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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