How does one determine the “primary purpose” of a series of transactions for purposes of subsection 245(3)?

1207192 Ontario Ltd v The Queen, 2012 FCA 259

There were two issues:

• Was the tax benefit the result of an avoidance transaction as defined by subsection 245(3)?
• If so, was there an abuse or misuse within the meaning of subsection 245(4)?

The FCA held that in determining the primary purpose of a series of transactions, one must look objectively at the purpose of each of the steps by reference to their consequences, and not according to the subjective belief or purpose of the taxpayer.  Thus, if the purpose of a sub-set of the series of transactions is not necessary to the non-tax motivated purpose, then that will render the tab benefit an avoidance transaction.

The question of misuse and abuse was decided as it was in Triad Gestco

FACTS

.Appeal from TCC decision 2011 TCC 383 dismissing the taxpayer’s appeal from a GAAR assessment.

The taxpayer transferred property to its wholly owned sub-corporation in exchange for shares of equal value.  These shares were then sold for less than their cost and used the capital loss to offset the capital gain realised on a prior arm’s length transaction.  The purchase of the shares was a trust established for the benefit of the controlling shareholder of the corporation. The sale occurred immediately after payment of a stock dividend on a separate class of shares of the sub-corporation.  The effect of the stock dividend was to shift value from the shares that were sold to the trust to the shares of the class in which the stock dividend was paid, which the taxpayer retained.

The MNR reassessed and denied the capital loss on the basis of GAAR. The TCC upheld the reassessment.

At the FCA, the taxpayer conceded the tax benefit issue.  There was a dispute as to the existence of an avoidance transaction and the application of the misuse or abuse rule.

The taxpayer corp sold the shares of a sub to an arm’s length purchaser, realising a CG of about $3M.  The shareholder was about to embark on a new venture with a significant risk of personal liability, which he was sensitive to due to personal bankruptcy years before.  He sought advice to protect his assets from future creditors.  The accountant gave advice based on a previous opinion for another client. After the decision to implement the plan, the accountant discovered that there was the side benefit of the tax savings.

ANALYSIS

The FCA noted that this case was heard immediately after Triad Gestco Ltd. v. Her Majesty the Queen (A‑286‑11, on appeal from 2011 TCC 259,  2012 FCA 258, SUMMARY here), but the facts in this case differ materially from that case.

Avoidance Transaction

Section 245(3) provides:

245. (3) An avoidance transaction means any transaction

(a) that, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit; or

(b) that is part of a series of transactions, which series, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.

Thus, one must determine the primary purpose of the transaction OR a series of transactions purported to comprise an avoidance transaction – a factual inquiry: Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54 at paragraph 29.  The result of the inquiry is of mixed fact and law: Housen v. Nikolaisen, 2002 SCC 33 at paragraphs 26 to 37.  The taxpayer bears the burden to establish a bona fide purpose other than to obtain a tax benefit.

The TCC accepted that the purpose of the transactions was creditor protection – thus a bina fide non-tax purpose. The TCC went on to as whether the principle purpose was the achievement of the tax benefit, looking at the entire series of transactions, on the basis of MacKay v. Canada, 2008 FCA 105 at paragraph 25:

The existence of a bona fide non-tax purpose for a series of transactions does not exclude the possibility that the primary purpose of one or more transactions within the series is to obtain a tax benefit.

The FCA stated that the subset of the series of transaction undertaken is an avoidance transaction – undertaken primarily to obtain a tax benefit (the devaluation and sale of shares to get the loss) (para 16).

The TCC held that here was no evidence that the creditor protection purpose could not have been achieved, and given that the onus was on the taxpayer, resulted in the finding that the issuance was not done primarily for a bona fide non-tax purpose.

The Taxpayer argued that from the perspective of the shareholder, all of the steps were essential to achieve the desired creditor protection, and the tax benefit was purely incidental but not the purpose of putting the plan into action.

The FCA didn’t agree with the taxpayer, but said that the TCC was correct in determining the purpose of the series of transactions on an objective basis – determining objectively the purpose of each step of the transaction by reference to its consequences.

Misuse or Abuse

The question on misuse or abuse was answered in the same manner as in Triad Gestco. [capital gains and losses are meant to be real not just paper gains and losses]

– Sas Ansari, BSc BEd PC JD LLM PhD (exp) CPA In-Depth Tax 1, 2 &3

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