The FA anti-avoidance rule in paragraph 95(6)(b) is intended to prevent tax avoidance by means of an acquisition or disposition of shares. When this rule applies, the acquisition or disposition of shares is deemed not to have taken place other than for purposes of section 90. For example, if paragraph 95(6)(b) applies, a dividend that is received from a FA could be included in income under subsection 90(1), but no deduction would be allowed under section 113 because the Canadian taxpayer is deemed not to own the shares.
The facts have been simplified for illustrative purposes.
The taxpayer is a Canadian corporation (Canco) that is part of a multi-national corporate group. As part of a refinancing in 1995 of a U.S. sister company's (US Sisterco) intercompany debt and equity, Canco borrowed $100 million and used the proceeds to invest in shares of a newly-formed foreign affiliate (Delaware LLC). In turn, Delaware LLC made interest-bearing loans to US Sisterco, some of the proceeds of which were used, indirectly, to redeem preferred shares that Canco held in the U.S. parent of US Sisterco. US Sisterco paid more than $15 million of interest to Delaware LLC from 1995 to 1997. Delaware LLC paid the interest it received from US Sisterco to Canco as dividends in 1996 and 1997. Canco deducted the dividends it received under section 113 of the Act.
Canco paid about $12 million in interest in 1996 and 1997 on its $100 million loan to the bank. As such, Canco's "commercial profit" from its investment in Delaware LLC was about $1.2 million (i.e., dividends received, less U.S. withholding tax, and less Canadian interest expense incurred).
The CRA disallowed Canco's exempt surplus dividend deduction on the basis that the FA anti-avoidance provision in paragraph 95(6)(b) applied. In the CRA's view, this rule applied because Canco's principal purpose for the acquisition of the Delaware LLC shares was to earn income that was tax exempt under section 113 and, at the same time, to obtain a tax deduction under paragraph 20(1)(c) for the interest it paid on the borrowed money used to make the share investment. The CRA believed "tax asymmetry" was the principal purpose for acquiring the shares.
The CRA also noted that Canco's direct investment in US Sisterco would not have been possible because it would have violated a bank covenant. Further, since US Sisterco had net operating losses and accumulated book losses, a direct capital investment in US Sisterco would not have enabled Canco to receive dividends.
Prior decision - TCC finds FA anti-avoidance rule does not apply
At issue in the TCC review was whether the FA anti-avoidance provision in paragraph 95(6)(b) applied to Canco's acquisition of shares in Delaware LLC. The TCC found in favour of the taxpayer and ruled that the FA anti-avoidance rule in paragraph 95(6)(b) did not apply such that the taxpayer was entitled to an exempt surplus dividend deduction under paragraph 113(1)(a) for dividends received in its 1996 and 1997 taxation years. Using a comprehensive textual, contextual and purposive analysis of paragraph 95(6)(b), the TCC concluded that tax was not avoided because of Canco's acquisition of a non-resident corporation's shares, as the taxpayer could have achieved the same result by making a direct investment in an existing U.S. resident corporation.
Although the decision in the case at the TCC level was in favour of the taxpayer, the TCC's analysis of the potential breadth of paragraph 95(6)(b) caused some concern. In particular, the TCC did not restrict the application of paragraph 95(6)(b) to situations in which there had been a "manipulation" of the shareholdings in an FA.
The TCC concluded that the FA anti-avoidance provision can apply to any acquisition or disposition of shares that is principally tax-motivated. Moreover, the TCC held that a relevant factor for determining the principal purpose of an acquisition or disposition is whether it is part of a series of transactions conducted with a view to avoiding tax. Even though there is no "series of transactions" test in paragraph 95(6)(b), the TCC found that a broader reading of the provision should include taking the entirety of the FA rules in the Act into account, and considering the overall purposes of a series of transactions that the acquisition or disposition forms a part.
At issue before the FCA were the same two issues as were before the TCC. Specifically, the FCA had to determine Canco's principal purpose in acquiring the shares of Delaware LLC, and the proper interpretation of paragraph 95(6)(b).
FCA upholds TCC's decision
In its analysis, the FCA primarily analyzed the proper interpretation of the FA anti-avoidance rule in paragraph 95(6)(b).
Text and contextual analysis
Citing Canada Trustco , the FCA noted that any interpretation of a statutory provision requires examination of its text, context and purpose. Following this approach, the FCA concluded that the words of paragraph 95(6)(b) are precise and unequivocal. This provision looks to the principal purpose for the acquisition or disposition of shares, not the principal purpose of the series of transactions of which the acquisition or disposition forms a part.
The FCA found no reason to read extra words into paragraph 95(6)(b). In support of this finding, the FCA pointed out that, whenever the Act broadens its focus from an individual transaction to a series of transactions, it uses specific words. Paragraph 95(6)(b) contains no such language - rather, the words require that the tax benefit must flow from a share acquisition or disposition itself and obtaining the tax benefit must be the principal purpose of the share acquisition or disposition.
