Not All Alternative Transactions Are Relevant For The Purposes Of The GAAR Abuse Analysis

• Published date: 29 November 2022
• Subject Matter: Corporate/Commercial Law, Tax, Corporate and Company Law, Income Tax, Tax Authorities, Shareholders
• Law Firm: McCarthy Tétrault LLP
• Author: McCarthy Tétrault Tax Group and Dominic Bédard-Lapointe

In 3295940,¹ the Tax Court of Canada decided that the GAAR applied to the circumvention of subsection 55(2) on a cross-redemption of shares. The plan involved circulating the capital dividend account ("CDA") of a parent company to its subsidiary (on the first redemption), then back to the parent (on the second redemption). Through such "CDA recycling", the parent company indirectly obtained a bump of its subsidiary's low basis shares prior to their sale in a context where paragraph 88(1)(d) was otherwise unavailable.² The decision has been appealed to the Federal Court of Appeal.

Summary of Findings

The facts of this case are complex. In essence, the parent formerly operated a pharmaceutical business³ and the purchaser was not interested in acquiring its high basis shares. The plan allowed the taxpayer to sell its operating subsidiary and obtain the tax benefit that would have resulted from the sale of the parent company shares.

The Court concluded that the purpose of the CDA regime is to trace corporate surpluses that can be distributed tax free to shareholders. In the present case, the CDA regime did not allow the tracing of surpluses towards the top of the corporate structure: a CDA balance was artificially circulated in a corporate group back to its original starting point. The application of subsection 55(2) was avoided in the process as capital dividends are not targeted by that provision.⁴

The Court also found that no double taxation resulted from the fact that the taxpayer was not able to benefit from the cost in its own shares as part of the sale of its assets.⁵

Relevance of Alternative Transactions for the GAAR Analysis

It is well-established that alternative transactions can be relied on to demonstrate the presence of a tax benefit.⁶ More recently, their potential relevance as part of the abuse analysis was confirmed in Univar:⁷

In GAAR cases the issue is whether the taxpayer has abused the provisions of the ITA. In my view, these alternative transactions are a relevant factor in determining whether or not there has been an abuse of the provisions of the ITA. If the taxpayer can illustrate that there are other transactions that could have achieved the same result without triggering any tax, then, in my view, this would be a relevant consideration in determining whether or not the avoidance transaction is abusive.⁸

In 3295, the Court refused to consider the sale of the parent corporation (which would have triggered less tax) as a relevant...