Judgments

[2002] 2 F.C. 288

A-424-99

2001 FCA 260

OSFC Holdings Ltd. (Appellant)

v.

Her Majesty the Queen (Respondent)

Indexed as: OSFC Holdings Ltd. v. Canada (C.A.)

Court of Appeal, Stone, Létourneau and Rothstein JJ.A. —Ottawa, May 9, 10 and September 11, 2001.

Income Tax — Income Calculation — Deductions — General anti-avoidance rule under Income Tax Act, s. 245 — MNR disallowing non-capital loss deduction in computing taxpayer’s 1993 income, deduction of related non-capital loss carry forward in 1994 taxation year — Taxpayer purchasing 99% interest in partnership created by Standard Trust Company (STC) — STC arranging series of 3 transactions creating tax benefit — Fourth transaction acquisition by taxpayer of interest in partnership with heavy losses — Whether taxpayer’s transaction avoidance transaction under Act, s. 245(3) — Taxpayer not denying tax benefit — Avoidance transaction subject to two tests: results test, purpose test — Each transaction in series of transactions must be pre-ordained to produce final result — For purpose of Act, s. 245(3)(b), series including three STC transactions, taxpayer’s acquisition of partnership interest — Series resulting in tax benefit to taxpayer — Primary purpose of taxpayer’s acquisition of interest in partnership to obtain tax benefit — Each of four transactions avoidance transaction — Tax benefit denied if transaction resulting in use, misuse of specific tax provision under Act, s. 245(4) — Avoidance transactions not resulting in misuse of Act, s. 18(13) — General policy of Income Tax Act against trading of non-capital losses by corporations — Exception in Act, allowing for use of losses from loss business by another business, not applicable as between STC, taxpayer — Avoidance transactions resulting in abuse of provisions of Act.

This was an appeal from a Tax Court of Canada decision that the taxpayer’s transaction was part of a series of transactions whose primary purpose was to obtain a tax benefit and, therefore, were avoidance transactions within the meaning of paragraph 245(3)(b) of the Income Tax Act, the general anti-avoidance rule (GAAR). Standard Trust Company, which was in the business of lending money on the security of mortgages of real property, became insolvent as a result of the downturn in the real estate market in the late 1980s and early 1990s. Ernst & Young, appointed as liquidator of the company, sought to maximize the recovery from the disposition of Standard’s assets. Its objective would best be accomplished if Standard’s loss could be preserved and then utilized by a third party to reduce its income tax. Standard arranged a series of three transactions: the creation and incorporation of 1004568 Ontario Inc. as its wholly-owned subsidiary, the formation of the STIL II Partnership and the sale of its 99% interest in that partnership, which created a tax benefit. Taxpayer entered into a fourth transaction whereby it bought the interest in the STIL II partnership which contained heavy losses. The Minister of National Revenue disallowed a non-capital loss deduction of $12,572,274 in the computation of taxpayer’s income in its 1993 taxation year and the deduction of a related non-capital loss carry forward in its 1994 taxation year. The Tax Court found the general anti-avoidance rule to be applicable and dismissed taxpayer’s appeal. Three main issues were raised herein: (1) whether there was a series of transactions and if so, which transactions were part of the series; (2) whether a tax benefit resulted from the series and what was the primary purpose of the transactions in the series; (3) whether any of the avoidance transactions would result in a misuse or abuse of a specific provision of the Income Tax Act.

Held (Létourneau J.A. concurring in the result only): the appeal should be dismissed.

Per Rothstein J.A. (Stone J.A. concurring): Subsection 245(2) of the Act only applies only where a tax benefit would result from a transaction that is an avoidance transaction or from a series of transactions that includes an avoidance transaction. Under subsection 245(3), to find that a transaction is an avoidance transaction, two tests must be satisfied. The first is a results test which requires a determination of whether a transaction or series of transactions would, but for the GAAR, result in a tax benefit. The second is a purpose test whereby it is necessary to consider the primary purpose of a transaction or series of transactions only if it would result in a tax benefit.

(1) Determining whether a series exists under paragraph 245(3)(b) of the Act involves a consideration of how closely tied individual steps or transactions must be in order to constitute a series. In enacting paragraph 245(3)(b), Parliament adopted the approach to a “series of transactions” developed by the House of Lords. According to the House of Lords, for there to be a series of transactions, each transaction in the series must be pre-ordained to produce a final result. Pre-ordination means that when the first transaction of the series is implemented, all essential features of the subsequent transactions are determined by persons who have the firm intention and ability to implement them. There must be no practical likelihood that the subsequent transactions will not take place. The three Standard Trust transactions were pre-ordained. However, under the House of Lords’ definition, the fourth transaction would not be part of a series with the Standard Trust transactions since it was not pre-ordained and was not practically certain to occur when these transactions were implemented. On the other hand, subsection 248(10) of the Act, which is a deeming provision, broadens the meaning of series from that defined by the House of Lords. The deeming nature of subsection 248(10) implies an enlargement of the common law series. Since subsection 245(1) defines “transaction” as including an arrangement or event, the expression “series of transactions” in subsection 245(2) and paragraph 245(3)(b) must be read as including “series of transactions or events” found in subsection 248(10). The taxpayer was aware of the series of Standard Trust transactions which were fundamental to the acquisition of its partnership interest. Taxpayer’s acquisition of its STIL II Partnership interest was a transaction related to the Standard Trust series and completed in contemplation of that series. Applying the deeming effect of subsection 248(10), the Court concluded that, for purposes of subsection 245(3)(b), the series included the Standard Trust series and the acquisition transaction.

(2) The Standard Trust transactions were part of a plan whereby a tax benefit could be obtained by an arm’s length purchaser of Standard Trust’s STIL II Partnership interest. They did not result in a tax benefit themselves even if that was their purpose. At the conclusion of these three transactions, there was no tax benefit resulting to Standard Trust or the appellant. However, the appellant did not deny that a tax benefit resulted from the acquisition of its STIL II Partnership interest, that is the tax saving from claiming the loss originating with Standard Trust. By that acquisition, taxpayer became entitled to share in the partnership’s loss and, therefore, obtained a tax benefit. As that transaction was part of a series with the Standard Trust transactions, the series resulted in a tax benefit to taxpayer.

If the primary purpose of any transaction is to obtain the tax benefit, it is an avoidance transaction. The words “may reasonably be considered to have been undertaken or arranged” in subsection 245(3) indicate that the primary purpose test is an objective one. There were both business and tax benefit purposes to the acquisition transaction. The appellant had a bona fide business purpose in acquiring the STIL II Partnership interest from Standard Trust. However, the transaction gave taxpayer access to expected tax losses of some $52 million that originated with Standard Trust. The question was therefore whether the primary purpose for the acquisition of the Partnership interest was the business purpose or the tax benefit purpose. The significant disparity between the potential tax benefit to the taxpayer of about $52 million and expected returns from the operation and disposition of the STIL II portfolio showed that taxpayer’s acquisition of Standard Trust’s 99% interest in the STIL II Partnership was not undertaken primarily for bona fide purposes other than to obtain the tax benefit. Although taxpayer had a business purpose in acquiring the Standard STIL II Partnership interest, its primary purpose was to obtain a tax benefit for itself and to assign to its SRMP partners that portion of the tax benefit it did not require for its own purposes. Each of the four transactions was an avoidance transaction.

(3) If any of the avoidance transactions would result in a misuse or an abuse of a specific provision of the Income Tax Act, the tax benefit resulting from the series will be denied. Determining whether there has been misuse or abuse is a two-stage analytical process. The first stage involves identifying the relevant policy of the provisions of the Act as a whole. The second is the assessment of the facts to determine whether the avoidance transaction constituted a misuse or an abuse having regard to the identified policy. The policy of relevant provisions or the Act as a whole must be sufficiently clear for the Court to safely conclude that the use made of the provisions by the taxpayer constituted a misuse or an abuse. In enacting subsection 245(4), Parliament has placed the duty on the Court to ascertain its policy as the basis for denying a tax benefit from a transaction that otherwise would meet the requirements of the statute. The first question was whether taxpayer could demonstrate that the avoidance transactions may reasonably be considered not to result in a misuse of subsection 18(13) of the Act as it read in 1993. Although subsection 18(13) is a stop-loss provision, nothing refers to transfers between arm’s length parties or, in any way, purports to limit dealings between arm’s length parties. Subsection 18(13) provides for a non-arm’s length transferee to utilize the loss denied to the transferor. Where one of the express purposes of the provision is to preserve losses in the hands of a non-arm’s length transferee and the transferee may be a partnership to which the partnership rules apply, it could not be said that the acquisition of an interest in the STIL II Partnership by taxpayer ran against the policy of subsection 18(13). Therefore, none of the avoidance transactions resulted, directly or indirectly, in a misuse of subsection 18(13).

The next issue was whether the avoidance transactions may reasonably be considered to result in abuse of the Income Tax Act. The general policy of the Act is against the trading of non-capital losses by corporations, subject to specific limited circumstances. There is no provision for the sale of a loss to an arm’s length purchaser as if it were inventory of the business. At the relevant time, there was also no general policy in the Act against the transfer of losses between partners. The taxpayer acquired some $52 million of Standard Trust’s loss that it and its SRMP partners could use to offset their share of STIL II’s income and their other income. What the avoidance transactions accomplished was the transfer of the loss from one corporation to another through the mechanism of subsection 18(13) and the Partnership Rules. Having regard to the general anti-avoidance rule, these transactions violated the general policy of the Act against the transfer of losses from one corporation to another. The change of control rules are not applicable since it is not a case of change of corporate control, but the sale of some of the assets of the corporation. The exception in the Income Tax Act, allowing for the use of losses from a loss business by another business, would not apply as between Standard Trust and taxpayer. The policy of the Act is not such as to allow losses incurred in the business of lending money on mortgages to be used to offset profits in the business of rehabilitating distressed real properties. The avoidance transactions have resulted in an abuse of the provisions of the Act, other than the general anti-avoidance rule, read as a whole.

Per Létourneau J.A. (concurring in the result only): Under paragraph 245(3)(a) of the Income Tax Act, a transaction can be an avoidance transaction if it results in a tax benefit and if it was undertaken or primarily arranged to obtain the tax benefit. Each and every transaction which is part of a series of transactions has, under paragraph 245(3)(b), to be assessed on its own to determine whether it has a bona fide purpose other than to obtain a tax benefit. Once it is found that a transaction in the series is an avoidance transaction, then all the other transactions that are part of the series are coloured or contaminated by that transaction. There was no valid or legitimate reason for the creation of the non-arm’s length STIL II Partnership and the transfer to it of the portfolio other than to create a tax benefit for future sale. An ultimate sale to an arm’s length party was part of the pre-ordained steps carried out by Standard Trust’s liquidator. The whole scheme developed and arranged by the latter was conceived and intended to create and transfer a tax benefit. The general anti-avoidance rule is result-oriented and, therefore, it matters little who produced the tax benefit. The Tax Court Judge was right in concluding that taxpayer’s transaction was part of a series of avoidance transactions which resulted in a substantial tax benefit for the taxpayer. The transaction was a misuse and an abuse of the Act as a whole whereby Standard Trust’s losses were made a marketable commodity and transferred from one corporation to another through the artifice of a partnership which had never incurred the losses but acted only as a conduit.

STATUTES AND REGULATIONS JUDICIALLY CONSIDERED

An Act to amend the Income Tax Act, the Canada Pension Plan, the Unemployment Insurance Act, 1971, the Federal-Provincial Fiscal Arrangements and Federal Post-Secondary Education and Health Contributions Act, 1977 and certain related Acts, S.C. 1988, c. 55, s. 185(2).

Income Tax Act, R.S.C., 1985 (5th Supp.), c. 1, ss. 18(13), 53(2)(c), 96(1)(g),(8) (as am. by S.C. 1994, c. 21, s. 44), 111(1)(a),(5), 245, 248(10).

