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Tax Avoidance: 1945-1995
Howard J. Kellough, QC*
P RÉCIS
Pendant de nombreuses années, les tribunaux et le gouvernement ont
régulièrement souscrit à la règle selon laquelle les contribuables
pouvaient planifier leurs affaires de sorte à payer le moins d’impôt
possible. Cette règle est particulièrement importante à un moment où
même le gouvernement convient que la situation financière du Canada
est déplorable et au moment où la plupart des citoyens croient que les
taux d’imposition sont à un niveau spoliateur. Toutefois, cette règle a été
remise en question et sa portée a été érodée surtout par le
gouvernement, depuis presque la mise en oeuvre. Chacune des
directions législative, administratrive et judiciaire du gouvernement a
formulé ses propres règles pour traiter l’évitement fiscal.
Sur le plan législatif, la présentation, en 1988, de la règle générale
anti-évitement devait obvier au besoin de la multitude habituelle de règles
anti-évitement compliquées et détaillées, mais cette promesse n’a pas
été tenue. Au chapitre de l’administration, Revenu Canada poursuit son
opposition à des opérations sous prétexte qu’elles contreviennent à
l’«esprit» de la Loi tout en admettant qu’aucun article particulier n’a été
transgressé. Au cours des deux prochaines années, plusieurs cas relatifs
à la DGAÉ qui sont devant la Cour canadienne de l’impôt permettront de
déterminer si cette approche est appropriée.
Le système judiciaire poursuit sa bataille avec les concepts de
l’allégement fiscal, de l’évitement fiscal et de la planification fiscale
inacceptable. Cette situation n’est pas surprenante étant donné le
manque de directives dans ce domaine de la part de la Cour suprême du
Canada et de la Cour d’appel fédérale, ni l’une ni l’autre n’ayant formulé
des règles uniformes et compréhensibles. Ainsi, Revenu Canada et les
contribuables doivent établir eux-mêmes les mesures qui sont
acceptables et celles qui ne le sont pas.
La solution, s’il en existe une, est complexe et elle doit être examinée à
la lumière tant des questions nationales que de la position du Canada sur
le plan international. Toute réforme importante du régime fiscal canadien
ne nécessitera rien de moins qu’une révision massive de l’aspect
financier du gouvernement afin d’obtenir un régime fiscal
compréhensible, plus simple et plus équitable pour tous ceux qui sont
concernés.
* Of Fraser & Beatty, Vancouver.
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ABSTRACT
For many years the courts and the government have consistently
endorsed the rule that taxpayers may plan their affairs so as to pay the
least amount of tax. This rule is especially important at a time when even
the government agrees that Canada’s fiscal situation is deplorable and
when most citizens believe that tax rates are at a confiscatory level.
However, this rule has been under attack and its scope eroded by the
government, in particular, for almost as long as it has existed. Each of the
legislative, administrative and judicial branches of government has
formulated its own rules for dealing with tax avoidance.
On the legislative side, the introduction of the general anti-avoidance
rule in 1988 was supposed to obviate the need for the usual plethora of
complex, detailed anti-avoidance rules, yet this promise has not come to
pass. Administratively, Revenue Canada continues to challenge
transactions on the ground that they do not meet the “spirit” of the Act,
even while admitting that no specific section has been violated. In the
next year or two several cases concerning GAAR, which are at the Tax
Court of Canada level, should determine whether this approach is
appropriate.
The judiciary continues to struggle with the concepts of tax mitigation,
tax avoidance, and unacceptable tax planning. This is not surprising given
the lack of direction in this area from the Supreme Court of Canada and
the Federal Court of Appeal, neither of which has formulated consistent,
understandable rules. This leaves both Revenue Canada and taxpayers to
determine for themselves what is acceptable and what is not.
The solution, if there is one, is complex, and must be considered in the
light of both domestic matters and Canada’s international position. Any
significant reform to the Canadian tax system will require nothing short of
a massive overhaul of the fiscal side of government in order to obtain a
tax system that is understandable, simpler, and fairer for all concerned.
INTRODUCTION
This paper is intended to be a synopsis of the Canadian legislative, administrative, and judicial treatment over the past 50 years in Canada of
the complex and growing fiscal area known generically as “tax avoidance.” The very nature of the phrase is ambiguous and invites debate, in
that tax avoidance can be either acceptable or unacceptable to fiscal administrators and the courts.
Tax avoidance usually can be distinguished from tax evasion, but no clear
distinction can be drawn between acceptable and unacceptable tax avoidance.
At best, it can be said that acceptable tax avoidance is that which is considered acceptable by the courts, notwithstanding that it may have been
considered unacceptable by Revenue Canada. Ultimately, of course, Parliament can make unacceptable or acceptable what was previously considered
acceptable or unacceptable by either the courts or Revenue Canada.
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Tax evasion is the deliberate and wilful failure to pay taxes legally
owing or the deliberate and wilful structuring of one’s affairs in direct
violation of the law. Revenue Canada defines tax evasion as “the commission or omission of an act knowingly, the conspiracy to commit such
an act or involvement in the accommodation of such an act, which can
result in a charge being laid in the Criminal Court under subsection 239(1)
of the Income Tax Act.”1 While the Income Tax Act2 as a whole is an
administrative statute, the offence provisions thereof are criminal in nature.3 In other words, tax evasion is a crime. 4
I know of no encompassing definition of the phrase “tax avoidance.” It
has been described as “[t]he art of dodging tax without actually breaking
the law.”5 Fiscal administrators tend to use the term in its pejorative sense
to depict situations where the “appropriate” amount of tax has not been
paid. Taxpayers see the term as describing circumstances where inordinately high tax burdens are properly reduced. There is, therefore, an
apparent continuum that ranges from acceptable tax avoidance to unacceptable tax avoidance to tax evasion. The courts, of course, are involved
as a third party, acting not only as the arbiter in the inevitable disputes
that arise but also setting their own guidelines in an attempt to help
resolve the disputes.
The courts have tried to define tax avoidance. For example, one court
drew a distinction between tax avoidance and tax planning by saying that
the latter involves transactions not repugnant to the minister. 6 This definition obviously assumes that all tax planning involves acceptable tax
avoidance, and is of little assistance. The courts have also tried to distinguish between “tax mitigation” and “tax avoidance”;7 this focus attempts
1 See
Information Circular 73-10R3, “Tax Evasion,” February 13, 1987, paragraph 8.
1985, c. 1 (5th Supp.), as amended (herein referred to as the “Act”). Unless
otherwise stated, statutory references in this article are to the Act.
3 See Knox Contracting Limited et al. v. The Queen, 90 DTC 6447 (SCC).
4 See Edward L. Greenspan, “Tax Evasion Is a Crime!” in Income Tax Enforcement,
Compliance, and Administration, 1988 Corporate Management Tax Conference (Toronto:
Canadian Tax Foundation, 1988), 1:1-9; and Gerald H. McCracken, “Preventing Tax Evasion Through Enforcement: The Government Perspective,” ibid., 2:1-14.
5 See G.S.A. Wheatcroft, “The Attitude of the Legislature and the Courts to Tax Avoidance” (May 1955), 18 The Modern Law Review 209-30, at 209. See also J. Ian M. Whitcomb,
“Judicial Approaches to Tax Avoidance,” in Report of Proceedings of the Eighteenth Tax
Conference, 1964 Conference Report (Toronto: Canadian Tax Foundation, 1965), 55-61,
at 56.
6 See Orr v. MNR, 89 DTC 557, at 564 (TCC).
7 In CIR v. Challenge Corp’n., [1987] AC 155, at 167-68 (PC), a majority of the board
attempted to distinguish between “tax mitigation” and “tax avoidance.” For a similar
definition, see Canada, Report of the Royal Commission on Taxation (Ottawa: Queen’s
Printer, 1966), vol. 3, at 541, footnote 4 and accompanying text. The Challenge distinction
between mitigation and avoidance was criticized as too “elusive” in its application to a
particular fact situation in Hadlee v. CIR, [1991] 3 NZLR 517, at 524 (CA), but it was
(The footnote is continued on the next page.)
2 RSC
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to define tax avoidance from an economic perspective. These judicial
characterizations may help to explain the court’s position in the particular
situation under review and provide taxpayers with a pigeonhole in which
to slot similar transactions, but they have limited general application.
