Copthorne Holdings Ltd. v. Canada

Copthorne Holdings Ltd. v. Canada
Collection
Supreme Court Judgments
Date
2011-12-16
Neutral citation
2011 SCC 63
Report
[2011] 3 SCR 721
Case number
33283
Judges
McLachlin, Beverley; Binnie, William Ian Corneil; LeBel, Louis; Deschamps, Marie; Fish, Morris J.; Abella, Rosalie Silberman; Charron, Louise; Rothstein, Marshall; Cromwell, Thomas Albert
On appeal from
Federal Court of Appeal
Subjects
Taxation
Notes
SCC Case Information: 33283
Decision Content
SUPREME COURT OF CANADA
Citation: Copthorne Holdings Ltd. v. Canada, 2011 SCC 63, [2011] 3 S.C.R. 721
Date: 20111216
Docket: 33283
Between:
Copthorne Holdings Ltd.
Appellant
and
Her Majesty The Queen
Respondent
Coram: McLachlin C.J. and Binnie, LeBel, Deschamps, Fish, Abella, Charron, Rothstein and Cromwell JJ.
Reasons for Judgment:
(paras. 1 to 128)
Rothstein J. (McLachlin C.J. and Binnie, LeBel, Deschamps, Fish, Abella, Charron and Cromwell JJ. concurring)
Copthorne Holdings Ltd. v. Canada, 2011 SCC 63, [2011] 3 S.C.R. 721
Copthorne Holdings Ltd. Appellant
v.
Her Majesty The Queen Respondent
Indexed as: Copthorne Holdings Ltd. v. Canada
2011 SCC 63
File No.: 33283.
2011: January 21; 2011: December 16.
Present: McLachlin C.J. and Binnie, LeBel, Deschamps, Fish, Abella, Charron, Rothstein and Cromwell JJ.
on appeal from the federal court of appeal
Taxation ― Income tax ― Tax avoidance ― Interpretation and application of general anti‑avoidance rule ― Series of transactions involving paid‑up capital of a corporation ― Treatment of paid‑up capital upon amalgamation ― Withholding tax on deemed dividend ― Whether these transactions resulted in a tax benefit ― Was the transaction giving rise to tax benefit an avoidance transaction ― Interpretation of “contemplation” in the test for a statutory series ― Whether transaction or series of transactions results in abuse and misuse of Income Tax Act ― Whether general anti‑avoidance rule applicable to deny tax benefit ― Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .), ss. 84(3) , 87(3) , 89(1) , 245(1) to (5) , 248(10) .
By a series of transactions, two Canadian corporations within the same corporate group (referred to in the reasons as Copthorne I and VHHC Holdings Ltd.) that had been parent and subsidiary became “sister” corporations — that is, corporations owned directly by the same non‑resident shareholder, Big City Project Corporation B.V. The sister corporations were then amalgamated — a “horizontal” amalgamation — and the paid‑up capital (“PUC”) of their respective shares was aggregated to form the PUC of the shares of the amalgamated corporation. Had they remained as parent and subsidiary, the PUC of the shares of the subsidiary would have been cancelled on amalgamation. The amalgamated corporation then redeemed a large portion of its shares and paid out the aggregate PUC attributable to the redeemed shares to its non‑resident shareholder. That payment was not treated as taxable income to the shareholder but instead as a return of capital.
No provision of the Income Tax Act (“Act ”) expressly required the return of PUC in this case to be treated as a taxable payment. Nonetheless, the Minister of National Revenue considered the transactions by which the parent and subsidiary became sister corporations to have circumvented certain provisions of the Act in an abusive manner and thus to have contravened s. 245 of the Act , the general anti‑avoidance rule, or the “GAAR”. Applying the GAAR, the Minister concluded that the PUC of the shares of the former subsidiary should have been cancelled upon amalgamation with its former parent corporation, as required by s. 87(3) . If the PUC of the shares of the amalgamated corporation was reduced, the amount paid to the shareholder in excess of the reduced PUC would have constituted a deemed dividend subject to tax. The Minister reassessed the amalgamated corporation for unpaid withholding tax on the deemed dividend portion of the amount paid to the non‑resident shareholder upon redemption. The Tax Court of Canada and Federal Court of Appeal upheld the reassessments.
