The Tax Court of Canada recently decided a new case under the general anti-avoidance rule (“GAAR”) in section 245 of the Income Tax Act. In Birchcliff Energy Ltd. v. The Queen, the Court held that the GAAR applied to restrict losses in an attempted non-acquisition of control transaction.

Veracel was a corporation with tax losses from its business of developing, manufacturing and marketing medical diagnostic instruments. Birchcliff had entered into an agreement to acquire a group of profitable oil and natural gas properties, and was interested in acquiring Veracel’s tax losses. Initially, Birchcliff’s value outweighed Veracel’s.

Clause 256(7)(b)(iii)(B) of the Income Tax Act was in issue. On an amalgamation, it in effect deems control of the smaller of two unrelated amalgamating predecessor corporations (Veracel in this case) to be acquired, thereby streaming the losses of the smaller predecessor corporation against income of the amalgamated corporation from the same or a similar business as that in which the losses were incurred.

Had the two corporations simply merged, control of Veracel would have been deemed acquired, with the result that Veracel’s losses would only be deductible against income of the amalgamated corporation from a business the same as (or similar to) Veracel’s historical business.

Therefore, the corporations devised the following plan. Veracel raised equity capital by way of subscription receipts. The subscription receipts were converted into Veracel Class B shares as part of a plan of arrangement, just before the two corporations were amalgamated as part of the same plan of arrangement. The holders of the subscription receipts would be refunded their monies if the plan of arrangement was not completed. After the Veracel equity financing (but before the amalgamation) Veracel’s value outweighed that of Birchcliff.

Justice Jorré of the Tax Court essentially ignored the Class B shareholders of Veracel in finding that the provision in issue “… does not include what might be described as contingent shareholders like the Class B shareholders here.”

Other comments in the judgment reinforce what appears to be Justice Jorré’s view that the Veracel Class B shares ought to be ignored in the GAAR analysis. He refers to the “artificial insertion of Class B shareholders” whose shares were “ephemeral” and “had such a short existence that they had to be deemed to be created by the plan of arrangement to be created before the amalgamation”.

Any provision of the Income Tax Act that is alleged to be abused must be analyzed using a “textual, contextual and purposive” analysis in order to determine its object, spirit or purpose (Copthorne). Having determined the purpose of the provision in issue, one can then consider whether it had been abused. In Birchcliff, the judge offered up no analysis to support the Crown’s allegation that clause 256(7)(b)(iii)(B) had been abused. His reliance on the late stage financing through the use of Class B Veracel shares seems misplaced when the provision itself (and others in the same section) directs one to look to the point in time “immediately before” the time of amalgamation to determine whether an acquisition of control has occurred.

The only comments regarding the policy of the provision are in para. 134 of the judgment, where the judge states:

The statutory provision itself shows that the policy underlying the provision is that the “minority” predecessor, i.e. the predecessor whose shareholders, were they acting in concert, would not have control in the amalgamated corporation, will lose its tax attributes, its losses, on an amalgamation with another corporation.

In other words, look to the text. However, the text supports the permissibility of the transactions undertaken. Indeed, in any GAAR case the transactions will comply with the text, otherwise GAAR would not have been invoked.

Birchcliff has filed an appeal to the Federal Court of Appeal.