Category Archives: 095(6)

Tax Avoidance and Share Acquisition – Interpretation 95(6)

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Tax Avoidance and Share Acquisition – Interpretation 95(6)

Canada v Leigh Cement Limited, 2014 FCA 103

The Minister appealed from the TCC decision of Paris J (2013 TCC 176), allowing the taxpayer’s appeal from the reassessment.  The reassessment denied the taxpayer’s deduction from income of dividends received from a foreign corporation (pursuant to s 113(1)(a)) relying on the anti-avoidance provision in paragraph 95(6)(b) of the ITA.

The TCC found that 95(6)(b) did not apply because “in these circumstances […] there was no tax that would otherwise been payable under the Act” (para 3).  The FCA agreed with the results of the TCC decision, but for different reasons.

FACTS

 Leigh Cement and CBR (wholly owned sub of Leigh) were Canadian companies belonging to the CBR corporate group operating in Europe, Asia, and North America.  The parent company was a Belgian company (CBR SA).

CBR US has significant book losses in the USA, and was financed by debt and equity.  The group decided to refinance the intercompany debt and equity in two parts: (1) the loans were replaced in  series of transactions, and (2) preferred shared were redeemed in another series of transactions.  See paragraph 9 of the FCA decision for details. In short, the refinancing was expected to produce tax savings in Canada (interest deduction and exempt dividend receipt), US (increased losses to be carried forward) and Belgium (exempt dividend receipt).  The refinancing, in addition to tax savings, also addressed other tax concerns raised by changes in Canadian tax law and the US-Luxemburg Tax Treaty.

The Canadian company received dividends from their foreign affiliate, and deducted these amounts from income under 113(1)(a).  The CRA denied these deductions relying on 95(6)(b), claiming that the acquisition of shares in the non-resident corporation was for the principal purpose of avoiding Canadian Tax.

ANALYSIS

The FCA began by reviewing the legislative regime:

  • Paragraph 95(6)(b), in subdivision I of Division B of Part I of the ITA, deals with taxation of income from non-resident corporations;
  • taxation of income from  non-resident corporations depends on (a) the type of income and (b) the ownership status of the non-resident corporation;
  • Type of income:
    • Dividends received by a Canadian taxpayer from a non-resident corporation must be included in income when received pursuant to subsection 90(1);
    • But, if dividends are received by certain non-resident corporations from “exempt surplus” are deductible by the Canadian resident recipient under paragraph 113(1)(a);
  • Ownership Status:
    • The deduction under 113(1)(a) is available for dividends paid by a “foreign affiliate”;
    • subsection 95(1) defines a “foreign affiliate” of a Canadian taxpayer as a non-resident corporation where in the Canadian taxpayer (a) owns at least 1% of any class of shares of the non-resident AND (b) when combined with the holdings of any related person, totals 10% or more of the class of shares of the non-resident.

The FCA notes that Canadian taxpayers can easily manipulate the status of non-resident corporations to get access to tax savings – acquire more shares to get foreign affiliate status or dispose of shares to avoid the status (of status of “controlled foreign affiliate”).  To address this manipulation, paragraph 95(6)(b) provides that “where a person acquires or disposes of shares of a corporation and it can reasonably be considered that the principal purpose of the acquisition or disposition is to permit a person to avoid, reduce, or defer the payment of tax, the acquisition or disposition is deemed not to have occurred” (para 20).   The effect is that the status is determined without the change in share ownership, and the dividend deduction may not be available.

The Minister took the position that the principal purpose of the share acquisition was to avoid taxes that would otherwise have been payable under Part I of the ITA.  The taxpayer took the position that the principal purpose was other than avoiding Canadian tax.

TCC Decision

The TCC held that the principal purpose of a change in share ownership is a question of fact to be determined in light of all circumstances of the case.  In considering a series of transactions, one indication of an avoidance purpose is whether the change in share ownership is arranged for a purpose different than the overall purpose of the series. The TCC  proceeded to a three -stage inquiry:

  1. identify the tax otherwise payable under the Act that the taxpayers are alleged to have intended to avoid,
  2. determine whether the acquisition or disposition of shares permitted this avoidance, reduction or deferral, and
  3. assess  the taxpayers’ principal purpose in acquiring the shares.

