In the recent decision of Deans Knight Income Corp v Canada, 2023 SCC 16 [Deans Knight], the Supreme Court of Canada gave an expansive interpretation respecting GAAR. The decision shows a willingness by the court to have the intent of Parliament as a guiding factor in determining whether GAAR should apply.
This article was prepared with the assistance of summer law student Cole Shrimpton.
Facts: A transaction to leverage non-capital losses and other deductions
Forbes Medi-Tech Inc. was involved in a British Columbia drug research and nutritional food additive business facing cash flow problems and a possible delisting on the NASDAQ. The corporation had $90,000,000.00 in non-capital losses, scientific research and development expenditures and investment tax credits (collectively, the “Tax Attributes”). Given that the corporation was in financial difficulty, it did not have the income to offset its past losses. Rather, it sought to monetize the value of the Tax Attributes through an investment arrangement with the venture capital firm, Matco Capital Ltd. The transaction was structured to avoid triggering an acquisition of de jure control because an acquisition of control would have triggered the restriction on carrying over non-capital losses of a corporation under the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp) (the “Act”). The operating name of the corporation after the investment arrangement was Deans Knight Income Corporation.
Although the Act permits non-capital losses to be carried back three years or carried forward twenty years to offset income, it is not possible to carry over non-capital losses predating an acquisition of that corporation, unless the corporation continues the same or a similar business that incurred the losses.
After the transaction took place from 2009 to 2012, the Tax Attributes were used, allowing Deans Knight Income Corporation to reduce its tax liabilities. The Canada Revenue Agency (CRA) reassessed Deans Knight Income Corporation and denied the deductions, relying on the general anti-avoidance rule (GAAR).
History
At the tax court, the corporation’s appeal was successful. However, that judgment was overturned by the Federal Court of Appeal, which held that the transaction abused the provisions of the Act. Although the Court of Appeal accepted that no change in de jure control took place, their reasons held that “actual control” had changed hands, thus violating the intention of the Act that changes in control should restrict the utilization of losses and other tax attributes:
[93] …I conclude that the object, spirit and purpose of subsection 111(5) is, at least in part, to restrict the use of specified losses, including non-capital losses, if a person or group of persons has acquired actual control over the corporation’s actions, whether by way of de jure control or otherwise. [emphasis added]
Previously, only two concepts of control have been recognized in tax jurisprudence. The first concept, de jure or legal control, is held by the shareholder owning a majority of voting shares and representing the power to determine the composition of the board of directors. The second concept, de facto or factual control, is held by the individual who, in fact, dictates the actions of the corporation and takes steps on its behalf. “Actual control,” as conceived by the Federal Court of Appeal, is a novel and unclear concept.
Supreme Court of Canada: An expansive interpretation given to parliamentary intent respecting GAAR
Justice Rowe, writing for the seven-to-one majority, held that the transaction was abusive and that GAAR applied, denying the carryover of tax attributes into the new entity since the taxpayer sought to take advantage of the loss carryover rule contained in paragraph 111(1)(a) of the Act without triggering the restriction in subsection 111(5).
In spite of the fact that Deans Knight Income Corporation complied with the text of the Act by ensuring there was no “acquisition of control,” the central issue was whether doing so amounted to an avoidance transaction that was abusive of the provisions of the Act.
The majority held that the transactions were abusive, concluding that the spirit and purpose of subsection 111(5) of the Act was to prevent unrelated parties from being acquired by corporations in order to deduct their unused losses against income from another business for the benefit of the new shareholders:
[104] Considering the foregoing circumstances as a whole, the result obtained by the transactions clearly frustrated the rationale of s. 111(5) and therefore constituted abuse. The object, spirit and purpose of s. 111(5) is to prevent corporations from being acquired by unrelated parties in order to deduct their unused losses against income from another business for the benefit of new shareholders. The transactions achieved the very results. 111(5) seeks to prevent. Without triggering an “acquisition of control,” Matco gained the power of a majority voting shareholder and fundamentally changed the appellant’s assets, liabilities, shareholders and business. This severed the continuity that is at the heart of the object, spirit and purpose s. 111(5).
Essentially, the majority’s view was that GAAR applied because the transaction’s outcome was one that Parliament had sought to prevent, even though Parliament’s actual choice of mechanism for detecting such outcomes – de jure control – had not been triggered.
Justice Côté’s strong dissent disagreed that the transaction amounted to abusive tax avoidance within the meaning of GAAR and was of the view that this case is of profound concern to Canadian taxpayers. She noted that Parliament can also be taken as having intended to signal clearly to taxpayers that a change in de jure control is the only event that matters for the purpose of the loss restriction rules, as it elected not to go further in extending the scope of those rules. Justice Côté’s view was that the majority’s reasoning failed to strike a careful balance between the interest of the taxpayer in minimizing their taxes through technically legitimate means and the legislative interest in ensuring the integrity of the tax system is highlighted, noting Justice Binnie’s dissent in Lipson v Canada, 2009 SCC 1 that the GAAR is a weapon that can have a widespread, serious and unpredictable effect on legitimate tax planning.
Justice Côté is concerned that the majority’s reasons depart from earlier GAAR cases, extending the Act’s scope too far beyond its text. That concern is encapsulated in the following passage:
[176] My colleague concedes that Parliament has opted for de jure control. But to his mind, “more is needed than the simple fact that Parliament settled on this test to operationalize its intent” (para. 94 (emphasis in original)). He contends that “the de jure control test in s. 111(5) does not, on its own, capture the full range of situations that Parliament sought to target; rather, the test in s. 111(5) is better understood as a rough proxy that seeks to give effect to Parliament’s broader aims” (para. 96 (emphasis in original)). There is only one difficulty with this position, but it is a major one: it completely ignores how Parliament actually defined what constitutes an acquisition of control. With respect, this is wholly inconsistent with this Court’s jurisprudence on interpreting the object, spirit and purpose of a provision under the GAAR. [underlined emphasis added]
Overall, Justice Côté stated that the majority’s ad hoc approach “ignore[s] the rationale behind the de jure and de facto control tests and erode[s] the distinction between them”, by taking into account a wide array of operational factors not clearly contemplated by the legislation. Such an approach invites exercises of unbounded judicial discretion.
Going Forward
The Deans Knight decision expands the scope of GAAR and represents the Court’s willingness to grant an arguably overbroad interpretation of Parliamentary intent in determining whether GAAR should apply, even where technical compliance with the Act is achieved.
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Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.