Introduction - GAAR and a series of corporate restructure transactions
Edward Samuel Rogers was the president and CEO of Rogers Communications Inc., a Canadian public corporation. From 1981 to 1991, twelve life insurance policies insuring the life for Mr. Rogers were issued to RPC Group which included several private corporations and a family trust. When each insurance policy was first issued, the policyholder was the beneficiary. After a series of corporation restructure, CGESR (a member of RPC Group) became the beneficiary of the policies while ESRL (another member of RPC Group), that held shares of CGESR through another corporation, ESRIL 98, became the policy holders of ten policies and paid the premium. The other two insurance policies were continued to be held by the family trust. When Mr. Rogers passed away, CGESR received life insurance proceeds of about 102 million dollars which was added to its capital dividend account ("CDA"). In 2009, CGESR paid dividends that was deemed to be capital dividends to ESRIL 98 by way of s.83(2) election, which then added those dividends to its CDA.
In August 2015, the Minister of National Revenue relied on General Anti-Avoidance Rule ("GAAR") to reassess Roger Enterprise (2015) Inc. ("RE 2015") which was the successor by amalgamation to both CGESR and ESRIL 98, and determined the dividends paid by CGESR to ESRIL 98 were tax dividends as opposed to capital dividends.
The Tax Court of Canada allowed the appeal based on the findings that:
- There was no tax benefit from the series of reorganization transactions;
- The definition of capital dividend account under s.89(1) indicated using the adjusted cost basis ("ACB") of a life insurance policy to a corporate beneficiary as opposed to the holder;
- There was no misuse or abuse of the tax provision as the series of transactions fell within the object, spirit or purpose of the provision.
Tax Court conclusion-There was no tax benefit resulted directly
or indirectly from the series of reorg transactions
The tax court started its analysis on the 1st step of the 3 steps GAAR analysis process - whether there was a tax benefit arising from a transaction. Under s.245(1) of the Income Tax Act, "tax benefits" 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 the Income Tax Act. Despite the argument by the Canadian tax lawyer for CRA that there were 4 tax benefits resulted from the transactions, the tax court ruled there was no tax benefit at all after examining each of them.
A CDA Increase of CGESR and ESRIL 98
With respect to the interpretation of s.245(1), the court disagreed with the Canada Revenue Agency's ("CRA")'s submission that "an increase in other amount under the act" constitutes a tax benefit. In its analysis, the tax court laid out five reasons:
- Based on the wording of the provision, the word "an" or "another" would have appeared before the phrase "other amount" if Crown's position were to be taken.
- Although the Explanatory Notes released by the Department of Finance when GAAR was introduced do not clarify how to read the provision, the ejusdem generis rule indicates the wording "other amount under the act" is generally referred to as interest, penalties and source deductions.
- In Canada Trustco, the Supreme Court of Canada ruled the phrase "other amount" means "something that a particular taxpayer has paid, or is required to pay" under the Income Tax Act.
- CRA's interpretation is not consistent with the analysis of the Income Tax Act.
- According to Robert Couzin's article regarding s.245(3) of the Income Tax Act, the phrase "other amount under this Act" indicates an amount that is refundable.
Reduction in Computation of Income
The Canadian tax lawyer for CRA also argued that a reduction in the computation of income was a tax benefit. However, the tax court ruled it was insufficient that there be a reduction in the computation income to constitute a tax benefit. Furthermore, the tax court concluded there would still be no reduction in tax even there was a reduction in income after examining the specific facts in the case.
Avoidance of Part III tax by ESRIL 98 and Reduction of Part I tax by its ultimate shareholders
The tax court first analyzed the Part III tax issue and adopted the comparison approach set out in Copthorne and Canada Trustco by essentially looking at what a corporation would have done if it did not stand to gain from the tax benefits. But because it was difficult to conclude whether ESRIL 98 would reasonably carry out the alternative based on the facts of the case, the tax court decided not to agree with the CRA.
Regarding Part I tax reduction by ESRIL 98's ultimate shareholders, the tax court cited the Federal Court of Appeal's ruling in Wild that the earliest time that CRA can make a determination is the first taxation year in which the taxpayer claims a benefit. Due to the fact that the ultimate shareholders are getting a future reduction, the CRA has to wait till that happens and cannot tax at this time.
Avoidance of Part III tax by CGESR
To tackle this issue, the tax court applied the alternative comparison principle identified by Justice Bonner in Canadian Pacific. Since the CRA's view was only a theoretical possibility, the tax court could not support their position.
Restructure transactions fell within the object, spirit or purpose of the provision
Since Step 2 of the GAAR test was not a major issue in this case, the tax court then moved to the 3rd step - whether there was misuse or abuse of the tax provision. At this stage, the tax court set out its analysis by identifying the applicable principle – whether a transaction or a series of transaction under s.245(3) was within the object, spirit or purpose of the provisions. It then followed the approach set out in Canada Trustco and Copthorne by analyzing the text, context and purpose of the reduction provision.
By examining the history of legislation and the effect of amendment, the tax court concluded that Parliament acted deliberately and intentionally in describing the adjusted cost basis of a life insurance policy and the text and purpose of the relevant provision clearly indicated that in determining the portion of the life insurance proceeds to be added to the capital dividend account of the corporate beneficiary in 2008 and 2009 (when reorganization transactions took place), the adjusted cost basis of a life insurance policy to a corporate beneficiary of the policy was to be used as opposed to the adjusted cost basis of the policy to the holder of the policy. CRA also failed to persuade the tax court that the purpose was inconsistent with text and context of the provision. Therefore, the tax court ruled there was no misuse or abuse of the reduction provision by RE 2015
Pro tax tips - carrying out tax planning – Beware the Tax Trap of GAAR When Carrying out Tax Planning
Although the taxpayer was successful in the case, GAAR is a formidable tool to counter aggressive tax planning. Whether a taxpayer could successfully implement a series of transactions to minimize his tax burden eventually comes down to how offensive those transactions are. If you are preparing to reorganize your corporations and need tax planning advice, contact our office to speak with an experienced Canadian tax lawyer to discuss the potential impact of the tax trap of GAAR.
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