The British Columbia Court of Appeal recently released its judgment in Veracity Capital Corporation v. Canada (National Revenue), 2017 BCCA 3, holding that a tax planning structure commonly referred to as the Québec year-end shuffle did not constitute an avoidance transaction for purposes of the British Columbia general anti-avoidance rule (the “BC GAAR”). This is the first appellate level case addressing a provincial general anti-avoidance rule in Canada.
The Court followed the spirit of the jurisprudence surrounding the application of the federal general anti-avoidance rule: (1) not all loopholes or plans to avoid tax are ipso facto abusive, and (2) our taxation regime is not a harmonious scheme, rather it is a patchwork where provinces have the power to legislate as they please. The Court concluded that taking advantage of the differences between provincial rules to avoid taxation is not on its face abusive tax planning.
In July 2002, in an attempt to avoid most of the B.C. tax on a capital gain that would otherwise apply to a share sale, the shareholders of a company transferred their shares on a rollover basis to a new company (“Veracity”) under s. 85(1) of the Income Tax Act, RSC 1985, c.1 (5th Supp.) (the “federal Act”). In Québec, Veracity had a taxation year ending on August 31, 2002, whereas in B.C. and federally, Veracity had a taxation year ending on June 30, 2003. In order to allocate 100% of the taxable capital gain resulting from the sale of the shares to B.C. for the purposes of the first year-end in Québec, small directors’ fees were paid to the B.C. resident directors in July 2002. After the Québec year-end passed, Veracity purchased units of a listed limited partnership in Québec with a September 30 year end, so that as at September 30, 2002 a pro rata portion of the gross revenues and salary expense of the limited partnership would be allocated to Veracity in its capacity as unit-holder. The result under the inter-provincial allocation rules was that approximately 90% of the taxable capital gain from the sale of the shares was allocated to Québec in respect of the second year-end in B.C. This allocation resulted in the avoidance of $1,175,249 of tax on the taxable capital gain that would otherwise have been taxed in B.C.
The Minister of National Revenue reassessed Veracity for BC provincial tax on its taxable capital gain on the basis that the transactions Veracity undertook to lower its tax liability constituted abusive tax avoidance. The Supreme Court of British Columbia affirmed the Minister’s reassessment in 2015, finding that the B.C. GAAR, as set out in s. 68.1 of the Income Tax Act, RSBC 1996, c. 215 (the “BC Act”) applied to all aspects of the transaction and the relevant tax provisions were abused:
- The rollover rules were abused because they are intended to facilitate a deferral of tax, not an avoidance of tax;
- The rules allocating income between provinces were abused because they were “designed to prevent both the over-taxation and the under-taxation of income earned by a corporation which is active in more than one province.” They were not designed to allow a corporation to escape any provincial taxation on that income; and
- The choice of differing year ends was an abuse because the various provisions in the BC Act, the Québec statute, and the federal Act “did not contemplate taxpayers using different year ends in different jurisdictions for the same income in the same year. Shuffling the year end dates to avoid taxes is an abuse.”
The overriding disposition of the trial court decision was highlighted in its observation that “this is a simple case of a tax not being paid anywhere which ought to have been paid somewhere.” The Court of Appeal strongly disagreed with this statement.
The Court of Appeal’s Decision
The appeal by Veracity to the BCCA was allowed and the tax reassessment by the Minister was set aside.
In discussing the BC GAAR, the Court noted that GAAR provisions are included in federal and provincial income tax statutes to achieve the effect of denying a taxpayer any “tax benefit”, despite the taxpayer having strictly complied with the letter of the statutory provisions in question, where the tax planning is abusive. The jurisprudence has outlined a three step GAAR analysis, but Veracity conceded the first two steps: (1) that their Québec Shuffle created a tax benefit, and (2) that it was not primarily undertaken for bona fide non-tax purposes. As a result, the appeal depended critically on the third step of the GAAR analysis, that is, whether the appellant’s tax avoidance transactions directly or indirectly misused or abused any provisions to which the BC GAAR applied. The Minister had to clearly demonstrate that the transaction resulted in an abuse. The benefit of the doubt is to be given to the taxpayer (Canada Trustco Mortgage Co v Canada, 2005 SCC 54,  2SCR 601 at para. 65).
The Court of Appeal framed the relevant issues as follows:
1) Does the B.C. GAAR apply to rollover and capital gains computing provisions under the federal Act? Did Veracity misuse or abuse these provisions?
2) Does the B.C. GAAR apply to allocation rules under the federal Act? Did Veracity misuse or abuse these provisions?
