Earlier this year, the Supreme Court of Canada released its landmark general anti-avoidance rule ("GAAR") decision in Lipson v. The Queen1 ("Lipson") (see our previous article for more details). In Lipson, the court applied GAAR to deny interest deductibility where a taxpayer sought to cleverly use the letter of the attribution rules to derive a tax benefit. However, deciphering principles of general application from Lipson has proven elusive.
In the recent case of The Queen v. Landrus2 ("Landrus") the Federal Court of Appeal appears to have stepped in to fill the gap left by Lipson with some potentially very taxpayer-friendly guidelines. In Landrus, the taxpayer relied on specific anti-avoidance rules that did not apply to the taxpayer's particular tax planning. The Canada Revenue Agency ("CRA") asked the court to look to the general purpose of the specific rules and, relying on GAAR, extend them to apply to the taxpayer's plan. The court refused, finding that GAAR could not be used to fill perceived holes in existing anti-avoidance rules.
Taxpayers have often argued that GAAR, if taken too far, and especially if used to add to specific existing anti-avoidance rules, would permit the CRA to re-write the law. The lesson in Landrus is that, if there are specific anti-avoidance rules and the taxpayer can successfully navigate them, then the CRA should not have the power to undo the plan by applying GAAR.
A limited partnership ("Partnership 1") owned a condominium building. Another limited partnership ("Partnership 2") owned an adjacent condominium building to the one owned by Partnership 1. The taxpayer, Gary Landrus, invested in Partnership 2 not long before the recession in the early 1990s struck. As a result, Mr. Landrus' investment significantly declined in value. Certain transactions were entered into resulting in and Partnerships 1 and 2 owning the units of a new partnership ("Partnership 3") in proportion to the fair market value of the buildings transferred to Partnership 3, and Partnership 3 owning the condominium buildings formerly owned by Partnerships 1 and 2.
Terminal losses arose for Partnership 1 and Partnership 2 on the dispositions of the buildings to Partnership 3. Mr. Landrus deducted his share of the terminal losses in computing his income for the 1994 tax year.
Assessment and Court Decisions
Tax Benefit and Tax Avoidance
The Minister of National Revenue reassessed Mr. Landrus' deduction of the terminal loss on various grounds including GAAR, but tried the case based on GAAR alone. Mr. Landrus had conceded that the first requirement for GAAR to apply had been met: there was a tax benefit resulting from the transactions. The Tax Court found that the second requirement for GAAR to apply was satisfied in that the transactions constituted tax avoidance. The Federal Court of Appeal did not disturb this finding.
Misuse of Abuse
The main issue the Federal Court of Appeal addressed was if the final requirement for GAAR to apply was fulfilled: Was there a misuse or abuse of relevant provisions of the Act? The appellate court satisfied itself that the transactions complied with the letter, object and spirit of the applicable tax rules governing the transactions (capital cost allowance and partnership provisions). Therefore, there was no misuse or abuse of those provisions.
The Act also has within it a specific set of anti-avoidance rules that prevent the artificial use of losses called the stop-loss rules. In this case, there was no particular stop-loss rule on point. The CRA wanted the court to use GAAR to fill the holes in the stop-loss rules. So the key questions before the court were:
- Do the stop-loss rules constitute a complete code of specific rules such that if a transaction does not offend any specific stop-loss rule, GAAR will not apply to fill in the holes; or
- Are the stop-loss rules part of an overall policy to prevent the use of losses arising from dispositions where there is no significant change in the economic ownership of property, such that if the specific stop-loss rules do not apply, GAAR can apply to fill in the holes?
The Federal Court of Appeal held that because a specific anti-avoidance rule does not apply to a certain transaction does not necessarily mean that Parliament would permit that transaction. However, the court held that "...where it can be shown that an anti-avoidance provision has been carefully crafted to include some situations and exclude others, it is reasonable to infer that Parliament chose to limit their scope accordingly"3. Therefore, the court held that the stop-loss rules are not part of an overall policy prohibiting the use of losses in respect of dispositions involving no significant change in ownership. Accordingly, there was no misuse or abuse and GAAR was not applicable.
However, the court added one general limitation to its finding that there was no misuse or abuse: if a transaction permitted a taxpayer to claim a loss while leaving the taxpayer's legal rights and obligations "wholly unaffected" , this could result in abusive tax avoidance.4 The court held that this limitation did not apply in Landrus because the legal relationships, risk and benefits after the transactions had materially changed from those that existed before the transactions. Moreover, the terminal loss for tax purposes claimed by Mr. Landrus resulted from the disposition of the building at fair market value and reflected a genuine economic loss.
Unlike the decision of the Supreme Court of Canada in Lipson, the decision in Landrus provides taxpayers with practical guidelines:
- The fact that specific anti-avoidance provisions do not apply to a particular situation, does not, in and of itself, indicate that the result was condoned by Parliament;
- Likewise, the existence of specific anti-avoidance provisions disallowing favourable tax consequences of transactions of a certain nature, is not necessarily indicative of a general unexpressed policy of Parliament to prohibit such consequences of every transaction of a similar nature that is not caught under the anti-avoidance provisions;
- Where Parliament has enacted specific anti-avoidance rules, to determine whether these rules represent a general policy to prohibit certain favourable tax consequences of transactions of a certain nature, consideration should be given to:
- The specificity of the provision;
- The scope of application;
- If the provision was drafted to include certain situations and exclude others; and
- Specific restrictions in place;
- GAAR cannot generally be used to plug the holes in the stop-loss rules because they were drafted with significant specificity to include certain situations and exclude others; and
- In determining if there was a misuse or abuse a provision in a GAAR analysis, consideration should be given to whether the tax result reflects economic reality, in which case an abuse or misuse is less likely to be found.
Taxpayers should be aware that the decision in Landrus is subject to a few important cautions:
- There is still time for the Minister to appeal this decision;
- Care must be exercised in relying too heavily on this decision. The fact pattern in Landrus, for a GAAR case, was very sympathetic to the taxpayer. With less sympathetic facts, the court could very well look for ways not to apply the principles in Landrus. and
- The Federal Court of Appeal left the door ajar in that GAAR may apply where the taxpayer claims a loss in respect of transactions where the taxpayer's legal rights and obligations are "wholly unaffected". It will be for another court on a different day to determine what degree of change in a taxpayers position constitutes "wholly unaffected".
Nevertheless, Landrus provides solid affirmation for tax planners who have argued for years that GAAR cannot be used to "re-write the law" where specific anti-avoidance rules exist and the taxpayer has carefully navigated around them. This case now lends support to the principle that the specific does not imply the general.