As much of the country's attention yesterday focused on the ongoing federal
budget debate taking place on Parliament Hill, another battle was being waged
not 500 metres away, inside Canada's highest court. The Supreme Court of Canada
yesterday heard its first ever general anti-avoidance rule or GAAR cases, in
front of an unusually packed courtroom. So full, in fact, that latecomers were
forced to sit on the radiators along the walls of the viewing gallery, which was
filled to the rim.
Why all the excitement to listen to a couple of tax trials? Well, these are
no ordinary tax cases, as the GAAR is one of the most ominous, elusive and
mysterious pieces of tax legislation in the entire act. Never heard of it?
You're not alone.
The GAAR was introduced nearly 17 years ago and is neatly contained within a
few pages of the Income Tax Act. The essence of the GAAR is that if a tax
planning transaction is classified as an "avoidance transaction," the Tax act
can deny any tax benefit resulting from that transaction. What, then, is an
avoidance transaction?
An "avoidance transaction" is a transaction (or part of a series of
transactions) which results in a tax benefit unless the transaction is carried
out primarily for bona fide, non-tax purposes. A "tax benefit" includes a
reduction, avoidance or deferral of tax.
The act also goes on to state that the GAAR will not apply to a transaction
as long as the transaction does not result in the "misuse" of a provision of the
Act or an "abuse having regard to the provisions of the Act read as a whole."
The first case, involving Eugene Kaulius and several other taxpayers,
concerned a series of transactions in which accrued losses on a mortgage
portfolio were transferred from a corporation, through a partnership formed
specifically for that purpose, to several taxpayers who then claimed those
losses personally. The CRA, invoking GAAR, disallowed the deduction of the
losses, concluding that the transactions were a series of avoidance transactions
that conferred a tax benefit on the taxpayers and were "an abuse of the Income
Tax Act as a whole."
This was confirmed by both the Tax Court of Canada and the Federal Court of
Appeal.
The second case heard yesterday, involving Canada Trustco Mortgage Company,
dealt with whether Canada Trustco was entitled to claim tax depreciation on
$120-million worth of trailers that it purchased, and then leased back to the
vendor in a complex sale-leaseback arrangement.
Al Meghji, one of Canada's preeminent tax litigators from the law firm of
Osler, Hoskin and Harcourt LLP, acting for Canada Trustco, gave an analogy in
his closing argument. Let's say, Mr. Meghji argued, that he wanted to invest in
Bell Canada -- should he buy their bonds or shares?
He concludes that perhaps he should buy shares since any dividends received
will qualify for the dividend tax credit whereas interest income from the bonds
would not.
"Is this a tax-avoidance transaction?" Meghji asked the court. "Why is my
purchase of BCE shares not a misuse or abuse?" Clearly, he concluded, the
threshold must be set higher in that every day commercial transactions, such as
Canada Trustco's sale leaseback arrangement, should not be caught by the
potentially wide tax net of the GAAR.
The Court reserved its decision in both GAAR cases to a later date.