Principal Issues: Position of the CRA following the TCC decision in Descarries v. The Queen, 2014 TCC 75.
Position: The CRA is still of the view that subsection 84(2) should have applied in this particular case. The CRA has also concerns with respect to the Court's analysis of subsection 245(2). The CRA will seek a decision of the Federal Court of Appeal or the Supreme Court of Canada on whether or not there is a specific scheme under the Act for taxing any direct distribution of surplus of a Canadian corporation as a taxable dividend in the hands of individual shareholders and a specific scheme under the Act against indirect surplus stripping.
Reasons: According to the relevant jurisprudence.
FEDERAL TAXATION ROUNDTABLE 10 OCTOBER 2014
2014 APFF CONFERENCE
Question 21
Descarries Judgment
In Descarries v. The Queen (footnote 1), the Tax Court of Canada (the "TCC") found that the general anti-avoidance rule (hereinafter "GAAR") applied to the transactions in question because of an abuse of the object and spirit of section 84.1. The TCC also reduced the amount of the deemed dividend provided in the CRA's assessment on the basis that if the transactions had been implemented in such a way that section 84.1 applied (i.e., if avoidance transactions had not been put in place), the taxpayers would have been entitled to access an amount of paid-up capital (hereinafter "PUC") that was $66,940 greater than the amount used by CRA in its calculation of the deemed dividend. The amount of the deemed dividend was reduced accordingly.
Question to the CRA
What is the CRA’s position respecting this decision?
CRA response
It should first be pointed out that the TCC decision in Descarries was favorable to the CRA, and was rendered under the informal procedure. This judgment is therefore of limited jurisprudential value. The CRA did not appeal this TCC ruling for this reason, despite the fact that the CRA disagrees with the reasoning adopted by the TCC in arriving at its findings.
Briefly, the issue in Descarries was whether subsection 84(2) applied to the appellants deemed to have received a dividend from Oka Incorporated (hereinafter "Oka") as a result of transactions related to the winding-up, discontinuance or reorganization of its business. Alternatively, the question was whether the GAAR applied in that case.
In general terms, in this case the individual shareholders of Oka, after the latter liquidated approximately 93% of its business assets in December 2004 and was in the course of liquidating the remainder of its assets, engaged in three avoidance transactions (hereinafter referred to as the "Three Avoidance Transactions") to appropriate the surplus of Oka.
First, on March 1, 2005, there was an internal rollover of their shares in the capital stock of Oka in order to crystallize in the adjusted cost base ("ACB") of new shares, the excess of the fair market value ("FMV") of the transferred shares over their ACB, thereby realizing a capital gain in respect of which the capital gains deduction in section 110.6 was not claimed.
The second transaction, effected on March 15, 2005, was to roll those new shares in the capital stock of Oka to a new corporation (9149-7321 Quebec Inc., hereafter « Quebec Inc. ») in exchange for shares of two classes in the capital of Quebec Inc.: the first class of shares having a low PUC and an ACB equal to their FMV (the "1971 FMV Shares") and the second class of shares having a high PUC (which was the purpose of the second transaction) and a high ACB equal to their FMV (the "Stripping Shares").
The third transaction was to redeem for cash on March 29, 2005 all of the Stripping Shares, and part of the 1971 FMV Shares, so as to generate a capital loss sufficient to eliminate the capital gain generated in the first transaction.
The CRA continues of the view that ITA subsection 84(2) should have applied in this case especially by reason of the recent decision of the Federal Court of Appeal in MacDonald (footnote 2). Furthermore, the CRA is concerned by the approach adopted by the TCC respecting the analysis of the avoidance transactions for purposes of the application of subsection 245(2).
Our concerns are as follows.
A. Re the application of subsection 84(2)
1. With respect, we are of the view that the TCC should have given preference to a textual, contextual and purposive interpretation of subsection 84(2) rather than a literal interpretation.
2. The TCC, relying on Merritt v. MNR (Footnote 3), MacDonald v. The Queen (footnote 4), and McNichol v. The Queen (footnote 5) is of the view that there was no distribution of the assets of Oka when the shares in the capital stock of Québec Inc. were repurchased in March 2005. According to the TCC, Oka's assets represented by the promissory note from Québec Inc. in consideration for the transfer of its cash of $544,354 were reduced only in December 2006 upon the adoption of resolutions with a view to its liquidation and winding-up (footnote 6).