CASES JUDICIALLY CONSIDERED

APPLIED:

Furniss v. Dawson, [1984] A.C. 474 (H.L.); Craven v. White, [1989] A.C. 398 (H.L.).

DISTINGUISHED:

Jabs Construction Ltd. v. Canada, [1999] 3 C.T.C. 2556; (1999), 99 DTC 729 (T.C.C.); Geransky v. Canada (2001), 2001 DTC 243 (T.C.C.); Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622; (1999), 178 D.L.R. (4th) 26; 99 DTC 5669; 247 N.R. 19; Canada v. Antosko, [1994] 2 S.C.R. 312; (1994), 94 DTC 6314; 168 N.R. 16.

CONSIDERED:

R. v. Verrette, [1978] 2 S.C.R. 838; (1978), 85 D.L.R. (3d) 1; 40 C.C.C. (2d) 273; 3 C.R. (3d) 132; 21 N.R. 571; RMM Canadian Enterprises Inc. v. Canada, [1998] 1 C.T.C. 2300; (1997), 97 DTC 302 (T.C.C.).

AUTHORS CITED

Arnold, Brian J. Tax Avoidance and the Rule of Law, Amsterdam: IBFD Publications, 1997.

Arnold, Brian J. and James R. Wilson. “The General Anti-Avoidance Rule-Part 2” (1988), 36 Can. Tax J. 1123.

Canadian Tax Foundation. 1988 Conference Report: Report of Proceedings of the Fortieth Tax Conference. Toronto: Canadian Tax Foundation, 1989.

Cooper, Graeme S. Tax Avoidance and the Rule of Law, Amsterdam: IBFD Publications, 1997.

Department of Finance. Report of the Technical Committee on Business Taxation. Ottawa: Department of Finance, 1997.

Department of Finance. Technical Notes to Bill C-139: Special Report No. 851. Don Mills, Ontario: CCH Canadian Ltd., 1988.

Dodge, David A. “A New and More Coherent Approach to Tax Avoidance” (1988), 36 Can. Tax J. 1.

Heakes, Edward A. “New Rules, Old Chestnuts, and Emerging Jurisprudence: The Stop-Loss Rule” in Report of Proceedings of the Forty-seventh Tax Conference, 1995 Conference Report. Toronto: Canadian Tax Foundation, 1996.

Hiltz, Michael. « Section 245 of the Income Tax Act » in Report of Proceedings of the Fortieth Tax Conference, 1988 Conference Report. Toronto: Canadian Tax Foundation, 1989.

Hogg, Peter W. et al. Principles of Canadian Income Tax Law, 3rd ed. Scarborough, Ont.: Carswell, 1999.

Income Tax Act and Regulations Department of Finance Technical Notes: A Consolidation of Technical Notes and other Income Tax Commentary from the Department of Finance, Toronto: Carswell, Consolidated to September 1994.

Krishna, Vern. Tax Avoidance: The General Anti-Avoidance Rule, Toronto: Carswell, 1990.

Krishna, Vern. The Fundamentals of Canadian Income Tax, 5th ed. Scarborough, Ont.: Carswell, 1995.

Krishna, Vern. The Fundamentals of Canadian Income Tax, 6th ed. Scarborough, Ont.: Carswell, 2000.

Tiley, John. “Series of Transactions” in Report of Proceedings of the Fortieth Tax Conference, 1988 Conference Report. Toronto: Canadian Tax Foundation, 1989.

APPEAL from a Tax Court of Canada decision ((1999), 46 B.L.R. (2d) 195; [1999] 3 C.T.C. 2649; 99 DTC 1044) that taxpayer’s transaction was part of a series of transactions whose primary purpose was to obtain a tax benefit and, therefore, were avoidance transactions within the meaning of paragraph 245(3)(b) of the Income Tax Act. Appeal dismissed.

APPEARANCES:

Brian A. Felesky, Q.C., H. George McKenzie, Q.C. and Alistair Campbell for appellant.

Luther P. Chambers, Q.C., and Robert Carvalho for respondent.

SOLICITORS OF RECORD:

Felesky Flynn LLP, Calgary, for appellant.

Deputy Attorney General of Canada for respondent.

The following are the reasons for judgment rendered in English by

Rothstein J.A.:

INTRODUCTION

[1]        This appeal from a decision of the Tax Court (1999), 46 B.L.R. (2d) 195 (T.C.C.) presents the first opportunity for this Court to consider, in substance, section 245 of the Income Tax Act [R.S.C., 1985 (5th Supp.), c. 1] the general anti-avoidance rule (GAAR). The appellant’s appeal to the Tax Court of Canada was from the Minister of National Revenue’s reassessment disallowing a non-capital loss deduction of $12,572,274 in the computation of the appellant’s income in its 1993 taxation year and the deduction of a related non-capital loss carry forward in its 1994 taxation year. The Tax Court found the GAAR to be applicable and dismissed the appellant’s appeal.

SECTION 245 AND SUBSECTION 18(13)

[2]        It is relatively straightforward to set out the GAAR scheme. It is much more difficult to apply it. Generally, where a transaction is an avoidance transaction (a transaction that would result in a tax benefit, and whose primary purpose was to obtain the tax benefit), the tax benefit resulting from the transaction will be denied. However, the tax benefit will not be denied if the avoidance transaction would not result in a misuse of the provisions of the Act or an abuse of the Act read as a whole.

[3]        Section 245, in relevant part, provides:

245. (1) In this section,

“tax benefit” means a reduction, avoidance or deferral of taxor other amount payable under this Act or an increase in a refund of tax or other amount under this Act;

“tax consequences” to a person means the amount of income, taxable income, or taxable income earned in Canada of, tax or other amount payable by or refundable to the person under this Act, or any other amount that is relevant for the purposes of computing that amount;

“transaction” includes an arrangement or event.

(2) Where a transaction is an avoidance transaction, the tax consequences to a person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that, but for this section, would result, directly or indirectly, from that transaction or from a series of transactions that includes that transaction.

(3) An avoidance transaction means any transaction

(a) that, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit; or

(b) that is part of a series of transactions, which series, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.

(4) For greater certainty, subsection (2) does not apply to a transaction where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of this Act or an abuse having regard to the provisions of this Act, other than this section, read as a whole.

(5) Without restricting the generality of subsection (2),

(a) any deduction in computing income, taxable income, taxable income earned in Canada or tax payable or any part thereof may be allowed or disallowed in whole or in part,

(b) any such deduction, any income, loss or other amount or part thereof may be allocated to any person,

(c) the nature of any payment or other amount may be recharacterized, and

(d) the tax effects that would otherwise result from the application of other provisions of this Act may be ignored,

in determining the tax consequences to a person as is reasonable in the circumstances in order to deny a tax benefit that would, but for this section, result, directly or indirectly, from an avoidance transaction. [Emphasis added.]

[4]        The provision of the Income Tax Act which the Minister says has been misused in this case is subsection 18(13) as it read at the relevant time. It provided:

18….

(13) Subject to subsection 138(5.2) and notwithstanding any other provision of this Act, where a taxpayer

(a) who was a resident of Canada at any time in a taxation year and whose ordinary business during that year included the lending of money, or

(b) who at any time in the year carried on a business of lending money in Canada

has sustained a loss on a disposition of property used or held in that business that is a share, or a loan, bond, debenture, mortgage, note, agreement of sale or any other indebtedness, other than a property that is a capital property of the taxpayer, no amount shall be deducted in computing the income of the taxpayer from that business for the year in respect of the loss where

(c) during the period commencing 30 days before and ending 30 days after the disposition, the taxpayer or a person or partnership that does not deal at arm’s length with the taxpayer acquired or agreed to acquire the same or identical property (in this subsection referred to as the “substituted property”), and

(d) at the end of the period described in paragraph (c), the taxpayer, person or partnership, as the case may be, owned or had a right to acquire the substituted property.

and any such loss shall be added in computing the cost to thetaxpayer, person or partnership, as the case may be, of the substituted property. [Emphasis added.]

FACTS

[5]        Standard Trust Company (Standard) was in the business of lending money on the security of mortgages of real property. As a result of the downturn in the real estate market in the late 1980s and early 1990s, Standard Trust became insolvent. On May 2, 1991, the Ontario Court of Justice (General Division) ordered that Standard be wound-up and appointed Ernst & Young (E & Y) as liquidator of the company.

[6]        E & Y sought to maximize the recovery from the disposition of Standard’s assets. To do so, E & Y devised a plan designed to sell Standard’s mortgage portfolio (including properties of which Standard had taken possession as mortgagee) to investors in a way that would make available to the investors:

1. the Standard mortgage portfolio in packages that would, in the liquidator’s opinion, maximize recovery; and

2. the substantial losses, for taxation purposes, that Standard had suffered as a result of the reduction in the market value of its mortgage portfolio.

[7]        The portion of Standard’s mortgage portfolio with which this appeal is concerned is referred to as the STIL II portfolio. It consisted of 17 non-performing loans where payments of principal and interest were 90 days or more in arrears.

[8]        The plan for maximizing the value of Standard’s assets was described by the Tax Court Judge at paragraphs 4 and 7 of his judgment which I paraphrase. According to the Tax Court Judge, it was essential that Standard not sell the STIL II portfolio directly to an arm’s length purchaser because that would result in the loss being realized by Standard which, because it was not profitable and therefore not taxable, was not in a position to utilize the loss to reduce taxes. E & Y’s objective could best be accomplished if Standard’s loss could be preserved and then utilized by a third party to reduce its income tax. The plan was that:

1. Standard would incorporate a wholly-owned subsidiary;

2. Standard and the subsidiary would form a partnership with Standard having a 99% interest and the subsidiary a 1% interest;

3. Standard would transfer the STIL II portfolio to the partnership as its contribution to the capital of the partnership and would lend the subsidiary sufficient cash to make its capital contribution;

4. By reason of subsection 18(13) of the Income Tax Act, the portfolio to be acquired by the partnership would be recorded, for income tax purposes, at Standard’s cost ($85,368,872) notwithstanding the then current market value (approximately $33,262,000) was much less;

5. At the end of its first fiscal year, the STIL II Partnership would incur a net loss for income tax purposes of some $52 million, by reason of the sale of properties for proceeds much less than Standard’s original investment and the write-down of the remaining properties from Standard’s original investment to their fair market value.

6. Prior to the end of the partnership’s first fiscal year, Standard’s 99% interest in the partnership would be sold to an arm’s length purchaser to whom, at the first partnership year end, the tax loss would accrue to the extent of 99%.

[9]        The actual steps taken were as follows:

1. October 16, 1992 — 1004568 Ontario Inc. was incorporated as a wholly-owned subsidiary of Standard.

2. October 21, 1992 — An order of the Ontario Court of Justice (General Division) was obtained authorizing the incorporation of the wholly-owned subsidiary, the formation of the STIL II Partnership and the transfer of the STIL II portfolio to the partnership.

3. October 23, 1992 — The STIL II Partnership was formed with Standard having a 99% and 1004568 having a 1% interest.

4. October 23, 1992 — Standard contributed the STIL II portfolio to the capital of the STIL II Partnership. Standard loaned sufficient funds to 1004568 to enable it to contribute cash in order to acquire its 1% interest in the partnership.

5. Soon after October 23, 1992 — E & Y began an intensive campaign to market the Standard 99% interest in the STIL II Partnership.

6. January 1993 — Negotiations began between the appellant and E & Y, with the STIL II portfolio together with potential tax losses of some $52 million being offered as a package deal. The appellant specializes in packaging and improving distressed real properties.

7. January to May 1993 — Negotiations took place between the appellant and E & Y which the Tax Court Judge characterized as difficult. Due diligence was carried out by the appellant with respect to valuing the STIL II portfolio.

