In Collins & Aikman Products Co v R,1 the appellant, a US resident corporation (“USCO”), realized a tax-exempt capital gain on the exchange of its shares in its wholly-owned subsidiary, Collins & Aikman Holdings Ltd. (“CAHL”), for a single share of a new Canadian holding company (“CanHoldco”). Through a series of transactions, this exchange indirectly resulted in an increase in the adjusted cost base (“ACB”) and paid up capital (“PUC”) in USCO’s CAHL shares equal to the amount of the tax-exempt capital gain. USCO was then able to extract such amounts from its subsidiaries without paying any tax.
Summary of Facts
USCO was the sole shareholder of CAHL, which was incorporated in Canada in 1929. CAHL was in the business of manufacturing auto parts until 1961, when this business was transferred to a wholly owned subsidiary (“CanOpco”) and CAHL ceased to be resident in Canada. At the time of this transfer in 1961, USCO’s ACB and PUC in respect of its CAHL shares was approximately $475,000.
In 1993 and 1994 a reorganization took place. USCO incorporated CanHoldco and transferred its CAHL shares to CanHoldco in exchange for the one and only share of CanHoldco. The fair market value of the CAHL shares at this time was $167 Million. This amount was added to the PUC and ACB of USCO’s single CanHoldco share. No Canadian tax was triggered on this exchange because the CAHL shares were not considered “taxable Canadian property” under the Income Tax Act (Canada) (the “ITA”).
Subsequently, CAHL was continued into Ontario under the Business Corporations Act (Ontario) and then amalgamated with CanOpco and a wholly-owned subsidiary of CanOpco to form Collins & Aikman Canada Inc. (“C&A”). As a result, USCO owned all of the shares of CanHoldco, which owned all the shares of C&A. C&A then paid a tax-free inter-corporate dividend of $104 million to CanHoldco, which then paid $104 million to USCO as a tax-free return of capital, reducing USCO’s PUC and ACB from $167 million to $63 million.
The Minister of National Revenue (“Minister”) reassessed C&A, CanHoldco and USCO on the basis that only $475,000 of the $104 million paid from CanHoldco to USCO could be a return of capital. The Minister determined that the General Anti-Avoidance Rule (“GAAR”), contained in section 245 of the ITA, applied to the series of transactions to recharacterize that portion of the return of capital in excess of $475,000 as a deemed dividend subject to Part XIII non-resident withholding tax. The Minister determined that C&A had acted as agent for CanHoldco in paying the $104 Million to USCO, and as such C&A was included in the reassessment for failing to withhold. All three corporations appealed the reassessments.
Summary of GAAR
GAAR applies to deny a taxpayer a particular tax benefit or result where three conditions are satisfied: (1) the taxpayer enjoyed a “tax benefit”; (2) the taxpayer entered into an “avoidance transaction”; and (3) the taxpayer engaged in "abusive tax avoidance".
A “tax benefit” includes any reduction, avoidance or deferral of tax under the ITA. An “avoidance transaction” is a transaction undertaken primarily for tax reasons and not for a bona fide commercial, family or charitable purpose where any tax savings are ancillary in the overall plan. Lastly, “abusive tax avoidance” exists where the transaction in question frustrates or defeats the object, spirit or purpose of the provisions relied on to realize the tax benefit.
Summary of Decision
At trial, the taxpayers conceded the first two conditions of GAAR: i) that the series of transactions resulted in a “tax benefit”, and ii) that these transactions were “avoidance transactions”. With respect to the last condition, that the transactions resulted in “abusive tax avoidance”, the Minister argued that the series of avoidance transactions resulted in an abuse of subsection 84(4) of the ITA.
Subsection 84(4) of the ITA provides that amounts that a corporation pays to a shareholder on a return of capital exceeding the PUC of the shares are deemed to be dividends paid to that shareholder for the purposes of the ITA, including Part XIII non-resident withholding tax. The Minister argued that there is an evident scheme in the ITA with respect to corporate distributions of which subsection 84(4) forms part which begins from the premise that distributions from corporations to shareholders are to be included in income in the case of residents or subject to withholding tax in the case of non-residents. The Minister referred to numerous provisions of the ITA as evidence of this scheme that corporate distributions are to be taxed except where provisions specifically provide otherwise and argued that although subsection 84(4) does provide otherwise for returns of capital, this should not extend to inappropriate or artificial increases of PUC. The Minister’s position was that the taxpayers’ circumvention of s. 84(4) amounted to abusive dividend stripping. The Minister did not submit any extrinsic aids in support of their view of the intended scheme of the ITA.
