What is the Underlying Purpose of ITA ss 3, 4, 9, and 111?
The Queen v Global Equity Fund, 2012 FCA 272
At issue here were two matters:
- i. Can the Crown rely in this appeal on new arguments which were not raised by the Minister in assessing the taxpayer nor relied upon by the Crown in the Tax Court of Canada?
- ii. Do the transactions in issue result in a misuse or abuse of the provisions relied upon by the taxpayer within the meaning of subsection 245(4) of the Act?
The FCA held that:
- i. New arguments raised must fall within subsection 152(9), and cannot be raised for the first time before the FCA where they involve questions of fact or mixed fact and law, and where the evidentiary record is incomplete because the matters were not present in the Notice of Assessment or in arguments before the TCC (the FCA was especially outraged with the Crown’s shifting and contradictory arguments and awarded the taxpayer costs at the highest tariff both before the TCC and itself irrespective of the outcome);
- ii. The purpose and object of ss 3, 4, 9, and 111, as they relate to business losses is that to be deductible for tax purposes there must at the very least be an air of economic or business reality associated with the loss. Therefore manufacture or mere paper losses are a misuse or abuse of the provisions for purposes of 245(4).
For Comments on the Crown’s argument in relation to wealth and economic loss see HERE.
This was an appeal from the decision of the TCC, at 2011 TCC 507, allowing the taxpayer’s appeal and setting aside the MNR’s reassessment denying business losses incurred during a planning strategy known as “value shift” on the basis of GAAR (ITA s 245). In short, a new corporation was incorporated and a new trust was settled, and through share purchase, stock dividend, and share sale transactions the value was shifted between shares realizing a loss on high ACB low-value shares. The taxpayer claimed the loss as business loss since it traded in securities. This loss gave rise to a significant tax benefit, which it carried back to nearly offset previous years’ earnings.
The TCC granted the appeal though she felt that the transactions were “shuffles of paper” and “highly artificial”, there being no “real economic loss”, and also found the transaction to be an avoidance transaction, but held that they were not misuses or abuses of any ITA provisions. The Crown appealed this conclusion, as they had argued that the transaction was an abuse or misuse of the ITA as a whole, as the ITA only permits bona fide losses as deductions from income or capital, relying on ITA ss . 18(13), 18(14), 18(15), 40(3.3), 40(3.4), 54, former section 55, and s. 111(3), 111(4) and 111(5). The TCC found that the Crown had failed to prove that the object, spirit, or purpose of the ITA was to restrict business losses to real losses realized outside an economic unit, mainly because each provision had a narrow focus.
The Crown advanced five position and argued:
- specifically relies on ss 3, 4, 9 and 111 of the ITA for GAAR purposes. The Crown relies on dictionary meanings of “income”, “loss”, and “business”, and the SCC decisions in Stewart v. Canada, 2002 SCC 46,  2 S.C.R. 645 and Canderel Ltd. v. Canada,  1 S.C.R. 147, to make two arguments:
(a) the first new rationale is that the object, spirit or purpose of sections 3, 4, 9 and 111 is to allow the deduction of business losses “only to the extent that they reflect an underlying actual economic loss” so as “to ensure that a taxpayer’s loss for a taxation year is an actual and accurate loss that reflects a true picture of the taxpayer’s business operations over a defined period of time” (Crown’s memorandum at paras. 59 and 61);
(b) the second rationale is that the object, spirit or purpose of these provisions is to allow the deduction of true losses that reflect an actual “reduction in wealth”
- relying on former subsection 245(1) of the ITA, though the provision was repealed with the introduction of GAAR, and deals only with expenses or disbursements, the Crown argues that by incorporating this provision in GAAR, the intent was to retain a general statutory presumption against transaction that produce artificial results in computing losses for tax purposes. It read:
In computing income for the purposes of this act, no deduction may be made in respect of a disbursement or an expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce income.
- that shares in the numbered company were not acquired as inventory, and the loss should be denied on the basis of s 9.
- that the shares were capital property in the taxpayer’s hands and the loss should be denied for reasons similar to that recently adopted by the FCA: Gestco Ltd. v. Her Majesty the Queen, 2012 FCA 258, and 1207192 Ontario Ltd. v. AGC, 2012 FCA 259.