The courts, as noted, are more than mere arbiters between taxpayers and
the government. They have actively formulated their own tests to determine
whether a transaction is within the legislation. It is not easy to reconcile the
bewildering array of judicial anti-avoidance doctrines, legislative antiavoidance rules, and many of the positions adopted by Revenue Canada.
Indeed, Revenue Canada’s position on the interplay of judicial antiavoidance rules and anti-avoidance legislation is that the various judicial
anti-avoidance rules are intended to fill apparent gaps in the legislative
scheme.8 In other words, Revenue Canada views the judicial anti-avoidance
rules as a means of covering “the exploitation of areas which the legislature intended to cover but, for one reason or another, did not.”9
A second view of the role of the judicial anti-avoidance rules that is
more in keeping with the perspective afforded by the courts is that judicial anti-avoidance rules are nothing more than a checklist designed to
determine whether a taxpayer has managed to design his affairs so as to
fall outside the charging provisions of the Act. Seen in this context, the
term “tax avoidance” is without any legal meaning, as one is either caught
by the Act or one is not; if one is not, then the transaction is not designed
to “avoid” but to “save” tax.10 In Atinco Paper Products Ltd. v. The
Queen, Mr. Justice Urie succinctly stated the role of the court:
I do not think that I should leave this appeal without expressing my views
on the general question of transactions undertaken purportedly for the purpose of estate planning and tax avoidance. It is trite law to say that every
taxpayer is entitled to arrange his affairs as to minimize his tax liability.
7
Continued . . .
followed in Ensign Tankers (Leasing) Ltd. v. Stokes (HMIT), [1992] BTC 110, at 123
(HL). In Ireland, the Challenge definition is, in effect, not part of the law. See McGrath v.
McDermott, [1988] IR 273 (SC). For case comments on Challenge, see P.J.H. Jenkin, “Tax
Avoidance, Politics, and Privy Councillors” [September 1988] New Zealand Law Journal
305-10, and Notes of Cases feature [1987], no. 3 British Tax Review 134-38. For a case
comment on McGrath, see the Current Cases feature (1988), vol. 36, no. 6 Canadian Tax
Journal 1523-25.
8 See Davant v. CIR, 366 F.2d 874, at 887, footnote 27 (5th Cir. 1966), cert. denied 386
US (1967). This is essentially the position taken by Revenue Canada in paragraph 5 of
Information Circular 88-2, “General Anti-Avoidance Rule: Section 245 of the Income Tax
Act,” October 21, 1988.
9 See V. Uckmar, “General Report,” in International Fiscal Association, Cahiers de
droit fiscal international, vol. 68a, Tax Avoidance/Tax Evasion (Deventer, the Netherlands:
Kluwer, 1984), 15-53, at 23, paragraph 0.35. This seems to have been the intent of former
subsection 246(6), which provided that the avoidance of tax could be improper even
though not illegal.
10 Ibid., at 23, paragraph 0.37. See also Orr, supra footnote 6 at 566, where the court
stated that “it is difficult to establish a clear distinction between tax planning and tax
avoidance.”
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No one has ever suggested that this is contrary to public policy. It is equally
true that this Court is not the watch-dog of the Minister of National Revenue. Nonetheless, it is the duty of the Court to carefully scrutinize
everything that a taxpayer has done to ensure that everything which appears to have been done, in fact, has been done in accordance with applicable
law. It is not sufficient to employ devices to achieve a desired result without ensuring that those devices are not simply cosmetically correct, that is
correct in form, but, in fact, are in all respects legally correct, real transactions. If this Court, or any other Court, were to fail to carry out its elementary
duty to examine with care all aspects of the transactions in issue, it would
not only be derelict in carrying out its judicial duties, but in its duty to the
public at large. It is for this reason that I cannot accede to the suggestion,
sometimes expressed, that there can be a strict or liberal view taken of a
transaction, or series of transactions which it is hoped by the taxpayer will
result in a minimization of tax. The only course for the Court to take is to
apply the law as the Court sees it to the facts as found in the particular
transaction. If the transaction can withstand that scrutiny, then it will, of
course be supported. If it cannot, it will fail.11
LEGISLATIVE ASPECTS
Legislatively speaking, the tax-avoidance area was relatively quiet until
the early 1980s. The new Income Tax Act, which became effective on
January 1, 1972, contained a number of anti-tax-avoidance measures, ostensibly to protect the revenue base of a more complex income tax system
which, for the first time, taxed capital gains and introduced highly structured statutory provisions and significant conceptual changes. Before the
1972 Income Tax Act, the Income Tax Act that had become effective
January 1, 1949 12 was a relatively stable piece of legislation, and few
amendments relating to tax avoidance were made over the years.
The Department of Finance (“Finance”) is responsible for drafting tax
legislation. No known group within Finance specializes in drafting taxavoidance legislation. The source of information for many of the
anti-avoidance provisions under the Act is something of a mystery, much
like many of the provisions contained in budgets and technical amendments that have been introduced over the years. However, it is understood
that types of transactions that Revenue Canada finds abusive are brought
to the attention of Finance through either the rulings or the audit directorate of Revenue Canada. In addition, taxpayers make submissions to
Revenue Canada and Finance that sometimes result in changes to the
legislation or regulations. Nevertheless, the precise relationship between
Revenue Canada and Finance is unclear even to those within the departments and certainly to tax practitioners, including those who have had
extensive dealings with both departments.
11 78 DTC 6387, at 6395 (FCA), followed in The Queen v. Gesser Estate, 92 DTC 6273
(FCA). That this is the correct view of anti-avoidance rules appears to have been confirmed in Ensign Tankers, supra footnote 7.
12 Replacing the Income War Tax Act, which introduced income tax in Canada in 1917.
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Legislative Tax-Avoidance Weapons
Ministerial Discretion
The use of legislative discretion whereby bureaucrats can simply dictate
the tax results is the crudest of the legislative tools designed to check
unwanted tax avoidance. It illustrates an inability to deal fairly with taxpayers by designing fiscal laws that are reasonable, fair, in accordance
with acceptable standards, and understandable. Section 138 of the pre-1972
Income Tax Act, which became section 246 of the Act, is probably the
most notorious of these provisions.
Former section 246 had its origins in 1938 with the introduction of
section 32 A to the Income War Tax Act. The section was repealed and
re-enacted in 1940; perhaps because of the war effort, it started to take on
the appearance of an authoritarian, undemocratic provision.13 Ministerial
discretion has been stated to have been the backbone of the income tax
system from 1917 to 1948. It grew by leaps and bounds after the First
World War, “and by 1945 there were some hundred discretion provisions
in the Act.”14
In 1943, section 32 A was again repealed and re-enacted in a form that
resembled what ultimately was to become section 246 of the Act. In his
speech to Parliament, the finance minister of the day, Mr. Ilsley, justified
the introduction of the provision by saying, in substance, that taxpayers
need not be concerned if their activities involved a legitimate business
purpose (without defining what that was), and adding that if Canada had
not been at war such a provision would not be as necessary.
Subsection 246(1) granted the Treasury Board sweeping powers to “give
such direction as it considers appropriate” to counter tax avoidance or
reduction of taxes when the board decided that one of the main purposes
for a transaction or transactions was such avoidance or reduction. Subsection 246(2) provided that a direction given under subsection 246(1) may
relate to taxes to be paid under one or more parts of the Act or any of its
predecessors by one or more persons for one or more taxation years.
Subsection 246(3) provided that once a direction had been given, tax was
to be collected or assessed or reassessed and collected notwithstanding
any other provision of the Act or any other act.
The Federal Court was given exclusive original jurisdiction in all actions pursuant to subsection 246(4). Subsection 246(6) provided that
“avoidance or reduction of taxes may be regarded as improper for the
purpose of this section although it is not illegal.” There is no reported
13 For a detailed review of this provision, see F.E. LaBrie, “The Uncertainties of Tax
Planning: Part I—Review by the Treasury Board” (May 1960), 9 Chitty’s Law Journal
114-25.
14 See Gwyneth McGregor, “Return of Ministerial Discretion,” in Report of Proceedings of the Seventeenth Tax Conference, 1963 Conference Report (Toronto: Canadian Tax
Foundation, 1964), 359-67, at 360.