8. May 31, 1993 — The effective date of the appellant’s purchase of Standard’s 99% interest in the STIL II Partnership in consideration for:

(1) $17,500,000 payable to Standard, of which $14,500,000 was in the form of a promissory note, and the balance was cash payable on closing;

(2) an additional amount, described as the “earn-out”, which was to be determined by a formula whereby the appellant and Standard would share any proceeds from the disposition of the STIL II portfolio in excess of $17,500,000, with the appellant’s proportionate share increasing as the proceeds increased;

(3) an amount, up to a maximum of $5 million, payable to Standard for the tax losses to be recognized by the partnership, contingent on the partners being successful in deducting those losses from their other income.

9. June 29, 1993 — closing of purchase by the appellant of Standard’s STIL II Partnership interest.

[10]      The first fiscal year end of the STIL II Partnership was September 30, 1993. For that fiscal year, the STIL II Partnership had a net loss, for income tax purposes, of $52,674,376 consisting of

(a)  loss on the sale of three properties	$11,535,238
(b) loss on the write-down of its remaining properties Total:	$41,725,941 $53,261,179
(c) less income from operations other than disposal of properties Net Loss	($ 568,803) $52,674,376

 

[11]      The appellant did not intend to retain its 99% interest in the STIL II Partnership. In transactions that were pre-arranged before the closing of its purchase of the STIL II Partnership interest, the appellant disposed of 76% percent of its STIL II Partnership interest. The transactions were as follows:

1. July 5, 1993 — Formation of SRMP Realty and Mortgage Partnership;

2. September 22, 1993 — Closing of sale of appellant’s 99% interest in STIL II Partnership to SRMP, with the appellant obtaining a 24% interest in SRMP.

[12]      For its fiscal year ended October 31, 1993, SRMP realized a loss for income tax purposes of $52,384,474 (of which $52,147,632 represented its 99% interest of STIL II’s loss of $52,674,376). The appellant’s 24% share of the SRMP loss was $12,572,274, which it sought to deduct against its other income in 1993, 1994 and future years. It was this non-capital loss that the Minister disallowed. The disallowance was upheld by the learned Tax Court Judge.

APPELLANT’S POSITION

[13]      The appellant has two broad grounds of appeal. The first is that there is no relevant avoidance transaction. The second is that even if there is a relevant avoidance transaction, the transaction would not result in a misuse of a provision of the Act or abuse of the Act as a whole.

ANAYSIS

Tax Benefit

[14]      The appellant does not deny that it received a tax benefit. From the reasons of the Tax Court Judge it appears that no issue was taken on this point in that Court. The appellant claimed a non-capital loss of $12, 572, 274, for the purpose of reducing its income tax otherwise payable. I accept that a tax benefit has occurred.

Avoidance Transaction

[15]      It is next necessary to consider whether there has been an avoidance transaction. Subsection 245(2), the charging section, only applies where a tax benefit would result from a transaction that is an avoidance transaction or from a series of transactions that includes an avoidance transaction.

[16]      The appellant submits that none of the transactions here were avoidance transactions. First, the appellant says that it acquired the STIL II Partnership interest primarily for business purposes, namely, the acquisition of a distressed mortgage portfolio which, with its expertise, could be disposed of for optimum proceeds. Second, the appellant says that with respect to the first three transactions, the incorporation of 1004568 Ontario Limited, the formation of the STIL II Partnership and the transfer of the STIL II Portfolio from Standard to the partnership (the Standard transactions), Standard did not obtain any tax benefit, and therefore could not have undertaken or arranged these transactions primarily to obtain a tax benefit. Third, the appellant argues that if one or more of the Standard transactions was an avoidance transaction, the fourth transaction, whereby the appellant acquired its STIL II Partnership interest, was an independent transaction and not part of a series with the Standard transactions. Therefore, the appellant’s acquisition of the STIL II Partnership interest should not be tainted by the Standard transactions.

[17]      Under subsection 245(3), to find that a transaction is an avoidance transaction, two tests must be satisfied. The first is a results test. The results test requires a determination of whether a transaction or series of transactions would, but for the GAAR, result in a tax benefit. The second is a purpose test. Here, the focus is on the primary purpose of the transaction, or the individual transactions that form the series, as the case may be. Only if a transaction or series of transactions would result in a tax benefit is it necessary to consider the primary purpose of the transaction or transactions.

Was there a series of transactions and if so, which transactions were part of the series?

Common Law Series

[18]      In The Fundamentals of Canadian Income Tax, 6th ed. (Scarborough: Carswell, 2000), at page 888, Professor Krishna explains that for the purposes of the GAAR a series of transactions:

… refers to the integration of individual and separate steps into a composite transaction. The linkage of the separate steps into a “series” results from their inter-dependence and the manner in which the transactions are structured. Thus, we must determine: when is a sequence of events (e.g. A to B, then B to C) considered a single composite transactions, such as A to C?

[19]      Determining whether a series exists under paragraph 245(3)(b) involves a consideration of how closely tied individual steps or transactions must be in order to constitute a series. Paragraph 245(3)(b) provides no guidance with respect to the degree of connection or relationship that is required before transactions will be regarded as constituting a series. Moreover, there is little Canadian jurisprudence on the point. However, the House of Lords addressed the issue in a number of cases in the 1980s including Furniss v. Dawson, [1984] A.C. 474 (H.L.); and Craven v. White, [1989] A.C. 398 (H.L.). In Craven v. White, Lord Oliver set out the approach at page 514:

As the law currently stands, the essentials emerging from Furniss v. Dawson, [1984] A.C. 474, appear to me to be four in number: (1) that the series of transactions was, at the time when the intermediate transaction was entered into, pre-ordained in order to produce a given result; (2) that that transaction had no other purpose than tax mitigation; (3) that there was at that time no practical likelihood that the preplanned events would not take place in the order ordained, so that the intermediate transaction was not even contemplated practically as having an independent life, and (4) that the pre-ordained events did in fact take place.

[20]      In Tax Avoidance: The General Anti-Avoidance Rule (Toronto: Carswell, 1990), Professor Krishna summarizes the approach in the following words at page 69:

To summarize: a composite transaction is one in which, when the first transaction is implemented, all of the essential features (not just the general nature) of the second transaction are determined by persons who have the firm intention and ability to implement the second transaction. That is, at the time that A sells to B, C must be identified as a prospective purchaser and all the main terms of the sale agreed to in principle. Otherwise the transactions will be viewed as independent transactions and not necessarily part of a series. [Italic in original.]

[21]      Besides the House of Lords’ approach to defining what is meant by “series of transactions”, academics and the U.S. courts have developed two other possible approaches. One is called the “mutual interdependence test” under which two or more transactions will constitute a series if the transactions are so interdependent that the legal relations created by one transaction would be meaningless without a completion of the series. The “end results test”, adopted by some American courts, holds that purportedly separate transactions will be amalgamated as a single transaction when it appears that they were really component parts of a single transaction intended from the outset to be taken for the purpose of reaching the ultimate result. (See John Tiley, “Series of Transactions” in 1988 Report of Proceedings of the Fortieth Tax Conference, Conference Report (Toronto: Canadian Tax Foundation, 1989) 8:1, at pages 8:3 — 8:4).

[22]      In a paper relating to Information Circular 88-2 dealing with the GAAR, Michael Hiltz, at that time Director, Reorganizations and Non-Residents Division, Specialty Rulings Directorate, Revenue Canada, Taxation, appears to have accepted, in the absence of statutory alteration, the House of Lords’ interpretation of “series of transactions”. At page 7:7 of an article entitled “Section 245 of the Income Tax Act” in Report of Proceedings of the Fortieth Tax Conference, 1988 Conference Report, supra, (Toronto: Canadian Tax Foundation, 1989), he says:

The series itself would include a preliminary and a subsequent transaction only if, at the time the preliminary transaction is carried out, all important elements of the subsequent transaction are settled, and the subsequent transaction is eventually carried out.

[23]      In an article entitled “A New and More Coherent Approach to Tax Avoidance” ((1988), 36 Can. Tax J. 1), David A. Dodge, then Senior Assistant Deputy Minister, Department of Finance, Ottawa, stated at page 15:

The step transaction doctrine, however, when completed by the business purpose test as suggested in Burmah and Furniss v. Dawson, represents a coherent and orthodox approach. For that reason, this doctrine has been included in proposed section 245 in the form suggested by these cases.

[24]      In view of Mr. Dodge’s express reference to Furniss v. Dawson, I think it may reasonably be inferred that Parliament, in enacting paragraph 245(3)(b), adopted the approach to a “series of transactions” developed by the House of Lords. For that reason, I do not think the “mutual interdependence” or “end results” tests are applicable and I would, subject to subsection 248(10), adopt the House of Lords approach. Thus, for there to be a series of transactions, each transaction in the series must be pre-ordained to produce a final result. Pre-ordination means that when the first transaction of the series is implemented, all essential features of the subsequent transaction or transactions are determined by persons who have the firm intention and ability to implement them. That is, there must be no practical likelihood that the subsequent transaction or transactions will not take place.

[25]      I have no difficulty concluding that the three Standard transactions were pre-ordained. All their essential features were planned by E & Y who, with court approval, had the intention and ability to implement them. They were implemented over a period of one week in October 1992. The result they were intended to produce was the transfer of the STIL II portfolio from Standard to the STIL II Partnership, which would be recorded by the partnership at Standard’s cost, i.e. the price paid by the partnership to which was added Standard’s loss, by reason of subsection 18(13) of the Income Tax Act. In other words, the intended result was the packaging of Standard’s loss in a form that would be marketable to an arm’s length purchaser. They clearly constituted a series under the House of Lords’ definition.

[26]      That then leaves the appellant’s acquisition of its STIL II Partnership interest from Standard. This transaction was not completed until May 31, 1993 with the closing occurring on June 29, 1993. The appellant did not come on the scene until January 1993 and the negotiations leading to the transactions were “difficult”. Under the House of Lords’ definition, this fourth transaction would not be part of a series with the Standard transactions since the fourth transaction was not pre-ordained and was not practically certain to occur when the Standard transactions were implemented.

Subsection 248(10) Series

[27]      Does subsection 248(10) change this conclusion? Subsection 248(10) provides:

248….

(10) For the purposes of this Act, where there is a reference to a series of transactions or events, the series shall be deemed to include any related transactions or events completed in contemplation of the series.

[28]      The subsection is not a model of clarity. Related transactions or events are not defined. Nor is the meaning of the term “completed in contemplation of the series” clear. On the one hand, subsection 248(10) might simply be a statutory codification of the House of Lords definition of “series of transactions”. Under this interpretation, “related transactions or events completed in contemplation of the series” would be the pre-ordained transactions which are practically certain to occur and which eventually do occur.

[29]      A broader interpretation would include in the series, transactions that would not fall within the House of Lords’ test for series. Under this approach, an independent transaction would be deemed to be included in the series for purposes of subsection 248(10) if it is related to the transactions in the common law series and if it is completed in contemplation of the common law series.

[30]      Had subsection 248(10) been a definition provision, I would be more inclined to the view that it might be a codification of the House of Lords’ test for series. The subsection was enacted just about two years after the House of Lords’ decision in Furniss v. Dawson, and the Technical Note (1985 T.N.) accompanying the subsection states it is only a clarifying provision:

New subsection 248(10) clarifies that a reference in the Act to a series of transactions or events includes any related transaction or event completed in contemplation of the series. [Emphasis added.]

Indeed, in his article in 1988, Mr. Dodge refers to the Furniss v. Dawson doctrine being included in the proposed section 245 in the form suggested by that case.

[31]      However, the term “any related transaction or event completed in contemplation of the series” would seem to carry a wider connotation than pre-ordained transactions.

[32]      Another reason supporting a broader interpretation is that, when section 245 was enacted on September 13, 1988, a “grandfather” provision was included pertaining to subsection 248(10). Section 245 was to be applicable to transactions entered into on or after September 13, 1988, other than transactions that were part of a series determined without reference to subsection 248(10) commencing before September 13, 1988 and completed before 1989. Subsection 185(2) of S.C. 1988, c. 55, An Act to amend the Income Tax Act, the Canada Pension Plan, the Unemployment Insurance Act, 1971, the Federal-Provincial Fiscal Arrangements and Federal Post-Secondary Education and Health Contributions Act, 1977 and certain related Acts which enacted the GAAR, provided in relevant part:

185….

