Copthorne Holdings Ltd. v. Canada, 2011 SCC 63 (CanLII) is a recent decision from the Supreme Court of Canada regarding the general anti-avoidance rule (“GAAR”)1 and provides the much-anticipated interpretation and confirmation of these rules. While the “main event” was whether the transactions undertaken by the taxpayer resulted in abusive tax avoidance to which the GAAR applies, this blog focuses on the Court’s analysis of the meaning of “series of transactions”. The “series of transactions” concept was critical to the outcome of this appeal. The Court provided guidance on how past, present and future transactions are “contemplated”, thereby confirming the framework by which a “series of transactions” would be identified for the application of the GAAR.
The case facts are exceedingly complex, but for purposes of this blog can be briefly summarized as follows: a Canadian corporation (“Holdco”) sold shares of its subsidiary (“Subco”) to its non-resident parent, thereby creating a sister company relationship between Holdco and Subco. This transaction created the opportunity for a horizontal amalgamation to occur between Holdco and Subco (“Amalco”), versus what would otherwise have been accomplished by way of a vertical amalgamation. What appears to have offended the Minister is that the taxpayer ultimately ended up with the same “structure”, i.e. non-resident parent owning an amalgamated corporation, however the horizontal amalgamation allowed the taxpayer to preserve $67 million of paid-up capital (“PUC”) of the issued shares of Subco, compared to a vertical amalgamation where the PUC would have otherwise disappeared.2 The significance of preserving (or, in the Crown’s view, “duplicating”) the $67 million of PUC is that it was later returned to the parent on a tax-free basis on a share redemption, thereby escaping the application of Canadian withholding tax. The Supreme Court of Canada affirmed the lower Courts’ decision, applying the GAAR to deny the tax benefits resulting from the series of transactions, which was found to include the sale of Subco, amalgamation of Holdco and Subco, and share repurchase by Amalco.
The definition of “series of transactions”3 includes transactions “completed in contemplation of the series”. The contentious question answered by the Court is whether an offending transaction has to be contemplated prospectively, i.e. the offending transaction is known at the time of a particular transaction, or is it possible to contemplate the offending transaction retrospectively, i.e. whether it is sufficient to connect an offending transaction to a transaction that occurred in the past. In Copthorne, did the taxpayer have to know at the time of the share sale that they were going to undergo a future share repurchase, or is it sufficient to create “a series of transactions” where the offending transaction was executed because the prior sale was contemplated?
In its analysis, the Court noted in the CRA’s 1988 Roundtable it was said that a “series of transactions” is to be applied prospectively, not retrospectively. The Court also cited academic commentary4 suggesting the “series of transactions” test should be applied prospectively, and even agreed that the more common sense use of the term “contemplation” is prospective.
Nevertheless, in upholding both lower Courts’ analyses, the Court decided that contemplation of a series may include retrospective contemplation. The main rationale seemed to be a reference to the Court’s earlier GAAR decision in Canada Trustco, in which the Court commented that the definition of “series of transactions” in subsection 248(10) included both prospective and retrospective contemplation. The Court was loathe to reverse its relatively recent decision in Canada Trustco. Interestingly, however, nothing in the Canada Trustco case turned on whether a series of transactions could include retrospective contemplation. Further, in its analysis, the Supreme Court stated that the text and context of subsection 248(10) leave open when the contemplation of the series must take place, i.e. the provision allows for either prospective or retrospective connection of a related transaction to a common law series.
Before the Court’s decision in Copthorne, some commentators expressed that if a retrospective contemplation is permitted, it is all too easy to find that when a later transaction is completed, earlier transactions were known and taken into account.5 Indeed, hindsight is 20/20. Irrespective of whether the result in Copthorne is equitable, it seems unfair to taxpayers to allow the Crown to argue with 20/20 hindsight that an earlier transaction was contemplated when the later transaction was completed, and therefore the later transaction was an avoidance transaction as being part of the same series.
The only common law saving “test” from a transaction being considered part of a “series of transactions” is that the transaction requires more than a “mere possibility” or connection with “an extreme degree of remoteness” with the other transactions. However as the Court demonstrated, these hurdles were easily met by the Minister in this case notwithstanding that two years had passed between transactions, and that the rationale for the sale transaction was because proposed changes to the foreign accrual property income rules were imminent. The Court clarified that a “strong nexus” is not required to connect transactions into a series as proposed by the Tax Court, and by the result of this case, establishing a nexus was not onerous.
The potential ramifications of this “reverse contemplation” principle extend well beyond the GAAR, because several other provisions of the Act contain a series of transactions test. One common example is in subsection 55(2). We sometimes recommend clients complete a “butterfly” reorganization to “purify” a corporation by transferring assets from an operating corporation (an “Opco”) to another corporation on a tax-deferred basis. The reasons for completing a butterfly/purification reorganization may include putting shareholders in a position to claim the $750,000 capital gains deduction in the event Opco shares are sold in the future. However, a butterfly reorganization is only tax-deferred if it is not part of a series of transactions that includes a sale of shares. As such, if clients are contemplating a specific sale, we would typically advise that a butterfly should not be completed because the sale could be part of the same series of transactions as the butterfly, and consequently, the anti-avoidance rule in subsection 55(2) would apply to trigger a taxable capital gain.
If a specific sale is not contemplated, or if the owners were not marketing Opco (and assuming a number of other conditions are satisfied) a butterfly reorganization may be completed – or so we had thought, prior to Copthorne. The problem is that now the CRA could arguably apply the “retrospective contemplation” analysis and take the position that the subsequent sale was completed in contemplation of the earlier butterfly transaction!
This result would be unfortunate, and we believe would not be consistent with the tax policy in the Act. We hope the CRA may administratively clarify that it would not apply the series of transactions test retrospectively other than in the GAAR context. In any event, taxpayers should be cautious when undertaking transactions that involve provisions of the Act that contain the “series” test, particularly where anti-avoidance rules are concerned.
1. Section 245 of the Income Tax Act RSC 1985, c.1 (5th Supp.), as amended and proposed to be amended, and including the regulations promulgated thereunder (the “Act”). Unless otherwise stated, statutory references in this blog are to the Act. No assurance can be given that proposed amendments to the Act will be enacted in the form proposed or at all.
2. See subsection 87(3) of the Act.
3. See subsection 248(10) of the Act.
4. D.G. Duff, “The Supreme Court of Canada and the General Anti-Avoidance Rule: Canada Trustco and Mathew” in David D. Duff and Harry Erlichmann, eds., “Tax Avoidance in Canada after Canada Trustco and Mathew, (Toronto: Irwin Law, 2007,1).
5. Michael Kandev et al, “The Meaning of Series of Transactions” as Disclosed by a Unified Textual, Contextual, and Purposive Analysis” (2010) vol. no. 58, no. 2, Canadian Tax Journal 277.