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decision under section 246 where the courts had to deal with the many
difficult issues inherent in this provision, including the government’s position that legal tax avoidance or reduction may itself be improper pursuant
to subsection 246(6). Section 246 was repealed, effective after February
15, 1984, not because it was undemocratic, unnecessary, and unwanted
but because of a fear that it would be set aside under the newly enacted
Canadian Charter of Rights and Freedoms.
General Anti-Avoidance Provisions
A second weapon employed by governments to prevent unwanted tax
planning is the enactment of general anti-avoidance provisions: a network
of specific anti-avoidance rules aimed at ensuring that particular amounts
are included in income and taxable income, buttressed by general and
broadly worded anti-avoidance rules. In this connection, the Canadian
income tax legislation is no exception; three general anti-avoidance provisions merit examination here.
The Undue and Artificial Reduction of Income
Subsections 137(1) and 137(2) have been in the Income Tax Act since
1948. Subsection 137(1) became subsection 245(1) of the Act, and was
repealed when the general anti-avoidance rule (GAAR) was introduced in
1988.
Subsection 137(1) dealt with “artificial transactions,” and prohibited
the deduction of a disbursement or expense made or incurred in respect of
a transaction or operation that, if allowed, would unduly or artificially
reduce income. The language of this provision has been subjected to
extensive analysis, which will not be repeated in this paper. 15 The application of subsection 137(1) was limited by its failure to provide criteria
by which the question of undue or artificial reduction of income could be
determined. Over the years, however, the courts helped define the parameters of the provision.16
Ultimately, with the introduction of the June 18, 1987 white paper on
tax reform, the government proposed to repeal former section 245(1) on
the basis that it was of limited application. The government stated that
former subsection 245(1) “deals only with deductions used in computing
15 See, for example, F.E. LaBrie, “The Uncertainties of Tax Planning: Part II—Review
by the Courts” (June 1960), 9 Chitty’s Law Journal 146-52; Stanley E. Edwards, “Tax
Avoidance—Recent Developments,” in Report of Proceedings of the Twenty-First Tax
Conference, 1968 Conference Report (Toronto: Canadian Tax Foundation, 1969), 442-52,
at 450; and Thomas E. McDonnell, “Recent Developments Relating to Sham, Benefits and
Business Purpose,” in Report of Proceedings of the Twenty-Ninth Tax Conference, 1977
Conference Report (Toronto: Canadian Tax Foundation, 1978), 89-113.
16 See, for example, Shulman v. MNR, 61 DTC 1213 (Ex. Ct.); Harris v. MNR, 66 DTC
5189 (SCC); and Hamilton Motor Products (1963) Limited v. MNR, 67 DTC 5230 (Ex.
Ct.), where Revenue Canada was the clear winner. See also Stubart Investments Limited v.
The Queen, 84 DTC 6305 (SCC); and Mendels v. The Queen, 78 DTC 6267 (FCTD).
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income and is based on the concept of artificiality, the meaning of which
is often varied, as has been pointed out during the consultation process.”17
Benefit Provisions
Subsection 137(2), former subsection 245(2), and, since 1988, section
246 make provision for taxing “benefits.” The notion of making “benefits” part of a taxpayer’s income has long been a mainstay in the
government’s attempt to combat tax avoidance. Partly because of its vagueness and malleability, it has been frequently used by Revenue Canada.
Specific anti-avoidance provisions 18 are generally enacted to permit the
benefit to be clearly recognized. One of the primary questions arising
under subsection 246(1) is what is meant by “a benefit.” The vague,
undefined nature of a general benefit provision invites the creation of
bureaucratic law until clarification can be obtained from the courts.19
Former subsection 245(2) dealt generally with the conferral of benefits
on a taxpayer by a person by means of one or more transactions of any
kind, notwithstanding the form or legal effect and whether or not there
was an intention to avoid or evade taxes. Subsection 245(3) exempted
certain benefits from this treatment. Subsection 246(1), which became
effective September 13, 1988, is more directed in its language and does
not contain the two stages of operation contained in former subsection
245(2), whereby the section operated regardless of the legal form of the
transaction and regardless of the intent. What is still not clear under the
redrafted section 246 is what a benefit is and when a person might be
considered to confer such a benefit on a taxpayer. Whether subsection
246(1) will be subject to the same bureaucratic abuses as former subsection 245(2) remains to be seen. 20
The General Anti-Avoidance Rule
The GAAR was introduced with the 1987 tax amendments, and applies to
transactions entered into on or before September 13, 1988.21 The government
17 See Canada, Department of Finance, Supplementary Information Relating to Tax
Reform Measures (Ottawa: the department, December 16, 1987), 99; See also David A.
Dodge, “A New and More Coherent Approach to Tax Avoidance” (1988), vol. 36, no. 1
Canadian Tax Journal 1-22, at 5-8.
18 See, for example, subsection 15(1).
19 See, for example, recent loss utilization cases where Revenue Canada has alleged
that the use of the loss itself is the conferral of a benefit: The Queen v. Husky Oil Limited,
95 DTC 5244 (FCA); The Queen v. Mara Properties Limited, 95 DTC 5168 (FCA); and
Fording Coal Limited v. The Queen, 95 DTC 571 (TCC).
20 In this regard, see Rosemarie Wertschek, “Corporate Reorganizations and Other Transfers of Tax Attributes: A Question of Taxable Benefits,” The Taxation of Corporate
Reorganizations feature (1994), vol. 42, no. 1 Canadian Tax Journal 268-87.
21 Two exceptions to this general rule are found at SC 1988, c. 55, section 185(2). For a
full explanation of the coming-into-force provisions as well as other aspects of GAAR, and
for secondary references to most of the published material in the area, see Howard J.
Kellough and Peter E. McQuillan, Taxation of Private Corporations and Their Shareholders,
2d ed., Canadian Tax Paper no. 95 (Toronto: Canadian Tax Foundation, 1992), 16:79-109.
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stated that GAAR was necessary because the existing provisions of the Act
were inadequate to deal with a number of blatant tax-avoidance arrangements, none of which were specified by the government. The government
further stated that existing subsection 245(1) was of limited application and
therefore was to be repealed. The change of direction was stated to be
required in order to reduce what was described by the Supreme Court of
Canada in the Stubart case as the “action and reaction endlessly produced
by complex, specific tax measures aimed at sophisticated business practices, and the inevitable, professionally guided and equally specific
taxpayer reaction.”22
The extremely broad application of the rule found in the definitions of
“tax benefit,” “avoidance transaction,” and “tax consequences” and the
vague and ambiguous concepts of “misuse” and “abuse” found under
subsection 245(4) have never been adequately addressed by Finance or
Revenue Canada. Numerous pointed analyses of the GAAR have been
given short shrift by Finance officials. The inherent uncertainty in the
GAAR was justified on the basis that the meaning of the word “artificial”
used in former subsection 245(1) was itself uncertain and some level of
uncertainty must be seen as inevitable. Taxpayers, it was said, seemed to
be satisfied instead with a “reasonably predictable result.”23
Specific Anti-Avoidance Provisions
As mentioned previously, the Act contains a multitude of specific antiavoidance provisions to help ensure that those items that form the basis
for the calculation of income and taxable income, and any deductions
therefrom, are treated as Finance intended. A review of several specific
anti-avoidance rules has been discussed elsewhere and will not be addressed in any detail in this paper. 24 It is apparent that specific antiavoidance provisions will continue to be enacted regardless of the GAAR:
they continue to be the prime legislative weapon against tax avoidance.
The early and mid-1980s were characterized by the bombardment of
press release legislation by Finance; each one attempted to deal with a
specific perceived tax avoidance arrangement. Many of these arrangements were the outgrowth of government initiatives, which, because of
poorly conceived and/or poorly drafted legislation, backfired on the government (for example, the scientific research tax credit program). Many
of the press releases dealt with one-off transactions (for example, the BC
Skytrain deal) and were an overreaction to the situation. An analysis of
22 Stubart, supra footnote 16, at 6324, quoted in Canada, Department of Finance, Tax
Reform 1987: Income Tax Reform (Ottawa: the department, June 18, 1987), 130. See also
the reasons given by David Dodge, then the senior assistant deputy minister, Department
of Finance, supra footnote 17.