(2) Subsection (1) [section 245] is applicable with respect to transactions entered into on or after the day on which this Act is assented to other than

(a) transactions that are part of a series of transactions, determined without reference to subsection 248(10) of the said Act, commencing before the day on which this Act is assented to and completed before 1989; or

John Tiley, supra, notes that subsection 248(10) was intended to widen the scope of the term “series”. Otherwise, what reason would there be for the “grandfather clause”? Tiley states at page 8:5:

Subsection 248(10) remains important not just because of what it does or does not bring in, but because of what it says about the draftsman’s understanding of the term “series”. The subsection is intended to widen the scope of this concept-why else put the grandfather clause in? This suggests that the concept of “series” is not itself wide enough to catch a related but contemplated transaction. If so, some greater degree of predictability is needed for the second step to be a part of the series of transactions. But what degree is required? Revenue Canada gives a very narrow interpretation to “series,” and so allows subsection 248(10) considerable scope.

[33]      Finally, subsection 248(10) is a deeming provision. A deeming provision imports into a term a meaning that the term would not otherwise convey. It normally plays a function of enlargement. In R. v. Verrette, [1978] 2 S.C.R. 838, Beetz J. explained at pages 845-846:

A deeming provision is a statutory fiction; as a rule it implicitly admits that a thing is not what it is deemed to be but decrees that for some particular purpose it shall be taken as if it were that thing although it is not or there is doubt as to whether it is. A deeming provision artificially imports into a word or an expression an additional meaning which they would not otherwise convey beside the normal meaning which they retain where they are used; it plays a function of enlargement analogous to the word “includes” in certain definitions; however, “includes” would be logically inappropriate and would sound unreal because of the fictional aspect of the provision. Thus, a scantily dressed person is not really nude; but if under certain conditions that person is deemed to be nude in a provision prohibiting nudity, the word “nude” keeps its ordinary meaning which at the same time is extended to something which is not nudity.

The deeming nature of subsection 248(10) implies an enlargement of the common law series.

[34]      For all the above reasons, I am of the opinion that subsection 248(10) broadens the meaning of series from that defined by the House of Lords.

[35]      Subsection 248(10) requires three things: first, a series of transactions within the common law meaning; second, a transaction related to that series; and third, the completion of the related transaction in contemplation of that series.

[36]      Thus, before applying subsection 248(10), “series” must be construed according to its common law meaning, which I have found to be pre-ordained transactions which are practically certain to occur. To that is added “any related transactions or events completed in contemplation of the series”. Subsection 248(10) does not require that the related transaction be pre-ordained. Nor does it say when the related transaction must be completed. As long as the transaction has some connection with the common law series, it will, if it was completed in contemplation of the common law series, be included in the series by reason of the deeming effect of subsection 248(10). Whether the related transaction is completed in contemplation of the common law series requires an assessment of whether the parties to the transaction knew of the common law series, such that it could be said that they took it into account when deciding to complete the transaction. If so, the transaction can be said to be completed in contemplation of the common law series.

[37]      The appellant says that because of the difference in wording between subsection 248(10) “series of transactions or events” and subsection 245(2) and paragraph 245(3)(b) “series of transactions”, subsection 248(10) has no relevance. However, I read subsection 248(10) to apply whether a series is a series of transactions, a series of events, or a series of transactions and events. In addition, as the respondent has pointed out, subsection 245(1) defines “transaction” as including an arrangement or event. Accordingly, series of transactions in subsection 245(2) and paragraph 245(3)(b) must be read as including “series of transactions or events”.

[38]      The Standard series resulted in the creation of the STIL II Partnership and the transfer of the STIL II portfolio to the partnership, with a cost base in the assets of the partnership that would include Standard’s loss. It was that cost base that would accrue to the appellant upon its acquisition of its partnership interest and give rise to the loss that would be available to it at the end of the partnership’s 1993 taxation year. The preamble to the Agreement of Purchase and Sale of the partnership interest, dated May 31, 1993, makes it clear that the appellant was aware of the series of Standard transactions and that they were fundamental to the appellant acquiring its partnership interest. It reads in part:

WHEREAS:

…

(B)   The Vendor [Standard] and the Remaining Partner [1004568 Ontario Inc.] entered into the Partnership Agreement on October 23, 1992 to form STIL Partnership II;

…

(D)  Pursuant to the Asset Contribution Agreement, the Vendor has transferred to STIL Partnership II certain assets, including the mortgages [the STIL II portfolio];

For these reasons, the appellant’s acquisition of its STIL II Partnership interest was connected to the series of Standard transactions. Standard, in liquidation, and the appellant, the parties to the acquisition transaction, knew of the Standard series and took it into account when deciding to complete the acquisition transaction. Therefore, the appellant’s acquisition of its STIL II Partnership interest was a transaction that was related to the Standard series and was completed in contemplation of that series.

[39]      Applying the deeming effect of subsection 248(10), I conclude that, for purposes of subsection 245(3)(b), the series included the Standard series and the acquisition transaction.

Did a tax benefit result from the series?

[40]      The Tax Court Judge’s avoidance transaction analysis dealt only with the Standard transactions. At paragraph 50 of his reasons he concludes:

I find that the primary purpose for which E & Y entered into the series of transactions whereby 1004568 was incorporated, STIL II was formed, and the portfolio was transferred to it by the liquidator, was to obtain the tax benefit.

[41]      The appellant says that it was not a participant in the Standard transactions and Standard did not obtain a tax benefit from them. However, I see no words in subsection 245(3) that express or imply that the person who obtains the tax benefit must necessarily have been the person that undertook or arranged the transaction in question. I think this interpretation is consistent with the scheme of section 245 which does not, in any of its subsections, link the obtaining of a tax benefit to the person or persons undertaking or arranging the transactions. In particular, subsection 245(2) speaks of the tax consequences to a person without identifying who the person is, other than that the tax benefit to that person would have resulted, directly or indirectly, from an avoidance transaction or from a series of transactions that includes the avoidance transaction. Simply put, subsection 245(3) does not say that the person who undertakes or arranges the transaction must be the one who obtains the tax benefit.

[42]      However, that conclusion does not fully deal with the appellant’s argument. I have no difficulty accepting that the Standard transactions were part of a plan whereby a tax benefit could be obtained by an arm’s length purchaser of Standard’s STIL II Partnership interest. That was their purpose. However, they did not result in a tax benefit themselves. The incorporation of 1004568 Ontario Limited and the formation of the STIL II Partnership had no relevant tax consequences. Nor is there any suggestion that a tax benefit resulted from the transfer of the STIL II portfolio from Standard to the STIL II Partnership. At the conclusion of these three transactions, there was no tax benefit resulting to Standard or the appellant. If the appellant’s acquisition of its STIL II Partnership interest was not part of the series with the Standard transactions, I think the purpose of the Standard transactions would be irrelevant because they did not result in a tax benefit and they would simply not be avoidance transactions.

[43]      However, the appellant does not deny that a tax benefit resulted from its acquisition of its STIL II Partnership interest, i.e. the tax saving from claiming the loss originating with Standard. By reason of paragraph 96(1)(g) of the Income Tax Act, by its acquisition of the STIL II Partnership interest, the appellant became entitled to share in the partnership’s loss. Paragraph 96(1)(g) provides:

96. (1) Where a taxpayer is a member of a partnership, the taxpayer’s income, non-capital loss, net capital loss, restricted farm loss and farm loss, if any, for a taxation year, or the taxpayer’s taxable income earned in Canada for a taxation year, as the case may be, shall be computed as if

…

(g) the amount, if any, by which

(i) the loss of the partnership for a taxation year from any source or sources in a particular place,

exceeds

(ii) in the case of a specified member (within the meaning of the definition “specified member” in subsection 248(1) if that definition were read without reference to paragraph (b) thereof) of the partnership in the year, the amount, if any, deducted by the partnership by virtue of section 37 in calculating its income for the taxation year from that source or sources in the particular place, as the case may be, and

(iii) in any other case, nil

were the loss of the taxpayer from that source or from sources in that particular place, as the case may be, for the taxation year of the taxpayer in which the partnership’s taxation year ends, to the extent of the taxpayer’s share thereof.

[44]      Therefore, the acquisition of its STIL II Partnership interest resulted in a tax benefit to the appellant. As that transaction was part of a series with the Standard transactions, the series resulted in a tax benefit to the appellant.

What was the primary purpose of the transactions in the series?

[45]      Once it is determined that a series of transactions results in a tax benefit, any transaction that is part of the series may be found to be an avoidance transaction. The question is the primary purpose of each of the transactions in the series. If the primary purpose of any transaction is to obtain the tax benefit, it is an avoidance transaction.

[46]      The words “may reasonably be considered to have been undertaken or arranged” in subsection 245(3) indicate that the primary purpose test is an objective one. Therefore the focus will be on the relevant facts and circumstances and not on statements of intention. It is also apparent that the primary purpose is to be determined at the time the transactions in question were undertaken. It is not a hindsight assessment, taking into account facts and circumstances that took place after the transactions were undertaken.

[47]      The Tax Court Judge found the primary purpose of the three Standard transactions to be to obtain the tax benefit. He conducted an extensive analysis of the evidence of the purpose of these transactions. He rejected the E & Y evidence that the primary purpose of these transactions was to enhance the value of the STIL II portfolio and to provide greater flexibility in dealing with the assets of Standard. These are findings of fact by the Tax Court Judge and I can see no error in them. Indeed, I agree with his analysis and conclusion. Each of the three Standard transactions was undertaken primarily to obtain the tax benefit. Each was therefore an avoidance transaction.

[48]      In view of this conclusion respecting the Standard transactions, it appears the Tax Court Judge did not consider it necessary to determine whether the appellant’s acquisition of its STIL II Partnership interest was also an avoidance transaction. However, in my respectful opinion, it is normally necessary to analyse the primary purpose of all the relevant transactions. The reason is that the analysis under subsection 245(4) involves assessing whether an avoidance transaction would result in a misuse or an abuse of provisions of the Act. It may be that some avoidance transactions in a series would not result in a misuse or abuse. Therefore, it is necessary to review all the relevant transactions to determine which ones are avoidance transactions, in order for the analysis under subsection 245(4) to be complete. Accordingly, an assessment of whether the appellant’s acquisition of its STIL II Partnership interest was an avoidance transaction must be undertaken.

[49]      On the evidence here, there is no doubt that there were both business and tax benefit purposes to the acquisition transaction. As the appellant has pointed out, it was in the business of acquiring, arranging and improving distressed properties; it conducted considerable due diligence at significant expense to enable it to determine the commercial potential of the STIL II portfolio and then to negotiate the acquisition of Standard’s STIL II Partnership interest on terms which would afford it the opportunity to realize a profit from the management and disposition of the portfolio. The appellant therefore had a bona fide business purpose in acquiring the STIL II Partnership interest from Standard. However, the transaction gave the appellant access to expected tax losses of some $52 million that originated with Standard. Therefore, obtaining the tax benefit was also a purpose for the appellant’s acquisition of the STIL II Partnership interest. The question still remains therefore whether the primary purpose for the acquisition of the Partnership interest was the business purpose or the tax benefit purpose.

[50]      The evidence indicates that at the time of the appellant’s acquisition of the STIL II Partnership interest, the proceeds of disposition of mortgaged properties were anticipated to be in the range of about $40 million. Under the earn-out formula, earnings of about $6 million before sales costs could be anticipated from the dispositions. Operating income was projected to be about $1 million.

[51]      The significant disparity between the potential tax benefit to the appellant of about $52 million and expected returns from the operation and disposition of the STIL II portfolio strongly suggests that the appellant’s acquisition of Standard’s 99% interest in the STIL II Partnership was not undertaken primarily for bona fide purposes other than to obtain the tax benefit.

