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GAAR: Keeping us off-balance?

In an episode of Corner Gas, the main character, Brent, (who is single, has no children and is 40 years old) finds himself overwhelmed by a hot-wheels-tossing 6 year old boy and besieged under a kitchen table while babysitting for a friend.  Brent enlists the help of his mother, Emma, who quickly gains control of the situation and explains her two-pronged philosophy for disciplining kids:

“Use their whole name.  They hardly ever hear all three of their names so it kind of puts them off balance [mentally].  Second, give them an open ended threat, nothing specific, that way their fertile little imaginations fill in the gap with the worst thing they can think of.  A child’s imagination is their strength and their weakness.”

To watch this portion of the episode “Oh Baby”, start at 3:38 of the linked video.

Emma’s philosophy made me think of the general anti-avoidance rule (the “GAAR”).  Until the introduction of the GAAR in 1988, one of the greater certainties in tax, while not absolute, was the Duke of Westminster principle that taxpayers may order their affairs so as to minimize the amount of tax payable.  The GAAR introduced significant uncertainty and great apprehension as to whether taxpayers could seek to minimize tax.  Initially, the GAAR was feared as a “big stick” to reign-in taxpayers and tax planners alike.  As the GAAR cases worked their way through the courts, the apprehension may have diminished, but uncertainty remained.

The decision from the Supreme Court of Canada (“Supreme Court”) in Canada Trustco Mortgage Co. v. The Queen 2005 SCC 54 provided a welcome framework in applying the GAAR and restored a measure of certainty.  Particular comfort was gleaned from the following words of the Supreme Court:

“The GAAR was enacted as a provision of last resort in order to address abusive tax avoidance, it was not intended to introduce uncertainty in tax planning.”

With the Supreme Court’s split decision in Earl Lipson v. The Queen 2009 SCC 1, many commentators have expressed concern that Lipson introduced new and improved uncertainty.  (We discussed the facts of Lipson in our January 9, 2009 blog.)  Consider the view of one dissenting judge:

“The approbation by the Court of the Minister’s resort to vague generalities or “overriding policy” would only increase the element of uncertainty in tax planning that Canada Trustco sought to avoid.”

There are fears that the “big stick” is back and even whispers of a smell test.

Lehigh

On May 17, 2010, the “certainty” of the GAAR took another twist when the Federal Court of Appeal (“Federal Court”) allowed the taxpayer’s appeal in Lehigh Cement Limited v. The Queen, 2010 FCA 124, reversing the decision of the Tax Court of Canada (the “Tax Court”).  The Tax Court had applied the GAAR to a series of transactions that resulted in the avoidance of withholding tax under subparagraph 212(1)(b)(vii) of the Income Tax Act (the “Act”), which, in general terms, exempted interest from withholding tax when paid to an arm’s length party on debt that under no circumstances was 25% of the principal required to be repaid within 5 years of the date of issue of the debt ( the “5/25 Exemption”).  Canada has since eliminated withholding tax on all arm’s length interest (other than participating interest payments).

Misuse or doubt?

The Crown’s primary argument in applying the GAAR in Lehigh was that a non-resident person is not entitled to benefit from the 5/25 Exemption where the right to receive interest is split from the right to receive the principal amount because the transaction did not result in Lehigh “accessing funds in an international capital market.”  This phrase is an excerpt from a 1975 Department of Finance budget paper that first proposed the 5/25 Exemption.

The Federal Court rejected the Crown’s invitation to conclude that entitlement to the exemption is “subject to a condition necessarily implied by the existence of a fiscal policy, evidenced only by a sentence in a 1975 budget paper that is said to explain why the exemption was enacted.”  The Federal Court emphasized:

“Most importantly, if there is any doubt as to whether the transaction in issue results in a misuse […], Lehigh is entitled to the benefit of that doubt.”

Although the reversal of Lehigh itself by the Federal Court may be viewed as contributing to the uncertainty surrounding the GAAR, the message may be broader than that.  Arguably, Lehigh restores a measure of certainty to the principle that when there is any doubt as to whether there is a misuse or abuse of the provisions of the Act when a taxpayer is arranging his or her affairs to minimize tax, the taxpayer should be entitled to the benefit of the doubt.  It also inspires confidence that, as questioned by the Supreme Court in Canada Trustco, the Federal Court is unwilling to formulate taxation policies that are not grounded in the provisions of the Act and certainly will not apply ungrounded policies to override the specific provisions of the Act.  So it would seem that certainty can be found in doubt.