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General Anti Avoidance Rule GAAR – Sas Ansari

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General Anti-Avoidance Rule – GAAR

Univar Holdco Canada ULC v The Queen, 2016 TCC 159

At issue was whether the transactions used to strip almost $1B in surplus from a Canadian subsidiary by a UK private equity firm was caught by GAAR – specifically whether the transaction was a misuse or abuse of the relieving exemption in 212.1.(4) of the ITA.

The Court held that the transactions “circumvented the application of the anti-avoidance rule in section 212.1 in a manner that “frustrated or defeated the object, spirit or purpose” of section 212.1 in general and subsection 212.1(4) in particular: Canada Trustco Mortgage Company v Canada, 2005 SCC 54 at paragraph 45.”

FACTS

A UK private equity firm acquired a Netherlands public corporation with a Canadian operating sub that had $899M in surplus.  A series of transactions were entered into to avoid the anti-avoidance rule in 212.1 by taking advantage of the relieving provision in 212.1(4).  The transactions involved are not reviewed here.

The CRA applied GAAR and the taxpayer admitted a tax benefit and an avoidance transaction. This left the issue of misuse and abuse.

ANALYSIS

 The TCC began by reviewing the legislation.  Subsection 212.1(1) deals with dispositions by non-residents of Canadian resident corporations to other Canadian resident corporations that is not at arm’s length with the non-resident, where immediately after the disposition the subject corporation is connected (s 186(4)) with the purchaser corporation.  The effect of the provision includes a deemed dividend to the extent that the FMV of non-share consideration exceeds the PUC of the shares disposed, and includes a PUC grind to prevent a step-up of PUC beyond the historic value.

Subsection 212.1(4) exempts a disposition from the application of 212.1(1) where the disposition is to a purchaser corporation that immediately before the disposition controls the non-resident seller.

The corporations were in a sandwich structure that, after a few ‘contortions’ resulted in the surplus to be stripped out of the Canadian corporation.  There were no shares of the Canadian sub sold and no money came into Canada to increase the PUC of the shares (para 41).

In order for GAAR to apply, one of the requirements is that there was “abusive tax avoidance in the sense that it cannot be reasonably concluded that a tax benefit would be consistent with the object, spirit or purpose of the provisions relied upon by the taxpayer.” (para 45 – Canada Trustco Mortgage Company v Canada, 2005 SCC 54).  The burden is on the Crown to prove this. Abuse may be found where “the relationships and transactions as expressed in the relevant documentation lack a proper basis relative to the object, spirit or purpose of the provisions that are purported to confer the tax benefit, or where they are wholly dissimilar to the relationships or transactions that are contemplated by the provisions”.

The “abuse or misuse” requirement can be met in three ways – Lipson v Canada, 2009 SCC 1:

  • the outcome is one the provision relied on seeks to prevent
  • the outcome defeats the underlying rationale of the provisions relied on, or
  • the outcome circumvents certain provisions in a manner that frustrates the object, spirit and purpose of those provisions.

Courts engage in two steps (para 62):

  1. the need to identify the object, sporit or purpose of the provisions of the ITA relied on to obtain the tax benefit as part of the overall scheme of the ITA, relevant provisions, and with premissible extrinsic aids; and
  2. consider whether the facts of the case at bar are such that the object, spirit or purpose of the provision is defeated or frustrated.

The Appellant argued that the reorganization was part of an arm’s length purchase,  and therefore was not what section 212.1 aimed at   – accessing undistributed cash of a corporation though non-arm’s length transactions where control of the corporation being stripped is not changed.  The Appellant argued that had the purchaser used a fully capitalized Canadian acquisition corporation to make the purchase of the Canadian sub, the amount could have been paid back  as tax-free intercorporate dividends.  However, the circumstances of this case required the purchaser to use a different route to get to the same result.  The use of 212.1(4) was contemplated at the acquisition stage to avoid the application of 212.1(1).

The Respondent argued that 212.1 is an anti-avoidance provision that aims to prevent dividend stripping that is integral to the PUC scheme of the ITA – Copthorne Holdings Ltd v Canada, 2011 SCC 63.  The purpose of the provision is to prevent tax-free distributions of a corporation’s retained earnings to a non-resident corporation through transactions designed to distribute funds in excess of the initial investment (para 59).

