It is a fundamental principle of Anglo-Canadian law that a taxpayer is entitled to arrange his or her affairs to minimize tax. The frequently decision is the judgment of the House of Lords in the Inland Revenue Commissioners v. His Grace the Duke of Westminster [1936] A.C. 1 (U.K. H.L.), which was the origin of the principle by the same name.

The Westminster principle is fundamental in Anglo-Canadian tax law and has been since the House of Lords decision. Over time, however, tax law balances the interest of the state in revenue collection and the private interests of taxpayers. As we have moved from the free market era of the mid-war years of the 20th century towards a more regulatory state, tax law has enacted statutory changes that circumscribe tax planning, such as, the general anti-avoidance rule (GAAR) in section 245, which limits the principle where tax plans are "abusive" of the Income Tax Act [ITA].

Thus, the statement that "every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be" raises the inevitable question: what are the circumstances when the principle does not apply?

Background of Tax Avoidance

Canada imported the doctrine of strict literal construction from England into its common law system and applies it despite section 12 of the Interpretation Act, which deems every enactment to be remedial and "shall be given such fair, large and liberal construction and interpretation as best ensures the attainment of its objects".

Similarly, in Construction of Statutes (2nd ed. 1983), E.A. Dreidger, stated the modern rule:

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 (at p. 87).

However, Canadian courts interpret tax law strictly and literally on the traditional constitutional theory of parliamentary supremacy in tax legislation. Canada has resisted non-formalist methods of interpretation partly, as the House of Lords remarked, due to the dominance of the accounting profession in Canadian tax law.1

The resilience to change is only partly attributable to the influence of the Westminster doctrine that a taxpayer is entitled to arrange his affairs under a tax statute so as to minimize tax, regardless of the purpose of the statute. The dominance of the accounting profession, untutored in the principles of statutory construction, in tax law and legislative drafting nurtured literal and strict construction. Thus, although statutory interpretation in other areas of law shifted away from the formal to purposive interpretation, tax law was left behind as an island of literal interpretation.

The Westminister principle is foundational in Canadian tax law, but subject to contrary provisions in the Act, such as, section 245.2

...this Court has never held that the economic realities of a situation can be used to recharacterize a taxpayer's bona fide legal relationships. To the contrary, we have held that, absent a specific provision of the Act to the contrary or a finding that they are a sham, the taxpayer's legal relationships must be respected in tax cases.

The Supreme Court's decision in Stubart3 was the primary impetus for the enactment of GAAR in section 245.

The facts in Stubart were simple. The taxpayer, Stubart, was a profitable business. Its sister corporation, Grover, had accumulated losses. Pursuant to amendments in 1951, the Income Tax Act prohibited the consolidation of income from separate corporate operations. To overcome the restriction on consolidation of income, Stubart sold its assets to its sister corporation ("Grover"), which had accumulated large tax losses.

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Concurrent with the agreement of purchase and sale of the assets, Grover appointed Stubart as its agent to carry on the business. Stubart continued to operate the business as usual, but now only as an agent of the sister corporation. At the end of each of the relevant fiscal years, Stubart paid Grover the net income that it realized from the business. Grover, in turn, reported the income in its corporate tax returns for the relevant years. The result was to merge the profits of the profitable business with the losses of the sister corporation. The sole purpose of the transactions was to mitigate taxes through the utilization of tax losses in the sister corporation. The transfer had no other business purpose.

Section 137 of the Income Tax Act (as it read at the time), an anti-tax avoidance provision, provided in part as follows:

"(1) In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income".

The Department of National Revenue reassessed Stubart, setting aside the entries transferring the net income to Grover, and charged the net income back to the Stubart's taxable income.

However, the Crown failed to plead section 137.

"The Attorney General of Canada expressly, in response to a question from the Court during the hearing of the appeal, said that the Crown was not relying upon s. 137" (per Estey J. at p. 547).

Estey J. in obiter would likely have upheld the assessment under section 137 (at p. 547):

"Clearly the cheque transferring the profit from the appellant to Grover at the end of the year is a disbursement, and it is a disbursement the deduction of which leaves no taxable income in the appellant from the business".

However, the Crown framed its appeal based on the absence of a "genuine business purpose" to the arrangements or the "abuse of rights" principle, which formed part of the taxation principles in the laws of the United Kingdom and the United States. The Crown argued that those laws were equally applicable in the interpretation of the Income Tax Act of Canada at the time.

The Supreme Court rejected the argument. The arrangement was valid because it complied with the technical requirements of the Income Tax Act, without the necessity of a commercial purpose. Per Justice Estey at para. 55: 4

"I would therefore reject the proposition that a transaction may be disregarded for tax purposes solely on the basis that it was entered into by a taxpayer without an independent or bona fide business purpose. A strict business purpose test in certain circumstances would run counter to the apparent legislative intent which, in the modern taxing statutes, [we] may have a dual aspect. Income tax legislation, such as the federal Act in our country, is no longer a simple device to raise revenue to meet the cost of governing the community. Income taxation is also employed by government to attain selected economic policy objectives. Thus, the statute is a mix of fiscal and economic policy. The economic policy element of the Act sometimes takes the form of an inducement to the taxpayer to undertake or redirect a specific activity. Without the inducement offered by the statute, the activity may not be undertaken by the taxpayer for whom the induced action would otherwise have no bona fide business purpose. Thus, by imposing a positive requirement that there be such a bona fide business purpose, a taxpayer might be barred from undertaking the very activity Parliament wishes to encourage. At minimum, a business purpose requirement might inhibit the taxpayer from undertaking the specified activity which Parliament has invited in order to attain economic and perhaps social policy goals."

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Footnotes

1. Inland Revenue Commissioners v. McGuckian [1997] STC 908 (HL).

2.Shell Canada Ltd. v. Canada [1999] 3 SCR 622 at para 39; Canada v. Antosko [1994] 2 SCR 312; Canada Trustco Mortgage Co. v R, 2005 SCC 54, para 31 and endorsed in Copthorne Holdings Ltd. v. Canada. [2011] 3 SCR 721, para 67; Copthorne Holdings Ltd. v Canada. [2011] 3 SCR 721, para 65.

3. Stubart Investments Ltd. v. The Queen, [1984] 1 SCR 536, [1984] CTC 294, 84 DTC 6305 (SCC).

4. Stubart Investments Ltd. v. R., 1984 CarswellNat 222, [1984] C.T.C. 294, 53 N.R. 241, [1984] 1 S.C.R. 536, 10 D.L.R. (4th) 1, 84 D.T.C. 6305, 15 A.T.R. 942, 84 D.T.C. 6323 (Supreme Court of Canada).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Mr Vern Krishna
TaxChambers LLP
155 University Avenue, Suite 300
Toronto
ON M5H 3B7
CANADA
Tel: 416 8477300
Fax: 8662856527
E-mail: catherine.ayiotis@taxchambers.ca
URL: www.taxchambers.ca

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