Held: The appeal should be dismissed.
The general anti‑avoidance rule scheme is set out in ss. 245(1) to (5) of the Act and requires that three questions be decided: (1) was there a tax benefit; (2) was the transaction giving rise to the tax benefit an avoidance transaction; and (3) was the avoidance transaction giving rise to the tax benefit abusive. The burden is on the taxpayer to refute the Minister’s assumption of the existence of a tax benefit. Where, as here, the Tax Court judge has made a finding of fact on the existence of a tax benefit, it is only appropriate for a reviewing court to overturn such a finding where an appellant can show a palpable and overriding error. The existence of a tax benefit can be established by comparing the taxpayer’s situation with an alternative arrangement that could reasonably have been carried out but for the existence of the tax benefit. In this case, the vertical amalgamation comparison used by the Minister was appropriate, and the finding of the Tax Court that there was a tax benefit should be affirmed.
Under s. 245(3) of the Act , a transaction will be an avoidance transaction if it results in a tax benefit, and is not undertaken primarily for a bona fide non‑tax purpose. An avoidance transaction may operate alone to produce a tax benefit, or may operate as part of a series of transactions to produce a tax benefit. Where, as here, the Minister assumes that the tax benefit resulted from a series of transactions rather than a single transaction, it is necessary to determine if there was a series, which transactions make up the series, and whether the tax benefit resulted from the series. The starting point is the common law test for a series upon which “each transaction in the series is pre‑ordained to produce a final result”. Section 248(10) of the Act extends the meaning of “series of transactions” to include any related transactions or events completed “in contemplation of” the series. The Court must decide whether the series was taken into account when the decision was made to undertake the related transaction in the sense that it was done, on a balance of probabilities, “in relation to” or “because of” the series. Each case will be decided on its own facts. The length of time between the series and the related transaction may be a relevant consideration in some cases, as would intervening events taking place between the series and the completion of the related transaction. Although the “because of” or “in relation to” test does not require a “strong nexus”, it does require more than a mere possibility or a connection with an extreme degree of remoteness.
“Contemplation” in s. 248(10) should be read both prospectively and retrospectively. The text and context of s. 248(10) leave open when the contemplation of the series must take place. Nothing in the text specifies when the related transaction must be completed in relation to the series. Specifically, nothing suggests that the related transaction must be completed in contemplation of a subsequent series. Here, the Tax Court and the Federal Court of Appeal correctly concluded that the redemption transaction was part of the same series as the prior sale and amalgamation, and that the series, including the redemption transaction, resulted in the tax benefit.
If there is a series that results, directly or indirectly, in a tax benefit, it will be caught by s. 245(3) as an avoidance transaction unless each transaction within the series could reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain a tax benefit. This determination is to be objectively considered, and must be based on all of the evidence available to the court. Here, the Tax Court judge was correct to find that the sale of the VHHC Holdings shares to the non‑resident parent corporation was not primarily undertaken for a bona fide non‑tax purpose. Because there was a series of transactions which resulted in a tax benefit, the finding that one transaction in the series was an avoidance transaction satisfies the requirements of s. 245(3).
In order to determine whether a transaction is an abuse or misuse of the Act , a court must first determine the object, spirit or purpose of the provisions that are relied on for the tax benefit, having regard to the scheme of the Act , the relevant provisions and permissible extrinsic aids. While an avoidance transaction may operate alone to produce a tax benefit, it may also operate as part of a series of transactions that results in the tax benefit. While the focus must be on the transaction, where it is part of a series, it must be viewed in the context of the series to enable the court to determine whether abusive tax avoidance has occurred. In such a case, whether a transaction is abusive will only become apparent when it is considered in the context of the series of which it is a part and the overall result that is achieved. The analysis will lead to a finding of abusive tax avoidance: (1) where the transaction achieves an outcome the statutory provision was intended to prevent; (2) where the transaction defeats the underlying rationale of the provision; or (3) where the transaction circumvents the provision in a manner that frustrates or defeats its object, spirit or purpose. These considerations are not independent of one another and may overlap.
