21 Décembre 2011
Copthorne Holdings - SCC Dismisses Taxpayer's GAAR Appeal
Francesco Gucciardo et John Lorito
(version française disponible bientôt)
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?
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 was key to the realization of a tax benefit. The SCC determined that "but for" the potential loss of PUC in the shares of Canco, Copthorne I would never have transferred the shares of Canco to DutchCo. As a result, a vertical amalgamation in which that PUC would have disappeared was a reasonable alternative arrangement against which to measure the existence of a tax benefit.
The SCC had to determine whether the redemption transaction in 1995 was part of the series of transactions that began with the sale by Copthorne I of the Canco shares to DutchCo in 1993 and included the subsequent amalgamation (i.e. the PUC Preservation Transactions). If so, any transaction in that series that was not undertaken for a bona fide non-tax purpose would be an avoidance transaction. In order to constitute a series within the common law meaning, each transaction in the purported series must be pre-ordained to produce a final result. The Act expands this common law meaning by including in a series "any related transactions or events completed in contemplation of the series". The redemption transaction would therefore be considered part of the same series of transactions that included the PUC Preservation Transactions if it was a "related transaction" undertaken "in contemplation of" the PUC Preservation Transactions.
The SCC confirmed that "in contemplation of" the series should be understood to mean a transaction undertaken "in relation to" or "because of" the series, and that while this test does not require a strong nexus between a transaction and a series, it does require more than a "mere possibility" or a connection with "an extreme degree of remoteness". On this point, the SCC noted that the length of time and any intervening events between the series and the related transaction may be relevant considerations. Additionally, the SCC refused to alter its conclusion, as stated in Canada Trustco, that "in contemplation of" should be read both prospectively and retrospectively, despite acknowledging that the "more common" usage of the term "contemplation" is likely prospective in nature. In this case, the SCC found no reason to disturb the Tax Court's determination that there was a nexus between the transactions sufficient to cause the redemption transaction to be related to the PUC Preservation Transactions and that the redemption transaction formed a part of the same series as the PUC Preservation Transactions. Further, the SCC was not prepared to disturb the finding of the Tax Court that the PUC Preservation Transactions were not primarily undertaken for a bona fide non-tax purpose and, therefore, that they constituted an avoidance transaction.
Abusive Tax Avoidance
The Minister alleged that three sections of the Act had been abused: (i) subsection 89(1), which defines PUC, (ii) subsection 87(3), which deals with the computation of PUC on an amalgamation, and (iii) subsection 84(3), which deems any amount distributed by a corporation as a return of capital in excess of PUC to be a dividend subject to tax.
The SCC ultimately agreed with the finding of the Tax Court and determined that the PUC Preservation Transactions served to frustrate and defeat the purpose of subsection 87(3) in light of the object, spirit and purpose of that provision in a manner that was abusive.
Before proceeding with its abuse analysis, the SCC issued a strong caution against courts viewing the words "abuse" or "misuse" as implying any moral opprobrium regarding the actions of a taxpayer to minimize tax liability by utilizing the provisions of the Act in a creative way. Practitioners and taxpayers have worried in recent years that the GAAR may be applied as a "smell test" whereby the fate of a taxpayer rests on a trial judge's visceral reaction to a set of particular facts as guided by the judge's own normative assumptions. The SCC has now provided clear and unequivocal instruction to the lower courts that the determination of the underlying rationale of particular 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."
The SCC dispensed quickly with the notion that subsection 84(3) of the Act could have been abused, since that provision merely accepts and applies the PUC computations made pursuant to other provisions. Further, subsection 89(1) of the Act only provides a baseline for the calculation of PUC referable to corporate stated capital with subsequent adjustments. Accordingly, the balance of the decision turned to an assessment of the underlying rationale of subsection 87(3) by considering its text, context and purpose.
