The Legal Background & Section 245's GAAR Policies
The general anti-avoidance rule ("GAAR") is found at section 245 of Canada's Income Tax Act. The purpose of GAAR is to prevent taxpayers from benefiting and engaging in a transaction or series of transactions "for the purpose of avoiding, reduction, or deferring the payment of tax, or increasing a refund for rebate or other amount". GAAR prohibits any transactions or series of transactions that violate and or exploit the rules of Canada's tax act. The GAAR allows the Minister power to "disregard or re-characterize" the "tax benefit" of a transaction or a series of transactions where a taxpayer engaged in a transaction that is found to be an "avoidance transaction". The characteristics of an "avoidance transaction" include "misuse or abuse" of individual provisions as well as the Income Tax Acts as a whole.
Subsection 245(2) of the Income Tax Act provides that where a transaction is found to be an "avoidance transaction", the "tax consequence" to the taxpayer is "determined as is reasonable", given the relevant circumstances, in order to deny a benefit that would result, directly or indirectly, from that transaction or a series of transactions, but for this section. Subsection 245(4) of the Income Tax Act provides the exception rules for subsection 245(2)
Per subsection 245(4) of Canada's tax act, subsection 245(2) applies only to transactions that "may reasonable be considered that the transaction would result in direct or indirect misuse of the provisions of:
- this Act;
- the Income Tax Regulations;
- the Income Tax Application Rules;
- a tax treaty; or
- any other enactment that is relevant in computing tax.
Additionally, subsection 245(2) of the Income Tax Act applies to transactions or series of transactions that would result "in an abuse" of the GAAR provisions and the Income Tax Act as a whole.
The Supreme Court of Canada, in Canada Trustco Mortgage Co v Canada, set out the three requirements that must be established for application of the GAAR:
- A tax benefit resulting from a transaction or part of a series of transactions;
- An avoidance transaction;
- Abusive tax avoidance.
An "avoidance transaction", directly or indirectly, may cause a misuse or abuse of the GAAR rules and of the Income Tax Act. Establishing that a transaction or a series of transactions are "abusive tax avoidance" requires showing that it "cannot be reasonably concluded that a tax benefit would be consistent with the object, spirit or purpose of the provisions relied upon by the taxpayer". However, in certain scenarios the existence of "abusive tax avoidance" in unclear and having only a tax purpose does not manifest an "abusive tax avoidance".
On the one hand, GAAR prevents "abusive tax avoidance" transactions and prohibits certain transactions including the transfer of tax attributes or trading of losses between arm's length taxpayers, subject to certain exceptions. On the other hand, the presence of an "abusive tax avoidance" can be vague, and the jurisprudence has shed light to the ongoing issues related to the proper interpretation of the GAAR provisions in light of their text, context and purpose. Needless to say, interpretations of the GAAR provisions and analysis are complex, and this can further complicate our understanding and determination of whether the GAAR may (or may not) apply. Furthermore, this sheds light on the issues associated with the GAAR provisions in the Income Tax Act and why this is a complex area of law that requires detailed analysis and advice from an experienced Canadian tax lawyer.
In CHR Investment Corporation v The Queen, the Appellant, CHR Investment Corporation, appealed the Minister's decision to reassess the "Appellant's respective 2009, 2010, 2011, 2012 and 2013 taxation years". Pursuant to section 245 of Canada's tax act, GAAR reassessments deny taxpayers the ability to utilize tax attributes, including a "loss carryover amount and a SR&ED carryover amount acquired by the Appellant through a corporate reorganization". In this case, the Appellant utilized these tax attributions to reduce its income for the aforementioned five consecutive years. In this appeal, the main issue before the Tax Court of Canada was whether the Appellant's use of the tax attributes constituted misuse or abused of subsections 37(6.1), 111(5) and 127(9.1) and or paragraph 256(7)(b) of the Income Tax Act?
Pursuant to section 110 of the Tax Court of Canada Rules (General Procedure), the Appellant, CHR Investment Corporation, brought an interlocutory motion before the Tax Court of Canada for an order that the Crown (Respondent) answer six undertaking requests made by the Appellant in the course of its discovery examination of the Respondent.
The six undertaking requests, all of which were declined by the Respondent, were:
- To provide a copy of the letter that the CRA Legislative Policy Directorate wrote to the Department of Finance on February 2, 2001.