To determine if there was abuse in this case, it is s. 87(3) of the Act , which deals with the PUC of shares of amalgamated corporations, that must be at the centre of the analysis. The text of s. 87(3) ensures that in a horizontal amalgamation the PUC of the shares of the amalgamated corporation does not exceed the total of the PUC of the shares of the amalgamating corporations. Section 87(3) also provides, in its parenthetical clause, that the PUC of the shares of an amalgamating corporation held by another amalgamating corporation is cancelled. Having regard to the text, context and purpose of s. 87(3) , the object, spirit and purpose of the parenthetical portion of the section is to preclude preservation of PUC of the shares of a subsidiary corporation upon amalgamation of the parent and subsidiary where such preservation would permit shareholders, on a redemption of shares by the amalgamated corporation, to be paid amounts as a return of capital without liability for tax, in excess of the amounts invested in the amalgamating corporations with tax‑paid funds.
The appellant, Copthorne Holdings Ltd., agrees that s. 87(3) would have led to a cancellation of the applicable PUC of the VHHC Holdings shares if it had been vertically amalgamated with Copthorne I. Instead of amalgamating the two companies, Copthorne I sold its VHHC Holdings shares to the non‑resident parent corporation in order to avoid the vertical amalgamation and cancellation of the PUC of the shares of VHHC Holdings. The transaction obviously circumvented application of the parenthetical words of s. 87(3) upon the later amalgamation of Copthorne I and VHHC Holdings, now as sister corporations.
The sale by Copthorne I of its VHHC Holdings shares, which was undertaken to protect $67,401,279 of PUC from cancellation, while not contrary to the text of s. 87(3) , does frustrate and defeat its purpose. The tax‑paid investment here was in total $96,736,845. To allow the aggregation of an additional $67,401,279 to this amount would enable payment, without liability for tax by the shareholders, of amounts well in excess of the investment of tax‑paid funds, contrary to the object, spirit and purpose or the underlying rationale of s. 87(3) . The sale of VHHC Holdings shares circumvented the parenthetical words of s. 87(3) and in the context of the series of which it was a part, achieved a result the section was intended to prevent and thus defeated its underlying rationale. The transaction was therefore abusive and the assessment based on application of the GAAR was appropriate.
Cases Cited
Applied: Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2 S.C.R. 601; referred to: OSFC Holdings Ltd. v. Canada, 2001 FCA 260, [2002] 2 F.C. 288; MIL (Investments) S.A. v. R., 2006 TCC 460, [2006] 5 C.T.C. 2552, aff’d 2007 FCA 236, 2007 D.T.C. 5437; Commissioners of Inland Revenue v. Duke of Westminster, [1936] A.C. 1; Ontario (Attorney General) v. Fraser, 2011 SCC 20, [2011] 2 S.C.R. 3; Lipson v. Canada, 2009 SCC 1, [2009] 1 S.C.R. 3; Collins & Aikman Products Co. v. The Queen, 2009 TCC 299, 2009 D.T.C. 1179, aff’d 2010 FCA 251, [2011] 1 C.T.C. 250; Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536.
Statutes and Regulations Cited
Business Corporations Act, R.S.A. 2000, c. B‑9, ss. 28, 182(2).
Canada Business Corporations Act, R.S.C. 1985, c. C‑44, ss. 26 , 182(2) .
Convention Between Canada and the Kingdom of the Netherlands for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, S.C. 1986, c. 48, Sch. I.
Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .), ss. 2(1) , 84(3) , 84.1 , 87(3) , 89(1) , 212.1 , 215(1) , 245 , 248(10) .
Authors Cited
Canada. Canada Customs and Revenue Agency. Interpretation Bulletin IT‑463R2, “Paid‑up Capital”, September 8, 1995.
Cardarelli, Corrado. “Transactions Involving Paid‑Up Capital”, in Report of Proceedings of the Fifty‑Sixth Tax Conference. Toronto: Canadian Tax Foundation, 2005, 26:1.
Dickerson, Robert W. V., John L. Howard and Leon Getz. Proposals for a New Business Corporations Law for Canada, vol. I. Ottawa: Information Canada, 1971.
Duff, David G. “The Supreme Court of Canada and the General Anti‑Avoidance Rule: Canada Trustco and Mathew”, in David G. Duff and Harry Erlichman, eds., Tax Avoidance in Canada After Canada Trustco and Mathew. Toronto: Irwin Law, 2007, 1.
