GAAR analysis framework – Purpose of ITA s 112 – meaning of “in proportion to”
Spruce Credit Union v The Queen, 2012 TCC 357
There were two issues in this case:
- Whether a dividend received by the credit union (“CU”) from a BC deposit insurance corporation (a taxable Canadian corporation) is deductible under s 112 inter-corporate dividend deduction in the ITA?
- If so, does GAAR apply to the receipt of the dividend?
The TCC provided a detailed guide to how a court ought to approach GAAR analysis. It first determined that the dividend paid met the legal definition of a dividend and was thus, absent GAAR, deductible pursuant to s 112. The Court then considered the GAAR question and noted that in light of the overall non-tax purpose of the transaction, and the fact that no step was inserted or undertaken primarily for obtaining a tax result, there was no avoidance transaction to which GAAR could apply.
Importantly, the Court noted that even if tax considerations play a primary role in a taxpayer’d choices this doesn’t necessarily make the transaction primarily tax motivated. The Court was very clear to differentiate between a “choice” and a “transaction”, and stated that the manner of distributing funds was a choice, and that the “act of choosing or deciding between or among alternative available transactions or structures to accomplish a non-tax purpose, based in whole or part upon the differing tax results of each, is not a transaction [as] making a decision can not be an avoidance transaction” (para 93). Taxpayer’s are free to choose among alternatives purely on the basis of tax outcomes.
The TCC did not deal with the question of whether there was a “tax benefit”, but this may be due to the arguments raised by the taxpayer (ie that the lack of tax benefit was not argued, and therefore the burden on the taxpayer on this issue was not met).
The TCC also noted, but only in passing without analysis, that the decision here was that of the deposit insurance corporation, and not that of the taxpayer and not one that could have been influenced by the taxpayer (lack of control).
The decision does, however, highlight the freedom of taxpayer’s to elect the least tax onerous manner of structuring their affairs – thus freedom of choice among alternatives purely on the basis of tax consequences- so long as no steps taken to achieve the non-tax purpose are not primarily for a bona fide non-tax purpose – ie a necessary connection between steps to acheive the non-tax purpose.
The CU was involved with two deposit insurance corporations (CUDIC and STAB) as per BC regulations of CUs.
CUDIC is a table Canadian corporation controlled and operated by the FI Commission, which is an arm of the BC government. It is funded by assessments paid by CUs, which are deductible by the CUs pursuant to section 9 and subsection 137.1(11) of the ITA. CUDIC was responsible for maintaining the deposit insurance fund.
STAB is a taxable Canadian corporation, and is a central credit union under the relevant BC statute. Each CU in BC was require to be a member and shareholder of STAB. STAB was funded by assessments, which were deductible to the payor CU pursuant to paragraph 137.1(11) of the ITA. STAB would rebalance its members’ shareholdings to reflect the current size of the members. STAB was responsible for maintaining the stability of CUs.
Due to some changes in the FI Commission’s views on the proper allocation of funds between CUDIC and STAB, there was a need to transfer funds between the two organizations. Because of the legal (lack of) relationship between these two corporations, and as result of discussions, alternatives were considered. STAB could make distributions to its members either by way of refund of premiums or by dividend. There was a need to distribute funds from STAB to CUs to pay for the imminent CUDIC assessment required by BC law. CUDIC assessed and independently STAB paid dividends to its members, but split it between two dividends due to the RUlind Directorate’s position that there is no GAAR concern with respect to the aggregate cumulative investment income amount (vs assessment income).
The crown argues that despite s 112, the dividend received by the Credit union is not deducible because of s 137.1, because ” (i) the dividend amounts were paid to the credit unions as allocations in proportion to assessments received by the deposit insurance corporation from the credit unions, and required to be included in the credit unions’ incomes under paragraph 137.1(10)(a); and (ii) section 137.1 is a complete code with respect to such amounts and does not permit them to then be deducted” (para 2).
Alternatively the crown argues that GAAR applies to the extent that the amount of the dividend is also an amount described in paragraph 137.2(10)(a) as being a refund of premiums that must be included in Income by subsection 137.1(10) of the ITA, so that its not a dividend that is thereafter deductible (para 3).