The first stage’s look at tax otherwise payable, the TCC held, requires comparison with alternative reasonable transactions to achieve the overall purpose without the change in share ownership.  The TCC then held that no tax would otherwise been payable in the alternate transactions, and as the tax savings could have been obtained without the share purchase.  The TCC also held that the principal purpose was to avoid US tax not Canadian Tax.

FCA Decision

The FCA referred to the principles of statutory interpretation (paras 38-43), setting out to “discern the meaning of the provision’s text using all the objective clues available” (para 44).  The FCA, accepted the taxpayer’s interpretation, stating:

[95] The words of paragraph 95(6)(b) are precise and unequivocal. Paragraph 95(6)(b) requires us to focus on the principal purpose for the acquisition or disposition of the shares, not the principal purpose of the series of transactions of which the acquisition or disposition forms a part. There is no basis for this Court to read in those extra words and, as shall be seen, good reason not to.

[…]

[56]           From the foregoing analysis then, it seems to me that the species of tax avoidance addressed by paragraph 95(6)(b) is the manipulation of share ownership of the non-resident corporation to meet or fail the relevant tests for foreign affiliate, controlled foreign affiliate or related-corporation status in subdivision i of Division B of Part I of the Act.

This was based particularly on the specific reference in paragraph 95(6)(b) to “disposition” and “acquisition”, and the failure (as other provisions do) to use the phrase “series of transactions” (paras 47-50).  The court also relief on amendments made to the Act that would not have been necessary if 95(6)(b) had the wide reach the Minister was claiming (para 52).  The narrow interpretation is supported by the structure of the ITA, given that it is found in the specific location dealing with shareholders of corporations not resident in Canada”, and not in a general part (eg art XVI dealing with tax avoidance).

The Court also considered that 95(6)(b) is an anti-avoidance provision, but stated that such provisions come in all kinds of sizes and must be analyzed individually.    The FCA criticized CRA’s interpretation of the provision as broad, and the statement that it would only be applied to stop unacceptable tax avoidance.  The FCA stated that “unacceptability is in the eye of the beholder [and] can shift depending on one’s subjective judgment and mood at the time” (para 64).  Such an interpretation would result in indiscriminate use of the provision which “creates the specter of similarly-situated taxpayers being treated differently for no objective reason” (para 64).  This would violate the legal principle that absent clear legislative wording, the same legal principles apply to all taxpayers: Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32 at page 46. The FCA stated:

[67]           Absent clear wording, I would be loath to interpret paragraph 95(6)(b) in a way that gives the Minister such a broad and ill-defined discretion – a standardless sweep – as to whether or not a tax is owing, limited only by her view of unacceptability. It would be contrary to fundamental principle. It would also promote arbitrary application, the bane of consistency, predictability and fairness.

The Court’s conclusions are best provided in full:

[68]           For the foregoing reasons, I conclude that paragraph 95(6)(b) is targeted at those whose principal purpose for acquiring or disposing of shares in a non-resident corporation is to meet or fail the relevant tests for foreign affiliate, controlled foreign affiliate or related-corporation status in subdivision i of Division B of Part I of the Act with a view to avoiding, reducing or deferring Canadian tax.

[69]           The principal purpose of the acquisition or disposition of shares in the non-resident corporation is a question of fact to be determined on the basis of all relevant circumstances. An entire series of transactions may form part of the circumstances relevant to discerning the principal purpose of the acquisition or disposition of shares in the non-resident corporation. But it is not open to the Minister to look at an entire series of transactions to discern a tax avoidance purpose that is not the specific target of paragraph 95(6)(b).

[70]           Manipulating the shareholdings in the non-resident corporation to change its status in subdivision i of Division B of Part I of the Act in order to avoid, reduce or defer Canadian tax by itself does not necessarily trigger paragraph 95(6)(b) of the Act. The purpose must be the principal – i.e. dominant or main purpose – not just one of many different purposes.

