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FEDERAL INCOME TAX - Tax avoidance - General anti-avoidance rule - Misuse and abuse

Wednesday, September 15, 2021 @ 5:28 AM  


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Appeal by the Crown from a Tax Court decision allowing the respondent’s deduction of unused non-capital losses and other deductions on the basis that the general anti-avoidance rule (GAAR) did not apply to a tax loss monetization agreement. The respondent was a Canadian public corporation that carried on a drug research and food additives business under the name Forbes Medi-Tech that had $90 million of unused non-capital losses and other deductions (tax attributes). When the respondent experienced serious cash flow difficulties, it and its shareholders undertook a reorganization in the form of a share exchange that, in part, was intended to facilitate a tax loss monetization arrangement. The reorganization was effected by a court-approved plan of arrangement under which the respondent’s shareholders exchanged their shares for shares of a newly-incorporated company, New Forbes. The shares of New Forbes were publicly traded in substitution of the shares of the respondent, and the respondent became a wholly-owned subsidiary of New Forbes. The respondent and New Forbes entered into an agreement with Matco Capital which provided a framework for the tax attribute monetization arrangement, an Investment Agreement. Under the Investment Agreement, the respondent’s existing business, except for its tax attributes, would be transferred to New Forbes; New Forbes would be entitled to receive a specified amount for the tax attributes, and New Forbes would pass the respondent control to Matco. These arrangements were to be undertaken in a way that avoided Matco acquiring control of the respondent or a right to acquire control. Matco invested $3.8 million and owned shares of the respondent with a value of $5 million at that time. New Forbes no longer owned any shares of the respondent and it had realized $3.8 million. The respondent deducted most of its tax attributes to reduce its tax liability. The Crown argued GAAR was applicable to the monetization arrangement because it resulted in an abuse of the provisions of the Income Tax Act which restricted the use of tax attributes following an acquisition of control by a person or group of persons.

HELD: Appeal allowed. The object, spirit and purpose of s. 111(5) of the Act was, at least in part, to restrict the use of specified losses, including non-capital losses, if a person or group of persons acquired actual control over the corporation’s actions, whether by way of de jure control or otherwise. The Tax Court’s conclusion that Matco had no effective control of the respondent and that the respondent freely participated in the transactions that resulted in the use of the tax attributes was inconsistent with the terms of the Investment Agreement. These terms gave Matco actual control over the actions of the respondent, including the approval of the Corporate Opportunity. The Investment Agreement dealt separately with control in general, and control over the approval of the Corporate Opportunity. The Investment Agreement resulted in New Forbes and the respondent handing over actual control of the respondent to Matco. New Forbes and the respondent realistically could do nothing relating to the actions of the respondent other than to ensure that they fulfilled their obligation to assist Matco with the implementation of the Corporate Opportunity. They were not free actors. The Crown demonstrated that through the Investment Agreement the transactions blatantly avoided an acquisition of control of the respondent. This was an abuse of s. 111(5). The Crown had clearly demonstrated that the transactions were abusive.

Canada v. Deans Knight Income Corp., [2021] F.C.J. No. 825, Federal Court of Appeal, D.W. Stratas, J.M. Woods and J.B. Laskin JJ.A., August 4, 2021. Digest No. TLD-September132021005