Tax planning implications
GAAR analysis


In Copthorne(1) the Supreme Court of Canada addressed anticipatory tax planning under the general-anti avoidance rule (GAAR). In this case, an additional step was added to a transaction that prevented paid-up capital from being eliminated. One year later, this planning allowed for a tax-free return of capital, in the form of a share redemption, in an amount that exceeded the amount of tax-paid capital originally invested.

Without the anticipatory planning, the redemption would have given rise to C$9 million in tax. The minister of national revenue reassessed the taxpayer by applying GAAR to impose tax as though the preserved paid-up capital was eliminated. The minister's reassessment was upheld by both the Tax Court of Canada and the Federal Court of Appeal. The taxpayer's further appeal to the Supreme Court was unanimously dismissed in a judgment penned by Justice Rothstein.

Tax planning implications

Taxpayers and advisers should be aware of the following implications of Copthorne on tax planning in Canada.

GAAR test is clear
The Supreme Court reaffirmed the test to be met before GAAR can apply:

  • A tax benefit must exist, often identified by comparison to an alternative transaction with a different tax result;
  • An avoidance transaction must exist, in the sense of a transaction (or single step within a transaction) that results in, and is undertaken to achieve, the tax benefit; and
  • After establishing the "object, spirit or purpose" of the relevant provisions, the minister must clearly establish that the transaction abused the object, spirit or purpose of at least one provision.

GAAR test is objective
The Supreme Court reiterated that GAAR is not a "moral opprobrium"; GAAR does not allow the minister simply to recharacterise transactions that he dislikes. Taxpayers are entitled to plan to reduce tax, subject to GAAR, which can be applied only through "an objective, thorough and step-by-step analysis". The court must go behind the words of the provisions at issue to understand their purpose. Once the purpose is carefully determined, the court can assess whether such purpose was clearly abused. In Copthorne the Supreme Court devoted more than one-third of its lengthy analysis to a consideration of the purpose of the provisions at issue.

Threshold to be part of series of transactions is low
GAAR could apply in Copthorne only if the avoidance transaction (which prevented paid-up capital from being eliminated) and the tax benefit (arising from the share redemption) were part of the same 'series of transactions'. This phrase is statutorily defined to deem any transaction that is "in contemplation of" a series to be part of that series. The Supreme Court held that this can be read both on a forward-looking basis and retrospectively. The court did not overturn the trial judge's decision that the redemption was completed in contemplation of the already completed paid-up capital preservation transaction. As such, both transactions were part of the same series. Whether a transaction is in contemplation of a series is a fact-specific analysis; factors to consider include the timeline of events and whether intervening events exist.

Appellate courts will defer to trial judge on factual matters
The trial judge in Copthorne found as a fact that there was a "strong nexus" between the anticipatory planning to preserve paid-up capital and the redemption. This factual finding made it easier for the Supreme Court to conclude that the anticipatory planning and redemption were part of the same series. The court would not overturn this factual finding unless there was a "palpable and overriding error". When a trial judge reaches a conclusion on a factual matter, such as the degree of connection between separate transactions, it is difficult to overturn such conclusion on appeal. Accordingly, success at trial is critical. Notably, the court has now heard four GAAR cases and in each case it has upheld the Federal Court of Appeal decision, which in turn upheld the Tax Court of Canada decision.


Corporate group
In the tax years under review, Li Ka-Shing and his son Victor Li controlled a group of Canadian and non-resident companies that included VHHC Investments Ltd, VHHC Holdings Ltd and Copthorne Holdings Ltd.

VHHC Investments received C$97 million in after-tax funds, resulting in paid-up capital of C$97 million in the shares of Investments.(2)

VHHC Investments paid C$67 million to acquire VHHC Holdings, resulting in paid-up capital of C$67 million in connection with the VHHC Holdings shares. The combined paid-up capital of the parent and subsidiary exceeded the actual amount of tax-paid funds invested, which occurs in many circumstances where a parent corporation invests in a subsidiary.

Internal restructuring (1991-1994)
Over time, VHHC Holdings had accrued capital losses and Copthorne had realised taxable capital gains. In order to apply VHHC Holdings' accrued losses against Copthorne's gains, Copthorne acquired VHHC Holdings in 1991 and the underlying assets were sold to an arm's-length party to recognise the losses.

In 1993 it was decided that Copthorne and its subsidiary VHHC Holdings would amalgamate. It was recognised that without any other step, the paid-up capital in connection with the VHHC Holdings shares would be eliminated on amalgamation.(3)

To avoid this elimination of paid-up capital, Copthorne first sold the VHHC Holdings shares to another related corporation such that, at the time of the amalgamation, Copthorne and VHHC Holdings were sister corporations. This anticipatory planning changed the vertical amalgamation into a horizontal amalgamation of sister corporations, resulting in a combination rather than an elimination of paid-up capital.