Section 212.1, the international counter part of 84.1, is meant to prevent dividend stripping – Collins & Aikman Products Co v R, 2009 TCC 299 at paras.55 and 105, aff’d 2010 FCA 251. A dividend strip is:

any transaction by a taxpayer that involves the shares of a Canadian corporation and that, directly or indirectly, effects a distribution to the taxpayer of all or part of that corporation’s surplus at a tax cost that is less than the tax otherwise payable on a dividend of that surplus to the taxpayer

– Blake Murray, “The 1977 Amendments to the Corporate Distribution Rules”(1978) 16:1 Osgoode Hall LJ 155 at 181.

The Court noted that the ITA doesn’t contain a general policy against dividend stripping and that surplus stripping is by itself not abusive tax avoidance – Gwartz v R, 2013 TCC 86Copthorne v The Queen, 2007 TCC 481.  But here, there is a specific provisions that aims to stop dividend or surplus stripping.

PUC, or Paid Up Capital, is defined in subsection 89(1) and is computed without reference to the TIA provisions other that those meant to modify it – in short, PUC is the modified stated capital of the corporation that records the capital input of shareholders per share across the classes of shares (paras 68-69). One of the adjusting provisions is 212.1 which prevents a non-resident person from avoiding Part XIII tax on dividends through non arm’s length sale of shares in certain circumstances.

There are two parts to 212.1. The first is a deemed dividend of any non-share consideration in excess of the PUC taxable under 212(2). The second is a PUC grind to prevent the increase of PUC without additional capital infusions, again preventing capital removal in excess of historic PUC.  The exception in 212.1(4) applies where the non-resident is controlled by the purchaser immediately before the sale. This would keep the surplus in Canada as the purchaser is a Canadian resident corp.

The transaction complied with the text of the provisions.  It is a defeat or frustration of the object, spirit, and purpose that is at question.

The context of 212.1 includes the provisions that affect how the ITA treats distributions from corporations resident in Canada generally.  The ITA attempts to integrate corporate and personal income tax so that the amount of tax isn’t unduly affected by the structure used to earn the income that flows to an individual resident in Canada.  Payment to non-resident of after-tax retained earnings of a corporation are subject to withholding tax  under Part XIII.   Section 212.1 is part of the withholding tax scheme imposed by 212(2).  The PUC scheme is also part of 212.1

The PUC scheme is also part of 212.1 and is meant to limit tax-free distributions to PUC – their skin in the game in Canada – so that any distribution in excess of their investment is taxable.   The excess distribution to a non-resident is subject to withholding tax (25% reduced by tax treaties) and must be withheld and remitted by the payor corporation pursuant to subsection 215(1).

The exception in 212.1(4) is in the context of this whole scheme, and cannot be used to defeat the very application of 212.1. The Court held that (para 83):

It is my view that subsection 212.1(4) is aimed at a narrow circumstance where the purchaser corporation, which is resident in Canada, actually controls the non-resident corporation without manipulating the corporate structure to achieve that control.

By reference to the budget documents and technical notes, the Court held that the purpose of 212.1 was to prevent the conversion of what would otherwise be taxable distribution of surplus into capital gains that may not be taxable in Canada – thus to “prevent non-resident shareholders from reorganizing their Canadian resident corporations so that they can convert dividend distributions that would ordinarily be subject to non-resident withholding tax under Part XIII into tax-free capital gains” (para 92).

The court went on to outline the purpose of the exception in 212.1(4) (para 97):

That purpose is to allow for a bona fide sale of shares from a non-resident corporation to a Canadian resident corporation where it is the Canadian resident corporation that controls the non-resident corporation. The exception should not apply in the situation where a non-resident owns shares of the Canadian resident purchaser corporation. The exception does not apply where a non-resident uses non-arm’s length reorganizations of their Canadian resident corporations to convert dividend distributions that would otherwise be subject to non-resident withholding tax under Part XIII into tax-free capital gains.

In response to the argument that the taxpayer could have achieved the outcome had it fully capitalized a Canadian corp to make the purchase of the Canadian subsidiary, the Court stated that this was not done and in tax law, form matters – Friedberg v The Queen, [1992] 1 CTC 1.

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

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Arrears Interest Calculation when GAAR Applied

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Arrears Interest Calculation when GAAR Applied

JK Read Engineering Ltd v The Queen, 2014 TCC 309

At issue was the calculation of arrears interest where the General Anti Avoidance Rule (GAAR) has been applied.   Specifically at issue was (1) the date at which the tax liability arises when GAAR is applied, and (2) when interest beings to accrue on that liability.