[52]      This conclusion is supported by the fact that by sale prearranged at the time it acquired Standard’s interest in the STIL II Partnership, the appellant sold its STIL II Partnership interest to SRMP. In return, it received $3,850,000 from the other SRMP partners and retained a 24% interest in the SRMP Partnership. However, by reason of an incentive fee built into the SRMP partnership agreement, the appellant actually retained an entitlement to 81% of SRMP’s income from the STIL II Partnership. In addition, the appellant was entitled to a $250,000 per year management fee from the STIL II Partnership.

[53]      What did its SRMP partners expect to receive for their investment and 76% interest in SRMP? They would receive only 19% of the income SRMP received from the STIL II Partnership, diluted by the management fee payable to the appellant by STIL II before distribution of income to SRMP. There is no indication the SRMP partners were involved in, or knowledgeable about, the rehabilitation and disposition of distressed mortgages. On the other hand, they would receive 76% of the tax benefit accruing to SRMP. I think it is a fair inference that the SRMP partners, other than the appellant, did not invest in SRMP to participate in the rehabilitation and sale of distressed mortgage properties. Rather, I think it is apparent from the documentation that their interest was to obtain their share of the tax benefit, that is, some $40 million in potential deductions.

[54]      The appellant made no secret of the close relationship between its acquisition of the STIL II Partnership interest and the SRMP transaction. Without the availability of the tax benefit to the SRMP partners, the SRMP transaction would not have occurred. I think therefore, notwithstanding its business purpose in acquiring the Standard STIL II Partnership interest, that was not the primary purpose for which the transaction was undertaken. Its primary purpose was to obtain a tax benefit for itself and to assign to its SRMP partners that portion of the tax benefit it did not require for its own purposes, in consideration for a substantial cash payment and other consideration from those partners.

[55]      Nonetheless, the appellant says that the transaction to acquire the STIL II Partnership interest from Standard was not conditional on it having access to the tax losses. It was only contingently liable to pay for the tax losses if they were deductible by it. If I understand this argument, it is that since the business aspect of the transaction is binding but the tax aspect is contingent, if the tax benefit is denied, all that would be left of the transaction is the business aspect and therefore the business purpose must be primary.

[56]      Although initially attractive, I do not believe that the appellant’s argument leads to a reasonable result. Following the argument to its logical conclusion, the contingent nature of the taxable benefit would have the practical effect of precluding the application of GAAR and thereby render the tax benefit unconditional. In other words, if by simply making the tax aspect contingent it could be said that the primary purpose was the business purpose, the appellant’s approach would always deprive a transaction of its avoidance character. While every case must be assessed on its own facts and circumstances, I think, as a general rule, this type of contingency will not be of assistance in characterizing the primary purpose of the transaction.

[57]      I therefore find that the primary purpose of the appellant’s acquisition of Standard’s interest in the STIL II Partnership was to obtain the tax benefit. In the result, the series of four transactions, which included the three Standard transactions and the appellant’s acquisition of its STIL II Partnership interest, resulted in a tax benefit to the appellant. Each of the four transactions was an avoidance transaction.

[58]      As a final observation, I would stress that the primary purpose of a transaction will be determined on the facts of each case. In particular, a comparison of the amount of the estimated tax benefit to the estimated business earnings may not be determinative, especially where the estimates of each are close. Further, the nature of the business aspect of the transaction must be carefully considered. The business purpose being primary cannot be ruled out simply because the tax benefit is significant.

Misuse and Abuse

The approach to determining misuse or abuse

[59]      I turn to subsection 245(4). The first question is whether it may reasonably be considered that any of the avoidance transactions would result in a misuse of a specific provision or provisions of the Income Tax Act. If so, the tax benefit resulting from the series will be denied. If not, it is then necessary to determine whether it may reasonably be considered that any of the avoidance transactions would result in an abuse, having regard to the provisions of the Act, other than section 245, read as a whole. Upon a finding of abuse, the tax benefit resulting from the series will be denied.

[60]      The English text of subsection 245(4) refers expressly to two tests, misuse and abuse, while the French text only identifies one test, “abus”. In RMM Canadian Enterprises Inc. v. Canada, [1998] 1 C.T.C. 2300 (T.C.C.), Bowman T.C.J. (as he then was) noted at paragraph 49:

The use of “misuse” and “abuse” in the English version rather than simply “abus” in the French version is attributable to a linguistic nuance rather than a shading of the legislative intent.

Having regard to the observation of Bowman T.C.J., I would interpret the French version as including both the tests in the English version.

[61]      In Tax Avoidance: The General Anti-Avoidance Rule, supra, Professor Krishna states at page 51:

What constitutes a “misuse” of the Act depends upon the object and spirit of the particular provision under scrutiny. What constitutes an “abuse” of the Act as a whole is a wider question and requires an examination of the inter-relationship of the relevant statutory provisions in context.

I think this is a convenient way in which to deal with each test. Therefore, in this case, for purposes of the misuse analysis, the avoidance transactions will be analyzed considering subsection 18(13) and the policy behind it. The abuse analysis will involve a consideration of the avoidance transactions in a wider context, having regard to the provisions of the Income Tax Act read as a whole and the policy behind them.

[62]      The appellant says that in assessing misuse and abuse, Parliament’s intended application of the provisions of the Act must be found in the language of the provisions themselves. The appellant relies on the words of McLachlin J. (as she then was) in Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622, at paragraph 43, that with clear provisions of the Income Tax Act, the Court must be cautious before finding an unexpressed legislative intention:

This Court has consistently held that courts must therefore be cautious before finding within the clear provisions of the Act an unexpressed legislative intention: … Finding unexpressed legislative intentions under the guise of purposive interpretation runs the risk of upsetting the balance Parliament has attempted to strike in the Act.

[63]      The difficulty with the appellant’s approach has been pointed out by the respondent. If, in a misuse or abuse analysis, the Court is confined to a consideration of the language of the provisions in question, it would seem inevitable that the GAAR would be rendered meaningless. The Minister invokes the GAAR when the transaction in question complies with the letter of the Act and the transactions are not a sham. Having regard only to the language of the provisions will therefore always result in a finding of compliance and therefore no misuse or abuse. I agree with the respondent that it will be necessary for the Court to have regard to the context of the provisions in question and, in the abuse analysis, the Act as a whole, and that reference may be made to extrinsic aids such as technical notes, writings, Hansard and enacting notes.

[64]      Academic writers in the income tax field have found the meaning of subsection 245(4) to be “opaque” (B. J. Arnold and J. R. Wilson, “The General Anti-Avoidance Rule-Part 2” (1988), 36 Can. Tax J. 1123, at page1164) or “rather obscure” (P. W. Hogg, J. E. Magee and T. Cook, Principles of Canadian Income Tax Law, 3rd ed. (Scarborough: Carswell, 1999), at page 509). They point out that the words misuse and abuse are not defined and they do not have obvious meanings. However, these writers appear to be unanimous that what is required is an object and spirit, or policy, analysis of the provisions in question or the provisions of the Act read as a whole (Arnold and Wilson, at pages 1164-1165; Hogg, Magee and Cook, at page 509; and Krishna, Tax Avoidance: The general Anti-Avoidance Rule, supra, at page 51).

[65]      I do not lightly distinguish the pointed statements of the Supreme Court of Canada in cases such as Shell, supra, and Canada v. Antosko, [1994] 2 S.C.R. 312, that where the words of the Income Tax Act are clear they must be applied. However, in none of the cases in which the Supreme Court has set out this view did the Minister invoke section 245 as it now reads. I agree with the respondent that these statements of the Supreme Court cannot be said to apply to a misuse and abuse analysis under subsection 245(4). Professor Krishna summarizes the approach which I think must be followed in such an analysis at page 1419 of The Fundamentals of Canadian Income Tax, 5th ed. (Scarborough: Carswell, 1995):

Determining whether a particular provision of the Act has been misused, or whether the Act read as a whole has been abused, requires an examination of the purpose (“object and spirit”) of the particular provision or scheme of provisions. It is not sufficient merely to rely on the technical language of the particular provision or scheme of provisions to determine whether there has been a misuse of the Act or an abuse of the Act read as a whole.

[66]      The approach to determine misuse or abuse has been variously described as purposive, object and spirit, scheme or policy. I will refer to these terms collectively as policy of the provisions in question or of the Act read as a whole.

[67]      Determining whether there has been misuse or abuse is a two-stage analytical process. The first stage involves identifying the relevant policy of the provisions or the Act as a whole. The second is the assessment of the facts to determine whether the avoidance transaction constituted a misuse or abuse having regard to the identified policy.

[68]      Ascertaining the relevant policy is a question of interpretation. As such it is ultimately the duty of the Court to make this determination. There is no onus to be satisfied by either party at this stage of the analysis. However, from a practical perspective, the Minister should do more than simply recite the words of subsection 245(4), and allege that there has been misuse or abuse. The Minister should set out the policy with reference to the provisions of the Act or extrinsic aids upon which he relies. Otherwise he places the taxpayer and the Court in the difficult position of trying to guess the relevant policy at issue. Trying to ascertain the policy of a specific provision or of an act as a whole, in the case of an act as complex as the Income Tax Act, is a difficult exercise, particularly when the transaction in question conforms to the letter of the act. Therefore, the Court requires the assistance of the parties to enable it to reach a correct conclusion. Nonetheless, with or without that assistance, the Court must attempt to determine the relevant policy. Of course, at the next stage, once the policy is determined, the onus remains on the taxpayer to prove the necessary facts to refute the Minister’s assumptions of fact that the avoidance transaction in question results in a misuse or an abuse.

[69]      It is also necessary to bear in mind the context in which the misuse and abuse analysis is conducted. The avoidance transaction has complied with the letter of the applicable provisions of the Act. Nonetheless, the tax benefit will be denied if there has been a misuse or abuse. This is not an exercise of trying to divine Parliament’s intention by using a purposive analysis where the words used in a statute are ambiguous. Rather, it is an invoking of a policy to override the words Parliament has used. I think, therefore, that to deny a tax benefit where there has been strict compliance with the Act, on the grounds that the avoidance transaction constitutes a misuse or abuse, requires that the relevant policy be clear and unambiguous. The Court will proceed cautiously in carrying out the unusual duty imposed upon it under subsection 245(4). The Court must be confident that although the words used by Parliament allow the avoidance transaction, the policy of relevant provisions or the Act as a whole is sufficiently clear that the Court may safely conclude that the use made of the provision or provisions by the taxpayer constituted a misuse or abuse.

[70]      In answer to the argument that such an approach will make the GAAR difficult to apply, I would say that where the policy is clear, it will not be difficult to apply. Where the policy is ambiguous, it should be difficult to apply. This is because subsection 245(4) cannot be viewed as an abdication by Parliament of its role as lawmaker in favour of the subjective judgment of the Court or particular judges. In enacting subsection 245(4), Parliament has placed the duty on the Court to ascertain Parliament’s policy, as the basis for denying a tax benefit from a transaction that otherwise would meet the requirements of the statute. Where Parliament has not been clear and unambiguous as to its intended policy, the Court cannot make a finding of misuse or abuse, and compliance with the statute must govern.

Misuse

[71]      The specific provision at issue is subsection 18(13) of the Act as it read in 1993. As it applies to this case, it may be summarized as follows: where Standard sustained a loss on the disposition of the STIL II portfolio to the STIL II Partnership, no amount shall be deducted in computing Standard’s income, and the loss sustained by Standard shall be added in computing the cost of the STIL II portfolio to the STIL II Partnership. Because of the requirement to add Standard’s loss to the cost of the portfolio to the Partnership, the cost of the portfolio would be recorded by the Partnership for tax purposes at Standard’s cost.

[72]      The question is whether the appellant can demonstrate that the avoidance transactions may reasonably be considered not to result in a misuse of subsection 18(13).