On January 1 1994 the amalgamation was carried out (forming Copthorne II) and the paid-up capital of the Copthorne II shares was C$67 million, all of which arose from the paid-up capital associated with the VHHC Holdings shares.(4) But for the anticipatory planning, the paid-up capital of the Copthorne II shares would have been C$1.

Restructuring and share redemption (1994-1995)
In June 1994 amendments to the foreign accrual property income rules in the Income Tax Act prompted further reorganisations within the related group of companies.

Subsequently, in 1994 LF Investments (Barbados) Ltd acquired all issued shares of Copthorne II (paid-up capital of C$67 million) and VHHC Investments (paid-up capital of C$97 million). The paid-up capital of both corporations arose from the same initial investment of C$97 million in after-tax funds in Investments.

On January 1 1995 the sister companies of Copthorne II and VHHC Investments were amalgamated (forming Copthorne III), the shares of which had paid-up capital of C$164 million as a result of combining the paid-up capital of the two companies.

Copthorne III then redeemed shares held by its non-resident shareholder LF Investments (Barbados) Ltd for a redemption amount of C$142 million. Since the redemption amount did not exceed the paid-up capital, the redemption did not give rise to a deemed dividend and no tax was withheld.

The minister assessed Copthorne III by applying GAAR to reduce the paid-up capital of Copthorne III by C$67 million. As a result of this paid-up capital reduction, the redemption payment exceeded paid-up capital, creating a deemed dividend. Copthorne III was assessed withholding tax on the deemed dividend at 15%, resulting in a tax bill of C$9 million, plus penalty and interest. The minister's reassessment was upheld by the Tax Court of Canada and the Federal Court of Appeal, and the taxpayer appealed to the Supreme Court.

GAAR analysis

Tax benefit
A tax benefit was found to exist by comparing the transaction as carried out with an alternative arrangement. The alternative arrangement was the amalgamation of Copthorne and VHHC Holdings without interjecting the share sale to preserve paid-up capital. The taxpayer argued that a vertical amalgamation "was never a live and reasonable option" because the taxpayer would never have chosen this higher tax option. The Supreme Court concluded that the comparison to a vertical amalgamation was appropriate and held that there was a tax benefit.

Avoidance transaction
Where a tax benefit is alleged to result from a series of transactions, rather than a single transaction, it is necessary to determine:

  • whether there was a series;
  • which transactions made up the series; and
  • whether the tax benefit resulted from the series.

If any transaction within the series was not undertaken primarily for a bona fide non-tax purpose, then an avoidance transaction exists.

Series of transactions
The taxpayer and the Crown agreed that the initial share sale completed to preserve paid-up capital and the amalgamation of Copthorne and VHHC Holdings were part of a series of transactions. However, the tax benefit was not realised until a year later, when shares of Copthorne III were redeemed. As such, the Supreme Court had to determine whether the redemption was part of the series.

Series of transactions defined: The starting point is the common law meaning of a 'series of transactions', which requires a finding that each transaction must be "pre-ordained to produce a final result" in order to be part of the series.(5) This meaning is extended by the statutory definition of a 'series of transactions' in Section 248(10) of the Income Tax Act, which deems "any related transactions" completed "in contemplation" of the series to be part of such series.

In OSFC Holdings(6) the Federal Court of Appeal applied the statutory definition by asking whether the parties knew of the common law series and took such series into account when deciding to complete the transaction under review. In Canada Trustco(7) the Supreme Court followed this approach and elaborated that courts are required to consider whether the series was taken into account when the decision was made to undertake the related transaction in the sense that it was done 'in relation to' or 'because of' the series.

In Copthorne the Tax Court of Canada agreed with the taxpayer that transactions only remotely connected to a common law series should not be included. However, the court concluded that there was a "strong nexus" between the series and the redemption and, as such, the series was deemed to include the redemption.

"Strong nexus" is not required: The Federal Court of Appeal confirmed the Tax Court's decision, but noted that a finding of a strong nexus between the redemption and the series was not necessary. A strong nexus involves a greater degree of connection than is needed for a related transaction to be 'because of' or 'in relation to' a series of transactions.

The Supreme Court agreed that a strong nexus was a stronger connection than required and confirmed, on the other end of the spectrum, that a "mere possibility" or a connection with "an extreme degree of remoteness" was insufficient. Relevant factors to consider as part of this factual analysis include the timeline of events and whether intervening events exist. The taxpayer argued that intervening events broke the series. The Supreme Court noted that the Tax Court was aware of the intervening changes to the foreign accrual property income rules and the timeline of events, and found that since there was no "palpable or overriding error", the trial judge's finding that there was a strong nexus could not be overturned. That factual finding was more than sufficient to reach a conclusion that the redemption was completed "in contemplation" of the anticipatory planning.