23 See Dodge, supra footnote 17, at 22.
24 See Kellough and McQuillan, supra footnote 21, at 16:6-28.
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some of the press release legislation and the accompanying grandfathering
provisions is presented elsewhere.25
Language Used in Anti-Avoidance Provisions
If there is a common thread in the language of tax-avoidance legislation,
it is the use of the purpose test. The now repealed subsection 246(1)
(formerly section 138) stated that one of the main purposes for a transaction or transactions was the improper avoidance or reduction of taxes.
Subsection 245(3) of the GAAR provisions defines an avoidance transaction in terms of whether a transaction may reasonably be considered to
have been undertaken or arranged primarily for bona fide purposes.
Although the term “purpose” is used in the Act in a number of specific
provisions, it is not used consistently. For example, the word “purpose”
may be used alone or in a phrase such as “the principal purpose,” “one of
the main purposes,” or simply “one of the purposes.”26 Finance has used
the various forms of the purpose test without attempting to define how a
taxpayer’s purpose or the purpose of a transaction is determined. The
purpose-type test is difficult to prove, particularly with the evidentiary
onus falling on the taxpayer.
“Purpose” has been described as the desire to bring about a particular
result. 27 A purpose test is said to focus on the person’s state of mind in
undertaking a particular cause of action, regardless of the consequences
of that action. The difference between “purpose” and “intention” is illustrated by the New Zealand case of Plimmer v. Commissioner of Inland
Revenue.28 The issue was whether the taxpayer had acquired certain preference shares for the “purpose of selling or otherwise disposing of them.”
The taxpayer had acquired the preference shares only because the vendor
had refused to sell the common shares, which the taxpayer really wanted,
without the preference shares. The taxpayer did not wish to retain the
preference shares and sold them immediately for a profit. The difference
between intention and purpose was described by Barrowclough CJ as
follows:
I feel very confidently that the preference shares, though acquired with the
intention of selling them, were not acquired for that purpose. The sale of
the shares was not the object which the appellant and his friends had in
mind. They did not buy them for the purpose or with the object of selling
25 See the article by K.T. Pullen and Howard J. Kellough, “Tax Treatment of
Intercorporate Dividends, Grandfathering Provisions, and the Use of Press Releases,” in
Current Developments in Measuring Business Income for Tax Purposes, 1987 Corporate
Management Tax Conference (Toronto: Canadian Tax Foundation, 1987), 3:1-61, at 3:48-60.
26 See Kellough and McQuillan, supra footnote 21, at 16:28-37, for a detailed examination of the purpose test and how it is used under the Act.
27 See J.F. Avery Jones, “Nothing Either Good or Bad, but Thinking Makes It So—The
Mental Element in Anti-Avoidance Legislation—I” [1983], no. 1 British Tax Review 9-43
and “. . . II” [1983], no. 2 British Tax Review 113-21.
28 (1957), 11 ATD 480 (NZ SC).
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them; but solely because they could not acquire the ordinary shares unless
they undertook contemporaneously to acquire the preference shares.29
Intention, therefore, is said to go beyond purpose by including the necessary consequences of a course of action, while purpose “stops short at
what was in the person’s mind.”30
ADMINISTRATIVE ASPECTS
Revenue Canada is faced with the task of applying the anti-avoidance
legislation and judicial tests to the practical commercial affairs of taxpayers. As might be expected in a country like Canada, which has a woeful
fiscal record and exceptionally high rates of income and other forms of
taxation, tax avoidance is a matter of concern. Revenue Canada has a
designated tax avoidance group charged with policing this area.
Development of the Tax-Avoidance Group
Somewhat surprisingly, Revenue Canada’s tax-avoidance group was an
outgrowth of its special investigations division, which deals with tax evasion. The special investigations division seems to have received impetus
as a separate group in the late 1950s and early 1960s because of perceived fraudulent activity being carried out in connection with certain
forms of dividend stripping.31 The earlier formation of the special investigations division, however, may have been as much a matter of the
personalities within Revenue Canada at the time as any other factor.
The tax-avoidance group officially came into existence around 1968.32
The group’s somewhat belated start coincided with the country’s economic growth after the Second World War and taxpayers’ predictable
attempts to reduce levels of tax that had increased from pre-war levels.
Although the general anti-avoidance provisions under section 137 were
available to Revenue Canada, they were not used until the early 1960s, at
which time the courts provided guidelines on the application of that section.
The tax-avoidance group began as a Revenue Canada head office function concerned with examining the more aggressive ruling requests. Over
time, the group became part of the audit function, but only within the
larger district offices. By 1980, tax avoidance had developed into a separate group, with contact people in each district office. The group attained
its present size of about 150 people by 1986, with sections comprising
29 Ibid.,
at 484. See Kellough and McQuillan, supra footnote 21, at 16:29.
“. . . I,” supra footnote 27, at 27. See also Kellough and McQuillan, supra
footnote 21, at 16:28-37, for further analyses and comment on the purpose test and on
several other tests used in anti-avoidance legislation.
31 See J.L. Gourlay, “Tax Planning or Tax Evasion” (October 1969), 95 Canadian
Chartered Accountant 250-54. J.L. Gourlay was the director of special investigations division, and provides his view of the “strip” cases in the article.
32 My thanks to Wayne Adams, acting director for tax avoidance and legislative recommendations division, who was able to provide me with helpful background into Revenue
Canada’s tax-avoidance group.
30 Jones,
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three separate groups aggregating about 20 people in the Vancouver, Toronto, and Montreal district offices and contact people in the other district
offices. The size and structure of the tax-avoidance group has so far
remained constant; with the government restraint program now in effect,
its size is not expected to change in the near future.
The early reassessments were raised as part of the normal audit procedure. Associated corporations were dealt with as a tax avoidance matter,33
as was the assessment of single-issue matters where unreasonable results
were considered to have arisen.34
In some instances, the concerns of the special investigations group
have overlapped with those of the tax-avoidance group. The chief difference between the two is that the special investigations group is primarily
concerned with obtaining a prosecution, while the objective of the taxavoidance group is to collect taxes. One such area was the review of
management companies used by athletes, entertainers, executives, and
professionals undertaken by Revenue Canada in the late 1970s and early
1980s. Some early cases that helped to establish guidelines35 were won by
the taxpayer and caused Revenue Canada to look for other ways of attacking management companies.36 Ultimately, the Federal Court of Appeal
decisions in Vivian37 and Parsons38 forced a legislative solution in order
to accommodate the government’s desire to effectively outlaw certain
types of management companies.
The mid-1980s was an active period for tax avoidance. It was fuelled
by the frenetic issue by press release of avoidance legislation involving
loss utilization concerns, the use of various types of preferred shares,
capital dividend account and refundable tax arrangements, the Vancouver
Skytrain, etc. In addition to these specific topics, tax avoidance dealt
with a number of diverse matters, many of which involved tax-shelterdriven products.
The recent combining of Taxation with Customs and Excise has placed
added manpower pressures on the tax-avoidance group, as has the review
of GAAR transactions. GAAR reviews are handled separately and are not
33 Reference should be made to Kellough and McQuillan, supra footnote 21, at chapter
6, “The Small Business Deduction and Associated Corporations,” where the topic of associated corporations is reviewed in detail.
34 See, for example, Esskay Farms Ltd. v. MNR, 73 DTC 169 (TRB), where a transaction structured to allow the taxpayer to claim a reserve was challenged unsuccessfully by
Revenue Canada as artificial.
35 See Sazio v. MNR, 69 DTC 5001 (Ex Ct.); Cameron v. MNR, 71 DTC 5068 (Ex. Ct.),
aff ’d. 72 DTC 6325 (SCC); and Petritz v. MNR, 73 DTC 5243 (FCTD).
36 See Howard J. Kellough and Peter E. McQuillan, Taxation of Private Corporations
and Their Shareholders (1st ed.), Canadian Tax Paper no. 72 (Toronto: Canadian Tax
Foundation, 1983), chapter 5, for a detailed historical review of the area. The second
edition, supra footnote 21, provides an update of management companies to 1992.
