Case law update: Her Majesty the Queen vs Global Equity (Canada): GAAR
08 November 2012
Posted by: SAIT Technical
By SAIT Technical
The Canadian Federal Court of Appeal recently delivered its judgment in the matter between Her Majesty the Queen ("the Crown”) and Global Equity Fund Ltd ("Global”) citation: 2012 FCA 272.
This matter was an appeal by the Crown from a judgment of the Tax Court of Canada (case 2011 TCC 507), allowing the appeal of Global Equity Fund Ltd. ("Global”) with respect to reassessments for the 1999, 2000 and 2001 taxation years issued by the Minister of National Revenue (the "Minister”). The Minister, relying on the general anti-avoidance rule (the "GAAR”) set out in section 245 of the Income Tax Act (the "Act”), had disallowed a business loss in the amount of $5,600,194 claimed by Global following the disposition of shares it held in 953565 Alberta Ltd. That loss arose from the implementation of a planning technique known in the tax community as a "value shift”.
Global was incorporated in 1999 for the purpose of investing in credit facilities and private placements. Its sole shareholder is a trust whose beneficiaries include Mr. Riaz Mamdani, his spouse, their children, grandchildren, parents, siblings, nieces and nephews. At the time the concerned transactions were entered into, Mr. Mamdani and his wife had two very young children.
Mr. Mandani sought professional advice to implement a plan to defer tax. The plan, in essence a "value shift”, entailed the following:
a. a new corporation, 953565 Alberta Ltd. ("Newco”) was incorporated;
b. a new trust was set up whose beneficiaries were Mr. Mandami's children and grandchildren (the "Children's Trust”);
c. Global subscribed to common shares of Newco for a consideration of $5,600,250;
d. Newco declared a dividend on the common shares held by Global in the form of non-voting preferred shares which were redeemable and retractable for $5,600,250 and which had a paid-up capital of $56;
e. Newco issued additional common shares to Global for a consideration of $200,000; however, it was acknowledged in the Tax Court that this step was inserted as window dressing in order to give the common shares some value;
f. Global sold all the common shares it held in Newco to the Children's Trust for a consideration of $200,000; it was as a result of this sale that Global claimed a loss of $5,600,194;
g. a loan was made by Newco to Global for $5,600,000; the loan bore interest at prime plus 2% and the loan agreement provided for an equity participation of 25% of the increase in fair market value of Global's assets while any part of the loan remained outstanding; an amendment to the loan agreement was made a few months later which deleted the interest and increased the equity participation to 50%;
h. Global granted an interest in its property to Newco to secure the loan.
At the time the plan was implemented, it was contemplated that the loss resulting from the sale of the common shares of Newco to the Children's Trust might be a business loss for tax purposes since Global itself was involved in the business of trading securities. Consequently, in the income statement and balance sheet filed with Global's corporate tax return for 2001, the transactions were reported as increasing its losses from operations. $56 was recorded as revenue from the stock dividend, and the subscription price for the common shares of Newco was deducted as part of the cost of sales. The overall result was that Global claimed a net business loss of $5,600,194. The claimed loss gave rise to a significant tax benefit through the elimination, or near elimination, of tax payable under the Act for Global's 2001, 2000 and 1999 taxation years.
The Minister, applying the GAAR, reassessed Global to deny this loss in its 2001 taxation year and the carry-back of the loss from the 2001 taxation year to the 1999 and 2000 taxation years. Global appealed to the Tax Court of Canada.
The Tax Court judge allowed the appeal on the GAAR issue even though she found that the transactions were "highly artificial” and that the loss resulted "from a shuffle of paper” by which "no real economic loss was suffered”. She also noted that she may well have upheld the reassessments under the GAAR had the Crown raised different arguments.
The submissions made by the Crown in its appeal were substantially different from those it made in the Tax Court. The Crown now relied on specific provisions of the Act for the GAAR analysis whereas it previously, in the Tax Court, it did not allege that any specific provision of the Act had been misused or abused, but rather that the transactions resulted in an abuse having regard to the Act as a whole.
In addition, the Crown also relied on the former subsection 245(1) which disallowed a deduction where income is "unduly or artificially” reduced. Furthermore, the Crown added that the Newco shares were not inventory but capital property.
The principal issues to be determined were as follows:
1. Can the Crown rely in this appeal on new arguments which were not raised by the Minister in assessing the taxpayer nor relied upon by the Crown in the Tax Court of Canada?
2. Do the transactions in issue result in a misuse or abuse of the provisions relied upon by the taxpayer within the meaning of subsection 245(4) of the Act?
1. Subsection 152(9) of the Act governs the right of the Minister to advance an alternative argument in support of an assessment. The Minister cannot include transactions which did not form the basis of the taxpayer's reassessment and the right of the Minister to present an alternative argument in support of an assessment is subject to paragraphs 152(9)(a) and (b), which speak to the prejudice to the taxpayer.
It was held that Global was prejudiced by two of the new arguments submitted for the first time during the appeal and that the Crown was therefore precluded from raising these arguments and these arguments must therefore be disregarded. The other arguments raised by the Crown are all legal arguments made on the basis of the existing evidentiary record and were therefore allowed.
2. The FCA held that the loss generated by Global as a result of the transactions resulted from a value shift between one of the classes of shares held by Global to another class of shares it held. This is simply a paper loss. The fundamentals of the transactions are simple: the inherent value of the common shares in Newco held by Global was moved to the preferred shares issued to Global, with the result that the common shares were left with little value but still with a high cost associated to them, while the preferred shares issued as a dividend had a high value but a low associated cost. Nothing was gained or lost, however in selling the common shares to the Children's Trust, Global technically realized a large loss on paper.
There is no air of economic or business reality associated with the loss. The appeal was allowed with respect to the GAAR issue. It was, however, held that Global be entitled to its costs in both the FCA and the Tax Court.