On March 19, 2008, the Federal Court of Appeal (the "FCA") rendered its decision in the MacKay appeal,1 reversing the judgment of the Tax Court of Canada (the "TCC") which had found that the GAAR2 did not apply as none of the transactions at issue constituted an avoidance transaction under paragraph 245(3)(b) of the Income Tax Act (the "Act").
In general terms, the TCC had suggested that in analyzing the primary purpose of each transaction within a series under paragraph 245(3)(b) of the Act, the Court should not merely consider in isolation the direct purpose of each such transaction. Instead, the TCC posited that the primary purpose of the series of transactions, as a whole, should also be a relevant, though not necessarily determinative factor in determining whether each particular transaction constitutes an avoidance transaction.
But, at the same time, the Court stated, in concluding its decision, that it did inter alia find that none of the transactions, when considered apart from the others, constituted an avoidance transaction.
The Transactions
The series of transactions at issue (the "Series") can be summarized as follows:
- In 1992, the National Bank of Canada (the
"Bank") commenced foreclosure proceedings in
respect of the Northills Shopping Centre (the "Shopping
Centre"). The amount owed to the Bank was approximately
$16 million and the Shopping Centre was listed for sale at
$12.5 million.
- By August 1993, the taxpayers and the Bank had agreed in
principle to transfer the Shopping Centre to the taxpayers
for $10 million. It was understood that this transfer would
be effected by the assignment of the Bank's interest
in the foreclosure proceedings (and therefore the assignment
of the Bank's mortgage receivable).
- Following the above agreement in principle, the taxpayers
proposed to structure the transaction so as to obtain the
benefit of the $6 million loss that had been incurred by the
Bank on the mortgage receivable. For the purposes of the
appeal, the FCA assumed that the taxpayers would have
proceeded with the acquisition regard less of whether they
would be afforded the benefit of the $6 million loss based on
the fact that this use of the loss had not been discussed
between the parties before agreeing to the $10 million sale
price.3
- Accordingly, in November 1993, the Bank and a newly
incorporated subsidiary thereof ("GPco") formed a
limited partnership (the "Partnership") under which
the Bank was a limited partner and GPco was the general
partner. The Partnership's first fiscal period would
end on December 31, 1993.
- The Bank then assigned the mortgage receivable and its
interest in the foreclosure proceedings to the Partnership in
exchange for limited partnership units with an aggregate
value of $10 million, being the fair market value of the
mortgage receivable and the interest in the foreclosure
proceedings. On a direct sale to the taxpayers of such
assets, the Bank would have realized a loss of $6 million.
However, since the Bank and the Partnership did not deal at
arm's length, subsection 18(13) of the Act applied to
prevent the deduction by the Bank of the $6 million loss and,
instead, added the amount of such loss to the
Partnership's cost of such assets —
increasing such cost from $10 million to $16 million.
- On December 29, 1993, the taxpayers acquired general
partnership units of the Partnership for $2 million.
- The Bank then loaned $9.7 million to the Partnership,
$8.6 million of which amount was to finance the redemption of
the Bank's limited partnership units.
- The Partnership then acquired the Shopping Centre by
completing the foreclosure. The Partnership's cost of
acquiring the Shopping Centre was equal to its cost in the
mortgage receivable and the interest in the foreclosure
proceedings, being $16 million as noted above.
- On December 30, 1993, the Partnership redeemed $8.6
million of the Bank's limited partnership units and,
on December 31, 1993, the Partnership redeemed the balance
for $1.4 million, using part of the amount contributed to the
Partnership by the taxpayers. Presumably, the balance of the
capital of the Partnership was to be used in the development
of the Shopping Centre.
- Lastly, on December 31, 1993, the Bank sold the shares of
GPco to two of the taxpayers.
- At year end, the Partnership took a write-down of its
cost in the Shopping Centre (which it considered to be
inventory) to its fair market value of $10 million, resulting
in a $6 million loss which was allocated proportionately to
its partners, the taxpayers.
Footnotes
1. The Queen v. MacKay et al. (2008 DTC 6238, 2008 FCA 105), reversing 2007 DTC 425, 2007 TCC 94.
2. The so-called General Anti-Avoidance Rule, expressed at section 245 of the Act.
3. One may speculate as to whether the taxpayers made a strategic decision to proceed in this manner in order to avoid having the Bank use the potential loss as a bargaining chip. However, the record before the FCA would not justify such speculation.
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