- To advise as to whether the CRA Legislative Policy Directorate received any response from the Department of Finance to the February 1st correspondence, and if it did, to provide a copy of same.
- To provide a copy of the correspondence from the CRA legislative Policy Directorate to the Department of Finance dated March 8, 2004.
- To enquire of the CRA Legislative Policy Directorate if the Department of Finance responded to the correspondence dated March 8, 2004.
- To provide a copy of the letter written by the CRA Legislative Policy Directorate in 2007 asking the Department of Finance to recommend legislative amendments.
- To require of the CRA Legislative Policy Directorate to disclose whether there was a response from the Department of Finance relative to the above requested undertaking [i.e. #5 above] and if so to provide a copy of the same.
Declining to fulfill undertaking requests made by the Applicant, the Respondent asserted that each of the six aforementioned requests respectively were "irrelevant and or constitutes a fishing expedition". In reassessing the Appellant, the Respondent Minister assumed that the "general scheme of the Income Tax Act is to prohibit the transfer of tax attributes or trading of losses between arm's length parties, subject to certain exceptions. The Minister also assumed that the "object, spirit or purpose" subsections 37(6.1), 111(5) and 127(9.1) and or paragraph 256(7)(b) of the Income Tax Act prevents an "arm's length of tax attributes to shelter from tax the income of the person acquiring access to the attributes".
The Appellant's motion seeks to challenge the policy that the Minister applied under the GAAR rules, that is, subsection 245(4). The grounds for the Appellant's motion included that the unanswered undertakings relate to the Appellant's "line of inquiry regarding the testing of the limits of the facts assumed by the Minister". The Appellant asserted that it is only seeking "public documents" and that the Minister's refusal to fulfill the aforementioned undertakings "contradicts or limits" access to "public documentation". Grounds for the Appellant's motion also included that it is "... entitled to production of the documents that may fairly lead to a train of inquiry that advances the Appellant's case or damages the Respondents' case, which these documents do." The Appellant argued that the text of the GAAR rules clearly apprehend when tax attributes can (and cannot) be utilized. Justice B. Russell agreed with the Appellant and explained that answers to the six refused undertakings would help the Appellants to "know the basis or bases of the policy pleaded by the Respondent".
The Caselaw on Relevancy on Discovery Examination
Tax Court of Canada affirmed that "threshold for relevance in respect of questions asked on discovery examination is notably low" by referencing the following caselaw:
- In Baxter v R, the Tax Court of Canada explained that "relevancy on disclosure must be broadly and liberally constructed and wide latitude should be given". It also affirmed that a motion judge should not "second guess the discretion of counsel" engaged in discovery examination and that while a trial judge may consider the relevancy in the context of evidence as a whole, he or she should not seek to impose his or her personal views of relevancy. Lastly, the Tax Court of Canada held that abusive questions that are created or designed to "embarrass or harass" a witness or delay a case "should not be permitted".
- In MP Western Properties Inc. v R, the Tax Court of Canada held that relevancy at discovery has a "lower threshold than that at trial". It also referenced Rule 90 of the Rules which provides that the "production of a document at discovery is not an admission of its relevance or admissibility".
- In Teelucksingh v R, the Tax Court of Canada held that while the threshold of relevance is low, "fishing expeditions are not permitted". It also held that an "exanimating party is entitled to have any information, and production of any documents, that may fairly lead to a train of enquiry that may directly or indirectly advance his case, or damage that of the opposing party".
- In John Fluevog Boots & Shoes Ltd. v R, the Tax Court of Canada stated that that on motion it the Court, would generally intervene to prevent counsel from pursuing questions only if they were:
- Clearly abusive;
- Clearly a delaying tactic;
- Clearly irrelevant.
The Tax Court of Canada in John Fluevog Boots & Shoes Ltd. v R explained that the term "fishing expedition" has generally been used to describe "an indiscriminate request for production, in the hope of uncovering helpful information".
- In Montana Band v Canada, the Federal Court explained that the "purpose of examination for discovery is to render the trial process fairer and more efficient by allowing each party to inform itself fully prior to trial of the precise nature of all the other parties' positions so as to define fully that issues between them". The Federal Court also affirmed that "it is sound policy for the Court to adopt a liberal approach to the scope of the questioning on discovery" since issues relating to "admissibility of evidence" may be "corrected by the trial judge".
- In R v Lehigh Cement Limited, the Federal Court of Appeal explained that while "the general principles established in the caselaw are useful, they do not provide a magic formula that is applicable to all situations. In such matters, it is necessary to follow the case-by-case rules".
