The Federal Court of Appeal (“FCA”) released three decisions in late October involving “paper losses” and the general anti-avoidance rule (“GAAR”). In each case, the taxpayer incurred a loss as a result of a series of transactions that was said to have “shifted value” from one class of shares to another. In each case the FCA denied the resulting loss on the basis that the transactions resulted in a misuse or abuse of the provisions of the Income Tax Act (the “Act”) relied upon by the taxpayer.
In the first case, Triad Gestco Ltd. (2012 FCA 258), the taxpayer carried out the “value shift” by transferring $8 million of assets to a corporation for common shares. The corporation then paid a stock dividend to the taxpayer by issuing 80,000 preference shares (redeemable for $8 million). The effect of the stock dividend was to reduce the value of the common shares to nil. On the next day, the taxpayer sold its common shares to a family trust and realized a capital loss of approximately $8 million. The FCA upheld the lower court’s decision and stated, “[I]t is common ground that the loss generated by the taxpayer as a result of the value shift is a loss on paper only in the sense that no economic loss was suffered.” In determining the purpose of the capital gain regime, the FCA did not endorse the trial judge’s reliance on the stop-loss regime for context but, instead, relied on the Carter Commission Report (1996) to show that the capital gain system in Canada is “aimed at taxing increases in economic power and economic power is unaffected by paper losses.”
The second case, 1207192 Ontario Limited (2012 FCA 259), was heard on the same day and by the same panel as the Trial Gestco case. In this case the taxpayer similarly realized a capital loss on the sale of common shares to a family trust. One distinguishing feature was that the lower court in 1207192 had determined that the principal motivation of the taxpayer in entering into the transactions was not to realize a capital loss but to achieve creditor protection. The Tax Court noted, however, that the transactions could have been structured differently so as not to generate the tax benefit and, as a result, concluded that there was an avoidance transaction. The FCA agreed with the lower court on all points including that the transaction was abusive.
The final case in the “paper loss” trilogy involved a non-capital loss for the taxpayer. In Global Equity Fund Ltd. (2012 FCA 272), the taxpayer carried on a securities trading business and reported the sale of the common shares to the trust as a business loss. The Tax Court held that GAAR did not apply as the Crown had failed to establish that there was a general policy in the Act that “restricted business losses to real losses realized outside of an economic unit.” The Crown made substantially different submissions at the FCA and argued that the “object, spirit or purpose of sections 3, 4, 9, and 111 of the Act is to allow the deduction of business losses only to the extent that they reflect an actual economic loss.” The FCA agreed with the Crown and held that “business losses must be grounded in some form of economic or business reality” and “if a business loss is to be used for taxation purposes … there must, at the very least, be an air of economic or business reality associated with that loss.”
We understand that leave to appeal to the Supreme Court of Canada will be sought in Global Equity on the issue of whether the transaction resulted in an abuse of the Act.
1207192 Ontario will also be seeking leave but only on the issue of avoidance transaction.
To date, no decision has been made by Triad Gestco.