[73]      It is first necessary to determine the policy behind subsection 18(13). By its words, subsection 18(13) is intended to do two things. The first is to deny a money lending transferor the use of a loss for tax purposes on a disposition of non-capital property to a non-arm’s length person or partnership. The second is to add the loss denied to the transferor, to the cost of the acquisition of the property by the non-arm’s length person or partnership.

[74]      In finding a misuse of subsection 18(13) the Tax Court Judge stated at paragraph 54:

Subsection 18(13) was enacted as a stop-loss provision, the object of which is to prevent taxpayers who are in the money-lending business from artificially realizing losses on assets which have declined in market value by transferring them to a person with whom they do not deal at arm’s length, while maintaining control of the assets through the non-arm’s length nature of their relationship with the transferee. The use of that provision to effect the transfer of unrealized losses from a taxpayer who has no income against which to offset those losses to a taxpayer which does have such income is clearly a misuse.

[75]      I agree with the learned Judge that subsection 18(13) is a stop-loss provision and with his explanation of the policy of subsection 18(13) as it affects the transferor. It is intended to preclude the triggering of an artificial loss to the transferor on a disposition to a person or partnership that the transferor controls. Even though there has been a legal disposition of the non-capital property, the transferor still controls the property through the non-arm’s length person or partnership.

[76]      However, I cannot agree with the learned Judge that subsection 18(13) has anything to say about transactions between arm’s length parties. Nothing in subsection 18(13) refers to transfers between arm’s length parties or, in any way, purports to limit dealings between arm’s length parties.

[77]      Further, in my respectful opinion, the Tax Court Judge has not set out the entire policy of subsection 18(13). While the subsection precludes the transferor from realizing a loss on a disposition of non-capital property to a non-arm’s length transferee, it also maintains the existence of the loss by adding it to the non-arm’s length transferee’s cost of the property. What then is the policy behind maintaining the existence of the loss? It must be to preserve it for recognition on a later occasion by the non-arm’s length transferee. In finding a misuse of subsection 18(13), the learned Tax Court Judge seems to have ignored that portion of the subsection that maintains the loss in the hands of the transferee.

[78]      Subsection 18(13) expressly provides that the non-arm’s length transferee may be a partnership. Accordingly, the partnership rules in section 96 of the Income Tax Act, where relevant, become applicable. Under the partnership rules, irrespective of when a partner enters the partnership, the partner’s share in the income or loss of the partnership is calculated at the year end.

[79]      That is what has occurred here and has given rise to the appellant’s loss which is the subject of the Minister’s disallowance under section 245. I can find nothing in subsection 18(13) from which I can infer a policy of limiting how a loss transferred to a non-arm’s length transferee under that provision is to be treated. The respondent has referred the Court to the Department of Finance’s Technical Notes. With respect to the loss in the hands of the transferee the 1988 Technical Note related to subsection 18(13) only states:

Any loss that is a superficial loss is added in computing the cost of the substituted property to the taxpayer or the person or partnership who owns the property 30 days after the sale or transfer.

The respondent also referred to a paper by E. A. Heakes in Report of Proceedings of the Forty-seventh Tax Conference, 1995 Conference Report (Toronto: Canadian Tax Foundation, 1996) entitled “New Rules, Old Chestnuts, and Emerging Jurisprudence: The Stop-Loss Rules”, in which the author states at page 34:1:

Another is to articulate appropriate consequential rules to allow a loss that is denied when realized by a taxpayer to be directly or indirectly recognized at some future time by the taxpayer or a related or connected taxpayer.

Both references confirm that subsection 18(13) provides for a non-arm’s length transferee to utilize the loss denied to the transferor.

[80]      Nothing in subsection 18(13), or indeed in paragraph 96(1)(g), limits or affects the transfer or acquisition of interests in the non-arm’s length transferee partnership. Specifically, ownership of an interest in the non-arm’s length transferee partnership by the transferor is expressly contemplated by the non-arm’s length relationship between the transferor and transferee. And nothing precludes the sale of that partnership interest by the transferor to an arm’s length third party.

[81]      Where one of the express purposes of the provision is to preserve losses in the hands of a non-arm’s length transferee and where that transferee may be a partnership to which the partnership rules apply, I cannot infer that the acquisition of an interest in the STIL II Partnership by the appellant runs against the policy of subsection 18(13). No extrinsic aid to interpretation provides a contrary indication. I therefore conclude that none of the avoidance transactions resulted, directly or indirectly, in a misuse of subsection 18(13).

Abuse

Relevant policy with respect to corporations

[82]      I turn to whether the avoidance transactions may reasonably be considered to result in an abuse of the Income Tax Act having regard to the provisions of the Act, other than the GAAR, read as a whole.

[83]      The wider subject-matter in the abuse analysis is the policy of the Income Tax Act, read as a whole, with respect to the treatment of losses. The Minister says that the scheme of the Act is that “income and taxable income is to be computed separately for each taxpayer and by source; there is no computation of income from several taxpayers together”. If I understand the Minister’s argument, it is that, reading the provisions of the Income Tax Act as a whole, there is a policy against the transfer of losses between taxpayers.

[84]      There is no doubt there has been a transfer of a loss to the appellant by reason of the series of four transactions. If the Minister is correct that there is a policy against the transfer of losses between taxpayers, the avoidance transactions in the series, whereby the appellant acquired Standard’s loss, resulted in an abuse of the provisions of the Act read as a whole. The question therefore is whether there is such a policy.

[85]      I agree with the respondent that under the Income Tax Act, every person has an independent status and is liable for tax on that person’s taxable income. It would also appear that, as a general policy, losses cannot be transferred from one taxpayer to another. (See, for example, Hogg, Magee and Cook, supra, at page 406.) However, for purposes of this case, whether that policy operates to preclude the transfer of non-capital losses, i.e. business losses, between taxpayers in all cases requires a closer examination of how losses are treated under the Act.

[86]      Where a business incurs a loss, that loss may have value for income tax purposes. Paragraph 111(1)(a) of the Income Tax Act permits the carry-back and carry-forward of losses for specified numbers of years, whereby the losses may be offset against the profits in those years. This results in a refund of tax paid in prior years and/or a reduction in tax otherwise payable on profits in future years. Therefore, to a taxpayer that has been or will be profitable, it is liability for income tax that gives a business loss its value. It is the opportunity to carry it back or forward that vests the loss with the attributes of an asset. Paragraph 111(1)(a) provides:

111. (1) For the purpose of computing the taxable income of a taxpayer for a taxation year, there may be deducted such portion as the taxpayer may claim of the taxpayer’s

(a) non-capital losses for the 7 taxation years immediately preceding and the 3 taxation years immediately following the year;

[87]      However, the use of the asset is restricted to use by the taxpayer that incurred the loss and is limited to use in only seven immediately prior years and three immediately subsequent years. Generally, there is no provision for the sale of a loss to an arm’s length purchaser as if it were inventory of the business.

[88]      However, the Act does recognize a way in which losses may be transferred on an arm’s length basis in the corporate context in a change of control through the sale of shares of the corporation. The Act is quite explicit with respect to the transfer of non-capital losses between corporations on a change of control. The opening words of subsection 111(5) make it clear that, generally, non-capital losses are not transferable. Subsection 111(5) provides:

111….

(5) Where, at any time, control of a corporation has been acquired by a person or group of persons, no amount in respect of its non-capital loss or farm loss for a taxation year ending before that time is deductible by the corporation for a taxation year ending after that time and no amount in respect of its non-capital loss or farm loss for a taxation year ending after that time is deductible by the corporation for a taxation year ending before that time except that

(a) such portion of the corporation’s non-capital loss or farm loss, as the case may be, for a taxation year ending before that time as may reasonably be regarded as its loss from carrying on a business and, where a business was carried on by the corporation in that year, such portion of the non-capital loss as may reasonably be regarded as being in respect of an amount deductible under paragraph 110(1)(k) in computing its taxable income for the year is deductible by the corporation for a particular taxation year ending after that time

(i) only if that business was carried on by the corporation for profit or with a reasonable expectation of profit throughout the particular year, and

(ii) only to the extent of the total of the corporation’s income for the particular year from that business and, where properties were sold, leased, rented or developed or services rendered in the course of carrying on that business before that time, from any other business substantially all the income of which was derived from the sale, leasing, rental or development, as the case may be, of similar properties or the rendering of similar services; and

(b) such portion of the corporation’s non-capital loss or farm loss, as the case may be, for a taxation year ending after that time as may reasonably be regarded as its loss from carrying on a business and, where a business was carried on by the corporation in that year, such portion of the non-capital loss as may reasonably be regarded as being in respect of an amount deductible under paragraph 110(1)(k) in computing its taxable income for the year is deductible by the corporation for a particular year ending before that time

(i) only if throughout the taxation year and in the particular year that business was carried on by the corporation for profit or with a reasonable expectation of profit, and

(ii) only to the extent of the corporation’s income for the particular year from that business and, where properties were sold, leased, rented or developed or services rendered in the course of carrying on that business before that time, from any other business substantially all the income of which was derived from the sale, leasing, rental or development, as the case may be, of similar properties or the rendering of similar services. [Emphasis added.]

[89]      Professor Krishna explains at page 513 of The Fundamentals of Canadian Income Tax, 6th ed., supra:

In the absence of consolidated corporate reporting for tax purposes, the Act applies stringent restrictions on the use of accumulated losses following a change of corporate control. The general thrust of these rules is to limit transfers of losses between unrelated corporate taxpayers and to discourage business arrangements that are nothing more than “loss-trading” or “loss-offset” transactions.

[90]      However, subsection 111(5) provides for an exception. In the case of non-capital losses, it provides that such losses may be carried forward after a change of control, subject to certain limitations:

1. the business of the corporation must be carried on by the corporation for profit or with a reasonable expectation of profit throughout the year; and

2. the prior losses are deductible against income from the same business and income from another business where substantially all the income of the other business was derived from the sale, lease, rental or development of properties or the provision of services similar to the properties or services of the business that incurred the prior loss.

[91]      The exception would appear to recognize that a corporation whose business incurred a loss (the loss business) may become profitable upon a change of control. Changes of control resulting in loss businesses becoming profitable should be encouraged by the carry forward of prior losses. Hogg, Magee and Cook, supra, explain at page 408:

Where a corporation with unused losses is taken over, and the new managers make the acquired corporation’s business profitable, then the acquired corporation’s unused losses can be applied against the profits from the formerly unprofitable business, even though the profits were earned after the change of control. In that situation, the takeover has accomplished the sound commercial objective of making an unprofitable business profitable, and there is no reason why the unused pre-takeover losses should not continue to be available.

[92]      The obviously limited nature of the exception allowing the transfer of losses appears to underscore the general policy that loss trading for tax purposes is not permitted. The requirement that prior losses are deductible only against income from the same or similar businesses is an indication that such losses are not generally available for use in offsetting other income.

[93]      The rationale for the general policy against the transfer of losses and the limited exceptions is described in the Report of the Technical Committee on Business Taxation (Ottawa: Department of Finance, December 1997) (the Mintz Report) commencing at page 4.12 and, in particular, at pages 4.14 and 4.15.

[94]      The Report indicates that there are theoretical reasons for allowing for the refundability or offset of losses. Transfer of losses between corporations is one mechanism for effecting a refund or offset of tax. Refundability treats annual losses and profits symmetrically. It improves neutrality in the tax system. It eliminates discrimination against more risky businesses that have more volatility in earnings than less risky businesses. It may improve competitiveness and market efficiency by allowing firms to enter and exit industries more readily.

[95]      However, the Report notes that governments around the world have uniformly rejected full refundability, generally permitting only limited means for using losses. One concern is that to permit full refundability in a globalized economy of multinational businesses would attract losses into Canada that could not be used elsewhere, thus reducing government revenue in Canada that would need to be offset by higher tax rates. It is also said that a major practical consideration is that full refundability would eliminate corporate income tax revenue for several years.

[96]      As a result, the present policy is to allow refunds or the transfer of losses only on a strictly controlled basis. It is a compromise between the desire to promote the full neutrality benefits of refundability and offsets on the one hand, and the need to maintain government revenues on the other.