3) Does the B.C. GAAR apply to fiscal year-end provisions in various tax statutes? Did Veracity misuse or abuse these provisions?
The Court was critical of a “false premise that permeated the [lower] judge’s overall analysis: it ignored the fact there is no uniform system of provincial taxation and no “moral” or “value” judgment in determining the rationale of income tax legislation.” The Court of Appeal found that:
1) Due to drafting irregularities in the B.C. Act which limit the B.C. GAAR’s scope to the B.C. Act itself, the B.C. GAAR does not apply to corporate rollover and capital gains provisions of the federal Act. Even if these provisions did apply, the purpose object and spirit of the sections were not abused. The Court found that the trial judge erred in principle by applying the premise that taxable capital gains “ought” to have resulted in taxes being paid somewhere.
2) The B.C. GAAR applies to federal allocation rules through a legislative pathway outlined at paragraph 97 of the decision. The purpose of the allocation rules is to “provide a basis for imposing tax liability in the appropriate province.” However, once the allocation has occurred, how the provinces actually tax that income is beyond the purpose, object and spirit of the allocation rules. The Minister did not discharge its high burden of clearly demonstrating Veracity abused the Allocation rules.
3) The B.C. GAAR applies to the fiscal year-end provisions under the B.C. Act. However, the purpose of these provisions, to facilitate the regular and periodic reporting of tax results, was achieved. The Court noted that there is no uniform system of provincial taxation and “the risks of differential treatment have long been recognized.” Veracity’s positions in regards to income reported for two differing year-ends were not contradictory. Rather the reported incomes were compliant responses to two different questions about two different time periods from two different taxation authorities set out under two distinct taxation regimes. Benefitting from these differences was not abusive.
The Court noted that the underlying “loophole” used by Veracity was later closed by the Québec Legislature. This was done by removing the option for electing to have a different fiscal year-end date for Québec tax purposes. These changes were made retroactive, but only to 2006. Therefore, Veracity’s transactions were not “caught” by the legislative changes in Québec. The Court was critical that the Minister’s argument might effectively use the B.C. GAAR to “judicially extend” the retroactivity of Québec’s legislative amendments to 2002. The Court stated the importance of caution in respect of judicial innovation, and of being mindful of the Court’s role as distinct from that of Parliament.
This case will require tax authorities to use more discipline in applying provincial general anti-avoidance rules. The Court held that the BC GAAR does not apply to provisions in the federal Act that are not expressly incorporated into the BC Act, and identified a number of instances in which the trial judge applied the BC GAAR to statutory provisions that were not expressly incorporated into the BC Act. The factually similar Québec trial decision that was relied upon by the trial judge (OGT Holding Ltd. v Québec (Deputy Minister of Revenue), 2006 QCCQ 6328) was distinguished on the basis that, unlike Veracity, the taxpayer in OGT abused a provision of the Québec Act itself, which was within the scope of the Québec GAAR. The Court observed that the BC Legislature had a choice in drafting the BC GAAR, and could have stipulated that it applied to the misuse or abuse of enactments other than the BC Act. The fact that the BC GAAR is essentially restricted to the BC Act does not allow the courts to add language expanding the application of the provincial GAAR when interpreting it.
The Court also held the premise that a taxable capital gain ought to have resulted in tax being paid somewhere is wrong. The interprovincial allocation rules do not result in income disappearing, but instead leave it to the provinces to decide how to tax the income that is allocated to them. The risk of differential treatment between the provinces has long been recognized as having the potential for anomalous results, but it is not abusive tax avoidance for a taxpayer to take the benefit of another province’s advantageous tax treatment.
The right of taxpayers to arrange their affairs to achieve a favourable tax result has been affirmed despite the existence of a provincial GAAR.
The Court summarized the position well in one of the decision’s closing paragraphs:
Legislatures do not intentionally enact loopholes, as the nomenclature implies. This is especially the case given the well-known precision legislatures bring to tax legislation. It would be a rare case where a loophole was contemplated by the legislature. To conclude that transactions benefiting from a loophole are ipso facto abusive for GAAR purposes because the outcome was not the legislature’s intent would, in my view, be inconsistent with the robust and rigorous approach set out by Supreme Court jurisprudence. Benefiting from unintended consequences from gaps in legislation is not necessarily abusive. The legislation does not prohibit tax avoidance. It prohibits abusive tax avoidance, and a textual, contextual and purposive analysis of the spirit, object and purpose of the provisions in each particular case must guide that inquiry.