The TCC noted that there is no reason on the basis of s 112 of the ITA to treat the two dividend payments differently. The amounts paid were in law dividends, and they are taxable dividends required to be included in income by 82(1).
The court stated that the purpose of s 112 ” inter-corporate dividends received deduction is to avoid double taxation of the after-tax profits of a corporation as they are paid by way of dividends to shareholder corporations. This forms part of the Act’s approach to achieving a degree of integration of corporate and personal taxation of income earned through a corporation.” (para 43).
The TCC did not believe that the Crown’s position was supported by the evidence – ie that the amount was paid by STAB as an allocation in proportion to assessments received from the CUs as contemplated by 137.1(10)(a). This is because the section uses the word “as” and not words such as “in respect of” or “as, on account, or in lieu of”, or more expansive language of that kind (para 46). ” It does not speak of amounts that could reasonably be considered to relate to, or directly or indirectly be funded by, assessments previously received. The form or nature of the amount of the payment is specifically described given the use of the word “as” in English and the words “à titre de” in French.” (para 46).
Definition of “in proportion to”
The amounts were paid by STAB as dividends in proportion to each shareholder’s shareholdings. The TCC said that the amounts could both be dividends and fall under 137.1(10)(a). The Court went on to say at paragraph 49:
The meaning of the term “in proportion to” is neither unclear nor ambiguous. A proportion is a comparative ratio that is a part considered in comparative relation to a whole. For two things to be in proportion to one another there must be an equality of ratios. For an amount to be paid to persons in proportion to their assessments, it is a requirement that the person receive that portion of the aggregate amount paid that assessments received from them is of the total of all assessments received. That is, there must be an equality of ratios. That the amount paid to them was arguably funded by the payer in whole or in part directly or indirectly, with assessments received, or income earned on such assessments, is clearly not sufficient. That position would require that the meaning of the words “in proportion to” be ignored. Similarly, the fact that a member received a portion of the pool paid out does not lead in any way to the conclusion it was paid proportionate to their assessments. For the Respondent’s position to be correct on the facts of this case, I would have to read “shareholdings” for the word “assessments” used in the legislation.
Since the court held that the amounts were not “paid in proportion to”, and therefore didn’t need to decide whether section 137.1 is a complete code.
[NOTE that the court provides a very detailed review of how to approach GAAR – not all of which is reproduces here]
The TCC referred to the decisions of the SCC in Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54,  2 S.C.R. 601, 2005 DTC 5523 and in Lipson v. Canada, 2009 SCC 1,  1 S.C.R. 3, 2009 DTC 5015, and most recently reaffirmed in Copthorne Holdings Ltd. v. Canada, 2011 SCC 63, 2012 DTC 5006, as setting out the test in GAAR.
The Court noted that absent GAAR, “taxpayers are entitled to select courses of action or to enter into transactions that will minimize their tax liability relying upon the Duke of Westminster principle . Taxpayers are entitled to know with a degree of certainty that the provisions of the Act apply to transactions with real economic substance ” (para 56). The Court went on to state at paragraph 57:
The GAAR is an exceptional provision of last resort that may be invoked by the Minister of National Revenue (the “Minister”) if he believes that the taxpayer’s chosen transactions, notwithstanding that they comply with the literal requirements of the provisions in question, are not in accord with the object, spirit, rationale or purpose of the provisions and indeed frustrate and abuse them. The GAAR creates an unavoidable degree of uncertainty for taxpayers and, for this reason, a court must undertake its analysis cautiously. It is the obligation of the Minister to demonstrate clearly the abuse he alleges. Any residual doubt is resolved in favour of the taxpayer.
This question of whether there is a “tax benefit” requires the court to identify and isolate the tax benefit from the non-tax purpose of the taxpayer’s chosen transactions in one of several ways:
 If a deduction against taxable income is claimed in the impugned transaction or series of transactions, the existence of a tax benefit is clear since a deduction results in a reduction of tax.