Duff, David G., et al. Canadian Income Tax Law, 3rd ed. Markham, Ont.: LexisNexis, 2009.
Hiltz, Michael. “Section 245 of the Income Tax Act ”, in Report of Proceedings of the Fortieth Tax Conference. Toronto: Canadian Tax Foundation, 1989, 7:1.
Krishna, Vern. The Fundamentals of Income Tax Law. Toronto: Carswell, 2009.
McGuinness, Kevin Patrick. Canadian Business Corporations Law, 2nd ed. Markham, Ont.: LexisNexis, 2007.
Oxford English Dictionary, 2nd ed., vol. III. Oxford: Clarendon Press, 1989, “contemplation”.
Sullivan, Ruth. Sullivan on the Construction of Statutes, 5th ed. Markham, Ont.: LexisNexis, 2008.
Webster’s Third New International Dictionary. Springfield, Mass.: Merriam‑Webster, 1986, “contemplation”.
APPEAL from a judgment of the Federal Court of Appeal (Desjardins, Evans and Ryer JJ.A.), 2009 FCA 163, 392 N.R. 29, [2009] 5 C.T.C. 1, 2009 D.T.C. 5101, [2009] F.C.J. No. 625 (QL), 2009 CarswellNat 1368, affirming a decision of Campbell J., 2007 TCC 481, [2008] 1 C.T.C. 2001, 2007 D.T.C. 1230, [2007] T.C.J. No. 335 (QL), 2007 CarswellNat 2808. Appeal dismissed.
Richard W. Pound, Q.C., and Pierre‑Louis Le Saunier, for the appellant.
Wendy Burnham, Deen Olsen and Eric Noble, for the respondent.
TABLE OF CONTENTS
Paragraph
I. Introduction..............................................................................................................
II. Summary of Facts....................................................................................................
III. Tax Court of Canada................................................................................................
IV. Federal Court of Appeal...........................................................................................
V. Analysis...................................................................................................................
A. Introduction............................................................................................................
B. Was There a Tax Benefit?......................................................................................
C. Was the Transaction Giving Rise to the Tax Benefit an Avoidance Transaction?
(1) Was There a Series of Transactions That Resulted in a Tax Benefit?..........................
(2) Was Any Transaction Within the Purported Series an Avoidance Transaction?..........
D. Was the Avoidance Transaction Giving Rise to the Tax Benefit Abusive?............
(1) The Relevant Sections..............................................................................................
(2) Which Provisions Are Abused?................................................................................
(3) The Object, Spirit and Purpose of Section 87(3).......................................................
(a) The Text of the Provision.......................................................................................
(b) The Context of the Provision............................................................................... 3
(i) The PUC Scheme of the Act....................................................................................
(ii) The Principle of Non-Consolidation..........................................................................
(iii) The Relevance of the Capital Gains Scheme..............................................................
(iv) The “In Rem” Nature of PUC...................................................................................
(v) Stop-PUC Rules in the Act.......................................................................................
(vi) Expressio Unius Est Exclusio Alterius...................................................................
(vii) Conclusion of Contextual Considerations..................................................................
(c) The Purpose of the Provisions...............................................................................
(d) Conclusion on the Object, Spirit and Purpose of the Parenthetical Portion of Section 87(3)...........................................................................................................
(4) Was There an Abuse of the Provisions of the Act?....................................................
VI. Conclusion...............................................................................................................
APPENDIX A — Detailed Facts
APPENDIX B — Relevant Provisions
1
7
21
29
32
32
34
39
42
59
65
74
85
87
88
91
92
97
100
104
106
108
112
113
122
123
128
The judgment of the Court was delivered by
Rothstein J. —
I. Introduction
[1] This appeal involves paid-up capital (“PUC”) of a corporation. Under the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), PUC represents capital invested in a class of shares of the corporation by its shareholders. When that class of shares is redeemed by the corporation in whole or in part, the amount paid by the corporation to the shareholders in excess of the PUC attributable to the redeemed shares is deemed to have been paid as a dividend that must be included in the income of the recipient shareholder. However, the PUC portion need not be included in the income of the recipient shareholder because it is viewed as a return of capital to shareholders.
