Supreme Court Applies GAAR In Copthorne

In a unanimous decision, released on December 16, 2011, the Supreme Court of Canada ruled in Copthorne Holdings Ltd. v Canada,1 that the general anti-avoidance rule (GAAR) applied to deny the taxpayer the benefits arising from a paid-up capital (PUC) preservation transaction. Copthorne is the fourth GAAR case heard by the Supreme Court.2 While the decision, delivered by Justice Rothstein, follows the approach to GAAR established in its prior decisions, particularly Canada Trustco (see our Osler Update dated October 27, 2005), the decision will be scrutinized for further insight into the approach of the Supreme Court to the application of GAAR.

At issue in Copthorne was the redemption for $142 million of shares of a Canadian corporation wholly owned by a non-resident. The redemption of shares held by the non-resident would give rise to a deemed dividend subject to Canadian withholding tax, to the extent the redemption price exceeded the PUC of the shares redeemed. The Canadian corporation arose from the amalgamation of two predecessor corporations which were originally parent and wholly-owned subsidiary. $96 million had been paid-in as share capital of the parent and, of that, $67 million was invested in and formed the PUC of the shares of the subsidiary. Prior to the amalgamation the shares of the subsidiary had been transferred to make the corporations sisters and their amalgamation a "horizontal" rather than "vertical" amalgamation.

Under the governing corporate law and subsection 87(3) of the Income Tax Act (the Act), the stated capital and PUC, respectively, of the shares of the former subsidiary, which would have been cancelled upon a vertical amalgamation, were preserved upon the resulting horizontal amalgamation. Subject to GAAR, upon the horizontal amalgamation the PUC of the shares of the parent and former subsidiary would be aggregated and no deemed dividend would arise on redemption of shares for $142 million, enabling a tax-free return of capital in excess of the $96 million original investment.

The Canada Revenue Agency reassessed the taxpayer for failure to withhold tax on the share redemption, invoking GAAR to deny the increase in PUC in respect of the shares of the former subsidiary otherwise resulting from the horizontal amalgamation. Both the Tax Court3 and Federal Court of Appeal4 upheld the reassessment.

Statutory Interpretation

The Supreme Court adopted in Canada Trustco a unified "textual, contextual and purposive"...