37 The Queen v. Vivian, 84 DTC 6452 (FCA).
38 The Queen v. Parsons, 84 DTC 6447 (FCA).
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intended to utilize the manpower resources of the tax-avoidance group,
although as requests for a review of the application of GAAR by the
district offices increase it is expected that both district office and head
office resources will be required.
Enforcement Through Bureaucrat-Made Law
Revenue Canada enforces the Act through its interpretation of legislative
provisions and judicial decisions. Revenue Canada’s position on a number
of areas is communicated through interpretation bulletins, information
circulars, published advance rulings, technical interpretations, and public
forums such as the Canadian Tax Foundation’s round tables. The information released by Revenue Canada is designed to assist taxpayers by, for
example, forewarning them of Revenue Canada’s positions. Those positions, however, are often a reflection of what Revenue Canada would like
to see rather than a reflection of the law. These stated positions are not
binding, and Revenue Canada has at times argued a position that is contrary to its published statements.39
The Search for Legislative Intent: The “Object and
Spirit” Test
There has long been concern about Revenue Canada’s often self-serving
attempts to determine whether a transaction comes within the intent of
the legislation. The so-called object and spirit test has given Revenue
Canada fresh ammunition.
Revenue Canada has chosen to use the Stubart case40 in a manner, it is
suggested, that was never intended and is not supported at law. It will be
recalled that the court suggested three principles “for the guidance of a
court faced with [an] interpretive issue.”41 Guideline 3 contained three
parts; the third, 3(c), provided as follows:
Moreover, the formal validity of the transaction may also be insufficient
where: . . .
(c) “the object and spirit” of the allowance or benefit provision is defeated by the procedures blatantly adopted by the taxpayer to synthesize a
loss, delay or other tax saving device, although these actions may not attain
the heights of “artificiality” in s. 137. This may be illustrated where the
taxpayer, in order to qualify for an “allowance” or a “benefit,” takes steps
which the terms of the allowance provisions of the Act may, when taken in
isolation and read narrowly, be stretched to support. However, when the
allowance provision is read in the context of the whole statute, and with
the “object and spirit” and purpose of the allowance provision in mind, the
39 In Stickel v. MNR, 72 DTC 6178 (FCTD), aff’d. 74 DTC 6268 (SCC), counsel for the
minister argued against the administrative position contained in an interpretation bulletin
because it was not in accordance with decided law on the issue. Mr. Justice Cattanach
agreed that the doctrine of estoppel was not applicable against the minister.
40 Stubart Investments Limited, supra footnote 16.
41 Ibid., at 6323.
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accounting result produced by the taxpayer’s actions would not, by itself,
avail him of the benefit of the allowance. 42
The guidelines are to be used when a court is faced with an interpretive issue: they are not a general test to be applied in situations where the
Act is otherwise clear. In Mr. Justice Estey’s words,
These interpretative guidelines, modest though they may be, and which fall
well short of the bona fide business purpose test advanced by the respondent, are in my view appropriate to reduce the action and reaction endlessly
produced by complex, specific tax measures aimed at sophisticated business practices, and the inevitable, professionally-guided and equally
specialized taxpayer reaction. Otherwise, where the substance of the Act,
when the clause in question is contextually construed, is clear and unambiguous and there is no prohibition in the Act which embraces the taxpayer,
the taxpayer shall be free to avail himself of the beneficial provision in
question. 43
It has been stated that the object and spirit of a provision is only a tool
to be used in determining the construction of a provision and does not
exist as a separate charging provision that Revenue Canada can use to
defeat a taxpayer’s transaction.44 When the words of the Act are clear, no
ambiguity arises and the object and spirit of the provision becomes
irrelevant.45
In my experience, Revenue Canada has adopted the object and spirit
approach in virtually every transaction it finds objectionable but cannot
fit within a specific provision of the Act. There is usually no indication of
where the object and spirit of the provision comes from, much less the
legal basis for applying such a test.
Information Circular 88-2 46 is but one, albeit extreme, example of
Revenue Canada’s application of “object and spirit” as a separate test.
Revenue Canada effectively reduces the GAAR to an object and spirit
exercise in deciding whether what is otherwise an avoidance transaction
constitutes a misuse or an abuse pursuant to subsection 245(4) of the Act.
Revenue Canada offers no analysis as to the meaning of what constitutes a misuse or abuse. Its authority for assuming that the object and
spirit test is the appropriate one probably comes from statements made by
Finance in the explanatory notes to the GAAR. 47 It is suggested, however,
that statements made by Finance in the explanatory notes are not supportive
42 Ibid.,
at 6324.
(emphasis added).
44 See the decision of Chief Justice Scott in Pembina on the Red Development Corporation Ltd. v. Triman Ind. Ltd. et al., 92 DTC 6174 (Man. CA).
45 This has been confirmed in several cases, including Antosko et al. v. The Queen, 94
DTC 6314 (SCC); Mattabi Mines Ltd. v. Minister of Revenue (Ontario), [1988] 2 CTC 294
(SCC); and Construction Industry Commission v. MUCTC (1986), 31 DLR (4th) 641 (SCC).
46 IC 88-2, supra footnote 8.
47 Canada, Department of Finance, Explanatory Notes to Legislation Relating to Income Tax (Ottawa: the department, June 1988), clause 186.
43 Ibid.
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of Revenue Canada’s use of the object and spirit notion. Indeed, the role
of subsection 245(4) as stated by the then assitant deputy minister for tax
policy, David Dodge, is regarded as a rule of construction rather than as a
substantive exemption from section 245.48 Others have said that Revenue
Canada’s attempt to equate the judicial statutory interpretation test of
object and spirit with the civil law doctrine of “abuse of rights” is inappropriate.49
The Fear Factor
Revenue Canada officers have often taken courage from statements made
by the minister or senior bureaucrats. In 1966, the then minister of national revenue, E.J. Benson, made the following comments on the subject
of tax avoidance:
I have become concerned about the evidence I have seen that some provisions in the Income Tax Act are being thwarted or circumvented in artificial
ways to avoid payment of tax.
There is, of course, one other way in which a tax statute might largely
eliminate artificial tax avoidance without a multiplicity of complex provisions and that is by the introduction of certain arbitrary rules and
discretionary powers. This is a step that would probably be repugnant to
most of the citizens of our country and could not be justified unless it were
decided that there was no feasible alternative.
Personally, I an not advocating similar legislation for Canada at this
time as it is my hope that taxpayers and their advisers will realize that it is
in their interests to put an end to avoidance schemes. It is also my hope
that members of the accounting profession will assist by refusing to take an
active role in any form of artificial tax avoidance.50
A more recent example of a minister’s attempt to enforce the Act
through threats is found in the statement of the current minister, David
Anderson:
You’re going to see a lot of professional people who’ve been cheating in
jail. That’s what we’re after. We’re going to audit and we’re going to enforce, and I’m telling our people I want prosecutions to the hilt. We want to
have some object lessons, clear object lessons of people serving time at Her
Majesty’s pleasure. (Editor’s comment: This phrase suggests insanity as a
defence because it is only the criminally insane who serve such sentences.)
We’re going to do it and they’re going to be sitting in penitentiaries
because I’m really upset about the number of professions, in particular,
48 Dodge,
supra footnote 17, at 21.
Brian J. Arnold and James R. Wilson, “The General Anti-Avoidance Rule—Part
2” (1988), vol. 36, no. 5 Canadian Tax Journal 1123-85, at 1168.
50 Remarks made to the New Brunswick Institute of Chartered Accountants, September
1966, quoted in Donald R. Huggett, “Tax Avoidance—Recent Developments,” in the 1968
Conference Report, supra footnote 15, 452-62, at 456. The minister’s comment and the
attitude expressed in Revenue Canada’s administrative policies were roundly criticized by
Donald Huggett and other members of the panel. The dissatisfaction with Revenue Canada’s administrative practices in the late 1960s and early 1970s is reminiscent of the early
1980s and today.
49 See
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chartered accountants, lawyers, people who should know, who have a professional responsibility to advise on tax matters effectively and they’re
turning their skills to evasion of taxes. 51
The minister apologized publicly after receiving letters from the presidents of the Canadian Bar Association and the Canadian Institute of
Chartered Accountants. However, his inappropriate and defamatory comments had already been communicated by the time of his apology, and the
damage had been done.