[2] As a general rule, when two corporations amalgamate, the PUC of the shares of both amalgamating corporations are aggregated to form the PUC of the shares of the amalgamated corporation. However, where the relationship between the amalgamating corporations is parent and subsidiary — a so-called “vertical” amalgamation — the PUC of the shares of both corporations are not aggregated. Rather the PUC of the shares of the subsidiary corporation which are owned by the parent is cancelled.
[3] In this case, by a series of transactions, two corporations that had been parent and subsidiary became “sister” corporations — that is, corporations owned directly by the same shareholder. The sister corporations were then amalgamated — a “horizontal” amalgamation. Had they remained as parent and subsidiary, the PUC of the shares of the subsidiary would have been cancelled on amalgamation. As sister corporations, the PUC of their respective shares was aggregated to form the PUC of the shares of the amalgamated corporation.
[4] The amalgamated corporation then redeemed a large portion of its shares and paid out the aggregate PUC attributable to the redeemed shares to its non-resident shareholder. That payment was not treated as taxable income to the shareholder but instead as a return of capital.
[5] No provision of the Income Tax Act expressly required the return of PUC in this case to be treated as a taxable payment. Nonetheless, the Minister of National Revenue considered the transactions by which the parent and subsidiary became sister corporations to have circumvented certain provisions of the Act in an abusive manner and thus to have contravened s. 245 of the Act , the general anti-avoidance rule, or the “GAAR”. Applying the GAAR, the Minister concluded that the PUC of the shares of the former subsidiary should have been cancelled upon amalgamation with its former parent corporation. If the PUC of the shares of the amalgamated corporation was reduced, the amount paid to the shareholder in excess of the reduced PUC would have constituted a deemed dividend subject to tax. The Minister reassessed the amalgamated corporation for unpaid withholding tax on the deemed dividend portion of the amount paid to the non-resident shareholder upon redemption. The Tax Court of Canada and Federal Court of Appeal upheld the reassessments (2007 TCC 481, [2008] 1 C.T.C. 2001; 2009 FCA 163, 392 N.R. 29).
[6] Upon a textual, contextual and purposive interpretation of the relevant provisions of the Act , in my respectful view, the transactions that took place in this case were properly reassessed under the GAAR. Accordingly, I would dismiss the appeal.
II. Summary of Facts
[7] The following is a summary of the facts pertinent to the issue to be decided on this appeal. The summary is essentially that set out in the reasons of the Federal Court of Appeal, which in turn is based on the agreed statement of facts submitted by the parties. The details of the complex set of transactions are contained in Appendix A.
[8] Li Ka-Shing and his son, Victor Li, control a group of Canadian and non-resident companies (“Li Group”). One is VHHC Investments Ltd. in which the Li Group invested $96,736,845. VHHC Investments purchased all the shares of VHHC Holdings Ltd. for $67,401,279. At the end of 1991, the shares of VHHC Investments had a PUC of $96,736,845 and the shares of VHHC Holdings had a PUC of $67,401,279.
[9] VHHC Holdings held shares in Husky Oil Ltd. directly and through a subsidiary corporation, VHSUB Holdings Inc. By 1991 the market value of the Husky shares had fallen such that VHSUB had an unrealized capital loss on those shares.
[10] Copthorne Holdings Ltd. (“Copthorne I”) was a wholly owned subsidiary of Big City Project Corporation B.V. (“Big City”), a Netherlands company and member of the Li Group. Copthorne I had purchased the Harbour Castle Hotel in 1981 and sold it for a substantial capital gain in 1989.
[11] By the end of 1991, the VHSUB shares had nominal fair market value, but an adjusted cost base of $84.3 million reflecting the accrued capital loss on the Husky shares. In 1992, VHHC Investments sold its common shares of VHHC Holdings with a PUC of $67,401,279 to Copthorne I for a nominal price. VHHC Holdings subsequently sold the majority of its VHSUB shares to Copthorne I (inheriting the high adjusted cost base under stop-loss rules) which in turn sold the VHSUB shares to an unrelated purchaser at their fair market value, and thus realized the capital loss. This allowed Copthorne I to carry the capital loss on the VHSUB shares back to shelter the capital gains from the sale of the Harbour Castle Hotel.