[97]      It is not for the Court to approve or disapprove of the government’s relevant taxation policy. Nor is the Court to pass on the wisdom of the compromises that have been struck between competing objectives. The Court’s only role is to identify a relevant, clear and unambiguous policy, so that it may then determine whether the avoidance transactions in question are inconsistent with the policy, such that they constitute an abuse of the provisions of the Act, other than the GAAR, read as a whole.

[98]      I have no difficulty concluding that the general policy of the Income Tax Act is against the trading of non-capital losses by corporations, subject to specific limited circumstances.

Relevant policy with respect to partnerships

[99]      With respect to partnerships, there were no restrictions on loss trading at the relevant time. Inherent in the Partnership Rules is that losses are transferable between partners. Irrespective of when a partner enters the partnership in a taxation year of the partnership, provided he is a partner at the end of the taxation year, the loss of the partnership from any source for its taxation year is the loss of the partner.

[100]   The one exception to there being no restriction against loss trading in partnerships is subsection 96(8) [as am. by S.C. 1994, c. 21, s. 44], dealing with foreign partnerships. In that case, the value of the partnership’s inventory at the time a person becomes a member of the partnership will be the lesser of its fair market value or its cost otherwise determined. In other words, accumulated losses, prior to a person becoming a member of the partnership, will not be available to that person. Paragraph 96(8)(b) provides:

96….

(8) For the purposes of this Act, where at a particular time a person resident in Canada becomes a member of a partnership, or a person who is a member of a partnership becomes resident in Canada, and immediately before the particular time no member of the partnership is resident in Canada, the following rules apply for the purpose of computing the partnership’s income for fiscal periods ending after the particular time:

…

(b) in the case of the partnership’s property that is inventory (other than inventory of a business carried on in Canada) or non-depreciable capital property (other than taxable Canadian property) of the partnership at the particular time, its cost to the partnership shall be deemed to be, immediately after the particular time, equal to the lesser of its fair market value and its cost to the partnership otherwise determined;

This exception highlights the fact that in the case of partnerships other than foreign partnerships, accumulated losses, prior to the entry of a new partner, are available to that partner.

[101]   I am satisfied that, at the relevant time, there was no general policy in the Income Tax Act against the transfer of losses between partners. If the present case is viewed as a transfer of a loss to a partner in a partnership, there was no policy that precluded such transfer and the conclusion would be that there had been no abuse of the provisions of the Act read as a whole.

Application of policy to the facts

[102]   However, the abuse analysis requires that the Court assess all the facts and circumstances surrounding the avoidance transactions. Why, having regard to the Income Tax Act read as a whole, did the parties enter into the avoidance transactions?

[103]   When the avoidance transactions are viewed in this wider context, it becomes obvious that the losses the appellant was acquiring for tax purposes, by acquiring its interest in the STIL II Partnership, originated with Standard. What we have here is the acquisition of Standard’s loss by the appellant. Essentially, the appellant acquired some $52 million of Standard’s loss that it and its SRMP partners could use to offset their share of STIL II’s income and then their other income.

[104]   Had the loss originated in the STIL II Partnership, I do not think any objection could be taken by the appellant accessing that loss by acquiring an interest in the Partnership. This would have been entirely a partnership context and, as I have said, there is no policy against the transferring of losses between partners.

[105]   However, to view the avoidance transactions here without taking account of the wider context would be to ignore relevant facts and in particular, the result of the series of transactions. What the avoidance transactions accomplished was the transfer of the loss from one corporation to another through the mechanism of subsection 18(13) and the Partnership Rules. Having regard to the GAAR, these transactions violated the general policy of the Act against the transfer of losses from one corporation to another.

[106]   Nonetheless, according to the appellant, if the corporate concepts of change of control and continuing the loss business were applied in this case, the appellant would be entitled to the Standard loss. The appellant argues that from its inception, the STIL II Partnership carried on the business of managing a mortgage portfolio and realizing on distressed properties. When the appellant acquired its interest in the STIL II Partnership, STIL II was a mortgagee in possession of a number of distressed properties with the objective of managing them, improving them, and ultimately realizing on them, and this business continued under the management of the appellant. According to the Tax Court Judge, ignoring the loss in 1993, the STIL II Partnership had the potential for profit and did make a profit.

[107]   The appellant itself was in the business of managing, improving and disposing of distressed real properties, a business similar to that of STIL II. If the corporate concept of change of control and continuation of the loss business applied and if the appropriate comparison was between the STIL II Partnership and the appellant, the appellant contends that it would come within the narrow exception to the general policy of the Income Tax Act against the transfer of losses between corporations.

[108]   However, in my view, the change of control rules are not applicable, and even if they were, I do not think the appropriate comparison is between the STIL II Partnership and the appellant. This is not a case of change of corporate control. It concerns a sale of some of the assets of the corporation. Except for the appellant’s use of subsection 18(13) and the Partnership Rules, there is no mechanism in the Income Tax Act for the sale of a loss from one corporation to another as if it were a sale of assets. The appellant asks that the transactions here be treated as if they were a sale of shares, either of Standard itself or a subsidiary incorporated to hold the STIL II portfolio. However, the Court cannot recharacterize the transactions so as to force them to fit within the terms of the exception to the general rule against loss trading.

[109]   Even assuming that the change of control rules could be applied by analogy, the necessary comparison, in my view, would be between Standard and the appellant. This is because the tax benefit resulting to the appellant was acquired by the appellant by reason of the series of four transactions which had the effect of transferring Standard’s loss to the appellant. The question would be whether the exception in the Income Tax Act, allowing for the use of losses from a loss business by another business, would apply as between Standard and the appellant.

[110]   I do not think it would. Standard was a money lender on the security of mortgages. The appellant was not. At the time of trial, Eugene Kaulius was the president of Samoth Capital, a public company that lent money to real estate developers and that was also in the hotel business. In 1993, Mr. Kaulius was president of the appellant. He was asked:

Q. What did OSFC do in those years as opposed to Samoth?

A. We typically bought undervalued deals, trying to minimize our risk, then looked to minimize our investment, that we would invest the company’s money into typically real estate projects, that was our focus.

It is clear that, while Samoth lent money to real estate developers and its business, at least in part, might be considered to be similar to Standard’s, the appellant was not in the money lending business. Instead, its business was purchasing, managing, and improving distressed real properties.

[111]   It is true, as the Tax Court Judge pointed out, that Standard’s business included dealing with its mortgages and in cases of default, dealing with the mortgaged properties as well. However, the loss which was acquired by the appellant from Standard did not arise from Standard’s dealing with distressed properties. It arose from the lending of money on properties whose value fell dramatically in the real estate downturn of the late 1980s and early 1990s.

[112]   The appellant did not acquire its STIL II Partnership interest to rehabilitate an unprofitable mortgage-lending business. Standard was in liquidation. The appellant’s sole business purpose (besides the tax benefit purpose) was to acquire its STIL II Partnership interest on terms which would enable it to profit from the management and disposition of distressed properties.

[113]   The business of lending money on the security of mortgages may occasionally include disposing of distressed properties. But the business of disposing of distressed properties does not include the business of lending money on mortgages. In these circumstances, I do not think the policy of the Act is such as to allow losses incurred in the business of lending money on mortgages to be used to offset profits in the business of rehabilitating distressed real properties.

[114]   Therefore, I am not satisfied that this exception to the general rule against the transfer of losses from one corporation to another would be applicable on policy grounds in this case.

Additional arguments relating to abuse

[115]   The appellant makes a number of additional arguments but they do not persuade me to a different conclusion. The appellant says, with reference to a number of the provisions of the Act, that Parliament has comprehensively legislated rules relating to the treatment of losses. I interpret this argument to mean that Parliament has completely addressed the issue of losses and has decided where losses may be transferred and where they may not. The appellant says that its circumstances are those in which losses may be transferred. However, the Income Tax Act is complex and the GAAR seems aimed at the unintended application of provisions of the Act by avoidance transactions that are against the policy of the Act. If, by reason of rules and exceptions in the Act, a clear and unambiguous relevant policy could not be ascertained, I would agree with the appellant that the application of the statutory provisions must prevail. However, the policy of the Act, with respect to the loss at issue here, is clear. And it is against that policy that the avoidance transactions must be measured to determine if they constitute an abuse. I have concluded that they do.

[116]   The appellant has referred to paragraph 53(2)(c) which provides for the reduction in the adjusted cost base of a partnership interest with the effect of recapturing, in a capital gain on a future disposition, losses previously deducted by a partner. However, I find paragraph 53(2)(c) somewhat remote from the issue at hand. For one thing, capital gains tax rates are significantly lower than income tax rates. I have difficulty concluding that Parliament considered that possible payment of capital gains taxes some time in the future was an appropriate offset for the immediate reduction of income taxes by the acquisition of a loss not originally incurred by the partnership.

Finding of abuse

[117]   I have concluded that the avoidance transactions have resulted in an abuse of the provisions of the Act, other than the GAAR, read as a whole. Notwithstanding this finding, it is important to note that there is no general rule against structuring transactions in a tax effective manner or a requirement that transactions be structured in a manner that maximizes tax. There has been strict compliance with the Act and that should normally be sufficient. However, Parliament has enacted subsection 245(4) and if any meaning is to be given to it, it must be to override the results of strict compliance when abuse of the provisions of the Act, read as a whole, is apparent.

CONCLUSION

[118]   The series of transactions which includes the Standard transactions and the appellant’s acquisition of its STIL II Partnership interest resulted in a tax benefit to the appellant. The Standard transactions and the transaction whereby the appellant acquired its STIL II Partnership interest were undertaken and arranged primarily to obtain the tax benefit. Accordingly, they were avoidance transactions. While not amounting to a misuse of subsection 18(13) in the narrow sense, these transactions resulted in an abuse, having regard to the provisions of the Income Tax Act, read as a whole, because they enabled the appellant to access Standard’s loss, contrary to the general policy of the Act against the transfer of losses between corporations. Accordingly, the Minister was entitled, under paragraph 245(5)(d), to ignore the tax effects from the application of subsection 18(13) and deny the tax benefit at issue to the appellant under subsection 245(2).

[119]   I would dismiss the appeal with costs.

Stone J.A.: I agree.

* * *

The following are the reasons for judgment rendered in English by

[120]   Létourneau J.A. (concurring reasons in result only): This appeal raises the application of the general anti-avoidance rule (GAAR) found in section 245 of the Income Tax Act (Act). I need not relate the facts and procedural incidents as my colleague Rothstein J.A. has already done that. However, for ease of reference, I reproduce in both languages the relevant parts of the provision:

245. (1) In this section,

“tax benefit” means a reduction, avoidance or deferral of tax or other amount payable under this Act or an increase in a refund of tax or other amount under this Act;

“tax consequences” to a person means the amount of income, taxable income, or taxable income earned in Canada of, tax or other amount payable by or refundable to the person under this Act, or any other amount that is relevant for the purposes of computing that amount;

“transaction” includes an arrangement or event.

(2) Where a transaction is an avoidance transaction, the tax consequences to a person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that, but for this section, would result, directly or indirectly, from that transaction or from a series of transactions that includes that transaction.

(3) An avoidance transaction means any transaction

(a) that, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit; or

(b) that is part of a series of transactions, which series, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.

(4) For greater certainty, subsection (2) does not apply to a transaction where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of this Act or an abuse having regard to the provisions of this Act, other than this section, read as a whole.

I also include the text of subsection 18(13) which will be relevant when assessing the nature of the appellant’s transaction under review in the present instance.

18….