First, the TCC found in its analysis that the assets of Oka were not reduced at the time of the redemption of the shares in the capital stock of Québec Inc. in favour of its shareholders. However, it seems to us that after giving effect to this redemption, the FMV, on a consolidated basis, of Québec Inc. and Oka was only about $70,000, despite the fact that the $544,354 note could appear as an asset of Oka.
Thus, it seems to us that it could be argued that Oka was impoverished in March 2005 at the time of the redemption by Québec Inc. of the shares in its capital stock given that the latter was no longer in a position to repay the note owed to Oka.
Furthermore, it emerges from the jurisprudence (footnote 7) that the words "distributed or otherwise appropriated in any way (footnote 8) ... on the winding-up, discontinuance or reorganization of its business" in subsection 84(2) have been accorded, in the majority of cases, a broad scope extending to both direct distributions and indirect distributions to shareholders of a corporation. Thus, the amount of the funds transferred to the appellants by Quebec Inc. ($544,354) on the redemption in March 2005 of Class "A" and "B" shares in its capital stock, corresponded closely in dollars to the advance which was made to it by Oka on December 1, 2004. To paraphrase Bowman JA's reasons in RMM (footnote 9), it seems to us that the funds in the shareholders’ hands were actually the funds of Oka, notwithstanding the interposition of Quebec Inc. (footnote 10)
3. The TCC was of the view that, for subsection 84(2) to apply, the distribution of the corporation's funds must be concurrent with the winding-up, discontinuance or reorganization of the corporation (footnote 11). In this case, the distribution took place in March 2005 while Oka, according to the TCC, continued to carry on its business until December 2006.
However, it appears that the word "on" [“lors”] used in the phrase "on the winding up, discontinuance or reorganization of its business" in subsection 84(2) should not, in our view, receive such a restrictive interpretation. Indeed, the Federal Court of Appeal in MacDonald noted that the winding-up of a corporation's operations is a process (footnote 12). In addition, the word "on" (footnote 13) used in this phrase was broadly interpreted by the courts to include distributions made throughout the winding-up (footnote 14). In Conrad David v. The Queen (footnote 15), a period of five months had elapsed between the cessation of business and the distribution. In interpreting subsection 81(1), the predecessor of subsection 84(2), the Court stated that the word "on" in the English version of that subsection could potentially mean "as a result of" or "consequential to."
4. Finally, in its analysis of the application of subsection 84(2), the TCC raised thee interesting question as to whether there is a conflict between the application of this provision and subsection 84(3 ). The TCC arrived at the following conclusion:
I do not think that subsections 84(2) and 84(3) of the Act may be applied at the same time to the same distributions. Only applying the GAAR can change the tax consequences of the series of transactions that the redemption of the 9149 shares fits into (footnote 16).
In practice, however, in a situation such as this, the CRA generally applies the provisions of paragraph 248(28)(a) to avoid the same amount being included more than once in computing a taxpayer's income for a taxation year. In this regard, it appears that the total net dividend subject to reassessment under subsection 84(2), in this case, amounted to only approximately $333,000 as the appellants had already taxed themselves on a deemed dividend under subsection 84(3) un the redemption of the preferred shares in the capital stock of Québec Inc.
B. Re the application of subsection 245(4)
Respecting the application of subsection 245(4), that is, respecting an analysis of the abusive character of avoidance transactions in the particular situation for the purposes of subsection 245(2), our concerns are as follows.
1. Although the Crown detailed the provisions of the ITA supporting the tax policy of taxing the surplus of a private corporation as taxable dividends in the hands of its shareholders who are individuals (hereinafter the "Integration Rules"), the TCC did not comment with regard to those arguments.
It appears to us that the TCC instead restricted the scope of its analysis of the abuse of the ITA, read as a whole, by stating that the transactions in issue were not abusive in that they did not frustrate the object and spirit of subsection 84(2). The TCC did not summarize the Crown's arguments, but merely noted that, in its view, they were essentially the same as those advanced in MacDonald, without further analysis or comment. The TCC restricted itself to quoting certain passages from the reasons of the trial judge in the MacDonald case, namely, paras. 63-69 and 128 (which, in our view, are irrelevant because the decision of the TCC respecting the application of subsection 84(2) was reversed in the Federal Court of Appeal) to conclude, with respect to its analysis of the abuse of the ITA for the purposes of subsection 245(4), that it concurred in its findings.