- finally, that whether or not the losses are deemed capital losses or not, they should be denied by relying on the above cases as applied to ss 3, 4, 9 and 111 of the ITA, being significantly similar to the transactions in the above cases, and that the vacuous nature of the transactions violated the object and purpose of those sections.
The taxpayer argued that the Crown hadn’t satisfied the first step of the abuse analysis, and suggests that the crown’s argument of a “clear rationale” that the act permits only deduction of losses representing decreases in wealth can’t be accepted given the Crown takes inconsistent and incompatible positions before the TCC and FCA.
The Taxpayer also challenges Crown’s argument that the losses are capital since this is in contradiction with the crown’s admissions before the TCC. If this was the Crown’s positions they should have assessed according to it and argued it before the TCC.
Further, they contend that the crown’s reliance on ss 3, 4, 9, and 111 is a Haig-Simmons economic formulation of income as net accretion of wealth between two points, a matter not enacted in law in Canada or any other country. None of the provisions refer to “artificial” “true losses” or “decreases in wealth”.
New Issues Raised
The FCA noted that most of the issue raised before it were not raised by the MNR in reassessment or by the Crown in the TCC. Subsection 152(9) governs the right of the MNR to advance alternative arguments in support of the assessment (a response to the SCC decision in Continental Bank v. Canada,  2 S.C.R. 358, and reads:
152. (9) The Minister may advance an alternative argument in support of a the existing evidentiary record (taxpayer counsel admitted no evidentiary prejudice). The FCA stated that it could not condone the Crown’s conduct being ever growing and moving Crown arguments and positions (some plainly contradictory), and that this was not the proper way of conducting GAAR litigation. The FCA granted the taxpayers costs both at the FCA and TCC levels irrespective of the result.
Abuse or Misuse
The FCA stated at paragraph 43 that the inquiry under subsection 245(4) has two parts: (1) identifying the object, spirit or purpose of the provisions of the ITA relied on for the tax benefit, having regard to the scheme of the ITA, relevant provisions and permissible extrinsic aids – a question of law looking at the rationale underlying the words but not necessarily captured by the bare meaning of the words of the ITA (para 44); and (2) examine the factual context to see whether the avoidance transaction would frustrate the identified object, spirit or purpose – a fact-intensive inquiry.
Abuse or misuse can be established where “the avoidance transactions (1) achieves an outcome that the statutory provisions relied on were intended to prevent; (2) defeats the underlying rationale of these provisions; or (3) circumvents certain provisions in a manner that frustrates or defeats their object, spirit or purpose: Lipson v, Canada, 2009 SCC 1″ (para 46).
The FCA looked at the object, purpose or spirit of ss 3, 4, 9, and 111, but refused to look to former subsection 245(1) or the capital loss provisions of the ITA for interpretive assistance because the latter and former sections were neither directly grouped together nor work together to give effect to a plausible or coherent plan (para 50). The FCA’s refusal to look at the section dealing with capital income to identify the underlying rationale of business income sections is (i) that the provisions usually operate independently from another, and (ii) it would result in the Court looking for an overarching policy to override the words of the ITA (para 52).
Looking at ss 3, 4, 9, and 111, the FCA stated:
 Regarding income and losses that are sourced in a business, it is apparent from reading these provisions that their underlying rationale is to make the taxpayer subject to tax on business profits in the year the profits are realized, and relieved from tax to the extent that there has been a business loss in that year. Business losses of a given year may also be carried back or carried forward to other years within a specified statutory period in order to offset for taxation purposes certain other income sources.
 The Act does not define the key expressions used in these provisions, notably the terms “income”. “profit” and “loss”. The fact that these key terms remain undefined is clearly a deliberate legislative choice. The GAAR cannot and should not be used to impute a special overarching meaning to these expressions. The use of GAAR for such a purpose would inappropriately place the formulation of fundamental taxation policy in the hands of the courts: Canada Trustco at para. 41. As a general principle, courts should avoid judicial innovations and rule making in tax law: Stewart at para. 4. As aptly noted by Iacobucci J. in Canderel (at para. 41): “The law of income tax is sufficiently complicated without unhelpful judicial incursions into the realm of lawmaking. As a matter of policy, and out of respect for the proper role of the legislature, it is trite to say that the promulgation of new rules of tax law must be left to Parliament.”
– Sas Ansari, BSc BEd PC JD LLM PhD (exp) CPA In-Depth Tax 1, 2 &3
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