On February 1, 2018, the Federal Court of Appeal ("FCA") released its decision in Canada v. Oxford Properties Group Inc.,1 a case dealing with the General Anti-Avoidance Rule ("GAAR") found in subsection 245(2) of the Income Tax Act (Canada) ("Act"). The FCA allowed the Crown’s appeal, holding that the series of transactions undertaken were abusive of various partnership rollover and bump provisions.
Tax Court of Canada Decision
The Tax Court of Canada ("TCC")2 held that while the taxpayer obtained a tax benefit and that there was one or more avoidance transactions, the series of transactions were not abusive under any of the relevant provisions.
Issue on Appeal
The only issue on appeal involved the last branch of the GAAR analysis; in particular, whether there was an abuse of ss. 97(2), 98(3), 88(1)(d), and 100(1) as a result of the sale of the partnership interests to the tax-exempt entity, given that the bumps resulted in minimal capital gains, and the tax-exempt entity would never be taxed on the deferred gains and recapture inherent in the underlying properties held by the partnerships.
The Transaction
Subsection 97(2) — first step in the series
The taxpayer engaged in a series of restructuring transactions involving the movement real estate assets into several limited partnerships ("First Tier Partnerships") on a tax-free rollover basis using section 97 of the Act, deferring the capital gains and recapture.
Paragraph 88(1)(d) and subsection 98(3) — next steps in the series
Subsequent restructuring resulted in a vertical amalgamation which formed the taxpayer. The taxpayer utilized the paragraph 88(1)(d) bump provisions to increase its adjusted cost base ("ACB") of the partnership interests it held in the First Tier Partnerships (which had a high fair market value).
A second tier of partnerships ("Second Tier Partnerships") was then created, the real properties were rolled into them using subsection 97(2) and the First Tier Partnerships were wound-up. The taxpayer used a similar bump provision found in subsection 98(3) to bump its new interests in the Second Tier Partnerships.
Throughout all of these transactions, the underlying real property held by the partnerships retained their low ACB and undepreciated capital cost (and high fair market value).
Subsection 100(1) — sale to the tax exempt
Subsection 97(2) allows for the deferral of recapture and capital gains of depreciable capital property when it is transferred to a partnership. However, if the partnership interests are later sold to a tax-exempt purchaser and a capital gain is realized on the sale of the partnership interests, paragraph 100(1)(b) of the Act deems 100 per cent of the gain on the sale of the partnership interests attributed to the value of depreciable capital property to be included in income.
When the taxpayer disposed of its interests in the Second Tier Partnership to the tax-exempt entities, little or no gain was generated by the sale because the ACB of the partnership interests was bumped. As a result, subsection 100(1) did not apply to trigger the deferred recapture on the depreciable properties held by the partnerships.
The Reassessment
The Minister relied on GAAR in issuing the assessment, taking the view that the rollovers and bumps were used to increase the ACB of the partnership interests in a manner which allowed the taxpayer to circumvent the application of subsection 100(1). The reassessment denied the bumps in their entirety and applied subsection 100(1) on the resulting gain. The Minister assessed a $148 million taxable capital gain, only $116 million being attributed to the deferred recapture on the partnerships underlying depreciable property.
FCA’s Analysis
Chief Justice Noël begins his analysis referencing the decision in Copthorne Holdings Inc.3 The Court noted, “rather than giving the relevant provisions a meaning which accords with their object, spirit and purpose, the TCC confined the effect of these provisions to their wording” (para 45). Chief Justice Noël uses multiple excerpts from the Copthorne decision to emphasise the importance of an “object, spirit, and purpose” GAAR construction. In fact, he concludes that “A GAAR analysis can therefore lead to a result that is different from that obtained by a traditional, textual, contextual, and purposive interpretation.”
Chief Justice Noël then reviews the “object, spirit, and purpose” of each of the provisions used to achieve the tax result under subsection 100(1). The mischief that caused the abuse according to Chief Justice Noël was the fact that the tax on the latent recapture sitting in the underlying properties held by the partnerships that were sold (which still had low ACBs and UCCs) was never going to be paid. Chief Justice Noël found that this was contrary to the intention of subsections 100(1), 97(2), 98(3) and paragraph 88(1)(d), since subsection 97(2) rolls over the tax attributes so that the transferee inherits the latent recapture; paragraph 88(1)(d) and subsection 98(3) expressly deny bumps of cost base on depreciable property to ensure recapture is still taxed when the property is eventually sold, and subsection 100(1) creates a deemed income inclusion when a partnership interest is sold to a tax exempt entity equal to 100 per cent of the portion of the capital gain on the partnership interest attributed to depreciable capital property. If the sale of the partnership interests was not made to a tax-exempt entity, the decision suggests there would not have been abuse because the tax on the recapture would have been paid on a subsequent sale by the purchaser.
