While the following cases are not exactly current, they are really good refreshers in how to see GAAR. (General Anti Avoidance Rules.)

This a first rate bench mark for deciding about a transactions.

For more information on how CRA sees things, go to www.taxauditsolutions.ca

 Dan White

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Most important tax decision in a generation
By Arnold Ceballos
Toronto
October 28 2005 issue

In a widely-awaited pair of decisions, the Supreme Court has set out guidelines which could make it easier for taxpayers to arrange their affairs in a way that minimizes taxes without violating the general anti-avoidance rule in the Income Tax Act.

The Court established a new test for determining when there is a violation of the general anti-avoidance rule (GAAR), which is set out in Section 245(4) of the Act.  The Court stated that three requirements must be established before the GAAR will be applied: a tax benefit must result; the transaction is an avoidance transaction; and there was abusive tax avoidance in the sense that the tax benefit would be inconsistent with the object, spirit or purpose of the provisions relied upon by the taxpayer. The burden is on the taxpayer to refute the first two prongs of the test, while the Minister must establish the third prong. If the existence of abusive tax avoidance is unclear, the Court said the benefit of the doubt goes to the taxpayer.

“The decision is enormously significant and sets out the parameters for legitimate tax planning,” said Vern Krishna, Executive Director of the Tax Research Centre at the University of Ottawa. He adds that the decision is particularly important because the GAAR is an overreaching section of the Act that hovers over the entire statute.

The new guidelines are set out in judgments released Oct. 19 arising out of two cases that considered the GAAR.

In Canada Trustco Mortgage Company v. Canada [2005] S.C.J. No. 56, the Court was considering a tax-reducing arrangement established by Canada Trustco Mortgage Company (CTMC). CTMC is a mortgage lender which derives revenues from leased assets. The company had purchased a number of trailers which it then leased back to the vendor in order to offset revenue from its leased assets by claiming a capital cost allowance on the trailers.  By doing so, CTMC was able to defer paying taxes on the profits reduced by the capital cost allowance deductions, which would be subject to recapture into income when the trailers were later sold.

The Minister of National Revenue disallowed the capital cost allowance claim and on appeal the Tax Court set aside the decision. The Federal Court of Appeal affirmed and the government appealed the matter to the Supreme Court of Canada.

The second case was Mathew v. Canada [2005] S.C.J. No. 55, involving Standard Trust Company (STC), whose business included lending money on the security of mortgages. The company became insolvent when the real estate market declined, leaving an unrealized loss of $52 million. The liquidator executed a series of transactions which, through the operation of certain provisions of the Income Tax Act, allowed a number of taxpayers to use the losses accrued on the mortgages against their own incomes. The Minister of National Revenue applied the GAAR and disallowed the deduction. Both the Tax Court and the Federal Court of Appeal upheld the Minister’s decision. The taxpayers appealed to the Supreme Court.

The basic issue before the Supreme Court in both cases involved an interpretation of the GAAR and specifically whether the there was abusive tax avoidance by the taxpayers in question.
The GAAR was added to the Income Tax Act in 1988 as a result of the 1984 Supreme Court decision in Stubart Investments Ltd. v. The Queen. In that decision the Court rejected a literal approach to interpreting the Income Tax Act, while also rejecting the business purpose test, which would have restricted tax reduction to transactions with a real business purpose. In response, the government introduced the GAAR in order to deny the tax benefits of certain arrangements that comply with a literal interpretation of the provisions of the Act, but which amount to an abuse of the provisions of the Act.

In the current Canada Trustco case, the government argued that the usual result of the capital cost allowance provisions should be overridden by the GAAR where there was no real financial risk or “economic cost” to the taxpayer, which it said was the case with CTMC’s leasing arrangement.

The Supreme Court, however, rejected this interpretation, agreeing with the Tax Court judge that the transaction was not so dissimilar from an ordinary sale-leaseback so as to take it outside the object, spirit or purpose of the capital cost allowance provisions. In doing so, the Court articulated a new two-part approach to interpreting whether the tax avoidance was abusive, based on what it called a unified textual, contextual and purposive approach.

Writing for a unanimous court, Chief Justice Beverley McLachlin and Justice John Major stated that the “first step is to determine the object, spirit or purpose of the provisions of the Income Tax Act that are relied on for the tax benefit, having regard to the scheme of the Act, the relevant provisions and permissible extrinsic aids. The second step is to examine the factual context of a case in order to determine whether the avoidance transaction defeated or frustrated the object, spirit or purpose of the provisions in issue.”

The Court continued: “the abusive nature of the transaction must be clear. The GAAR will not apply to deny a tax benefit where it may reasonably be considered that the transactions were carried out in a manner consistent with the object, spirit or purpose of the provisions of the Act, as interpreted textually, contextually and purposively.”

“The Court established a legal standard for GAAR and it did that very well,” said Al Meghji of Osler Hoskin & Harcourt LLP in Toronto, who acted for Canada Trustco. He added that the Court’s task was to ensure that GAAR was an effective anti-avoidance tool while at the same time applying it in a way that did not result in unacceptable commercial uncertainty.

The difficulty with GAAR, he continued, was that it “was very capable of becoming a smell test.” According to Meghji, the new legal standard allows a determination of whether something is abusive without reference to subjective views about what is or is not acceptable.

In Mathew, the Court applied its reasoning from Canada Trustco and held that, based on a contextual and purposive interpretation of the relevant sections of the Income Tax Act, and in particular the partnership provisions relied upon by the taxpayers, the impugned transactions were abusive and frustrated Parliament’s purpose.

Kim Hansen, a Vancouver sole practitioner who represented the taxpayers in the Mathew case, agreed that the Court did a good job of providing direction with respect to applying GAAR, pointing out that “the rule itself provides uncertainty.”

Calling the Canada Trustco decision a “major setback for the government”, Professor Krishna says he expects the Department of Finance to respond to the decision in much the same way it did following the Stubart decision. “They overreacted in 1988 and I expect they’ll overreact again and bring technical amendments to bolster the rule,’ said Krishna.

Justice lawyer Anne-Marie Levesque, who represented the government in both cases, agreed the Court gave “clear guidance to the government, to taxpayers, and to courts on how it sees GAAR being applied in the future.”

However, she added that “the Court has put GAAR in a box and I’m not sure the government saw the same box as the Court.” She said that the government will consider the decision and its impact before deciding how it will affect the future application of GAAR.