Copthorne: Supreme Court Of Canada's Latest Views On Statutory Interpretation And GAAR

Copyright 2011, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Tax, December 2011

1. Overview

   On December 16, 2011, the Supreme Court of Canada (the SCC) released its decision and reasons in Copthorne Holdings Ltd. v. Canada (Copthorne). All nine of the SCC judges unanimously determined that the taxpayer's appeal should be dismissed as it had been in the two lower courts below. The decision thoroughly canvasses issues relating to the application and interpretation of section 245 of the Canadian Income Tax Act (the Act), known as the General Anti-Avoidance Rule, or the GAAR.

   Not surprisingly, the decision reinforces and consolidates principles enunciated in three earlier GAAR cases decided by the SCC (Canada Trustco, Kaulius and Lipson) and expresses both caution and direction about the future application of the GAAR by tax officials. In doing so, the SCC has also left readers of the decision with a number of impressions about the types of circumstances in which the GAAR should and should not be applied in future and the ability of taxpayers to arrange their affairs in order to minimize taxes payable.

   Perhaps most striking in the reasons of the SCC are the latest comments about the appropriate methodology for the interpretation of taxing statutes and the unique methodology that is to be used when the GAAR is in play. The SCC has also openly admonished both the lower courts and readers of tax legislation (including the GAAR) that "determining the rationale of the relevant provisions of the Act should not be conflated with a value judgment of what is right or wrong nor with theories about what tax law ought to be or ought to do" (para. 70). So it seems that judges are not to use a "smell test" or an interventionist approach when deciding tax cases and the so-called "end must not justify the means". However, it remains to be seen whether this admonition will be heeded.

   All readers of Copthorne are no doubt trying to discern whether the commentary and analysis of the SCC favours taxpayers or the Crown. It has elements that both sides will embrace. Some aspects will be discussed below. Both sides, however, must realize that it seems unlikely that the SCC will be open to granting leave in another GAAR case any time soon given that the Copthorne reasons (the Reasons) were written by Mr. Justice Rothstein. Justice Rothstein, one of the dissenting justices in Lipson, unanimously expressed the consolidation of earlier principles enunciated in Canada Trustco (Trustco) and the more fractured decision in Lipson. The SCC made it very clear in para. 57 of the Reasons that "Trustco is a very recent decision" and that there must be "substantial reasons to believe the precedent was wrongly decided" in order for it to be revisited. To the extent that any points about the interpretation of GAAR issues are not addressed in Copthorne, one should presume that any applicable comments in Trustco and the other two earlier SCC decisions will govern.

2. Impact of Copthorne

   Overall, Copthorne reaffirms past pronouncements and reaffirms through a unanimous bench how the SCC perceives the GAAR is to be interpreted. Its decision may still not create any more certainty, consistency or predictability regarding the application of the GAAR than before its release.

   What appeared to offend the SCC in Copthorne was the "double counting " of paid-up capital (PUC) and its "artificial" preservation in a way that frustrated a statutory provision (Reasons, para. 127). Yet the SCC indicates in its Reasons (para. 70) that abuse determinations should not involve value judgments of what is right and wrong and theories about what the tax law ought to be or ought to do. There is no doubt that the lower courts are being told to apply this message when rendering decisions in GAAR cases.

   However, each judge's perception of the underlying rationale for a statutory provision may differ, particularly if there is little or no guidance in the Act from statutory provisions throughout the text of the Act. What may be clear to one person may not be clear to another. Nevertheless, the SCC and taxpayers expect that the lower courts will consistently apply the words in paragraphs 68 and 72 of the Reasons:

   "... the GAAR can only be applied to deny a tax benefit when the abusive nature of the transaction is clear" (Trustco, at para. 50), and "... the Minister must clearly demonstrate that the transaction is an abuse of the Act, and the benefit of the doubt is given to the taxpayer." C. Summary of Copthorne Facts

   By a series of transactions, two corporations that had been parent (Copthorne I) and subsidiary (VHHC Holdings) became "sister" corporations, that is, corporations owned directly by the same shareholder. The sister corporations were then amalgamated — a "horizontal" amalgamation. Had they remained as parent and subsidiary, the PUC of the shares of VHHC Holdings would have been cancelled on amalgamation. As sister corporations, the PUC of their respective shares was aggregated to form the PUC of the shares of the amalgamated corporation. The amalgamated corporation then redeemed a large portion of its shares and paid out the aggregate PUC attributable to the redeemed shares to its non-resident shareholder. That payment was not treated as taxable income to the shareholder but instead as a return of capital.

   No provision of the Act expressly required the return of PUC in this case to be treated as a taxable payment. Nonetheless, the Minister of National Revenue (the Minister) considered the transactions by which the parent and subsidiary became sister corporations to have circumvented certain provisions of the Act in an abusive manner and thus to have contravened the GAAR. Applying the GAAR, the Minister concluded that the PUC of the shares of the former subsidiary should have been cancelled upon amalgamation with its former parent corporation. If the PUC of the shares of the amalgamated corporation was reduced, the amount paid to the shareholder in excess of the reduced PUC would have constituted a deemed dividend subject to tax. The Minister reassessed the amalgamated corporation for unpaid withholding tax on the deemed dividend portion of the amount paid to the non-resident shareholder upon redemption. The Tax Court of Canada and Federal Court of Appeal upheld the reassessments.

4. Summary of Reasons of Mr. Justice Rothstein

   The GAAR scheme is set out in subsections 245(1) to (5) of the Act and requires a determination of three questions: (1) was there a tax benefit? (2) was the transaction giving rise to the tax benefit an avoidance transaction? and (3) was the avoidance transaction giving rise to the tax benefit abusive?

   1. Tax Benefit

      The burden is on the taxpayer to refute the Minister's assumption of the existence of a tax benefit. Where the Tax Court judge has made a finding of fact on the existence of a tax benefit, it is only appropriate for a reviewing court to overturn such a finding where an appellant can show a palpable and overriding error. The existence of a tax benefit can be established by comparing the taxpayer's situation with an alternative arrangement that could reasonably have been carried out but for the existence of the tax benefit. The vertical amalgamation comparison used by the Minister was appropriate (Reasons, paras. 34-35) and the finding of the Tax Court that there was a tax benefit was affirmed.

   2. Avoidance Transaction

      Under the GAAR, a transaction will be an avoidance transaction if it results in a tax benefit, and is not undertaken primarily for a bona fide non‑tax purpose. An avoidance transaction may operate alone to produce a tax benefit, or may operate as part of a series of transactions to produce a tax benefit. Where the Minister assumes that the tax benefit resulted from a series of transactions, rather than a single transaction, it is necessary to determine if there was a series, which transactions make up the series, and whether the tax benefit resulted from the series (Reasons, paras. 39-41, 59 and 64).

      2.1 Series of Transactions

      The starting point is the common law test for a series upon which "each transaction in the series is pre‑ordained to produce a final result". Subsection 248(10) of the Act extends the meaning of "series of transactions" to include any related transactions or events completed in "contemplation" of the series. A Court must decide whether the series was taken into account when the decision was made to undertake the related transaction in the sense that it was done, on a balance of...