The overall result of the series of transactions was the circumvention of subsection 100(1) by eliminating the capital gain which would otherwise have resulted from the sale of the partnership interests to the exempt entities. This was achieved by bumping the tax cost of the partnership interests to approximate their fair market value, thereby eliminating the gain on which subsection 100(1) could apply and making the deferral of accrued gains and latent recapture permanent (para 108).
Decision
In the result, the FCA only allowed part of the appeal. The FCA allowed the appeal with respect to the $116 million recapture, stating that the “abuse” did not apply to the increase in cost of property that is taxed in the same way as the property from which the transferred costs originate. The FCA stated that the bumps are not permitted on depreciable property because allowing property that is taxed on the basis of a 50 per cent rate of inclusion to augment the value of property that is taxed on the basis of a 100 per cent rate of inclusion (i.e.: recapture on depreciable property) would result in an obvious revenue loss. The exclusion of depreciable property for the bumps, when taking into account subsection 100(1), is not intended to exclude the capital gain portion of the increase in value, just the recapture since recapture is taxed at a higher rate (100 per cent) than the disposition of shares or partnership interests (50 per cent).
Takeaways
Object, spirit and purpose
The Court emphasizes the importance of delving into the “object, spirit, and purpose” of a law when conducting the abuse branch of the GAAR analysis. As the Court notes, this may result in an interpretation that is different than a textual, contextual and purposive approach.
Subsequent amendments
The FCA provided some insight post Univar Holdco Canada ULC4 into how subsequent amendments are to be treated in the context of a GAAR “abuse” analysis, taking a less taxpayer friendly approach.
Based on the Court’s discussion in paragraph 86, a subsequent amendment can either clarify or alter the prior law, which means that the existence of a subsequent amendment does not necessarily mean that the amended law did not already exist. A subsequent amendment which addresses the mischief in question is therefore insufficient to assert there has been no abuse of the prior law, since the “object, spirit, and purpose” of the prior law may already include that subsequent amendment. Whether an amendment operates as a new law or a clarification of an old one requires a purposive analysis of the old law (within GAAR). The FCA states:
However, the question whether new subparagraph 88(1)(d)(ii.1) operates as new law in a GAAR context must be assessed having regard to the meaning of the prior provisions, when construed with a focus on their underlying rationale or reason for being. In this respect, it can be seen from the Tax Court judge’s own analysis of the provisions as they stood before the amendment … that new subparagraph 88(1)(d)(ii.1) conveys in express terms a rationale which was already present in these provisions. Notably, these provisions already drew the distinction between depreciable and non-depreciable property and the only reason for making this distinction is to take into account the distinctive tax treatment afforded to each type of property under the Act in determining which is eligible for a bump and which is not. The use of tiered partnerships to bypass this distinctive treatment frustrates the reason for the distinction which these provisions already drew. (para 90)…
When the prior law is construed with a focus on its object, spirit and purpose as it must be, the amendment does not operate as new law. Its practical effect is simply that the GAAR will no longer have to be resorted to in order to prevent the result achieved in this case. [Emphasis Added]
This decision gives further guidance on how subsequent amendments are to be treated under the third branch of the GAAR test. The result being more CRA friendly, as the FCA states that subsequent amendments may clarify the “object, spirit, and purpose” of a prior law, merely putting them into writing.
Looking Forward
An appeal has not yet been filed (an application for leave to appeal to the SCC must be filed by April 2nd, 2018). While the decision is very section specific, this is the second FCA decision touching on subsequent amendments in the context of the GAAR, and the SCC may wish to clarify.
For more information, please contact the author or key contacts noted below.
1 2018 FCA 30 [Oxford Properties].
2 2016 TCC 204.
3 2011 SCC 63 [Copthorne].
4 2017 FCA 207 [Univar].