From a contextual perspective, the FCA noted that, if paragraph 95(6)(b) could be read as broadly as the CRA suggests, anti-avoidance provisions such the rules related to indirect loans to non-resident persons (in subsection 17(2)) and the FA dumping rules would be unnecessary. Accordingly, paragraph 95(6)(b) should be viewed as just one of many anti-avoidance provisions in the Act.
The FCA found that another contextual factor to the meaning of paragraph 95(6)(b) is that it is part of subdivision i (Shareholders of Corporations Not Resident in Canada) of Division B (Computation of Income) of Part I of the Act and not part of a more general part of the Act, such as Part XVI (Tax Avoidance). The FCA noted that this placement supports the conclusion that paragraph 95(6)(b) addresses concerns related to acquisitions or dispositions of "shares of corporations not resident in Canada", not other transactions of a more general tax avoidance nature.
The FCA noted that, on the facts of the case, the relevant tax advantage is created by section 113, which depends on whether or not the corporation is an FA under subsection 95(1). The FCA further stated that a corporation's status as an FA is easily manipulated by acquisitions and dispositions of shares. Accordingly, paragraph 95(6)(b) was enacted to combat such manipulation by requiring that the acquisition or disposition be ignored in appropriate cases. The FCA noted that, if paragraph 95(6)(b) is aimed at a broader issue, it would contain language that was more clear.
Purpose of the provision
The FCA stated that, even when the wording is clear and unequivocal, it must review the underlying purpose of the provision to understand its meaning. As a result, the FCA reviewed the avoidance techniques addressed by paragraph 95(6)(b), how far this provision goes to redress the avoidance of tax, and the circumstances to which it applies.
In considering the underlying purpose of paragraph 95(6)(b), the FCA noted that "anti-avoidance provisions come in all shapes and sizes" and must therefore be analyzed individually. In this context, the FCA stated that its analysis suggests the purpose of paragraph 95(6)(b) is to address a particular "species" of avoidance only, and is not aimed at general anti-avoidance. The FCA also rejected the CRA's view that the underlying purpose of paragraph 95(6)(b) is to combat "unacceptable" tax avoidance, noting that "unacceptability is in the eye of the beholder," and that to interpret paragraph 95(6)(b) in such a manner gives the CRA the indiscriminate discretion to treat similarly situated taxpayers differently for no objective reason.
To illustrate this problem, the FCA considered a hypothetical situation in which a Canadian corporation borrows to buy the shares of a non-resident corporation that carries on an active business. The FCA noted that, in these circumstances, the tax result will always exceed the commercial result. Specifically, the Canadian corporation will be able to deduct both interest and dividends. The FCA questioned whether paragraph 95(6)(b) would always be an issue in this scenario and, if so, what would determine the extent of the CRA's discretion regarding whether or not to apply this provision. The FCA pointed out that, unlike GAAR (which requires the presence of abuse or misuse), paragraph 95(6)(b) does not contain such limiting language. The FCA concluded its analysis by stating that:
Absent clear wording, I would be loath to interpret paragraph 95(6)(b) in a way that gives the Minister such an unlimited and ill-defined discretion - a standardless sweep - as to whether or not a tax is owing, limited only by her view of unacceptability. It would be contrary to fundamental principle. It would also promote inconsistent and arbitrary application, the bane of consistency, predictability and fairness.
The FCA concluded that paragraph 95(6)(b) is targeted at taxpayers whose principal purpose for acquiring or disposing of shares in a non-resident corporation is to meet or fail the relevant tests for FA, controlled FA or related-corporation status in subdivision i of Division B of Part I of the Act, with a view to avoiding, reducing or deferring Canadian tax.
The FCA said that the principal purpose of the acquisition or disposition of shares in the non-resident must be determined on the basis of all relevant circumstances. The CRA cannot look at an entire series of transactions to discern a tax avoidance purpose that is not the specific target of paragraph 95(6)(b). Manipulating the shareholdings to change its status does not necessarily trigger paragraph 95(6)(b) of the Act. The purpose must be dominant, not just one of many different purposes.
The FCA said that the TCC did not err in principle when it found that the principal purpose behind Canco's acquisition of shares in Delaware LLC, viewed in light of the entire series of transactions, was to achieve overall U.S. tax savings. The TCC found that the Canadian tax savings could have been obtained without acquiring the shares in the non-resident corporation and that the acquisition of shares in Delaware LLC did not result in an avoidance of Canadian tax. As a result, the FCA confirmed that paragraph 95(6)(b) does not apply in this case and the CRA's reassessments for the 1996 and 1997 taxation years cannot stand.
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