As tax planners, we often work with clients to implement transactions that ‘strip’ surplus assets from corporations: this is just a fancy way of describing how an individual obtains corporate assets, while paying the least tax possible. Why else would you hire a tax lawyer?

After the death of a shareholder, the “Pipeline Strategy” is one method to achieve the surplus strip. Recently, the Canada Revenue Agency (the “Agency”) publicly questioned these transactions, and when the Agency questions, taxpayers usually end up paying significantly more income tax. Dr. MacDonald was one such taxpayer, in what Justice J.E. Hershfield described as a “bizarre” case: MacDonald v. The Queen.

After practicing as an interventionist heart surgeon in New Brunswick, Dr. MacDonald and his spouse, a veterinarian, wished to move to the warmer pastures of Greenville, North Carolina. Dr. MacDonald proceeded to wind-up his valuable professional corporation (“PC”), and obtained tax advice to deal with the ‘departure tax’ rules for emigrants from Canada. Under these rules, Dr. MacDonald is ‘deemed’ to have sold his PC shares when he left Canada. Unfortunately, the United States does not recognize this Canadian deemed disposition - the US requires an actual sale - so Dr. MacDonald would pay tax twice. Under the tax plan, Dr. MacDonald sold the PC shares to his brother-in-law, and received a capital gain, rather than a dividend. Dr. MacDonald used his existing capital losses to offset this capital gain, resulting in no tax. The Agency did not like this result, and recharacterized the capital gain as a dividend, using the ‘winding-up’ and general anti-avoidance (“GAAR”) rules.

Justice Hershfield dealt with the ‘winding-up’ rule first, by carefully applying the “...express language of subsection 84(2)...” which required that any distribution or appropriation from the PC be to a shareholder. At the time, Dr. MacDonald was a creditor, not a shareholder: his shares were sold to his brother-in-law. This distinction was fundamental to the ‘winding-up’ rule, and could not be ignored. Perhaps most importantly for tax planners, Justice Hershfield commented extensively on “Post-Mortem Transactions”, concluding that the Agency’s position on the ‘winding-up’ rule was incorrect – a clear victory for the Pipeline Strategy.

When Justice Hershfield applied the GAAR, his reasons for judgment were remarkable. As Dr. MacDonald’s emigration from Canada would have resulted in a capital gain on the ‘deemed disposition’ of his PC shares, the tax plan placed him in exactly the same position! In the words of Justice Hershfield: “To deny a tax benefit to which he was entitled by an express provision of the Act because he achieved it by a different legally effective means is, frankly, bizarre. “Bizarre” might be putting it too strongly...however, the circumstances of the case at bar do not invite a struggle...”

Why does the MacDonald case matter? It encourages taxpayers, and tax planners, to use tax plans, such as the Pipeline Strategy, as an acceptable means of arranging one’s affairs. It also emphasizes that the Agency’s view of the Act, no matter how forcefully expressed, can be wrong: the Agency may have an opinion, but it is not the law.