The taxpayers were private companies controlled by a resident individual (Grenon), whose RRSP held 58% of the units of a publicly traded income fund (“FMO”). They engaged in a series of transactions that were intended to result in the realization by them of substantial capital gains (resulting in additions to their capital dividend accounts (CDAs), that were immediately distributed by them), followed by the realization of largely offsetting capital losses later that day.
In very general terms, the following steps were significant elements of the series of transactions:
- Grenon’s RRSP transferred its units of FMO to a newly-formed unit trust (“TOM”) in exchange for units of TOM representing close to 100% of the issued and outstanding TOM units.
- The taxpayers acquired such FMO units from TOM in consideration for issuing $161M in promissory notes.
- The public transferred their units of FMO (the “public FMO units”) to a new unit trust (“FIF”), that was intended to be the replacement public vehicle for FMO, in exchange for units of New FIF.
- The taxpayers acquired the public FMO units for $115M in promissory notes.
- FMO realizing $226M in capital gains on one of the internal steps.
- After various steps to clean up the structure, FMO distributed essentially all its assets (being some FIF units and promissory notes) to the taxpayers, and treating this as a distribution of the capital gains realized by it in 5 above.
- The units of FMO were repurchased by FMO for nominal consideration. The appellants had full (FMV) cost for their FMO units when acquired in steps 2 and 4, and the capital gains distribution in step 6 did not reduce the ACB of their units by virtue of s. 53(2)(h)(i.1)(A) and (B)(I). Accordingly, such repurchases resulted in the realization of largely offsetting capital losses (and, in light of the distribution of the increase to their CDAs arising in step 6, also resulted in negative CDAs.)
In finding that there was a tax benefit, Monaghan JA stated (at para. 188):
Undoubtedly avoiding or reducing Part III tax is a perfectly acceptable tax benefit in many circumstances, but it nonetheless is a tax benefit.
Furthermore, the transactions could have accomplished their professed objectives without the taxpayers’ involvement (i.e., acquiring the FMO units at a high cost in steps 2 and 4, being allocated a capital gain by FMO in step 6 so as to generate a CDA increase which could then be distributed, and having their high cost FMO units redeemed in Step 7 so as to generate a capital loss to offset the capital gain in step 6) and “the only purpose for the appellants’ participation in the series of transactions was to pay capital dividends to their parent corporations and to avoid Part III tax in doing so” (para. 202) – and there accordingly was an avoidance transaction.
Finally, it was improper for the Tax Court to state that the taxpayers were not entitled to rely on elections made pursuant to s. 184(3) to convert the capital dividends into taxable dividends, as this issue was not before it.