat the object spi