– Sas Ansari, JD LLM PhD (exp)

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Anti-Avoidance Rule in Paragraph 95(6)(b) Clarified – Lehigh Cement

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Anti-Avoidance Rule in Paragraph 95(6)(b) Clarified

Canada v Lehigh Cement Limited, 2014 FCA 103

An appeal from the TCC decision in 2013 TCC 176, granting the taxpayer’s appeal of the MNR’s reassessment.

At issue was the proper interpretation of paragraph 95(6)(b) of the Income Tax Act, specifically how wide the inquiry into the “principal purpose” of a share transaction could be.

FACTS

Lehigh and CBR acquired shares of a non-resident corporation as part of a complex and wide restructuring involving many steps (Details at paras 9-10 of the FCA decision).  They received dividends from this non-resident company and claimed a deduction under paragraph 113(1)(a).  The MNR disallowed the deductions and applied paragraph 95(6)(b) on the basis that the taxpayers had acquired the shares of the non-resident with the  principal purpose of avoiding the payment of tax that would otherwise be payable under the ITA.

The FCA agreed with the TCC outcome (taxpayer succeeding) but for different reasons. The TCC had determined that the principal purpose of the acquisition or disposition was a question of fact to be determined in light of all relevant circumstances and that one salient consideration is whether the share purchase or sale was part of a series of dispositions or acquisitions conducted with a view to avoid tax.  The TCC then considered the effect of the phrase “tax…that would otherwise be payable”, and stated that this required looking at the alternate scenario where the share transaction has not occurred.  In this case, the TCC determined that there was no change in tax consequences before or after the share transaction and therefore 95(6)(b) did not apply.

The MNR’s position at the FCA was that in applying 95(6)(b), was that it was proper to look at a series of transactions to see if there was a tax avoidance purpose. The Taxpayer’s position was that only the share transaction itself must be looked at.

ANALYSIS

The FCA began by providing a thorough overview of the legislative regime which paragraph 95(6)(b), in subdivision I of Division B of the ITA is part of.  How a Canadian resident is taxed on income derived from a non-resident corporation depends on two factors:

  1. the type of income; and
  2. the ownership status of the non-resident corporation.

Subsection 90(1) requires that dividends received by a Canadian taxpayer from  non-resident corporation be included in income when received.  But, 113(1)(a) provides an offsetting deduction for dividends paid by “foreign affiliate” corporations paid out of exempt surplus.  Very simply stated, 95(1) defines “foreign affiliate” to be a non-resident corporation in which a Canadian taxpayer holds at least 1% interest of any class of shares AND that taxpayer’s holdings combined with the holdings of any related person total 10% or more of the class.

The court noted that the ownership status of the non-resident corporation can easily be manipulated so as to realise tax savings. The court quoted from Vern Krishna, The Fundamentals of Canadian Income Tax (9th ed., 2006) at page 1327, where it is said that ““taxpayers jockey to get on the right side of the distinctions to take advantage of the rules”.  Paragraph 95(6)(b) was enacted to address taxpayers’ ability to manipulate the ownership status of non-resident corporations.  The court stated (para 20):

 Broadly speaking, paragraph 95(6)(b) provides that where a person acquires or disposes of shares of a corporation and it can reasonably be considered that the principal purpose of the acquisition or disposition is to permit a person to avoid, reduce or defer the payment of tax, the acquisition or disposition is deemed not to have occurred.

The FCA referred to the decision in Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, where the rule for statuary interpretation was laid out. The FCA then set out the rules in relation to Income Tax provisions:

[39]           The provisions in taxation statutes are often detailed and particular. The Income Tax Act is “an instrument dominated by explicit provisions dictating specific consequences,” and this invites “a largely textual interpretation”: Canada Trustco, at paragraph 13.

[40]           As a result, “[w]here Parliament has specified precisely what conditions must be satisfied to achieve a particular result, it is reasonable to assume that Parliament intended that taxpayers would rely on such provisions to achieve the result they prescribe”: Canada Trustco, supra at paragraph 11. Where the provision at issue is “clear and unambiguous,” its words “must simply be applied”: Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622 at paragraph 40. In such circumstances, a supposed purpose “cannot be used to create an unexpressed exception to clear language” or “supplant” clear language: Placer Dome Canada Ltd. v. Ontario (Minister of Finance), 2006 SCC 20, [2006] 1 S.C.R. 715 at paragraph 23, citing P. W. Hogg, J. E. Magee and J. Li, Principles of Canadian Income Tax Law (5th ed. 2005), at page 569.