Such public comments are thankfully rare, but they do set a tone within
Revenue Canada and perhaps signal an attitude in areas such as tax avoidance, where exceptional latitude already exists to issue reassessments.
Revenue Canada has made some attempts to alleviate the confrontational relationship between taxpayers and tax administrators; for example,
Revenue Canada now says that taxpayers are its “customers.” In my experience, the effect of this policy depends upon the individuals within the
particular district offices.
JUDICIAL ASPECTS
The judiciary has played a significant role in formulating anti-avoidance
guidelines to assist in determining whether a taxpayer comes within the
charging provisions of the Act. The basic judicial tests have remained
constant over the years, although there has been a great deal of commentary by the courts and some refinements in respect of these concepts.
The courts have consistently supported the notion that a taxpayer is
free to organize his affairs in order to pay the least amount of tax possible
under the applicable legislation.52 This principle appears to be alive and
well in Canadian tax jurisprudence and, at least in theory, continues to be
recognized by Canadian fiscal authorities. The difficulty, of course, is in
the interpretation of the applicable legislation: there is often a wide gulf
between the views of taxpayers and the views of the revenue authorities.
It also must be remembered that the Act has been amended many times
since the Westminster case was decided by the Privy Council in 1936. A
complex network of specific and general anti-avoidance rules have been
enacted, and the courts have whittled away at Lord Tomlin’s dictum.
The courts have scrutinized transactions on the basis of the judicial
anti-avoidance concepts. The use of these rules and what is viewed by
some as their constant extension raises the concern that the courts are
exercising a legislative function (that is, they are making rather than
merely interpreting the law). Of as much concern as judge-made law is
51 See “Two Strikes!” (March 1, 1994), 16 The Canadian Taxpayer 36-37, at 36 (the
quotation shows the publication’s editorial comment in italics); and The Vancouver Sun,
February 12, 1994.
52 See Ayrshire Pullman Motor Services and D.M. Ritchie v. The Inland Revenue Commissioners (1929), 14 TC 754, at 763-64 (Ct. Sess.); Inland Revenue Commissioners v.
Westminster (Duke), [1936] AC 1, at 19 (HL); and Stubart Investments Limited, supra
footnote 16.
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bureaucrat-made law—for example, the creative interpretation and application of the judicial concepts by Revenue Canada officials.
Judicial Anti-Avoidance Doctrines
The following is a very brief summary of a number of doctrines that have
been used by the courts in the context of tax-avoidance cases. The doctrines are not strictly anti-tax-avoidance doctrines: some are legal principles
that apply generally but that have been used by the courts to test whether
there has been compliance with legislative provisions. Notwithstanding
the enactment of the GAAR, the judicial anti-avoidance rules remain in
full force and effect and are applied by Revenue Canada and the courts to
tax-avoidance situations. The following is a brief review of the most
significant judicial anti-avoidance tests.53
The Business Purpose Test
The business purpose test states that a transaction will be ignored for tax
purposes if the only reason for the transaction is to save taxes—that is, if
there is no non-tax motivation for the transaction. The justification normally put forward in support of the test is that the Act is intended to
apply to “real” transactions, and not to transactions undertaken merely to
save taxes.
In Stubart Investments Limited, the business purpose test was, in the
main, rejected for Canadian tax purposes. In that case, a parent corporation had two subsidiaries, one with losses and one with income-earning
assets. The parent caused the profitable subsidiary to transfer its assets to
the loss subsidiary. The income earned by the loss subsidiary was sheltered by the losses. Because the transaction appeared to have no motivation
other than the saving of tax, Revenue Canada attacked it on the basis that
it failed the business purpose test and therefore could be ignored. The
court held that, for the most part, the business purpose test forms no part
of tax law in Canada. As long as a transaction is covered by the words of
the Act, properly interpreted in the light of their context, object, and
spirit, the transaction cannot be ignored for tax purposes.54
It should be noted, however, that the court did not reject the business
purpose test entirely: it stated that the formal validity of a transaction
(the fact that it conforms to the literal words of the Act) may be insufficient where the provisions of the Act necessarily relate to an identified
business function. 55
Although it is always difficult (and sometimes dangerous) to summarize a complex case such as Stubart, the main reason the court rejected
53 See Kellough and McQuillan, supra footnote 21, at 16:43-79, for a detailed analysis
of these doctrines.
54 The “object and spirit” rule is discussed in the previous portion of this paper and is
briefly described later under this heading.
55 Stubart, supra footnote 16, at 6324, guideline 3(b).
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the business purpose test appears to be this: the Act does not contain only
business-related provisions; many of its provisions are designed for reasons other than business purposes. Accordingly, it would be improper to
deny a tax benefit owing to a lack of a business purpose when Parliament
may not have intended that a business purpose be required in the first place.
Sham
The sham doctrine was discussed by the Supreme Court of Canada in at
least three cases between 1984 and 1991—an unusually high number for
a court that hears a minuscule number of tax cases in any one year.
In Stubart, Mr. Justice Estey referred to the classic definition of “sham”
put forward in Snook v. London & W. Riding Invest.:56 “There is, in short,
a total absence of the element of deceit, which is the heart and core of a
sham.” 57 The court in Stubart made it clear that “sham” and “business
purpose” are two different concepts: a transaction may have no business
purpose but it may be open for all the world to inspect—the very antithesis of a sham. Because of the decision in MNR v. Leon et al., 58 this
differentiation was significant. The court in Leon confused the two concepts by stating: “If the agreement or transaction lacks a bona fide business
purpose, it is a sham.” In Stubart, the court expressly rejected the Leon
decision because it had confused these two concepts.
Notwithstanding the acceptance in Stubart of the Snook definition of
sham, a seemingly different definition was adopted in The Queen v.
Bronfman Trust: 59 even though there was no suggestion that a hypothetical transaction that was carried out within a brief period of time would
have carried with it any element of deceit, it nonetheless might be considered a sham. This implied that the court was developing a new definition
of sham, although it was not clear what that definition might be.
The Supreme Court revisited the sham concept in The Queen v.
McClurg. 60 It is notable that the majority decision was again written by
Dickson CJC . The court noted that Revenue Canada had not argued sham,
which the court defined as a transaction constructed to create a false
impression in the eyes of the taxing authorities. This is of course the
classical Snook definition, which implies that the court did not seek to
expand the definition in Bronfman Trust. Furthermore, the cases subsequent to McClurg have used the Snook definition of sham, not the expanded
Bronfman Trust definition.61
56 [1967]
1 All ER 518 (CA).
supra footnote 16, at 6321.
58 76 DTC 6299 (FCA).
59 87 DTC 5059 (SCC).
60 91 DTC 5001 (SCC).
61 See R v. Cancor Software Corp. et al., 92 DTC 6090 (Ont. Gen. Div.); and Lutheran
Life Insurance Society of Canada v. The Queen, 91 DTC 5553 (FCTD).
57 Stubart,
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Incomplete Versus Illegal Transactions
The Act is merely an accessory system to provincial (non-tax) law. In
other words, the Act does not define whether a transaction has taken
place for non-tax purposes; it merely determines the tax consequences of
such a transaction. Accordingly, it is often necessary to determine, for tax
purposes, whether the applicable non-tax law has been followed in effecting a transaction. 62 This gives rise to two separate doctrines—incomplete
transactions and illegal transactions—that may affect the tax analysis of a
transaction.63
Agency
The Act taxes a person on “income.” Money (or property) in a person’s
hands is not necessarily income unless it has the “quality of income.”
Money will not have the quality of income unless it is beneficially owned
by the person in whose hands it is found. An agent is required to hold
money in his hands for the benefit of his principal; accordingly, money in
an agent’s hands does not have the quality of income, and the principal,
not the agent, is taxed on money received in the agent’s hands for the
benefit of the principal. Moreover, because the agent’s receipt is deemed
to be the principal’s receipt of the money, the principal is taxed at the
time the agent receives the money, notwithstanding that the agent may
not pay over the money to the principal until some later time.64
Taxpayers have sometimes attempted to argue that losses incurred by
another person should properly be deductible by the taxpayer, on the
basis that the other person is really only an agent of the taxpayer. Although no principle of tax law states that an agency agreement must be in
writing,65 in a tax case the onus of proof is on the taxpayer; if a taxpayer
alleges an agency arrangement, he must prove it. It is usually difficult to
do so without a written agreement. Consequently, in most cases of alleged agency, the courts have held that no such agency exists.
