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 |  Subject: Canada: Top court boosts tax avoidance rule  Sun Feb 15, 2009 2:13 am | |
| Dissent says legitimate tax planning threatened by GAAR interpretation
The Supreme Court has ramped up the importance of the Income Tax Act’s general anti-avoidance rule (GAAR) with what one expert calls “the most significant tax decision in 70 years.”
The court launched its new year on Jan. 8 by releasing Lipson v. Canada, which applies, and elaborates on, the law established by the judges in their first two GAAR decisions, Canada Trustco Mortgage Co. v. Canada, [2005] 2 S.C.R. 601 and Mathew v. Canada, [2005] 2 S.C.R. 643 (Kaulius).
Canada Trustco and Kaulius set out the framework for identifying abusive tax avoidance under the GAAR in s. 245(4) of the ITA. The court held that abusive tax avoidance occurs where the impugned transaction, or series of transactions, frustrates the object, spirit or purpose of one or more of the provisions relied on by the taxpayer.
The smug looking criminal thieving scum: Department of Justice co-counsel Wendy Burnham and Daniel Bourgeois won a landmark tax case this month at the Supreme Court. (Patrick Walton/Department of Justice)
However, Lipson illustrates that the best legal minds can apply the Canada Trustco test for abuse and reach opposite conclusions.
Tax practitioners told The Lawyers Weekly they expect less certainty and predictability in the wake of the decision.
In Lipson, the high court split 4-3 to affirm, for the most part, the decision below in favour of the Canada Revenue Agency (CRA).
The lower courts ruled that, viewed as a whole, a series of steps taken by the appellant taxpayer Earl Lipson and his wife, Jordanna, to make their mortgage interest on their home tax deductible was contrary to GAAR.
While each of the four transactions in the series complied with the ITA — if viewed in isolation — their combined result frustrated the purpose of the ITA’s spousal attribution rules and violated GAAR, concluded majority Justices Louis LeBel, Morris Fish, Rosalie Abella and Louise Charron.
In dissent, Justices Ian Binnie and Marie Deschamps vigorously argued that “far from offending” the purpose of the spousal attribution rules, the Lipson tax avoidance scheme “fulfilled” those rules and thus was not abusive. Justice Marshall Rothstein separately contended that the CRA should have proceeded under a specific-anti-avoidance rule in s. 74.5(11) of the ITA, which targets some roll-overs, rather than under GAAR which Canada Trustco says is to be used as a “last resort.”
Counsel for the Attorney General of Canada, Department of Justice (DOJ) senior general counsel Wendy Burnham, told The Lawyers Weekly “what the Supreme Court is saying in this case is that the analytical approach that it set out in... Canada Trustco is the approach that has to be followed in GAAR cases, and that if you follow a consistent and principled approach, that’s the best way to ensure predictability and certainty in tax planning.”
Vern Krishna, a University of Ottawa tax law professor, said the split amongst the judges reveals a philosophical divide over GAAR.
The majority’s approach has “enormous” practical implications, he suggested.
“I believe the Lipson decision is probably the most significant tax decision in the last 70 years,” he said. “It addresses a very fundamental issue that has been causing tension in tax law for decades, and that is balancing the rights of the taxpayer to arrange his affairs to minimize tax — a principle that we generally refer to as the Westminster principle —against a statutory constraint, which in this particular case was imposed by GAAR, a very broadly-based anti-avoidance rule.”
Justice Binnie’s dissenting view of that balance would have “emasculated” the GAAR, he suggested.
Krishna added Lipson vividly illustrates that transactions that otherwise comply with the ITA may be “GAAR-able.”
“A tax practitioner would be foolhardy not... to put any tax plan under the microscope and ask the question: ‘Is this transaction subject to GAAR.’ It’s not enough to say, ‘Dammit, I have complied with the statute’.”
Burnham’s co-counsel, DOJ general counsel Daniel Bourgeois, said Lipson teaches that the way to avoid GAAR violations “is basically [to ask] whether or not the conferral of a tax benefit frustrates the purpose of the provisions that are used — that’s the way to ensure predictability and certainty in tax planning, as opposed to determining on a case-by-case basis whether the Duke of Westminster, or some non-statutory test should be applied.”
The Lipsons’ counsel, Ed Kroft of Vancouver’s McCarthy Tetrault, said tax practitioners are debating whether the majority has made it easier for the Crown to prove abusive tax avoidance. Kroft pointed to Justice LeBel’s statement that the Crown must prove abuse on the “balance of probabilities.” This raises the question whether the majority has applied a lower threshold than the Canada Trustco standard which says the abuse must be “clear” and a conclusion of non-abuse “cannot be reasonably entertained.”
The Lipson majority and minority clashed over the balance to be struck between GAAR and the Westminster principle. Westminster is alive, but it “has never been absolute,” said Justice LeBel.
“My colleague Binnie J. essentially guts the GAAR and reads it out of the ITA,” he wrote. Yet “the GAAR is neither a penal provision nor a hammer to pound taxpayers into submission. It is designed, in the complex context of the ITA, to restrain abusive tax avoidance and to make sure that the fairness of the tax system is preserved. A desire to avoid uncertainty cannot justify ignoring a provision of the ITA that is clearly intended to apply to transactions that would otherwise be valid on their face.”
Justice Binnie called the majority’s fears for GAAR “apocalyptic” while it is the Westminster principle that is ailing. “The GAAR is a weapon that, unless contained by the jurisprudence, could have a widespread, serious and unpredictable effect on legitimate tax planning.” It should not be used every time the tax department is upset that a taxpayer has failed to maximize the tax payable. The majority’s holding that Lipson engaged in abusive tax avoidance “gives the GAAR too wide a field of potential operation,” said Justice Binnie.
Justice LeBel concluded that the series of transactions that began with Lipson’s wife borrowing money from a bank to purchase shares in her husband’s company, followed by other steps that ultimately led to her legitimate deduction for the interest expenses being attributed to her husband, amounted to abusive tax avoidance. The tax department was correct to deny the husband those tax benefits.
The wife had borrowed $562,500 from the bank to buy shares, at market value, in her husband’s company. The next day she and her husband took out a joint mortgage of $562,500 from the same bank. They immediately used the mortgage money to repay the bank the $562,500 share loan. Relying on the ITA’s spousal attribution rules the husband, being the higher income earner, subsequently deducted the mortgage interest and reported the taxable dividends on the shares as income.
http://www.lawyersweekly.ca/index.php?section=article&articleid=840 |
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