On September 7, 2011, the Tax Court of Canada released its reasons for judgment in 1207192 Ontario Limited v. The Queen, the latest general anti-avoidance rule (GAAR) case to be considered by the Tax Court.

In short, the Minister applied the GAAR to deny a capital loss of $2,999,900 realized by the taxpayer in its taxation year ending February 28, 2003 on the disposition of common shares it held in a corporation (Newco).  The Tax Court (per Paris J.) found that the GAAR applied and dismissed the taxpayer’s appeal.

The facts can be briefly summarized as follows: The loss on the common shares was generated by the declaration of a stock dividend by Newco on the common shares prior to the disposition by the taxpayer.  The payment of the stock dividend had the effect of decreasing the value of the taxpayer’s common shares in Newco by an amount equal to the value of the stock dividend.  The stock dividend consisted of preferred shares with a low paid-up capital and a high redemption amount.

After the payment of the stock dividend, the taxpayer’s loss on the common shares was crystallized by a disposition of those shares to a family trust of which the beneficiaries were family members of the sole shareholder of the taxpayer corporation.  The capital loss was used by the taxpayer to offset a capital gain of $2,974,386 it realized during its 2003 taxation year.

The Tax Court concluded that (a) there was an avoidance transaction, as one of the transactions in the series was undertaken primarily to obtain a tax benefit, and (b) there was an abuse or misuse, as the transactions undertaken by the taxpayer frustrated the spirit and purpose of the capital loss provisions of the Income Tax Act (namely paragraphs 38(b), 39(1)(b) and 40(1)(b)).