[12] In 1993, the Li Group decided to amalgamate Copthorne I, its wholly owned subsidiary VHHC Holdings and two other corporations. It was recognized that because VHHC Holdings was a wholly owned subsidiary of Copthorne I, without any other steps, the PUC of $67,401,279 of the shares of VHHC Holdings would be eliminated on the vertical amalgamation. However, if VHHC Holdings and Copthorne I were “sister” corporations their amalgamation would result in aggregation of the PUC of each of the companies’ respective shares. To avoid the elimination of the PUC of VHHC Holdings shares, on July 7, 1993, Copthorne I sold its VHHC Holdings shares to Big City, its parent corporation, for their fair market value which was nominal. On January 1, 1994, Copthorne I, VHHC Holdings and two other corporations amalgamated under the name Copthorne Holdings Ltd. (“Copthorne II”). All the issued shares of Copthorne II were owned by Big City. The PUC of the Copthorne II shares owned by Big City was essentially the PUC of the shares of VHHC Holdings ($67,401,280) as the PUC of the shares of the other amalgamating corporations was nominal.
[13] The proceeds of the 1989 Harbour Castle Hotel sale had been invested by Copthorne I in Copthorne Overseas Investment Ltd. (“COIL”), a wholly owned Barbados company that carried on an active bond-trading business in Singapore. In response to June 1994 amendments made to the foreign accrual property income (“FAPI”) provisions of the Income Tax Act which would have made COIL’s income FAPI, the Li Group decided to dispose of the business of COIL to another entity within the Li Group and to remove some or all of the proceeds of disposition from Canada.
[14] To achieve this result, in 1994, L.F. Investments (Barbados) Ltd. (“L.F. Investments”) was incorporated in Barbados. L.F. Investments acquired all of the issued shares of Copthorne II and VHHC Investments. The disposition of these shares by Big City resulted in a capital gain. However, this gain was not taxable. A tax treaty between Canada and the Netherlands provides that aside from enumerated exceptions, capital gains accruing to a resident of the Netherlands (Big City) will not be taxable in Canada. Effective January 1, 1995, those two corporations and two others that were owned within the Li Group amalgamated under the name Copthorne Holdings Ltd. (“Copthorne III”). On this amalgamation, L.F. Investments received 164,138,025 Class D preferred shares (“Class D shares”) having an aggregate redemption amount, fair market value and PUC of $164,138,025 or effectively $1.00 per share. In essence, the PUC of the Class D shares was the total of the PUC of the shares of VHHC Investments at the end of 1991 and the PUC of VHHC Holdings shares that was derived from the share subscriptions made by VHHC Investments.
[15] Immediately following this amalgamation, Copthorne III redeemed 142,035,895 of its Class D shares that were held by L.F. Investments, a non-resident of Canada, for $142,035,895. Since the redemption amount was no more than the PUC of the Class D shares, the redemption did not give rise to a deemed dividend under the Income Tax Act . Accordingly, Copthorne III did not withhold or remit any tax on behalf of L.F. Investments.
[16] The Minister assessed Copthorne III by applying the GAAR to reduce the PUC of its Class D shares by $67,401,280, which was the portion of the PUC that was attributable to the shares of VHHC Holdings.
[17] The Minister determined that a deemed dividend arose on the redemption by Copthorne III amounting to $58,325,223, which was the proportion of the redemption attributable to the VHHC Holdings PUC, and that 15 percent of that amount should have been withheld. Accordingly, the Minister assessed Copthorne III tax of $8,748,783.40. In addition, the Minister assessed a penalty of 10 percent of that amount.
[18] In an unrelated transaction that occurred in 2002, Copthorne III was amalgamated with five other corporations owned within the Li Group and continued as Copthorne Holdings Ltd., the appellant in this appeal.
[19] Copthorne objected to the assessment, the Minister confirmed it, and Copthorne appealed to the Tax Court of Canada.
[20] The Tax Court found in favour of the Minister but overturned the penalty assessment. The Federal Court of Appeal affirmed the decision of the Tax Court. Copthorne now appeals to this Court.
III. Tax Court of Canada
[21] At the Tax Court, Campbell J. found that all elements necessary to apply the GAAR had been established: a series of transactions, a tax benefit, an avoidance transaction, and the abusiveness of the transaction.
