Recent tax ruling undermines purpose of proposed reforms to general anti-avoidance rule: lawyer

The recent Supreme Court of Canada decision involving the Income Tax Act’s general anti-avoidance rule has undercut the need for the federal government’s proposed legislative reforms, says Laurie Goldbach, a tax litigator at BLG.

The court released its ruling in Deans Knight Income Corp. v. Canada, 2023 SCC 16 on May 26. The case dealt with a company that executed a complex series of transactions to capitalize on tax benefits held by another company. The SCC found the transactions, which transferred tax deductions acquired through non-capital losses, were abusive under the general anti-avoidance rule (GAAR).

As part of the test determining abusiveness, the court examines whether a taxpayer’s conduct defeats the “underlying rationale” of an Income Tax Act provision. The provision at issue in the case, s. 111(5), prohibits companies acquiring control of others for the sole purpose of using the target’s business losses to reduce their tax burden. The court’s majority found that the test courts use to determine control – whether the entity has “de jure control,” where the controlling party must hold enough shares to elect the majority of board directors – did not fully capture s. 111(5)’s rationale. De jure control is not a “perfect reflection or complete explanation of the mischief that Parliament sought to address,” they said.

In this year’s budget, Ottawa proposed changes to GAAR that would add an interpretive preamble, alter the definition of an “avoidance transaction,” add a new “economic substance” test to the analysis, and extend the reassessment period. The Department of Finance engaged in a consultation process from March 28 to May 31.

With Deans Knight, the SCC has shown it is prepared to interpret the GAAR flexibly and broadly, says Goldbach, a partner at BLG who specializes in tax disputes and legislation. In Deans Knight, Goldbach represented an intervenor, the Canadian Chamber of Commerce.

“The government's rationale for proposing those amendments was to make it easier to apply the GAAR. The government perceived that there'd been a reluctance on the part of the courts to find an abuse or misuse of the Act’s provisions, which is part of the test for GAAR.”

“The court showed that the existing GAAR does the trick, so there's really no need to change it,” she says. “Ironically, if the government changes it now, that legislative reform will just lead to more court challenges.”

Further court challenges could destabilize economic certainty for Canadian taxpayers, she says.

The judgment is fact specific and can be incorporated into existing tax planning, says Goldbach. While there is a new test, she says that the test is workable and will lead to government invoking the GAAR more often, which was the purpose behind the proposed legislative amendments.

“We think it accomplishes those same goals.”