Copthorne Holdings - SCC Dismisses Taxpayer's GAAR Appeal

On December 16, 2011, the Supreme Court of Canada ("SCC") dismissed the taxpayer's appeal in Copthorne Holdings Ltd. v. R., 2011 SCC 63 ("Copthorne") and upheld the decision of the lower courts that transactions designed to preserve paid-up capital ("PUC") in what would have been a vertical amalgamation constitute abusive tax avoidance under the general anti-avoidance rule ("GAAR").

The facts in Copthorne are relatively complex, but can be summarized as follows. In 1992, Copthorne Holdings Ltd. ("Copthorne I") owned all of the shares of a Canadian corporation ("Canco") having PUC of $67,401,279. In 1993, it was determined that Copthorne I and Canco should be amalgamated. Pursuant to subsection 87(3) of the Income Tax Act (Canada) (the "Act"), the PUC in respect of the Canco shares would have disappeared upon the vertical amalgamation of Copthorne I and Canco. Accordingly, in order to preserve the PUC in the Canco shares, Copthorne I sold the Canco shares to its parent corporation in the Netherlands ("DutchCo") in July 1993 and on January 1, 1994, Copthorne I, Canco and two other corporations were amalgamated to form Copthorne II as planned (the "PUC Preservation Transactions"). Through a series of sales and further amalgamations a Barbadian corporation ("BarbadosCo") ended up receiving 164,138,025 preferred shares in Copthorne III (the successor to Copthorne II) having an aggregate redemption amount, fair market value and PUC of $164,138,025 ($1 per share) (such PUC being derived, in part, from the PUC that had been preserved as a result of the PUC Preservation Transactions). Copthorne III then redeemed the preferred shares held by BarbadosCo. Since the redemption amount did not exceed the PUC of the preferred shares, the redemption did not give rise to a deemed dividend under the Act and Copthorne III did not withhold or remit any tax on behalf of BarbadosCo.

The Minister assessed Copthorne III by applying the GAAR to reduce the PUC of the preferred shares by $67,401,280. The taxpayer appealed to the Tax Court of Canada, which dismissed its appeal. After the judgment of the Tax Court was upheld by the Federal Court of Appeal the taxpayer appealed to the SCC.

The SCC reiterated the three questions to be decided in any GAAR analysis, as set out in its decision in Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54 ("Canada Trustco"):

Was there a tax benefit? Was the transaction giving rise to the tax benefit an avoidance transaction? Was the avoidance transaction giving rise to the tax benefit abusive? Tax Benefit

The SCC saw no reason to disturb the finding of the Tax Court that the transfer by Copthorne I of the Canco shares to DutchCo...