The SCC discerned from the text of subsection 87(3) that it is intended to deny the so-called "doubling-up" of PUC through the device of an amalgamation in circumstances where the shares of one amalgamating corporation are held by another amalgamating corporation. In the context of a vertical amalgamation, for example, the SCC determined that the preservation of the PUC in respect of the shares of a subsidiary corporation held by a parent corporation would enable the tax-free withdrawal of funds in excess of the capital originally invested in the parent corporation.
Turning to context, the SCC determined that subsection 87(3) must be read together with other provisions of the Act that restrict PUC, such as sections 84.1 and 212.1, which serve to reduce or "grind" PUC in non-arm's length transactions. The existence of such grinds indicated to the SCC that those provisions are mostly intended to prevent the preservation of PUC and the tax-free distribution of amounts in excess of any original investment made with tax-paid funds. The SCC determined that subsection 87(3) should be viewed as one provision within a series of PUC grind provisions sharing that same purpose.
The SCC rejected the taxpayer's argument that the principle of non-consolidation should be applied so as to justify the preservation of PUC when a parent and subsidiary are amalgamated. The SCC also rejected the taxpayer's argument that PUC should be treated solely as an attribute attaching to a particular share without regard to the identity of the owner of the share on the basis that subsection 87(3) is a direct example of where the treatment of PUC expressly depends on who owns the share. Also rejected was the taxpayer's "implied exclusion" argument pursuant to which the taxpayer argued that since the PUC Preservation Transactions were not caught by one of the detailed PUC provisions contained in the Act they could not be found to be abusive of any particular provision. The SCC explained that the principle of "implied exclusion" has no place in determining the underlying rationale of legislation, reasoning that if such an approach were accepted, it would be a full response to the GAAR in all cases since the actions of a taxpayer in a GAAR assessment will always be permitted by the text of the Act. Before moving on, however, the SCC commented that the underlying rationale of a provision may simply be found within the text of the provision leaving no scope for the application of the GAAR.
Based on the foregoing, the SCC concluded that one context-based rationale for subsection 87(3) is that payments from an amalgamated corporation to shareholders on a share redemption should only escape taxation as a deemed dividend to the extent that such payments reflect the return of an investment made with tax-paid funds.
Turning to purpose, the SCC determined that subsection 87(3) seeks to preclude corporations from preserving the PUC of the shares of a subsidiary corporation on amalgamation with the parent corporation as that PUC reflects an investment of the same tax-paid dollars as in the parent corporation. The rule, therefore, suggests that Parliament believed that aggregating PUC upon a vertical amalgamation would result in excessive preservation for tax purposes.
Notwithstanding the purpose it had identified in the PUC-related sections of the Act, the SCC noted that in the normal course, as it relates to transactions undertaken primarily for a bona fide non-tax purpose, PUC will continue to be a valid attribute that allows for the return of an amount equivalent to PUC to be paid to new shareholders without inclusion in their income. The SCC emphasized that the purchase of shares from a third party may have a tax purpose that is not necessarily the primary reason for the transaction. These statements, along with the SCC's general reluctance to disturb the findings of the Tax Court, stress the need for a taxpayer to ensure that the trial judge is fully and properly apprised of all the facts and circumstances surrounding the impugned transactions.
In the end, having regard to text, context and purpose of subsection 87(3), the SCC concluded that the object, spirit and purpose of the provision is to preclude the preservation of the PUC of the shares of a subsidiary corporation upon amalgamation of the parent and subsidiary where such preservation would permit shareholders, on a redemption of shares by the amalgamated corporation, to be paid amounts as a return of capital without any liability for tax in excess of the amounts originally invested in the amalgamating corporations with tax-paid funds. In the SCC's view, the PUC Preservation Transactions defeated the object, spirit and purpose of this provision and were therefore abusive.
Many tax practitioners had anticipated that the reason the SCC granted leave to appeal and agreed to hear Copthorne was so that it could make a major pronouncement on the application of the GAAR. That pronouncement was not evident in the decision and, at best, it appears that the SCC simply wanted the opportunity to re-affirm the approach it had adopted with respect to the application of the GAAR in its earlier decision in Canada Trustco.
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