Contemplation can be prospective or retrospective: The Supreme Court rejected the taxpayer's argument that the extended meaning of a series of transactions in Section 248(10) should be considered only on a prospective basis. The court acknowledged that the more common use of the term 'contemplation' is prospective. However, the court concluded that the text of Section 248(10) does not restrict when the contemplation must take place. The court further noted that the context of the statutory definition is to expand the definition of a series and that the court had recently concluded, in Canada Trustco, that the test can be applied retrospectively. As such, completing a transaction "in contemplation" of prior anticipatory tax planning may result in the transaction being part of the same series as the anticipatory planning.

Avoidance transaction within series
The court rejected the taxpayer's argument that all steps of the series were undertaken for a non-tax purpose. The avoidance transaction was the addition of the share sale before the amalgamation of Copthorne and VHHC Holdings. This planning step allowed for the amalgamation to be horizontal rather than vertical, resulting in the preservation of the paid-up capital related to the VHHC Holdings shares. Since there was an avoidance transaction within the same series of transactions that resulted in the tax benefit, the Supreme Court had to consider the remaining issue of whether there was an abuse within the meaning of GAAR.

Abusive tax avoidance
The Supreme Court reaffirmed the Duke of Westminster(8) principle that taxpayers are entitled to structure their affairs to minimise tax and then acknowledged that GAAR does introduce some uncertainty. However, this uncertainty is reduced by the obligation of the courts to approach GAAR cases cautiously and the fact that the abusive nature of the transaction must be "clear" before GAAR can apply. The court's role is to conduct an objective, thorough and step-by-step abuse analysis, explaining the reasons for its conclusion.

Provisions at issue
The court considered each provision alleged to be abused and concluded that Section 87(3) was central to the abuse analysis. The definition of 'paid-up capital' in Section 89(1) incorporates, as a starting point, stated capital as determined under corporate law, which amount reflects the investment made in the corporation. Paid-up capital then deviates from corporate stated capital based on specific adjustments, such as provided for in Section 87(3).

The court found that the text of Section 87(3) operates to ensure that the paid-up capital of an amalgamated corporation will be reduced if it exceeds the paid-up capital of the shares of the amalgamating corporations. The text also operates to aggregate the paid-up capital of amalgamating corporations, except on a vertical amalgamation. Where a subsidiary amalgamates with its parent, the paid-up capital of the subsidiary's shares is cancelled. The Supreme Court then turned to a contextual and purposive analysis of this provision.

Context of Section 87(3)
Scheme of the act relating to paid-up capital: The Supreme Court's contextual analysis focused on the paid-up capital scheme in the act which involves several provisions, making observations including the following:

  • Section 84(3) provides for the tax-free payment of paid-up capital to shareholders on a share redemption, in recognition of the fact that the initial investment in the corporation is made with tax-paid funds. As such, Section 84(3) deems a redemption payment to be a dividend only to the extent that it exceeds paid-up capital; and
  • The paid-up capital definition in Section 89(1) incorporates by reference provisions (including Section 87(3)) that reduce or 'grind' paid-up capital in situations where determining paid-up capital, based only on stated capital, would not achieve Parliament's intended purpose of allowing only the return of tax-paid investment on a tax-free basis.

Within this context, the Supreme Court concluded that Section 87(3) is designed to preclude the preservation of paid-up capital where such preservation would allow for a tax-free payment from a corporation in excess of the tax-paid investment in the corporation.

Non-consolidation: The taxpayer argued that since the act does not generally consolidate the financial results of separate corporations for tax purposes, the shares of a corporation have their own paid-up capital that exists independently from the paid-up capital of the shares of other corporations, whether or not the corporations are related. The court acknowledged that the principle of non-consolidation recognises the valid creation of paid-up capital in a subsidiary corporation; however, it does not justify the preservation of paid-up capital when the subsidiary and its parent are amalgamated.

No single, integrated scheme: The taxpayer asserted that the statutory provisions relating to capital gains and paid-up capital form a single integrated scheme that ensures that shareholder returns are eventually taxed, either as a deemed dividend or as a capital gain. The court found no such integrated scheme, noting that:

  • the paid-up capital related to shares, which is used to calculate deemed dividends, often differs from adjusted cost base of such shares for a taxpayer, which is used to calculate capital gains;
  • tax rates for dividends and capital gains are not the same; and
  • tax treaties may treat capital gains and dividends differently.