(13) Subject to subsection 138(5.2) and notwithstanding any other provision of this Act, where a taxpayer

(a) who was a resident of Canada at any time in a taxation year and whose ordinary business during that year included the lending of money, or

(b) who at any time in the year carried on a business of lending money in Canada has sustained a loss on a disposition of property used or held in that business that is a share, or a loan, bond, debenture, mortgage, note, agreement of sale or any other indebtedness, other than a property that is a capital property of the taxpayer, no amount shall be deducted in computing the income of the taxpayer from that business for the year in respect of the loss where

(c) during the period commencing 30 days before and ending 30 days after the disposition, the taxpayer or a person or partnership that does not deal at arm’s length with the taxpayer acquired or agreed to acquire the same or identical property (in this subsection referred to as the “substituted property”), and

(d) at the end of the period described in paragraph (c), the taxpayer, person or partnership, as the case may be, owned or had a right to acquire the substituted property,

and any such loss shall be added in computing the cost to the taxpayer, person or partnership, as the case may be, of the substituted property.

[121]   The issue is whether Bowie T.C.J. erred in applying subsection 245(3) of the Act to the transaction whereby the appellant (OSFC) purchased 99% interest in a partnership (STIL II partnership) created by Standard Trust Company (STC). The learned Tax Court Judge found that the appellant’s transaction was a transaction that was part of a series of transactions whose primary purpose was to obtain a tax benefit and, therefore, were avoidance transactions within the meaning of paragraph 245(3)(b) of the Act.

[122]   It will be recalled that STC arranged a series of three transactions which, it is acknowledged by the parties, created a tax benefit. The appellant’s transaction was a fourth transaction whereby it bought the interest in STIL II partnership which contained heavy losses. Speaking of the first three transactions arranged by STC, i.e., the creation and incorporation of the company 1004568, the formation of the partnership STIL II and the sale of its 99% interest in that partnership, the learned Tax Court Judge wrote at paragraph 36 of his decision:

The first three of the transactions alleged by the Respondent to be avoidance transactions are certainly part of a series of pre-ordained steps carried out by the liquidator as part of a deliberate plan.

I shall now determine whether the appellant’s transaction was an avoidance transaction as found by the Tax Court Judge.

Whether the appellant’s transaction was an avoidance transaction

[123]   I readily concede that section 245, and especially subsection 245(3), is not, as is too often the case in income tax matters, a model of clarity. As I understand subsection 245(3), a transaction can be, under paragraph (a), an avoidance transaction if it results in a tax benefit and if it was undertaken or primarily arranged to obtain the tax benefit.

[124]   However, a transaction which is not an avoidance transaction under paragraph (a) because it was undertaken for a bona fide purpose may still become an avoidance transaction under paragraph (b) if it is part of a series of transactions, if the series of transactions results in a tax benefit and if “the transaction” was undertaken for no bona fide purposes other than to obtain the tax benefit. I have underlined the words “the transaction” because they are source of ambiguity.

[125]   Indeed, a literal interpretation of these words, whether taken in French or in English, could lead one to conclude that, in the present instance, they refer to the appellant’s transaction, i.e., the fourth transaction which followed and perfected the three transactions initiated by STC. Such an interpretation would render paragraph (b) completely inoperative and useless. If we accept, for the sake of argument, that the appellant’s transaction had a bona fide purpose other than to obtain a tax benefit, that transaction assessed on its own for what it is would have been ruled, under paragraph (a), not to be an avoidance transaction. Then it would not matter, under paragraph (b), that it is part of a series of other transactions which are avoidance transactions because it would be again reassessed on its own as if it were not part of that series of avoidance transactions. Having been ruled not to be an avoidance transaction under paragraph (a) because it had a legitimate business purpose, the transaction would, once again and with no surprise, be ruled not to be an avoidance transaction because it had a legitimate business purpose. Indeed, it would amount to assessing the appellant’s transaction both under paragraphs (a) and (b) as if it were a single transaction, notwithstanding that paragraph (b) defines as an avoidance transaction “any transaction” that is part of the series of transactions which produced the tax benefit and were arranged or undertaken primarily for that purpose.

[126]   In my view, each and every transaction which is part of a series of transactions has, under paragraph 245(3)(b), to be assessed on its own to determine whether it has a bona fide purpose other than to obtain a tax benefit. Once it is found that a transaction in the series is an avoidance transaction, then all the other transactions that are part of the series are coloured or contaminated by that transaction. The appellant agrees with this approach taken by the Department of Finance in its Technical Notes to Bill C-139, Special Report No. 851, CCH Canadian Ltd., 1988, at page 315 where it writes:

Thus, where a series of transactions would result in a tax benefit, that tax benefit will be denied unless the primary objective of each transaction in the series is to achieve some legitimate non-tax purposes. Therefore, in order not to fall within the definition of “avoidance transaction” in subsection 245(3), each step in such a series must be carried out primarily for bona fide non-tax purpose.

See also the following passage of Brian J. Arnold found in Chapter 7 of the book Tax Avoidance and The Rule of Law, Amsterdam: IBFD Publications, 1997, at pages 232-233, dealing with the canadian general anti-avoidance rule:

Under paragraph 245(3)(b), if a transaction is part of a series of transactions and the series result in a tax benefit, each transaction in the series must be tested to determine whether it was carried out primarily for non-tax purposes. The series of transaction as a whole need not be justified by a non-tax purpose, and there is no attempt to reorder the series or to determine its true character.

[127]   In the present instance, as previously mentioned, the Tax Court Judge found that the three transactions arranged and undertaken by STC had no bona fide purpose other than to obtain a tax benefit. I see no error in this finding. Quite the reverse, there was overwhelming evidence that the incorporation of company 1004568, the formation of the STIL II partnership as well as the transfer to them of the portfolio assets were not necessary for STC to effectively sell these assets to an arm’s length third party such as the appellant.

[128]   However, and the evidence so reveals, the transfer of the assets to a non arm’s length party prior to the sale to an arm’s length party was required to trigger the application of subsection 18(13) of the Act and create, in the hands of the non-arm’s length STIL II partnership, the pregnant losses by increasing its adjusted cost base. In my considered opinion, there was no valid or legitimate reason for the creation of that partnership and the transfer to it of the portfolio other than to create a tax benefit for future sale.

Whether the appellant’s transaction was part of a series of transactions

[129]   The appellant contends that it was not privy to or involved in the STC transactions arranged by STC’s liquidator. It submits that, even if the STC’s transactions were avoidance transactions, its own transaction was not an avoidance transaction because it was not part of the series arranged by STC. In addition, the appellant avers that there was no “reasonable nexus” or interdependence between its transaction and the STC’s transactions.

[130]   It is obvious to me as it was to the Tax Court Judge that an ultimate sale to an arm’s length party was part of the pre-ordained steps carried out by STC’s liquidator. The pregnant losses resulting from a transfer of the portfolio to the STIL II partnership needed the interaction of an arm’s length third party to come to life. The whole scheme developed and arranged by STC’s liquidator was conceived and intended to create and transfer a tax benefit. It was predicated upon an acquisition by a third party whereby the pregnant losses would become real losses in the hands of that third party. In other words, the appellant may not have been a party in conceiving or creating the tax benefit, but it was the missing and necessary link in materializing and actualizing it. The entire sequence of events had to be carried out or all the steps completed for the tax plan to work: see Vern Krishna, The Fundamentals of Canadian Income Tax, 5th ed., at page 1409. The appellant’s transaction satisfied, in my view, both the “mutual interdependence” test and the “end result” test under which two or more transactions constitute a series either if they are so interdependent that the results of one transaction would be meaningless in the absence of the completion of the other transactions, or they are in substance component parts of a single transaction which were intended from the outset to be taken for the purpose of reaching the ultimate result: see Brian J. Arnold and James R. Wilson, “The General Anti-Avoidance Rule—Part 2” (1988), 36 Can. Tax J. 1123, at page 1162.

[131]   The appellant also submitted that subsection 245(3), in relation to the tax benefit, uses the word “obtain” and not “confer”. Had Parliament intended to cover the situation the appellant finds itself involved in, the submission goes, it would have referred to transactions within a series of transactions arranged primarily to “confer” a tax benefit.

[132]   As attractive as this argument of the appellant may be, it is not supported by the terms of the general anti-avoidance provision found in subsection 245(2) or the terms of the definition of avoidance transaction in subsection 245(3). A close reading of these provisions reveals that the GAAR is result-oriented and, therefore, it matters little who produced the tax benefit. The fact that the tax benefit could also result indirectly from the transaction or the series of transactions indicates, as the respondent puts it, that “Parliament intended to divorce the author of tax avoidance transactions from the beneficiary of the tax benefits flowing from these transactions”: see respondent’s amended memorandum of fact and law, paragraph 41.

[133]   In my view, the Tax Court Judge was right in his conclusion that the appellant’s transaction was part of that series of avoidance transactions which resulted in a substantial tax benefit for the appellant.

Whether the transaction amounted to a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act read as a whole

[134]   The Tax Court Judge, as it appears from the following excerpt of his decision, at paragraph 54, concluded that the use of subsection 18(13) of the Act was a misuse of that provision:

Counsel for the Appellant argues that subsection 18(13) is not misused in this case, because the result for which he contends is the very result that the subsection dictates in the circumstances. That will always be the case when a section of the Act is put to a use for which it was not intended in furtherance of an avoidance transaction, or a series of avoidance transactions. That unintended application of the section is the very mischief at which GAAR is aimed. Subsection 18(13) was enacted as a stop-loss provision, the object of which is to prevent taxpayers who are in the money-lending business from artificially realizing losses on assets which have declined in market value by transferring them to a person with whom they do not deal at arm’s length, while maintaining control of the assets through the non-arm’s length nature of their relationship with the transferee. The use of that provision to effect the transfer of unrealized losses from a taxpayer who has no income against which to offset those losses to a taxpayer which does have such income is clearly a misuse.

I agree. Subsection 18(13) was not intended to be used by a corporation to increase the adjusted cost base of a related corporation or partnership for the purpose of selling its losses to an arm length corporation.

[135]   I also share his view that the transaction was an abuse of the Act as a whole whereby STC’s losses were made a marketable commodity and transferred from one corporation to another corporation through the artifice of a partnership (the STIL II partnership) which had never incurred the losses and acted as a conduit.

[136]   The appellant relied upon two decisions of Associate Chief Justice Bowman of the Tax Court of Canada for the principle that it is no misuse or abuse of the Act for a taxpayer to structure a transaction in a tax effective way or not structure it in a manner that maximizes the tax: see Jabs Constuction Ltd. v. Canada, [1999] 3 C.T.C. 2556 (T.C.C.), at paragraph 46; Geransky v. Canada (2001), 2001 DTC 243 (T.C.C.), at paragraph 42.

[137]   I do not quarrel with the principle enunciated by Associate Chief Justice Bowman. However, this is not what took place in the present instance and, for that reason, these two cases relied upon by the appellant are easily distinguishable from our case.

[138]   In Jabs Construction Ltd., the owners of the company, Mr. and Mrs. Jabs, were known philanthropists. The company that they controlled owned 50% interest in 13 properties. That interest had to be sold to a partner in a joint venture after the joint venture was terminated in a bitter dispute. The company had two options. On its own, it could sell the properties to the partner or it could donate them to a charity and have them sold by the charity. Mr. and Mrs. Jabs took the second option and made gifts to a charity according to subsection 110.1(3) of the Act.

[139]   The Tax Court found that there was no misuse of subsection 110.1(3) of the Act as the tax mitigation resulting from such gifts is precisely what the section contemplates: see decision at paragraph 46. In addition, the Tax Court also found that it would have been financially more advantageous for the company to sell the properties rather than have them sold by the charity. However, it would not have been as advantageous for the charity if the company had proceeded to the sale itself: see decision at paragraph 13. Thus, the Tax Court concluded that there was no avoidance transactions in these circumstances.

[140]   The Geransky case is on appeal to our Court and I will simply say this in order not to pre-empt the appeal. The case involves a finding by the Tax Court that the tax assessor had made an erroneous assessment and qualification of the transaction which he saw as an avoidance transaction as well as an erroneous assessment of the tax benefit. There is no such thing in our case.

[141]   For these reasons, I would dismiss the appeal with costs.