[41]           When interpreting provisions in taxation statutes, we must keep front of mind their real life context: many taxpayers study closely the text of the Act to manage and plan their affairs intelligently. Accordingly, we must interpret “clear and unambiguous” text in the Act in a way that promotes “consistency, predictability and fairness,” with due weight placed upon the particular wording of the provision: Canada Trustco, at paragraph 12, citing Shell Canada Ltd., supra at paragraph 45.

[42]           We must not supplant or qualify the words of paragraph 95(6)(b) by creating “unexpressed exceptions derived from [our] view of the object and purpose of the provision,” or by resorting to tendentious reasoning. Otherwise, we would inject “intolerable uncertainty” into the Act, undermining “consistency, predictability and fairness”: 65302 British Columbia Ltd. v. Canada, [1999] 3 S.C.R. 804, at paragraph 51, citing P. W. Hogg and J. E. Magee, Principles of Canadian Income Tax Law (2nd ed. 1997) at pp. 475-76; see also Canada Trustco, at paragraph 12.

[43]           In the course of applying these principles, legislative history and explanatory documents such as technical notes, budget papers and committee minutes can offer assistance.

[44]           Overall, though, our task is to discern the meaning of the provision’s text using all of the objective clues available to us.

In applying this test, the court accepted the taxpayer’s interpretation.  Paragraph 95(6)(b) focuses precisely and unequivocally on the principal purpose of the acquisition or disposition of the shares and NOT on that of the series of transactions on which the particular acquisition or disposition is part of.  The FCA held that 95(6)(b) is aimed at a particular species of tax avoidance (manipulation of foreign affiliate status), and does not use the words “series of transactions or event”.  The FCA stated (para 50):

Rather, the words of paragraph 95(6)(b) require that the tax benefit must flow from the share acquisition or disposition itself and obtaining the tax benefit must be the principal purpose of the share acquisition or disposition.

The court also considered other contexts, including amendments made to other anti-avoidance provisions and the architecture of the ITA (provision in a specific area not a general area).  The provision is only aimed at dealing with manipulations of foreign affiliate status (para 55).

The FCA also dealt with the MNR’s argument based on the purpose of the provision. It did so by considering the potential effects of the alternative interpretations, and held that the MNR’s interpretation would result in unacceptable (board and ill-defined) discretion leading to uncertainty (para 64):

[64]           Unacceptability is in the eye of the beholder. It can shift depending on one’s subjective judgment and mood at the time. Using it, as the Crown suggests, to restrain the indiscriminate use of paragraph 95(6)(b) creates the spectre of similarly-situated taxpayers being treated differently for no objective reason. This would violate the principle that, absent clear legislative wording, the same legal principles should apply to all taxpayers: Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32 at page 46.

The court concluded:

[68]           […]  paragraph 95(6)(b) is targeted at those whose principal purpose for acquiring or disposing of shares in a non-resident corporation is to meet or fail the relevant tests for foreign affiliate, controlled foreign affiliate or related-corporation status in subdivision i of Division B of Part I of the Act with a view to avoiding, reducing or deferring Canadian tax.

[69]           The principal purpose of the acquisition or disposition of shares in the non-resident corporation is a question of fact to be determined on the basis of all relevant circumstances. An entire series of transactions may form part of the circumstances relevant to discerning the principal purpose of the acquisition or disposition of shares in the non-resident corporation. But it is not open to the Minister to look at an entire series of transactions to discern a tax avoidance purpose that is not the specific target of paragraph 95(6)(b).

[70]           Manipulating the shareholdings in the non-resident corporation to change its status in subdivision i of Division B of Part I of the Act in order to avoid, reduce or defer Canadian tax by itself does not necessarily trigger paragraph 95(6)(b) of the Act. The purpose must be the principal – i.e. dominant or main purpose – not just one of many different purposes.

In this case, the principal purpose of the share transaction was to avoid US tax and not Canadian Tax, and 95(6)(b) had no application.

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

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