By Marissa L Halil LLB, BCL
A new case on the General Anti-Avoidance Rule (“GAAR”), Collins & Aikman Products Co. v. The Queen (“Collins“), was released by the Tax Court of Canada on June 3, 2009. The issue in Collins was whether the GAAR should apply to a reorganization which increased the paid-up capital (“PUC”) of shares.
The reorganization was as follows: Products (a US resident company) sold its shares in CAHL (a company resident in a non-treaty country) to a Canadian subsidiary, Holdings.1 In consideration for the CAHL shares, Holdings issued one common share to Products. The FMV of the CAHL shares at the time of the sale ($167 million) was added to the stated capital of the Holdings share held by Products. CAHL was then continued under the Canada Business Corporations Act so that it could amalgamate with its Canadian subsidiaries.2 In short, following the reorganization, Products (the US parent), owned all the shares of Holdings (the Canadian holding company), which in turn held all the shares in C&A (the Canadian amalgamated company). After dividends were paid from C&A to Holdings, Holdings distributed money to Products as a return of capital. No withholding tax was incurred on the cross-border distribution from Holdings to Products. The taxpayers had conceded that the transactions were avoidance transactions and that there had been a tax benefit. Thus, the only issue in the case was whether there had been misuse of subsection 84(4) – the provision that allows for a tax-free return of PUC.
The Minister argued that there is an evident scheme in the Act that all corporate distributions are to be taxed as income unless a provision specifically provides otherwise. According to the Minister, subsection 84(4), which allows for tax-free returns of capital on a reduction of PUC, is an exception to this general rule and should not apply where PUC has been artificially increased. Boyle J. could not find anything in the contextual scheme of the Act that would support the premise that all corporate distributions are income, and noted that earlier GAAR cases (McNichol, RMM) which stood for this very proposition were no longer being followed since Canada Trustco. Boyle J. writes:
“When considering the statutory provisions dealing with corporate distributions there is no clear need to step back from the Act altogether, begin from an unstated premise, and then treat the Act as only setting out the exceptions.” [par 62]
Thus, the Crown’s position that subsection 84(4) must be read in light of a wider scheme of the Act was rejected by the Court, as this supposed wider scheme was not anchored in the Act nor, as Boyle J. noted, was the Minister able to quote any extrinsic aids in support of this proposition.
Boyle J. then conducted a textual, contextual, and purposive analysis of subsection 84(4) and came to the unsurprising conclusion that the purpose of subsection 84(4) is: (i) to allow for tax free returns of capital invested in the corporation, and (ii) to tax any distributions in excess of the invested capital as income. Boyle J. then found that the transactions undertaken by the Collins group did not defeat or frustrate the purpose of subsection 84(4). He noted that Products could have sold the CAHL shares for cash (without incidence of Canadian tax) which cash could have then been invested in a Canadian holding company with “any imaginable tax characteristics”. The Crown’s argument – rejected by the Court – was that an abuse of subsection 84(4) resulted from the fact that no new money was invested in the shares that would justify a stated capital increase to $167 million. In response, the Court stated that:
“The Act clearly never limits itself to money transactions.(…) Money’s worth and value are not just incorporated into the income computation in the Act, but are also to be accounted for in other tax accounts such as cost and paid-up capital. The definition of “amount” in subsection 248(1) makes this abundantly clear.” [par.97]
The Court also pondered (in obiter) whether abuse may have somehow resulted from the fact that CAHL became a Canadian resident as part of the reorganization (which it did to minimize tax costs associated with having the Canadian operations held by a non-treaty resident company). However, the Crown did not argue that section 128.1 had been abused (which deals specifically with PUC adjustments when non-resident corporations become Canadian residents). Nor did the Crown argue that section 212.1 had been abused (which deals with the transfer of Canadian resident corporations by non-residents). In any event, the Court intimated that both these rules had been fully complied with. In light of the above, the Court held that subsection 84(4) had not been abused in this case.
Excerpted below are noteworthy quotes from the decision:
“Determining the purpose of the relevant provisions or portions of the Act is not to be confused with abstract views of what is right and what is wrong nor with arbitrary theories about what the law ought to be or ought to do. These latter views and theories are unhelpful in purposive and contextual statutory analysis and may even create mischief unless they are grounded in the realities of the codified legislation. The purpose of the legislated scheme should be demonstrably evident from the provisions of the Act, aided by any relevant, permissible extrinsic aids. One’s sense of right and wrong or what good tax policy should provide for or should not allow is not, for these purposes, a permissible extrinsic aid. [par.72]
This is not to say that mere paper transactions will necessarily survive a GAAR challenge. In this case, however, there were real Canadian tax consequences to the reorganization. [par. 98]
While these may be reasons that the chosen plan worked as tax-effectively as it did, none of these involved the degree of artificiality, boldness, vacuity or audacity to rise to the level of being a loophole or gimmick in common parlance, nor abusive tax avoidance using the language of the Act and the GAAR.” [par. 109]
The last two quotes raise interesting questions. For example, in the last quote, do the words “artificiality, boldness, vacuity etc…” and “loophole, gimmick” introduce a new standard for GAAR’s application? In our opinion, they do not. It is likely that Boyle J.’s only motivation in using these terms was to translate arcane legalese into “common parlance” or plain English. Moreover, the second-to-last quote (“This is not to say that mere paper transactions will necessarily survive a GAAR challenge…“) is striking. Arguably, all transactions are but “mere paper”, and any Canadian tax consequences flowing therefrom are “real” given that tax consequences in Canada are determined on the basis of “form” and not “substance” (since Shell).
Overall, Collins is a well written and well reasoned decision which represents a good win for the taxpayer.
1. Products was not taxable in Canada on the sale of its CAHL shares given that Products was a US resident and the CAHL shares were not taxable Canadian property.
2. CAHL thus became a resident of Canada at that time.