The Caselaw on Discovery Questions in a GAAR Context
In Superior Plus Corp v R, the Federal Court of Appeal affirmed is previous decision to "compel production and answers to refused questions, on the basis that the GAAR was invoked, in circumstances where a change in the Income Tax Act's underlying policy is in issue". The Federal Court noted in previous decision in, R v Lehigh Cement Limited, that "information pertaining to the policy if the Act can be relevant on discovery, even if not taxpayer specific". To illustrate, the Federal Court of Appeal presented two ways in which relevance can be establish:
- First, relevance can be established by disclosing an internal policy memorandum dealing with the same subject,
- Second, relevance can also be established where the documents at issue had been "prepared in an audit context of the taxpayer or had been considered by officials involved in the audits".
The Tax Court of Canada in Superior Plus Corp v R also explained that it is with "reference to legislative intent [..] that the GAAR analysis is made" and that whether (or not) finance officials believe such policy to exist "has no bearing on the object, spirit or purpose of the relevant provisions"
Legal Analysis & Tax Court of Canada Ruling
As previously mentioned, the Appellant's motion seeks to challenge the policy that the Minister applied under the GAAR rules, subsection 245(4). Justice B. Russell held that regardless of whether subsection 245(4) policy is (or is not) the "correct policy" constitutes a "question of law rather than of fact". Justice B. Russell explained that the caselaw already accepts that "documentation is admissible" to the issue at the "discovery stage". This includes "documentation in CRA's file in relation to the taxpayer's audit and or objection stages and documentation that had been considered by the CRA official involved in the taxpayer's audit or objection stages". This demonstrates how the Tax Court of Canada is being cautious at what is (or is not) the policy in this case.
Justice B. Russell held that it should be acceptable for a taxpayer to rely on and request "other CRA or related documentation" at the discovery stage. Justice B. Russell explained this is not an attempt of "fishing expeditions" but such requests allow for "focused questions seeking production of a relatively well define document, should it exist". On the one hand, the words "other CRA or related documentation" are vague and may complicate our understanding and determination of what does (or does not) constitute "other CRA or related documentation". On the other hand, in this analysis the Court appears to be contributing valuable context to the notion of "relevancy on disclosure" at the discovery stage and how such issues may be addressed in future cases.
In presenting the Tax Court of Canada's decision pertaining to the six aforementioned undertakings, Justice B. Russell held that if the requested documents exist, they should be produced by the Respondent to the Appellant. Justice B. Russell explained while the policy in subsection 245(4) of Canada's tax act is "a question of law", it is "relevant to know and test the bases of the Minister's statement as to what is the underlying policy". Further, Justice B. Russell held that it would be "inappropriate to be zealous in restricting the intended broad ambit of discovery examination". This, according to Justice B. Russell, is an application of the "case-by-case" rule, as illustrated by the Federal Court of Appeal in R v Lehigh Cement Limited. Justice B. Russell ordered costs fixed in the amount of $3,750.00 in favor of the Appellant.
Interestingly, this demonstrates how the Tax Court of Canada is broadening its approach to the GAAR analysis. At first, the Tax Court of Canada was cautious about addressing whether (or not) subsection 245(4) was the "correct policy" in this case primarily because it is a "question of law". However, in its final decision the Tax Court of Canada affirmed that the policy in subsection 245(4) is relevant to analyzing and testing the Minister's statement with respect to "what is the underlying policy?". This contrast may be the Court's attempt at identifying scenarios, such as the facts presented in this case, where the application of the policy in subsection 245(4) may be suitable.
Interestingly, Justice B. Russell presented the same decision, using the same exact wording, for each of the aforementioned undertakings respectively and separately. This could imply that the Tax Court of Canada is not giving weight to certain documents over another including "other CRA or related documentation", at the discovery stage. Furthermore, this could be the Court's attempt at setting a precedent in context of documentation production at discovery and the relevance on disclosure.
Tax Tips – "Policy and the GAAR Analysis"
As previously mentioned, the GAAR provisions in the Income Tax Act are a complex area of law that requires detailed analysis and advice from an experienced Canadian tax lawyer. If you have questions regarding a certain transaction or series of transactions and whether (or not) they violate the GAAR provisions or the Income Tax Act as a whole, please contact our office to speaking with one of our experienced Canadian tax lawyers.