[22] Based on this Court’s ruling in Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2 S.C.R. 601, she found that a related transaction is part of a series of transactions if it is completed in contemplation of the series “not in the sense of actual knowledge but in the broader sense of ‘because of’ or ‘in relation to’ the series” (Trustco, at para. 26) and that related transactions may occur before or after the series.
[23] In this case she found that there was a “strong nexus” between the redemption of Copthorne III shares, which she considered the related transaction, and the series of transactions, which included the sale of VHHC Holdings to Big City in 1993 to preserve its PUC and the subsequent amalgamation of Copthorne I and VHHC Holdings, because the redemption “was clearly done in contemplation of” the share sale in 1993 (paras. 39-40). She concluded that all of the relevant transactions could be considered a “series of transactions” for the purposes of the GAAR.
[24] Second, she found that preserving the PUC had reduced the tax that L.F. Investments was liable to pay, and that Copthorne III was required to withhold and remit, and that this tax reduction constituted a tax benefit.
[25] Third, she noted that an avoidance transaction is a transaction that is not undertaken for a “bona fide purpose other than to obtain a tax benefit” (para. 47). While Copthorne argued that the sale of VHHC Holdings to Big City was simply part of a reorganization to simplify the Li Group corporate structure, she concluded that it did nothing to simplify the corporate structure and thus was an “avoidance transaction”.
[26] As to whether the avoidance transaction was an abuse or misuse, she considered three impugned sections together: ss. 89(1) , 87(3) and 84(3) . She concluded that the provisions were intended “to operate to prevent the artificial increase of PUC on amalgamation and its subsequent return to shareholders on a tax-free basis” (para. 74).
[27] She found that the avoidance transaction had misused these provisions “to artificially increase the PUC on amalgamation with the subsequent return of this artificial increase to shareholders on a tax-free basis, the very result that these provisions were intended to prevent” (para. 57).
[28] She concluded that the Minister had properly applied the GAAR to disallow the addition of the $67,401,279 PUC of the shares of VHHC Holdings to the PUC of the shares of Copthorne III, and that the proportion of the subsequent redemption attributable to the $67,401,279 PUC from VHHC Holdings was taxable. However, she overturned the Minister’s penalty assessment.
IV. Federal Court of Appeal
[29] The Federal Court of Appeal affirmed the judgment of the Tax Court for the reasons written by Ryer J.A.
[30] On the first three issues — the series of transactions, the tax benefit, and the avoidance transaction — Ryer J.A. deferred to the factual findings of the Tax Court judge. However, he noted that the Tax Court judge had applied too stringent a legal test to assessing the series of transactions. He concluded that a “strong nexus” need not exist between a series and a related transaction to find that the related transaction is part of the series. Instead, the series need only be a “motivating factor” for the related transaction (para. 49). Given the Tax Court judge’s finding that a “strong nexus” existed, he concluded that this less stringent motivating factor test was clearly met.
[31] Finally, he upheld the conclusion of the Tax Court judge that the avoidance transaction had been abusive, but differed in his application of the GAAR. He concluded that it was only necessary to consider one provision: s. 89(1). However, he agreed that the Tax Court judge had properly identified the purpose of s. 89(1): “. . . to avoid duplicative increases in computing the PUC of the amalgamated corporation” (para. 73). He confirmed the Tax Court judge’s finding that the transaction had abused this provision, and that the GAAR had properly been applied by the Minister. He dismissed the appeal.
V. Analysis
A. Introduction
[32] It is relatively straightforward to set out the GAAR scheme. It is much more difficult to apply it. Where a transaction is an avoidance transaction (a transaction that would result in a tax benefit and whose primary purpose was to obtain the tax benefit), the tax benefit resulting from the transaction will be denied. However, the tax benefit will not be denied if the avoidance transaction would not result in an abuse or misuse of the Income Tax Act . The scheme is set out in ss. 245(1) to (5) of the Act (see Appendix B).
[33] In Trustco, this Court set out the three questions to be decided in a GAAR analysis:
1. Was there a tax benefit? (para. 18);
2. Was the transaction giving rise to the tax benefit an avoidance transaction? (para. 21); and
3. Was the avoidance transaction giving rise to the tax benefit abusive? (para. 36).
I will address each in turn.
