On October 28, 2011 the Tax Court of Canada released Judgment and Reasons for Judgment of the Honourable Justice Judith Woods in Global Equity Fund Ltd. v. Her Majesty The Queen, 2011 TCC 507. Global Equity Fund Ltd. (“Global”) had appealed the application of the General Anti-Avoidance Rule (the “GAAR”) by the Minister of National Revenue (the “Minister”) to disallow the deduction of a $5,600,250 business loss incurred on the sale of shares in a private corporation.
The Court found that the loss was produced after Global subscribed for shares of a new subsidiary corporation, which then issued preferred shares to Global which were redeemable and retractable for $5,600,250 but had a paid up capital of $56 and which resulted in an income inclusion of $56. The stock dividend had the effect of reducing the fair market value of the shares of the new subsidiary to a nominal amount but did not affect Global’s adjusted cost base in those shares. Global then disposed of the common shares to a newly settled family trust at a loss in the amount of $5,600,250.
The Court did not accept Global’s argument that the transactions leading up to the loss were implemented for creditor protection purposes. Accordingly the Court held that a number of transactions in issue were avoidance transactions within the meaning of subsection 245(3) of the Income Tax Act (the “Act”).
The Court also noted that this case was similar to two recent decisions of the Tax Court of Canada where similar strategies were used by other taxpayers to create capital losses. In both cases (Triad Gestco Ltd. v. The Queen, 2011 TCC 259 and 1207192 Ontario Ltd. v. The Queen, 2011 TCC 383) the Tax Court upheld the application of the GAAR to deny the losses. The Court noted that both of these decisions are under appeal to the Federal Court of Appeal.
However, in Global’s case the Court was not prepared to accept the Crown’s argument that the object and spirit of the provisions of the Act identified by the Crown evidenced a policy to disallow losses realized within an economic unit to real losses. The Court held that Parliament did not intend that the object and spirit of provisions identified by the Crown which targeted capital losses were intended to inform as to the object and spirit of the provisions relied upon by Global in the facts of this case.
Relying on the Supreme Court of Canada decision in Canada Trustco Mortgage Co. v. The Queen (2005 SCC 54), Justice Woods held that the provisions in the Act relied upon by Global to produce the losses had not been misused and she was also unable to discern a general policy from these provisions that restricted business losses in the manner suggested by the Crown. The Tax Court rejected the Crown’s argument that there was a general restriction against the deduction of artificially-created business losses. For all of these reasons the Tax Court held that the Minister had not met the onus of establishing abusive tax avoidance under subsection 245(4) of the Act and allowed the appeal.