Tracing, analogy and implied exclusion arguments unsuccessful: The taxpayer argued that paid-up capital is in rem - that is, it exists independently of who owns the shares and therefore should not be traced back to an initial investment in the corporation. Noting that Section 87(3) provides that the paid-up capital of a subsidiary corporation is cancelled on a vertical amalgamation, the court concluded that the treatment of paid-up capital may depend on the identity of the owner of the shares.

The taxpayer argued that the act does not have a policy against paid-up capital preservation since it does not have specific stop-paid-up capital rules similar to the stop-loss rules that exist in the act. The court held that Section 87(3) could viewed as a stop-paid-up capital rule.

The taxpayer further argued that since the detailed paid-up capital provisions in the act did not address this precise situation, the transactions could not be considered to abuse the purpose of those provisions. While not ruling out the possibility that this 'implied exclusion' argument could have merit where the text of a provision fully explains its underlying rationale, the court concluded that such an interpretation would render GAAR useless in most cases:

"the implied exclusion argument is misplaced where it relies exclusively on the text of the paid-up capital provisions without regard to their underlying rationale. If such an approach were accepted, it would be a full response in all GAAR cases, because the actions of a taxpayer will always be permitted by the text of the Act."(9)

Purpose of Section 87(3)
Multiple purposes: The Supreme Court agreed with the taxpayer that one purpose of Section 87(3) is to prevent corporate law increases to stated capital on horizontal amalgamations. However, the court noted that provisions can have more than one purpose. Another purpose of Section 87(3) is to prevent corporations from preserving the paid-up capital of the shares of a subsidiary corporation on an amalgamation with a parent corporation, because the subsidiary's paid-up capital reflects investment of the same tax-paid dollars as in the parent corporation.

Purpose goes beyond maintaining consistency: The court dismissed the taxpayer's assertion that Section 87(3) is simply intended to maintain consistency between corporate law and tax law, and that Section 87(3) takes its purposes from the corporate law cancellation of shares upon a vertical amalgamation. It was noted that the cancellation of paid-up capital under Section 87(3) occurs independently from corporate law, suggesting that Parliament had a tax reason for precluding the aggregation of paid-up capital on a vertical amalgamation. The court emphasised that its conclusion was not based on a determination of a general policy in the act against surplus stripping, but instead was based on an analysis of the purpose of the specific paid-up capital provisions that apply to amalgamations and redemptions.

Not creating impermissible uncertainty: The court also rejected the taxpayer's argument that upholding the application of GAAR would create impermissible uncertainty for taxpayers as to whether paid-up capital validly created in a subsidiary would be subject to cancellation if it were sold to an unrelated non-resident purchaser. The court responded that unless there was an avoidance transaction resulting in a tax benefit, a sale of shares to an unrelated non-resident purchaser would not trigger GAAR.

Purpose limits tax-free return to tax-paid investment: Based on a detailed textual, contextual and purposive analysis, the court concluded that the object, spirit and purpose of the part of Section 87(3) dealing with vertical amalgamations is:

"to preclude preservation of paid-up capital of the shares of a subsidiary corporation upon amalgamation of the parent and subsidiary where such preservation would permit shareholders, on a redemption of shares by the amalgamated corporation, to be paid amounts as a return of capital without liability for tax, in excess of the amounts invested in the amalgamating corporations with tax-paid funds."(10)

Application of abuse test
The court held that the anticipatory step of preserving paid-up capital , which later allowed for a tax-free return of capital from Copthorne III in excess of the tax-paid investment in Copthorne III, circumvented the application of Section 87(3). The transaction was therefore abusive and the court affirmed the GAAR assessment.

For further information on this topic please contact Patrick Lindsay or Stephanie Wong at Borden Ladner Gervais LLP by telephone (+1 403 232 9500), fax (+1 403 266 1395) or email ([email protected] or [email protected]).


(1) Copthorne Holdings Ltd v The Queen, 2011 SCC 63, released December 16 2011.

(2) Paid-up capital generally represents the amount a corporation can return to shareholders as a tax-free return of capital.

(3) On a 'vertical amalgamation' of a parent and wholly owned subsidiary, paid-up capital of the subsidiary, which reflects the same tax-paid funds invested in the parent corporation, is eliminated.

(4) The paid-up capital of the Copthorne shares prior to the amalgamation was only C$1.

(5) As noted in Copthorne, para 43.

(6) OSFC Holdings Ltd v Canada, 2001 FCA 260.

(7) Canada Trustco Mortgage Co v Canada, 2005 SCC 54.

(8) Commissioners of Inland Revenue v Duke of Westminster [1936] AC 1.

(9) Copthorne, para 111.

(10) Copthorne, para 122.