On January 8, 2009, the Supreme Court of Canada released its decision in the Lipson case. In a split decision, the majority of the Supreme Court concluded that the general anti-avoidance rule (GAAR) applies to a series of transactions that were considered to be abusive tax avoidance. At the same time, the Supreme Court confirmed that the series of transactions would not have been subject to GAAR but for the fact that they involved the spousal attribution rules. Thus, the spousal "twist" added to a series of transactions similar to those in the Singleton case, which had been decided earlier by the Supreme Court, was found to tip the balance against the taxpayer. Further, in applying the GAAR, the Supreme Court provided relief that had not been considered in the earlier appeals in the Lipson case.


The taxpayer, Earl Lipson, owned shares of an investment company (Holdco). His wife, Jordanna, borrowed $562,500 from a bank to acquire some of his Holdco shares at fair market value. As part of the same series of transactions, the Lipsons agreed to purchase a house for $750,000, for which Mr. Lipson used the proceeds from the sale of his Holdco shares. On closing of the house deal, the Lipsons took out a $562,500 mortgage secured by the house. Proceeds of the mortgage were used to pay off Mrs. Lipson’s bank loan for the Holdco share purchase.

The interest on the mortgage loan was deducted from the taxable dividends on the Holdco shares held by Mrs. Lipson by virtue of the operation of a number of provisions in the Income Tax Act (Canada). Paragraph 20(1)(c) and subsection 20(3) allowed Mrs. Lipson to deduct interest expense on money borrowed to acquire or refinance the acquisition of an income-producing asset, i.e., the Holdco shares. Subsection 73(1) permitted Mr. Lipson to transfer his Holdco shares to Mrs. Lipson without immediate tax consequences, such that any future gain or loss resulting from the disposition by Mrs. Lipson of the Holdco shares would be attributed back to Mr. Lipson. Finally, any income or loss from the Holdco shares held by Mrs. Lipson (the taxable dividends less the interest expense) was attributed back to Mr. Lipson under subsection 74.1(1). As a result of these provisions, Mr. Lipson was entitled to deduct the interest on the loan obtained by Mrs. Lipson to purchase the Holdco shares, as refinanced with the mortgage loan.

The Minister disallowed the interest expense claimed by Mr. Lipson on the basis that the GAAR applied and that the series of transactions amounted to abusive tax avoidance. The dividend income remained taxable to Mr. Lipson, and Mrs. Lipson was not permitted to deduct the interest expense.

The Minister succeeded in both the Tax Court of Canada and Federal Court of Appeal. As a result, serious issues arose for Canadian taxpayers as to the application of the GAAR to tax planning in a wide range of circumstances and in particular as it might affect the deductibility of interest.

At the Tax Court, the taxpayer agreed that the transactions were "avoidance transactions" resulting in a tax benefit. The only issue before the Tax Court was whether the transaction involved abusive tax avoidance such that the resulting tax benefits were prohibited by the GAAR. The Tax Court held that the GAAR applied, on the basis that the "overall purpose" and the use to which the relevant provisions of the Act were put was to make interest on money used to buy a personal residence deductible. Thus the series of transactions resulted in a misuse of those provisions.

The Federal Court of Appeal dismissed Mr. Lipson’s appeal. This Court held that, viewed separately, none of the transactions appeared to be abusive. In its view, however, the Tax Court was entitled to consider the transactions as a series and to conclude that the transactions resulted in a misuse of the statutory provisions upon which Mr. Lipson relied to obtain tax benefits.

Supreme Court of Canada

The Supreme Court (LeBel J. writing for the majority) held that:

  1. The transactions whereby Mr. Lipson sold his shares to his wife (who financed the purchase with debt), and then financed the purchase of the house with the proceeds of that sale, were "unimpeachable," such that interest on the debt was deductible. Thus, debt-structuring to obtain an interest deduction, which had been in doubt as a result of the Federal Court of Appeal decision, was confirmed as acceptable under the GAAR.
  2. The transactions were considered abusive tax avoidance and the GAAR applied. The use of the attribution rules in the Act to permit Mr. Lipson to claim his wife’s interest deduction was contrary to the purpose of subsection 74.1(1) of the Act. This rule was "to prevent spouses from reducing tax by taking advantage of their non-arm’s-length relationship when transferring property between themselves." The majority focused on the words "directly or indirectly" in subsection 245(4) and concluded that "Parliament intended the GAAR to apply even where abuse is an indirect result of a transaction." The majority concluded that regard may be had to a series when determining whether a transaction within the series is abusive.
  3. In applying the GAAR to disallow the interest deduction to Mr. Lipson, the majority held that Mrs. Lipson was entitled to deduct the interest expense, as being a "reasonable outcome" in the circumstances. Mr. Lipson remained taxable on the dividend income.  

In two separate dissents, the minority disagreed with the majority on the application of the GAAR to these transactions. In the first dissent, Binnie J. (with whom Deschamps J. concurred) held that the spousal “twist” — the addition of a spousal rollover that operates precisely as it was intended by Parliament to operate - should not cause the entire series of transactions to be characterized as abusive. Applying the GAAR in the circumstances of this case means paying lip service to the Duke of Westminster principle — that taxpayers are entitled to arrange their affairs to minimize the amount of tax payable — without taking seriously its role in promoting consistency, predictability and fairness in the tax system.

In the second dissent, Rothstein J. agreed with both the majority and the dissent insofar as they concluded that the GAAR did not apply to taxpayers who arranged their affairs so as to finance their personal assets out of equity- and income-earning assets out of debt. However, he further held that the GAAR did not apply because there was a specific anti-avoidance rule in subsection 74.5(11) that precluded the use of the GAAR, which the Minister should have applied. The failure to apply a specific rule was fatal to the reassessment. Rothstein J. went on to find that if the Minister had applied the specific anti-avoidance rule, the effect would have been to disallow the use of the attribution rules and to leave the dividend income and interest deduction in the hands of Mrs. Lipson, without affecting the tax-deferred sale by Mr. Lipson.

The Significance of this Decision

Three sets of reasons of the Supreme Court demonstrate that there are many aspects of the GAAR that will be developed in future jurisprudence. These may include the ability to look at the entire series of transactions in determining whether one of the steps in a series results in a misuse or abuse and the interplay between the operation of specific anti-avoidance rules and the GAAR. Of particular significance is that all the judges concurred that the interest expense was deductible and acknowledged the right of taxpayers to plan their affairs to achieve tax-deductible interest expense for their income-producing assets and business operations. This conclusion is consistent with earlier decisions of the Supreme Court, including cases decided prior to the introduction of the GAAR. There was common ground among the judges on a number of points. However, they did not agree on all aspects of the application of the GAAR, such as the burden of proof.