B. Was There a Tax Benefit?
[34] The first question that must be answered is whether there was a tax benefit. The burden is on the taxpayer to refute the Minister’s assumption of the existence of a tax benefit (Trustco, at para. 63). Where, as here, the Tax Court judge has made a finding of fact on the existence of a tax benefit, it is only appropriate for a reviewing court to overturn such a finding where an appellant can show a palpable and overriding error.
[35] 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.
[36] Copthorne argues that an amalgamation while VHHC Holdings was owned by Copthorne I — a vertical amalgamation — “was never a live and reasonable option” and thus the Minister should not have used such a comparison (A.F., at para. 137). A vertical amalgamation would have resulted in the cancellation of the PUC of VHHC Holdings shares. This meant that a greater proportion of the funds returned as a result of the redemption would have been subject to tax as a deemed dividend. Copthorne says that a taxpayer would never have chosen this higher tax option, and thus that such option was unreasonable.
[37] An amalgamation was necessary for Copthorne to achieve the outcomes it sought in 1993 when it undertook the transactions between VHHC Holdings, Copthorne I and Big City — a simplification of the corporate structure, and the ability to shelter anticipated gains with losses within the four amalgamating corporations. The only question was whether the amalgamation would be horizontal or vertical. As the Tax Court judge pointed out, the vertical amalgamation would have been the simpler course of action. It was only the cancellation of PUC that would arise upon a vertical amalgamation that led to the sale by Copthorne I of its shares in VHHC Holdings to Big City. To use the words of Professor Duff, “but for” the difference in how PUC was treated, a vertical amalgamation was reasonable.
[38] The comparison was entirely appropriate. Copthorne has not satisfied its onus of showing that there was no tax benefit. I would affirm the finding of the Tax Court that there was a tax benefit.
C. Was the Transaction Giving Rise to the Tax Benefit an Avoidance Transaction?
[39] According to s. 245(3) of the Act , a transaction will be an avoidance transaction if it results in a tax benefit, and is not undertaken primarily for a bona fide non-tax purpose. An avoidance transaction may operate alone to produce a tax benefit, or may operate as part of a series of transactions which produces a tax benefit.
[40] Where, as here, the Minister assumes that the tax benefit resulted from a series of transactions rather than a single transaction, it is necessary to determine if there was a series, which transactions make up the series, and whether the tax benefit resulted from the series. If there is a series that results, directly or indirectly, in a tax benefit, it will be caught by s. 245(3) unless each transaction within the series could “reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain [a] tax benefit”. If any transaction within the series is not undertaken primarily for a bona fide non-tax purpose that transaction will be an avoidance transaction.
[41] The first consideration is whether there was a series that resulted in a tax benefit. As I will explain below, it will be necessary to consider when a transaction which is related to a common law series of transactions is part of a series of transactions as defined in s. 248(10) of the Income Tax Act . The second consideration is whether any of the transactions within the purported series is an avoidance transaction.
(1) Was There a Series of Transactions That Resulted in a Tax Benefit?
[42] 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.
[43] In Trustco, this Court accepted that the scheme of the Act provides for an expansive approach to the series issue. The starting point is the common law series taken from English law where “each transaction in the series [is] pre-ordained to produce a final result” (OSFC Holdings Ltd. v. Canada, 2001 FCA 260, [2002] 2 F.C. 288, at para. 24). This common law series is expanded by s. 248(10) of the Act which deems any “related transactio[n]” which is completed “in contemplation of” a series to be part of that series. Section 248(10) provides:
248. . . .
(10) For the purposes of this Act , where there is a reference to a series of transactions or events, the series shall be deemed to include any related transactions or events completed in contemplation of the series.
[44] The parties have agreed that the sale of VHHC Holdings to Big City and the subsequent amalgamation were part of a series. However, the agreed facts do not address whether the redemption transaction was part of this series. The question which must be answered is whether the redemption which gave rise to the tax benefit can be considered to be a “related transaction” which was done “in contemplation of” the prior series of transactions.
[45] The Minister assumed that there was a series that included the redemption transaction that led to a tax benefit. Again, Copthorne has the onus of showing that the Minister’s assumption is refuted (Trustco, at para. 63).
[46] The Tax Court judge found that there was a “strong nexus” between the redemption and the earlier series which included the 1993 sale of VHHC Holdings to Big City, and the horizontal amalg