Litigation – Corporate Tax
Corporate tax litigation involves disputes engaging tax planning for high net worth individuals; individual types of tax such as HST, income and withholding tax; taxation of commercial transactions; corporate structures, reorganizations, and financing; taxation of particular industries; and international tax matters such as transfer pricing.
When it comes to the general anti-avoidance rule in the Income Tax Act, the Supreme Court of Canada is akin to a fractious clubhouse in the sports world: in the end, the team's fans are the ones who suffer. So it is with Canada's taxpayers, who have been in a state of uncertainty since the provision's enactment in 1988 about what GAAR, found in s. 245 of the ITA, actually means.
Hope springs eternal. So when the SCC agreed to revisit GAAR by granting leave to appeal in Copthorne Holdings v. The Queen, tax lawyers united in a collective hope that the court could add some certainty to the issues by reconciling its earlier opinions.
The essence of GAAR is that the government can attack transactions that are otherwise in accordance with the law if the transaction “abuses” the policies underlying the ITA. Needless to say, there are no bright lines. When it comes to the thin strip between non-abusive avoidance and abusive evasion, abuse is in the eyes of the beholder — even, it appears, when the beholder is Canada's highest court.
It took 18 years before the SCC dealt with its first GAAR cases. In 2005, the court released its companion decisions in Canada Trustco Mortgage v. The Queen and Mathew v. The Queen. Although the results were mixed – the taxpayer won in Canada Trustco and lost in Mathew – the cumulative reasoning of the unanimous court provided what appeared to be a consistent and definitive interpretative guide. The rulings established that a tax structure that was technically sound because it complied with a literal reading of the ITA would fall to GAAR if it frustrated the policy behind the rules.
While that guide provided no bright-line answer as to what and what does not offend GAAR, it offered useful guidance for advisors analyzing a specific proposal.
To be sure, no one thought that giving GAAR opinions would be simple going forward. And it wasn't.
In the ensuing years, lower courts' interpretations of GAAR turned out to be irreconcilable.
So in 2009, just four years after it decided Canada Trustco, the SCC decided to try again, this time in Lipson v. The Queen. The 4-3 result emanating from a badly divided court featured no less than three strong differing opinions.
Make no mistake about it: this wasn't a division on fine technical points. It was a dissembling of what appeared to be the unified philosophical approach to GAAR evidenced in Canada Trustco by at least two widely diverging points of view that were difficult, if not impossible, to reconcile.
Indeed, some tax professionals complained that the majority's opinion, which gave lip service to Canada Trustco but added an element requiring courts to look at the “overall results,” amounted to little more than a “smell test.” Critics also groused that tax planning based on GAAR now bore a startling resemblance to a crapshoot.
The specific issues in Copthorne were whether surplus-stripping is abusive tax avoidance; whether the transactions in question were sufficiently connected to form a “series” that could be subject to attack under GAAR; and whether GAAR could be applied to transactions authorized under corporate law statutes.
Because it addressed corporate reorganizations and planning that involve choices made by taxpayers regarding the distribution of paid-up capital, Copthorne was bound to have significant impact. The concept of paid-up capital is important for Canadian tax purposes because Canada permits corporations to return capital to shareholders – even if they have accumulated earnings and profits for tax purposes – without payment of Canadian non-resident withholding tax.
As it turned out, the Supreme Court of Canada decided Copthorne in favour of the government. While there's generally not much cheer for taxpayers in a 9-0 decision in favor of the Canada Revenue Agency, Copthorne is an exception. To begin with, commentators have been quick to laud the Copthorne court's unanimity in articulating a cautionary approach to GAAR, and the “clarity and precision” of the reasons written by Justice Marshall Rothstein and adopted by the entire court. For despite the ruling against the taxpayer on the specific facts of the case, the message that the Court sent to the business community was that no general principle against corporate reorganization existed and that GAAR was properly invoked only when a reorganization is primarily for tax purposes.
The Court also concluded that GAAR is a provision of last resort, that the Crown must clearly demonstrate abuse of the ITA, and that whether or not GAAR applies is not to be determined by a smell test based on subjective ideas of right and wrong.Copthorne involved a non-resident taxpayer who made a $96-million capital contribution to a Canadian holding company and then organized a series of transactions in an attempt to withdraw $142 million free of withholding tax. On these facts, the Court came to the understandable conclusion that GAAR precluded a tax-free return of capital greater than the total of the capital contribution.