Conversely, the mere fact that a person has created a corporation or
other entity that is under his control does not make the entity his agent
62 See Transport Desgagnés v. MNR, 91 DTC 270 (TCC). One commentator has expressed the principle this way: “Where the Code follows life, life is determinative.” See
Joseph Isenbergh, “Musings on Form and Substance” (Summer 1982), 49 The University
of Chicago Law Review 859-84, at 865. See also Richard B. Kuzyk, “Selected Aspects of
the Interplay Between Tax and Corporate Law,” in Report of Proceedings of the
Forty-Second Tax Conference, 1990 Conference Report (Toronto: Canadian Tax Foundation, 1991), 46:1-42.
63 See Kellough and McQuillan, supra footnote 21, at 16:50-54, for a review of these
doctrines.
64 See Ingram v. MNR, 91 DTC 939 (TCC); and William J. Bies, “Agency in Canadian
Income Tax Law,” in Report of Proceedings of the Thirty-Fourth Tax Conference, 1982
Conference Report (Toronto: Canadian Tax Foundation, 1983), 927-39.
65 Transport Desgagnés, supra footnote 62; Wessell v. MNR, 85 DTC 206 (TCC); and
United Color and Chemicals Limited et al. v. MNR, 92 DTC 1259 (TCC).
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for tax purposes. Revenue Canada is thus precluded from using the agency
argument against taxpayers in such circumstances.66
Piercing the Corporate Veil
The common law doctrine of piercing the corporate veil (as opposed to
the statutory doctrine, as found, for example, in subsection 245(2) of the
Act), allows a court to ignore temporarily the existence of a corporation
and to attach tax consequences to the shareholders as if they had personally been involved in the relevant transaction.
At least one writer has argued that courts in Canada have no authority
to pierce the corporate veil, because the enabling statutes under which
businesses are incorporated specifically deem the corporations to be validly existing.67 Nevertheless, the Supreme Court of Canada has affirmed
the authority of Canadian courts to pierce the corporate veil in appropriate circumstance. 68 In a non-tax case, the Supreme Court of Canada stated
that the law on when a court may pierce the corporate veil follows no
consistent principle;69 this is also true in a tax context.
With respect to tax avoidance, two cases especially should be noted. In
The Queen v. Kieboom, the court stated:
[T]he concept of the corporation as a separate legal entity with shareholders having no proprietary interest apart from the shares is no longer absolute.
The principle has been eroded to reflect the realities of business law. This
is a development which is especially applicable to small corporations where
there is a main shareholder as is found in the present case.70
It appears that Kieboom goes further than any other Canadian tax case in
merging the corporate identity with that of the principal shareholder.
In McClurg, the court stated: “[I]t is always open to the Courts to
‘pierce the corporate veil’ in order to prevent parties from benefiting
from increasingly complex and intricate and tax avoidance techniques.”71
In my view, this passage does not give carte blanche authority to subsequent courts to pierce the corporate veil so as to restrict tax benefits
otherwise validly achieved by a taxpayer, unless the piercing is done in
accordance with the normal rules.
66 See The Queen v. MerBan Capital Corporation Limited, 89 DTC 5404 (FCA), for an
example of a case in which the real ownership of a subsidiary was held not to make that
subsidiary an agent of the parent.
67 See Bruce Welling, Corporate Law in Canada: The Governing Principles, 2d ed.
(Toronto: Butterworths, 1991), 123-24. The first edition was cited with approval in K.J.
Beamish Construction Co. Limited v. MNR, 90 DTC 1584, at 1593 (TCC) and Lachappelle
v. MNR, 90 DTC 1876 (TCC). Also see Kellough and McQuillan, supra footnote 21,
chapter 1, “Introduction: The Corporation as a Person in Tax Law,” 1:1-36.
68 See Buanderie Centrale de Montréal v. Montreal, [1994] 3 SCR 29; Kosmopoulos v.
Constitution Insurance Co., [1987] 1 SCR 2; and McClurg, supra footnote 60, at 5012.
69 Kosmopoulos, supra footnote 68, at 10.
70 91 DTC 5478, at 5483 (FCTD).
71 Supra footnote 60, at 5012.
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Step Transaction
At present, the exact boundaries of the step transaction doctrine are not
settled. Nevertheless, two decisions of the House of Lords have clarified
its meaning to a great extent,72 and it is to be hoped that future courts will
follow these decisions in applying the doctrine.
The step transaction doctrine states, in essence, that in examining the
tax consequences of a series of transactions a court is not limited to
looking at each step in the series as if it were independent of each other
step; the court is entitled to look at the series as a whole to determine
whether the taxpayer has achieved the result sought.73 In W.T. Ramsay
Ltd. v. IRC, Lord Wilberforce stated:
For the commissioners considering a particular case it is wrong, and an
unnecessary self-limitation, to regard themselves as precluded by their own
finding that documents or transactions are not “shams” from considering
what, as evidence by the documents themselves or by the manifested intentions of the parties, the relevant transaction is. They are not, under the
Duke of Westminster doctrine or any other authority, bound to consider
individually each separate step in a composite transaction intended to be
carried through as a whole. This is particularly the case where (as in
Rawling) it is proved that there was an accepted obligation once a scheme
is set in motion, to carry it through its successive steps. It may be so
where . . . there is an expectation that it will be so carried through, and no
likelihood in practice that it will not. In such cases (which may vary in
emphasis) the commissioner should find the facts and then decide as a
matter (reviewable) of law whether what is in issue is a composite transaction, or a number of independent transaction.74
Abuse of Law
The concept of “abuse of law” essentially means that a taxpayer may be
prevented from taking advantage of his strict rights under the Act because
to do so would be an “abuse of the Act.” It is fair to say that the concept
of abuse of rights is foreign to the common law world.75 If, after applying
the statute as construed to the facts found, a court holds that the taxpayer
has escaped taxation, the court has no power under the abuse of rights
doctrine to charge him with tax simply because the court does not appre72 Craven
v. White, [1988] 3 All ER 495 (HL); and Ensign Tankers, supra footnote 7.
the United States, the step transaction doctrine is well developed in the sense that
it has been applied in a great many cases. Even there, though, there is no agreement on
what the doctrine really means. See John Tiley, “Judicial Anti-Avoidance Doctrines: The
US Alternatives—Part II” [1987], no. 6 British Tax Review 220-44.
74 [1981] STC 174, at 180 (HL).
75 But see Orsini, Re (1991), 2 BLR (2d) 271, at 317 (OSC), where it was held that the
commission could discipline a stock trader for “abuse” even if no technical breach of the
law had taken place. Also see Stecko v. The Queen, 95 DTC 5215 (FCTD) where the
taxpayer alleged an abuse of process by Revenue Canada but the court did not hold the
Crown to the standards of the House of Lords decision of in Re Preston, [1985] AC 835
(HL), wherein the commissioners were held to be guilty of unfairness amounting to an
abuse of power.
73 In
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ciate the taxpayer’s ingenuity. It is here that Lord Tomlin’s dictum from
Duke of Westminster has its true application: every man is entitled to
order his affairs so as to pay the minimum amount of tax. Nevertheless,
the abuse of rights doctrine has now become part of the Act, at least to
the extent that it is embodied in subsection 245(4).76
Object and Spirit
In Stubart, the court stated:
Today there is only one principle or approach, namely, the words of an Act
are to be read in their entire context and in their grammatical and ordinary
sense harmoniously with the scheme of the Act, the object of the Act, and
the intention of Parliament.77
This passage gave birth to what has come to be known as the object
and spirit test. The previous section of this paper discussed Revenue
Canada’s very broad interpretation of the test. Its position is summed up
in an information circular, in which it states that the object and spirit test
is embodied in the GAAR:
Transactions that rely on specific provisions, whether incentive provisions
or otherwise, for their tax consequences, or on general rules of the Act, can
be negated if these consequences are so inconsistent with the general scheme
of the Act that they cannot have been within the contemplation of Parliament. On the other hand, a transaction that is consistent with the object and
spirit of provisions of the Act is not to be affected. Revenue Canada will
follow this principle in interpreting section 245 of the Act.78
While much has been written about the object and spirit test, it is
suggested that it comes down to nothing more than this: if a provision of
the Act can reasonably be interpreted in two or more ways, the court
should adopt the interpretation that most closely accords with the overall
object and intent of the provisions and of the statute in which the provision is found. The “object and spirit” of a provision does not exist as a
separate charging provision that may defeat a taxpayer’s transactions if
the taxpayer is otherwise within the plain meaning of the provision. If, in
construing the statute, the court finds the words plain and unambiguous,
then that is the end. Otherwise, the court may look to the object and spirit
of the legislation as an aid in construing the provisions in question.
