On November 19, 2009, the Federal Court of Appeal upheld the decision of the Tax Court of Canada in Frank Remai (Estate of) v. The Queen. The case concerned whether a taxpayer was prevented from claiming donation tax credits in respect of a gift of certain debt obligations which were then transferred from a controlled foundation to another corporation. The Federal Court of Appeal upheld the Tax Court’s decision that the transfers were acceptable.
We reported on the Tax Court decision in the October 2008 issue of the Miller Thomson Charities Newsletter. The facts of the case, in brief, are that the donor, Mr. Remai, gifted certain interest-bearing promissory notes to a foundation controlled by him. Because the notes had been issued by a corporation (FRM) related to Mr. Remai, he could not claim a donation tax credit for the gift (as a result of the anti-avoidance rules in the Income Tax Act related to non-qualifying securities (“NQS”) which prevent taxpayers from recognizing gifts of securities from non-arm’s length companies). However, Mr. Remai sought to take advantage of a provision which allows recognition of the gift if the donee (i.e. the Foundation in this case) disposes of the NQS within 5 years of the original gift. After considering various options, Mr. Remai arranged for the purchase of the notes by a corporation, Sweet Developments Inc. (“Sweet”), controlled by his nephew. Sweet purchased the notes in exchange for identical promissory notes from Sweet in favour of the Foundation.
CRA had challenged the transaction on the basis that the donor and Sweet were not dealing at arm’s length, and that the transaction was, in any event, an avoidance transaction in violation of the general anti-avoidance rule (“GAAR”).
For a unanimous Court, Evans J.A. upheld the Tax Court’s conclusion that the donor and Sweet were operating at arm’s length. Although Evans J.A. acknowledged that Mr. Remai was the driving force behind the proposed transaction, he concluded that Mr. Remai did not control Sweet. Evans J.A. was also satisfied that Sweet was pursuing its own separate interests in the transaction. In particular, he noted that Sweet was at risk to the extent that FRM (which had originally issued the notes to Mr. Remai) might be unable to honour the notes, and was therefore willing to purchase the notes only after investigating FRM’s ability to repay. This overcame a key difficulty with NQS – namely, the difficulty of determining their fair market value. Because the notes’ value ultimately depends on the ability of the issuer to honour them, the purchase price that Sweet was willing to pay enabled a determination of the fair market value of the notes, which thus allowed the notes to be receipted at that value.
Evans J.A.’s conclusion regarding valuation also enabled him to conclude that GAAR did not apply to prevent Mr. Remai from claiming the tax credits. He stated that one of the purposes of the NQS provisions was to disallow charitable tax credits in respect of certain gifts whose fair market value is difficult to determine because of the non-arm’s length nature of the transaction. The provisions, however, clearly permit a taxpayer to claim a credit where recipient charity disposes of the NQS to a third party in an arm’s length transaction. Evans J.A. rejected CRA’s contention that the purpose of the NQS provisions is to disallow tax credits for charitable gifts where the donor retains control of the capital of the gift. Evans J.A. held that this latter situation is covered by the loan-back provisions in the Income Tax Act, which did not apply.
As we noted in October 2008 regarding the Tax Court decision, this decision confirms that donors may avail themselves of the redemptive provisions in the NQS rules even if the sole purpose of the redemptive transactions is to allow for the tax benefit. It also confirms the centrality of the valuation issue in the NQS rules – where this can be resolved through an arm’s length transfer of the securities by the charity that received the gift of NQS, the donor will be able to claim tax credits for the gift.