The court found that the company's conduct abused provisions of the Income Tax Act
The General Anti-Avoidance Rule, which tax authorities can use to deny benefits to taxpayers trying to circumvent tax rules, applies to an Ontario company that transferred shares and moved to a new jurisdiction to defer taxes related to anticipated capital gains, the Federal Court of Appeal has ruled.
The tax dispute dates back to 2015, when DAC Investment Holdings Inc. acquired shares of a company from Jacal Holdings Ltd. in a “rollover” transaction under s. 85 of the ITA, which allows taxpayers to defer tax consequences that would usually arise. DAC and Jacal are both Canadian-controlled private corporations, or CCPCs, run by the same sole director, David Civiero.
Shortly after, DAC changed its jurisdiction from Ontario to the British Virgin Islands, thereby no longer qualifying as a CCPC. The company sold the shares it acquired from Jacal to another party two weeks later, realizing $2.3 million in capital gains.
Under ss. 123.3 and 123.4 of the ITA, taxes cannot be deferred on investment income earned by a CCPC.
In its decision on Friday, the appellate court said DAC Investment Holdings Inc.’s transactions related to the rollover and jurisdiction change abused provisions of the ITA, including ss. 123.3 and 123.4.
“I agree with the Crown when it says that if one can so easily obtain tax benefits by circumventing anti-deferral measures, the effectiveness of these measures is severely eroded,” the FCA said, referring to DAC’s move to the British Virgin Islands.
“Canada’s system of taxing investment income of CCPCs ensures that tax is not deferred,” the appellate court added. “In this case, the anti-deferral measures become elective in practice because they were circumvented so easily. Parliament did not intend this result.”
DAC brought the case to the appellate court after the Minister of National Revenue reassessed DAC’s taxes for 2016, the year for which DAC had reported the capital gains. The reassessment, conducted in 2020, determined that the general anti-avoidance rule (GAAR) applied to DAC’s case, resulting in the company owing nearly $300,000 in additional taxes for the 2016 tax year.
To apply GAAR, tax authorities must prove that a transaction meets three criteria. First, the transaction must yield a tax benefit. Second, the transaction must be a so-called avoidance transaction – i.e., one that is entered into for the sole purpose of obtaining a tax benefit. Lastly, the transaction must be abusive.
Because DAC admitted that it had received a tax benefit and that there were two avoidance transactions – the rollover of shares from Jacal to DAC and DAC’s move to the British Virgin Islands – the only question that a tax court had considered in the dispute was whether the transactions were abusive. The tax court found that the conduct was not abusive because Parliament recognized that companies have the right to move to jurisdictions with different tax regimes, and anti-deferral measures under the Income Tax Act apply only to CCPCs. DAC was no longer a CCPC when it realized capital gains from the shares it sold in 2015.
However, the FCA disagreed, stating that “the Tax Court expressed Parliament’s intent too broadly.”
“The result of these transactions is to defeat Parliament’s objective that an individual not be allowed to defer tax on investment income by holding investments in a corporation,” the appellate court said. “Parliament did not intend the result that was achieved in this case. Although the statutory provisions relied on do not prevent this result, the GAAR was enacted to address situations such as this.”
The tax court had found that DAC’s avoidance transactions are not abusive because Parliament wanted to allow CCPCs to take steps to become non-CCPCs. The appellate court countered that “even if Parliament recognizes that generally a corporation may take steps to cease to be a CCPC, this does not mean that the GAAR cannot apply on the facts of a particular case.”
Under subsection 250(5.1) of the ITA, corporations that move into another jurisdiction are deemed from the time of continuance to be incorporated in the new jurisdiction. The FCA found that DAC abused the provision, whose “object, spirit and purpose” is to “make tax provisions fairer for corporations moving into or leaving Canada by way of continuance.”
The appellate court noted that DAC’s move to the British Virgin Islands had nothing to do with business or developing ties in the jurisdiction and was simply a means of obtaining tax benefits.
The FCA also found that the transactions abused ss. 123.3 and 123.4 of the ITA “because the transactions defeated the anti-deferral rationale of these provisions.”
Because the appellate court found the transactions abusive, it concluded that GAAR applies.
Counsel for the parties did not respond to requests for comment.
