Tax Insights: Tax Court of Canada finds corporate reorganization abuses section 84.1

Issue 2014-20

As the Tax Court of Canada pointed out in the recent decision of Gwartz, a decision dealing with the application of the general anti-avoidance rule (GAAR), the Income Tax Act (the Act) does not contain any general prohibition against surplus stripping. However, transactions put in place to extract a corporation’s value can be subject to specific anti-avoidance provisions, which operate to eliminate beneficial tax consequences arising from these transactions. Section 84.1 of the Act is one of those provisions. As the Court pointed out in Gwartz, section 84.1 ‘aims at precluding the stripping of corporate surpluses where shares are sold in non-arm's length transfers implemented through transaction steps […].’

In a judgment rendered on March 7, 2014, under the Informal Procedure, the Tax Court of Canada provided an example of a situation where, in the Court’s view, the object and spirit of section 84.1 had been abused, triggering the application of the GAAR. Although theoretically of no precedential weight because of its status as an Informal Procedure decision, this decision is nevertheless of interest to the tax community since it provides insights into the application of this broad provision. It also raises the fundamental issue of the extent of the Minister’s burden, in the GAAR context, to persuade the court that an abuse of the Act or a provision thereof has in fact occurred.

The case of Descarries involved six individual taxpayers who, in 1982, inherited 3178 common shares of a Canadian-resident corporation, Oka Inc. (Oka), from their father (or father-in-law). The deceased had held them at December 31, 1971 (V-Day). Thus, although the shares were deemed to be disposed of on the father’s death at fair market value (FMV), only the portion of the capital gain that accrued after that date was taxable on the father’s death due to the ‘tax free zone’ rules.

The individual taxpayers had also acquired 820 shares of Oka from a third party for $25,000 and had subscribed for two additional shares of $100, bringing the total issued shares to 4,000.