The non-capital losses of $90M, and other tax attributes (the “Tax Attributes”) of the taxpayer, were effectively sold to arm’s length investors pursuant to transactions under which:
- The existing shareholders of the taxpayer exchanged their shares for shares of a “Newco” under a Plan of Arrangement
- A venture capital company facilitator (Matco) entered into an “Investment Agreement” with the taxpayer and Newco pursuant to which Matco (principally in consideration for $3M in cash) acquired a debenture of the taxpayer that was convertible into shares representing 79% of its equity shares but only 35% of its voting shares.
- The taxpayer then transferred its assets (including the proceeds of issuing the debenture) and its liabilities to Newco.
- Matco then identified a mutual fund management company which wanted to effect a public offering of shares of the taxpayer and use the proceeds (of $100M) for a new bond trading business to be carried on in the taxpayer.
- The subscription price for the newly-issued common shares under this offering caused the securities of the taxpayer held by Newco and Matco to appreciate which, in the case of Matco, effectively was its fee.
Rowe J noted that in determining whether s. 245(4) applied on the basis of an abuse of s. 111(5), the Court’s goal was “to discern the underlying rationale of the provision” (para. 65) and that it must then be determined “whether the result of the particular series of transactions at issue is inconsistent with the rationale underlying s. 111(5)” (para. 120), and also indicated that s. 111(5) addresses where “the identity of those behind the corporation has changed” and “functions so that the tax benefits associated with those losses will not benefit a new shareholder base carrying on a new business” (para. 88).
In finding that the transactions did not accord with the rationale of s. 111(5), Rowe J stated (at paras. 124, 126, 128):
[T]he appellant was gutted of any vestiges from its prior corporate “life” and became an empty vessel with Tax Attributes. …
Moreover, the shareholder base of the taxpayer underwent a fundamental shift throughout the transactions … .
Matco achieved the functional equivalent of … an acquisition of [de jure] control through the Investment Agreement, while circumventing s. 111(5), because it used separate transactions to dismember the rights and benefits that would normally flow from being a controlling shareholder.
In this regard, he noted that “Matco contracted for the ability to select the corporation’s directors” (para. 129), “the Investment Agreement in effect placed severe restrictions on the powers of the board of directors” (para. 131) and the “restrictions in favour of Matco resemble[d] the fettering of discretion that would normally occur through a unanimous shareholder agreement and which would lead to an acquisition of de jure control” and the only reason it was not a USA was a “circuit-breaker transaction” pursuant to which a director of Matco purchased 100 shares through a holding company which was not a party to the agreement (para. 132).
Use of the Tax Attributes was properly denied pursuant to s. 245(2).