Keep your eye on the time: Timing liability under Subsection 160(1) in Eyeball Networks

In Eyeball Networks, the TCC alerted tax planners to the pitfalls of issuing and cancelling a promissory note with nominal value in the context of a tax-neutral rollover under section 85 of the ITA. The Minister applied section 160 to assess the Appellant ("Newco") for the tax liabilities of its non-arm's length affiliate ("Oldco") following the set-off of two promissory notes at the conclusion of a series of transactions designed to transfer revenue-generating video technology ("Transferred Assets") from Oldco to Newco. The TCC found that section 160 permitted the minister's collection efforts in the context of the issuance and cancellation of promissory notes between non-arm's length parties where the FMV of one promissory was considerable and the FMV of the promissory note tendered in exchange was nominal. The TCC's decision reminds practitioners of the role that economic substance plays in the analysis under subparagraph 160(1)(e)(i) and the flexible timing engaging section 160.

Section 160 is a collections mechanism that assigns tax liability to a non-arm's length transferee for money or property transferred by a person who owes tax. Under paragraph 160(1)(e), the transferee is liable for the FMV of transferred property, minus the FMV of any consideration given in return. Despite the frequency and range of litigation under section 160, the TCC decision in Eyeball Networks addressed language in subparagraph 160(1)(e)(i) that has not received extensive judicial notice.^[1] The TCC interpreted the phrases "at the time" and "at that time" in subparagraph 160(1)(e)(i) in the context of a transaction where the FMV of consideration for tendered property changed over time. The TCC's flexible interpretation of timing in subparagraph 160(1)(e)(i) is consistent with the broad-ranging application of the provision generally.

The TCC's analysis focused on the FMV of the consideration tendered in exchange for the Transferred Assets in a section 85 rollover. At the beginning of the series of transactions, Oldco transferred revenue-generating video conferencing technology valued at $30,000,000, in addition to debts owing to creditors, to Newco in exchange for shares in Newco. Subsequently, Newco redeemed the shares and Oldco and Newco set-off promissory notes pursuant to an agreement to cancel Oldco's and Newco's mutual debt ("Cancellation Agreement"). The promissory note issued to Newco by Oldco, however, had only nominal value on the open market because Oldco lacked the liquidity or assets to repay it.

The first issue before the TCC was whether Newco provided consideration for the Transferred Assets. The TCC rejected the Respondent's argument that no aggregate consideration was tendered for the Transferred Assets at the "time of transfer". Instead, the TCC found that the documents properly and substantively reflected the purpose of the transaction. The second issue for determination was whether the FMV of the tendered consideration changed to a value less than the FMV of the tendered property within the definitional scope of the "time of transfer" for the purposes of subparagraph 160(1)(e)(i). Importantly, the phrase "time of transfer" does not appear in section 160. Rather, the TCC uses the phrase because of its semblance to the phrases "at the time" and "at that time" as used in subparagraph 160(1)(e)(i). The TCC undertook a textual, contextual and purposive analysis of the phrases "at the time" and "at that time" in subparagraph 160(1)(e)(i) to ascertain the FMV of the tendered consideration during the "time of transfer". The TCC found that the phrases "at the time" and "at that time" suggested a point in time analysis and that the provision takes a value snapshot of the transfer of property when it occurs. The TCC's contextual analysis determined that the charging provision and the phrase "by any other means whatever" in the preamble of subsection 160(1) should be applied in the same manner. As a result, the TCC found that the context of subparagraph 160(1)(e)(i) does not permit the examination of the net result of a series of transactions. The TCC also found that the purpose of section 160 is to prevent a taxpayer from transferring its property to thwart the minister's efforts to collect money owed to her. However, the TCC found that the purpose of section 160 does not permit the minister to ignore the separate nature of each event that creates an identifiable transfer. Instead, the value of the tendered property and the tax debtor liability must be established at the moment of transfer. The text, context and purpose of the provision established that the minister is not permitted to assess liability under section 160 based on the net result of a series of transactions.

Nevertheless, the TCC's decision appears to have based the Appellant's liability on the net result of the section 85 rollover. It appears to do so by characterizing the Cancellation Agreement as a distinct transaction within the series of transactions. For example, the TCC determined the FMV of the tendered consideration at various stages of the transaction. At the inception of the series, the TCC found that the FMV of the tendered consideration was symmetrical with that of the Transferred Assets. However, the TCC looked at the result of the Cancellation Agreement, characterizing it as a "single, distinct stand-alone transaction", to determine when the FMV of the tendered consideration changed. The TCC characterized the debt forgiveness by cancellation or set-off as a distinct transfer "by any other means whatever" that need not have been contemporaneous with the asset transfer. Importantly, the TCC found that the restriction precluding the Minister from analyzing the result of a series of transactions does not apply to a distinct transaction such as the Cancellation Agreement. The TCC proceeded to determine whether the relative FMV between the mutually forgiven Newco promissory note ("Newco Note") and the Oldco promissory note ("Oldco Note") was unequal. The TCC found that the FMV of the Oldco Note at the time of transfer was nominal because Oldco had no assets with which to back the note.

Finally, the TCC determined whether the FMV of the tendered property exceeded, and by how much, that of the tendered consideration "at the time of transfer". The TCC found that the tendered consideration for the Transferred Assets disappeared at the point in time when the Cancellation Agreement took effect. The FMV of the Oldco Note was nominal and the FMV of the Newco Note was considerable as its worth was backed by the $30,000,000 in assets owned by Newco. At the moment of transfer, the consideration for the surrender or forgiveness of the valuable Newco Note was the surrender or forgiveness of the Oldco Note with nominal value. It was precisely "at the time" of this transfer that the tendered consideration, in the form of the Oldco Note with nominal value, was deficient.

A particularly bad fact for the Appellant was its failure to assume Oldco's contingent tax liabilities along with the liabilities of Oldco's trade creditors. Newco could have assumed Oldco's contingent tax liabilities, which Oldco could not satisfy after the section 85 rollover because of the uncompensated transfer of Oldco's assets. The TCC found that the "tit-for-tat" cancellation of promissory notes between non-arm's length parties where one promissory note had considerable value and the other little or none did not thwart the collection efforts of the minister.

The TCC's decision should give tax planners pause when issuing a promissory note of nominal value in a section 85 rollover. The TCC adopted a flexible approach to interpreting the moment of transfer in the series of transactions. Even though the TCC found that the net result of a series of transactions could not be analyzed under section 160, the TCC identified the moment of transfer for the purposes of subparagraph 160(1)(e)(i) to be the transaction that produced the final result of the series. The TCC may focus on discreet transactions within section 85 rollovers and consider the transactions distinct when applying section 160. The decision potentially broadens the scope of section 160 and the range of transactions that it may engage.