Justice Boyle for the Tax Court replied: “I do not accept the Crown’s view. When considering the statutory provisions dealing with corporate distributions there is no clear need to step back from the Act altogether, begin from an unstated premise, and then treat the Act as only setting out the exceptions.”2 Justice Boyle determined that the purpose of subsection 84(4) is “to tax distributions, other than dividends, paid by a particular corporation to its shareholders to the extent the distribution exceeds the amount of capital invested in that corporation by that corporation’s shareholders.”3 In response to the Minister’s argument that the ITA contains a scheme whereby distributions from corporations to shareholders are to be included in income subject to specific exceptions, Justice Boyle stated:
72 Determining the purpose of the relevant provisions or portions of the Act is not to be confused with abstract views of what is right and what is wrong nor with arbitrary theories about what the law ought to be or ought to do. These latter views and theories are unhelpful in purposive and contextual statutory analysis and may even create mischief unless they are grounded in the realities of the codified legislation. […] One’s sense of right and wrong or what good tax policy should provide for or should not allow for is not, for these purposes, a permissible extrinsic aid.”
Justice Boyle also cited Campbell J. in Copthorne Holdings Ltd. v. R.,4 who held that “reliance on a general policy against surplus striping is inappropriate to establish abusive tax avoidance”, and Lamarre J. in McMullen v. R.,5 who determined that the Minister had “not presented any evidence establishing […] that the policy of the Act read as a whole is designed so as to necessarily tax corporate distributions as dividends in the hands of shareholders. In any event, the Supreme Court of Canada has said, ‘[i]f the existence of abusive tax avoidance is unclear, the benefit of the doubt goes to the taxpayer’”.
The Tax Court determined that the series of transactions did not defeat or frustrate the object, spirit or purposes of subsection 84(4) but that the Collins & Aikman group took professional advice on how to accomplish their reorganization in a tax effective manner. The taxpayers acknowledged that the primary purpose of transferring the CAHL shares from USCO to Holdings was to obtain the benefit of the high cross-border PUC that could then be used to pay funds to USCO as tax-free returns of capital.
Justice Boyle determined that each step in the reorganization was appropriate and none were abusive. Unlike Copthorne, there was no double-counting of PUC upon the amalgamation, and the transfer of CAHL shares from USCO to Holdings was not done to avoid a provision that would deny PUC recognition.
The last argument of the Minister was that no new money had been invested in the Collins & Aikman group’s Canadian companies that would justify the cross-border PUC being increased from $475,000 to $167 million. Boyle J. dismissed this argument explaining that the ITA is not limited to money transactions. “Consistently and throughout, the Act considers money’s worth or value the equivalent to money whether in the context of employee and shareholder benefits, shareholder appropriations, share-for-share exchange or the rollover of assets into corporations.” Justice Boyle also pointed out that there were real Canadian tax consequences to the reorganization as CAHL became a Canadian taxpayer and was now subject to income tax under the ITA. Boyle J. affirmed that “[t]he most important considerations of consistency, fairness and predictability would be significantly eroded if GAAR were to be lightly applied and upheld relying on the fact that there was no new money in circumstances where it is clear there was real value and money’s worth.”6
Justice Boyle concluded with a quote from Justice Paris in Landrus v. R.,7 that “the Minister has tried to use the GAAR to fill in what he perceives to be a possible gap left by Parliament; that would be an inappropriate use of the GAAR.”
Despite some pre-Canada Trustco8 decisions to the contrary, the Tax Court has affirmed in Evans, Copthorne, McMullen, and now Collins & Aikman, that the Minister cannot rely on a general policy against surplus stripping in order to establish abusive tax avoidance under GAAR.
Collins & Aikman has also made it clear that in establishing the purpose of a provision of the ITA the Minister may not rely on “abstract views of what is right and what is wrong” or “arbitrary theories about what the law ought to be or ought to do.” As Justice Boyle explains: “[o]ne’s sense of right and wrong or what good tax policy should provide for or should not allow for is not, for these purposes, a permissible extrinsic aid.” This is an important ruling for taxpayers as the courts have placed the burden of establishing the purpose of the relevant ITA provision and whether that purpose was abused on the Crown. Where no extrinsic aids are available, the Crown may have difficulty establishing the purpose of a particular provision, and thus whether that purpose was abused.
Collins & Aikman also followed the standard of proof established by the Supreme Court of Canada in Canada Trustco, that when conducting a GAAR analysis “the abuse of the Act must be clear, with the result that doubts must be resolved in favour of the taxpayer”,9 and not the standard alluded to by the majority of the Supreme Court in Lipson, that proof on a balance of probabilities is the standard required of the Minister to establish abusive tax avoidance.10
Collins & Aikman upheld a series of transactions that allowed shares of a non-resident corporation to be exchanged for the only share of a resident holding company. As a result, such share was deemed to have an ACB and PUC of $167 million, allowing the holding company to pay $104 million to its sole US shareholder on a tax-free basis.
This case confirms that the Minister cannot rely on a general policy against surplus striping in order to establish abusive tax avoidance under GAAR. The Tax Court has made clear that the Minister will generally have to reference permissible extrinsic aids in order to properly establish the purpose of a provision alleged to have been abused under GAAR. Finally, the Supreme Court of Canada’s holding in Canada Trustco that alleged abuse under GAAR must be clear, with any doubts to be resolved in the taxpayer’s favour, has been reaffirmed.