2. In deciding the question of the abuse of the ITA read as a whole, the TCC preferred to rely on the position stated in Gwartz v. The Queen (footnote 17), to the effect that:
…the Act does not contain any general prohibition stating that any distribution by a company must be done in the form of a dividend. However, I also specified in that case that, although the taxpayers may arrange to distribute surpluses in the form of dividends or of capital gains, that option is not limitless. Any tax planning done for that purpose must comply with the specific anti-avoidance provisions found in sections 84.1 and 212.1 of the Act.
The Tax Court in its analysis of abuse of the provisions of the ITA read as a whole for purposes of determining whether the avoidance transactions were abusive in that case, limited its analysis to two provisions: subsection 84(2) and section 84.1. It even described sections 84.1 and 212.1 as being the sole anti-avoidance provisions applicable to surplus stripping,
With all due respect, it appears to us that paragraph 82(1)(b), section 121 and subsections 84(1), as well as subsections 84(2), 84(3), 84(4) and 15(1) should be taken into account in this analysis, which support a tax policy whose purpose is to tax exclusively in the form of dividends the surplus of a corporation which is paid directly to individual shareholders.
These provisions reflect, in our view, a clear and unambiguous tax policy on the part of the Department of Finance, commonly referred to as the Integration Rules, which is also supported by a wide range of other provisions (among others, section 84.1 as well as subsections 84(2), 246(1) and 245(2), and taking into account former subsection 247 (1), and in particular the Explanatory Notes of the Department of Finance respecting that subsection), whose purpose is to prevent individual shareholders from indirectly accessing the surplus of a corporation otherwise than as a dividend. In short, in a situation such as in the Descarries case, the three avoidance transactions, in our view, would constitute an abuse of the Integration Rules.
3. We also are concerned by the specificity of the principle proposed by the TCC to the effect that in carrying out the three avoidance operations, subsection 84.1(1) could be utilized to distribute surplus of a corporation in the form of a capital gain to the extent that that the capital gain was not reduced by a capital loss which was sustained from the disposition of shares whose ACB was derived from the FMV of those shares on valuation day (December 22, 1971). In so doing, it appears to us that the TCC, in its analysis of the application of subsection 245(4) effectively modified the nature of the "tax benefit" that was otherwise conceded by the appellants, which consisted in a reduction of tax resulting from a transformation of part of a deemed dividend under subsection 84(2) into a capital gain.
With all due respect, we suggest that the principle thus adopted by the TCC was not based on a textual, contextual and purposive interpretation of the provisions of the ITA and appears to us to be contrary to the tax policy under the Integration Rules.
Section 84.1 is not an elective provision and does not contain any conditions relating to the computation of a taxpayer's income (whether or not a capital loss is deducted) to determining the application of paragraph 84.1(1)(b).
C. Conclusion
In light of the above and the unfavorable findings of the TCC respecting the analysis of subsections 84(2) and 245(2) in cases involving surplus stripping, the CRA is of the view that it is necessary, while being respectful of the position taken by the TCC, to address this before the Federal Court of Appeal or the Supreme Court of Canada, so that a higher court, for its part, can confirm the very broad scope of subsection 84(2) recently established by the Federal Court of Appeal in MacDonald (footnote 18) and, also, whether or not there is a specific scheme under the Act for taxing any direct distribution of surplus of a Canadian corporation as taxable dividends in the hands of individual shareholders, as well as a specific scheme under the Act against indirect surplus stripping.
Jean Lafrenière
(613) 941-2956
October 10, 2014
2014-053809
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 2014, TCC 75 (hereafter « Descarries »).
2 2013 FCA 110 (hereafter « MacDonald »).
3 [1941] Ex. C.R. 175 (hereafter « Merritt »).
4 Supra, note 2.
5 97 DTC 111 (TCC), (hereafter « McNichol »).
6 Descarries, supra, note 1, in paragraph 28.
7 See, among others, the decisions in MacDonald, supra, note 2, Merritt, supra note 3 and Smythe v. MNR, [1970] SCC 64.
8 In English: in any manner whatever.
9 RMM Canadian Enterprises Inc. et al. v. The Queen, 97 DTC 302 (TCC).
10 Ibid., at page 308.
11 Descarries, supra, note 1, at paragraph 29.
12 MacDonald, supra note 2, at paragraph 28.
13 In English: on.
14 See in this regard Emma MacLaren v.. MNR, 1 DTC 246 (Ex.CC.), Lilian V. Gilmour v. The Queen, 81 DTC 5322 (FCTD).
15 75 DTC 5136 (FCTD).
16 Descarries, supra, note 1, at paragraph 37.
17 2013 TCC 86.
18 Supra, note 2.