 Alternatively, the existence of a tax benefit can be established by comparing the taxpayer’s chosen transactions with an alternative transaction that might reasonably have been carried out but for the existence of the tax benefit.
 The burden is on the taxpayer to refute the Minister’s assumption of the existence of a tax benefit.
 Whether or not there is a tax benefit is a question of fact, subject to review on the basis of palpable and overriding error.
The Question of whether there is an “avoidance transaction”, looks to whether the step that led to the tax benefit was undertaken primarily for a bona fide non-tax purpose, and ” If there is a series of transactions that results directly or indirectly in a tax benefit, any transaction or step in the series will be an avoidance transaction if that step is not undertaken primarily for a bona fide non‑tax purpose” (para 66). The TCC stated at paragraph 68:
 The courts must at this stage examine the relationship between the parties and the actual transactions that were executed between them. A transaction cannot be an avoidance transaction because some alternative transaction that might have achieved an equivalent result would have resulted in more tax. That will not suffice to establish an avoidance transaction, though, as summarized above, it may suffice to establish a tax benefit.
The limitation of this approach was highlighted by the TCC at paragraph 69:
 Consistent with its decision in Trustco, the Supreme Court of Canada in Copthorne does not suggest that it is appropriate at the avoidance transaction stage of the analysis to compare the taxpayer’s chosen transaction or series to other available structures to see if the taxpayer chose among the alternatives primarily based on tax considerations or consequences. This makes sense. If it were otherwise, taxpayers would be obliged to choose a more taxable alternative and the Duke of Westminster principle would be completely for naught. It appears to be at least to this extent that the Supreme Court of Canada repeatedly sets out that the Duke of Westminster principle co-exists with the GAAR.”
So long as each step of a transaction is primarily for a non-tax purpose, incidental tax benefits will not render the transaction an avoidance transaction. (para 70). The TCC noted that ” tax considerations may play a primary role in a taxpayer’s choice of available structuring options to implement a transaction or series of transactions without necessarily making the transaction itself primarily tax motivated” (para 71).
The Court note that the “overall non-tax objective” of the transaction was admitted by the Crown, and this was not a case were a step was inserted or undertaken primarily for being able to obtain a desired tax result (paras 91-92). The Court stated at paragraph 93:
 The act of choosing or deciding between or among alternative available transactions or structures to accomplish a non-tax purpose, based in whole or in part upon the differing tax results of each, is not a transaction. Making a decision can not be an avoidance transaction.
In this case STAB made a decision in line with the Duke of Westminster Principle, and such a decision “can not be considered a transaction for GAAR purposes” (para 94). The Court concluded beginning at paragraph 95:
 This is an example of a case where a taxpayer:
(i) decides to do something for entirely business or other non-tax purposes – (that is, put money in its shareholders’ hands to allow them to pay their business obligations and to recalibrate the level of the deposit insurance and stabilisation fund maintained for their benefit to the level now needed);
(ii) considers the alternatives available to them to accomplish what is needed to be done, including a consideration of the tax consequences and costs of each; and
(iii) chooses an available option that is not the one with the greatest tax cost and may be the one with the least tax cost or no tax cost at all.
 Provided no steps or transactions were inserted into the commercial transactions implementing the chosen structure primarily to obtain the tax benefit, neither the taxpayer’s choice nor its implementation can meet the statutory definition of “avoidance transaction” as interpreted by the Supreme Court of Canada.
The Court also noted as an aside that the decision here was that of STAB and not that of the taxpayer (para 97), and went on to hold that there is no fault for choosing a more tax efficient route, ” Provided the structure of the transactions used to implement their choice does not include any step the primary purpose of which is to position themselves to obtain the desired tax benefit, or is otherwise primarily tax driven, their tax benefit can not result from an avoidance transaction and the GAAR by its terms can not apply. See, for example, former Chief Justice Bowman’s decision in Geransky v. Canada, 2001 DTC 243.” (para 97).
The Court said that there was no need to move on to consider the “abuse or misuse” test as there was no “avoidance transaction” allowing GAAR to apply.