The taxpayer argued that subsection 245(7) of the Income Tax Act requires that the Minister first issue a Notice of Assessment based on the GAAR before the tax consequences of abusive avoidance transactions can be determined.  The tax liability, therefore, arises only on the date of the GAAR assessment.

The Minister argues that GAAR applies automatically and without the Minister’s actions, giving rise to the tax liability on the taxpayer’s balance due date.

The Court held that GAAR operates as a transaction is being carried out without the need for the Minister to Assess.

ANALYSIS

Justice Hogan reviewed the taxpayer’s and Minister’s positions.

The taxpayer argued that the SCC in Copthorne Holdings Ltd. v. The Queen,  2007 TCC 481, affirmed in 2009 FCA 163, affirmed in 2011 SCC 63, held that taxpayer’s cannot self-assess on the basis of GAAR because of subsection 245(7), and on this basis the tax liability only arises when the Minister assesses on the basis of GAAR.  Hogan J disagreed with this analysis, and stated that implicit in the SCC decision s that “GAAR operate[s] as the abusive transactions [are] being carried out, and not […] when the GAAR-based assessment [is] issued by the Minister” (para 16).

The Court considered the proper interpretation of subsection 245(7) of the ITA, which reads:

Notwithstanding any other provision of this Act, the tax consequences to any person, following the application of this section, shall only be determined through a notice of assessment, reassessment, additional assessment or determination pursuant to subsection 152(1.11) involving the application of this section.

Justice Hogan noted that the decision of the SCC did not deal with the striking out of the penalty (the basis of the taxpayer’s no-self-assessment argument), and therefore could not be used to interpret the provision.  This reminds us of the importance of actually looking at what issues were before a court, and what part of the decision is the ratio and what parts are obiter (see para 22-24).   The SCC in  R. v. Henry, [2005] 3 S.C.R. 609, rejected the idea that the obiter of the SCC majority is binding on lower courts, and stated that having obiter bind lower courts is not desirable because:

. . . the effect would be to deprive the legal system of much creative thought on the part of counsel and judges in other courts in continuing to examine the operation of legal principles in different and perhaps novel contexts, and to inhibit or skew the growth of the common law.

. . . All obiter do not have, and are not intended to have, the same weight. The weight decreases as one moves from the dispositive ratio decidendi to a wider circle of analysis which is obviously intended for guidance and which should be accepted as authoritative. . . .

Justice Hogan also referred to the decision in S.T.B. Holdings Ltd. v. The Queen, 2002 DTC 1254, where it was held that an assessment issued under subsection 245(7) does not require specific reference to GAAR and does not prevent the use of GAAR as an alternative assessing tool.  The FCA, 2002 FCA 386, on appeal held, appeal to SCC dismissed, that 245(7) applies only to third party taxpayers affected by the assessment of a target taxpayer, and who are seeing an adjustment under 245(6).  Justice Miller in the decision quoted from the explanatory notes accompanying the enactment of GAAR:

New subsection 245(7) of the Act provides that a person may not rely on subsection 245(2) in order to determine his income, taxable income, or taxable income earned in Canada of, tax or other amount payable by, or amount refundable to, any person under the Act as well as any other amount under the Act which is relevant for the purposes of the computation of the foregoing, except through a request for adjustment under subsection 245(6). This prevents a person from using the provisions of subsection 245(2) in order to adjust his income, or any of the above-mentioned amounts without requesting that adjustment following the procedures set out in subsection 245(6). [emphasis added]

The Court held that GAAR application for determination of the tax liability of a taxpayer does not depend on the date of the Notice of Assessment (para 41), or that in the alternative it is retrospective in effect (para 42).

As for the arrears interest on the tax liability, the court held that the interest accrues from the taxpayer’s balance-due-date if there is tax payable outstanding at that time.   The FCA in The Queen v. Whent2000 DTC 6001 at para. 44,  held that “outstanding” refers to an amount “that stands over; that remains undetermined, unsettled, or unpaid”.  Also, the definition of “tax payable” in subsection 248(1) does not provide an exception for the application of GAAR.  Thus arrears interest begins to accrue from the balance due date.

– Sas Ansari, JD LLM PhD (exp)

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