76 For a review of the doctrine of abuse of rights, see David A. Ward and Maurice C.
Cullity, “Abuse of Rights and the Business Purpose Test as Applied to Taxing Statutes”
(1981), vol. 29, no. 4 Canadian Tax Journal 451-75, which was expanded upon in David
A. Ward et al., “The Business Purpose Test and Abuse of Rights” [1985], no. 2 British Tax
Review 68-123. The Department of Finance has stated that “abuse of rights” was the
foundation for the “misuse or abuse” rule in subsection 245(4). There have been various
comments on this notion as applied to subsection 245(4); see, for example, Howard J.
Kellough, “A Review and Analysis of the Redrafted Anti-Avoidance Rule” (1988), vol. 36,
no. 1 Canadian Tax Journal 23-78, at 63-69. See also Canada, Department of Finance,
“General Anti-Avoidance Rule: Explanatory Notes,” in Supplementary Information Relating to Tax Reform Measures, supra footnote 17, at 135-45.
77 Supra footnote 16, at 6323.
78 IC 88-2, supra footnote 8, at paragraph 5.
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Substance over Form
To date, the “substance over form” doctrine is possibly the most difficult
judicial anti-avoidance rule to define. It has also been difficult to predict
when the courts will apply the doctrine. In part, this is because the courts
will often refer to “sham,” “step transaction,” and “substance over form”
in the same judgment without differentiating between the three concepts
and without using precise language in either their analysis or their reasons for judgment.
Some authorities have argued that because the doctrine was not discussed in Stubart, the court in that case must have meant to imply that no
such doctrine existed in Canadian tax law. 79 It is suggested, however, that
Stubart did discuss the doctrine of substance over form, properly understood. More precisely, I suggest that the substance over form doctrine is
nothing more than the first step of the step transaction doctrine: the step
whereby the courts determine the “real” legal relationships between the
parties. Stubart’s guideline 3(c) is the equivalent of the new approach to
the step transaction doctrine as interpreted in Craven v. White80 and Ensign Tankers. 81 Thus, Stubart implicitly adopted the doctrine of substance
over form by incorporating it into guideline 3(c); the second step is to
apply the statute to the facts as found.
The majority of the court in McClurg stated:
Thus, in proceeding to analyze the tax consequences of the application of
the discretionary dividend clause, it is necessary to determine both the
purpose of the legislative provision and the economic and commercial reality of the taxpayer’s actions. To a certain extent, the latter inquiry in the
case at bar already has been answered by my determination that the use of
the discretionary dividend clause is a valid means whereby directors of a
company can distribute dividends. 82
Thus, it appears that the majority is saying that as long as the “form”
of the transaction (that is, the true legal rights and obligations of the
parties as determined by non-tax law) is valid, that form will determine
the economic and commercial realities of the transaction.
Statutory Interpretation
The subject of statutory interpretation is dealt with in a separate paper. 83
A few comments are in order, however, in respect of the impact of statutory interpretation on tax avoidance.
79 See Brian J. Arnold and James R. Wilson, “The General Anti-Avoidance Rule—Part
1” (1988), vol. 36, no. 4 Canadian Tax Journal 829-87, at 871.
80 Supra footnote 72.
81 Supra footnote 7.
82 Supra footnote 60, at 5011.
83 See the paper by S.W. Bowman, “Statutory Interpretation,” in this issue of the Canadian Tax Journal.
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There has been enormous development in the interpretation of fiscal
legislation since the 1866 statement by Lord Cairns in Partington v. The
Attorney General in the House of Lords that
[i]f the person sought to be taxed comes within the letter of the law he must
be taxed, however great the hardship may appear to the judicial mind to be.
On the other hand, if the Crown, seeking to recover the tax, cannot bring
the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be.84
This rule was cited with favour by the courts for almost the next 100
years. It was gradually eroded through changing economic and social
circumstances and the ever-changing role of fiscal legislation.
The “modern rule” of statutory interpretation was adopted by the Supreme Court of Canada in the Stubart case. The Supreme Court affirmed
and commented further on the movement toward a more liberal “object
and spirit” approach to the interpretation of taxing states when Dickson J
in Bronfman Trust stated that not only has there been a trend away from
the strict construction of taxing statutes, but “so too has the recent trend
in tax cases been towards attempting to ascertain the true commercial and
practical nature of the taxpayer’s transactions.”85
In my view, the courts for the most part have failed to understand an
Act that countenances—indeed endorses—tax avoidance. In 1973, when
considering whether the attitude of the courts at that time could be adjusted in the light of the then new Act, David Ward stated:
Surely, then, if the judicial trend continues unchecked, the taxpaying public, having been forced into the straight-jacket of artificiality by the policy
makers in the Department of Finance and the legislative draftsmen from
the Department of Justice, is in real peril of being held hostage by the
administrators in the Department of National Revenue. To add to the concern, I believe it is fair comment to say that, with somewhat alarming
regularity, the administrators have exhibited somewhat less than a perfect
understanding of and sympathy with what others have generally thought to
be the intent of various provisions of the Income Tax Act.86
There have been only sporadic indications that the courts understand
the unique nature of the Act and the implications of their judgments.87
Only when the courts limit their inclination to make sweeping, liberal
interpretations will Revenue Canada’s tendency to constitute a law unto
itself be checked. Parliament has little if any understanding of tax legislation, and there is no effective parliamentary structural mechanism through
84 (1869-70)
4 LRHL 100, at 122.
footnote 59, at 5067.
86 David A. Ward, “The Judicial Approach to Tax Avoidance,” in Report of Proceedings
of the Twenty-Fifth Tax Conference, 1973 Conference Report (Toronto: Canadian Tax Foundation, 1974), 408-24, at 422.
87 See the recent cases of Husky Oil, supra footnote 19 and Continental Bank of Canada
et al. v. The Queen, 94 DTC 1858 (TCC).
85 Supra
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which open and considered debate can occur to curb legislative excesses.
The scores of material produced by tax practitioners on technical and
structural aspects of the law largely go unheeded. The last line of defence, therefore, is the courts.
Notwithstanding the rather confused state of affairs in statutory interpretation, it is suggested that there is a judicially supportable road map to
the interpretation of fiscal legislation, as follows:88
1) The goal is to ascertain the intention of Parliament.
2) Parliament’s intent is found in the words used in the statute. If
those words are factually unambiguous, then the task of “interpreting”
those words does not arise. Effect must be given to those words notwithstanding the absurdity of the result.
3) An absurd result is a reason to ask in a serious way whether the
words used by Parliament are really unambiguous; but if the answer is
yes, then rule 2 applies. Only if the answer is no may a “contextual”
approach (that is, a teleological approach) be used.
4) If there is an ambiguity, then the interpretation that leads to the
result most consistent with Parliament’s intention (as determined by other
provisions in the statute, the legislative history, etc.) is to be preferred,
even if this interpretation is less literal than another. But the interpretation arrived at by the contextual approach cannot give the words actually
used by Parliament a meaning they are not reasonably capable of bearing.
5) Where Parliament’s intent is impossible to determine, the contextual approach cannot be used.
6) If, after the above rules are applied, there is still an ambiguity in
the statute, the interpretation most favourable to the taxpayer is to be
preferred.
88 Joel A. Nitikman, “Statutory Interpretation in the Supreme Court of Canada” (1995),
vol. 3, no. 4 Tax Litigation 206-8. See also Kerri L. Mooney, “The Teleological Approach
Used by the Supreme Court in Rendering Judgements,” ibid., 202-5.
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