In December 2009, individual taxpayers participated in a tax shelter that involved making both a leveraged investment (the "LP Program") and leveraged donation. In the lP Program, they used money borrowed from a lender trust (FT) (the "Unit Loans") to purchase units in an Ontario LP, which used most of the proceeds to purchase notes of a BVI company (Leeward). The return on the notes was linked to whichever of a stock market index and a notional balanced portfolio performed the better, with Leeward then lending the funds back to FT via a second trust.
Respecting the leveraged donation, they borrowed money from FT (under the TGTFC Loans") at 7.85% p.a. – of which 3.75% of p.a. was required to be paid annually in cash (“cash-pay interest”) and with the balance was capitalized each year (“capitalized interest”). This borrowed cash was then contributed by them to a registered charity ("TGTFC") on condition that TGTFC invest most of such proceeds in a note of Leeward, that matured in 2028, and bore interest of 4.75%, of which 3.75% was cash-pay interest, and the balance capitalized interest of 1% (which would cause the amount owing under the note to accrete by over 1/3 by 2028). These funds also were mostly circled back to FT. The ability of Leeward to be able to repay this note owing to the charity depended on the small portion of the funds received by it from the individuals (via the LP) under the investment component, that it invested in a fully-indexed note rather than on-lending back to FT via the second trust, appreciating at a rate of 10% p.a. over the close to 20 years until 2028.
After finding that their donation did not qualify as a “gift” under common law principles given that the interest rate of 7.85% that was charged to them by FT was less than a reasonable rate of interest, Owen J went on to find that bona fide arrangements had not been made for repayment of the loan from FT (which had a term of 9.3 years) as required by ss. 248(32)(b) and 143.2(7)(a). He stated (at para. 345):
[T]he phrase bona fide speaks to the fundamental character of the arrangements and requires that the arrangements reflect what one would reasonably expect arm’s length commercial relations to look like in the circumstances. …
After noting that the taxpayers had not disclosed their debts incurred from their previous participation in tax shelters, he stated (at paras. 352-4):
In my view, a borrower’s unilateral determination that a significant liability need not be disclosed on a loan application coupled with the failure of FT to insist on full disclosure is strong evidence of an absence of the sort of good faith and genuineness contemplated by paragraph 143.2(7).
I have already commented on the shortcomings of the ULAA Forms, the generalized information provided to FT by those forms, the failure of FT to require documentation to support the information provided on the forms and the failure of FT to perform thorough credit checks on all the Participants prior to closing and at the time of each additional advance. All of these factors point away from the arrangements regarding the Program Loans being bona fide arrangements… .
I also draw a negative inference … from ... no one from FT testif[ying] regarding the borrowing arrangements with the Participants.
In finding that the Unit Loans were not also limited-recourse debt reasonably "relating to" the gifts by the taxpayers to TGTFC, Own J stated (at para. 359):
It is true that the existence of the LP Program may indirectly support the TGTFC Program by ostensibly placing more assets in Leeward than would be the case if only the TGTFC Program existed and by allowing the LP Units to be given as security for the TGTFC Loans. However, in my view, that remote a connection is not sufficient for one to conclude that the Unit Loans can reasonably be considered to relate to the gifts made by the Appellants to TGTFC.