Mony C. The King, 2022 DTC 5111 (Tax Court of Canada) — GAAR Applies To Attribute To Taxpayer Capital Gain Realized by Taxpayer’s Spouse on the Sale of Shares

Background

In this case, Mr. Charles Mony (the “Taxpayer”) appealed a reassessment, issued on October 13, 2017, by which the Minister of National Revenue (the “Minister”) attributed to the Taxpayer a capital gain of $450,373 realized by his spouse, Mrs. Isabella Vitté (the “Spouse”), on the sale of the capital stock of Créaform Inc. (“Créaform”). The Minister attributed the capital gain to the Taxpayer pursuant to the general anti-avoidance rule (the “GAAR”) set out in section 245 of the Income Tax Act (“ITA”).

On March 23, 2009, the Taxpayer received an offer from third-party investors to purchase his shares in Créaform, which was a Canadian-controlled private corporation in the business of selling digital technology for taking measurements in three dimensions. Sometime thereafter, the Taxpayer accepted this offer.

On June 25, 2009, the Taxpayer gifted to his Spouse 114,907 shares in Créaform (the “Gifted Shares”). Also on June 25, 2009, the Taxpayer sold to his Spouse another 114,907 shares in Créaform (the “Sold Shares”) in exchange for an interest-bearing note (the “Promissory Note”) in the amount of $985,728 (which was equal to the fair market value (“FMV”) of the Sold Shares at the time). Later that same day, the Spouse sold the Gifted Shares and the Sold Shares to third-party investors for proceeds of $1,971,455.

Pursuant to subsections 73(1) and (1.01) of the ITA, the Taxpayer was deemed to have disposed of the Gifted Shares, and his Spouse was deemed to have acquired the Gifted Shares, for proceeds equal to the adjusted cost base (“ACB”) of the Gifted Shares, which was $1,242. Accordingly, the Taxpayer did not realize any capital gain or loss on the transfer of the Gifted Shares.

Subsections 73(1) and (1.01) would h ave applied similarly to the Sold Shares as they did to the Gifted Shares, except that the Taxpayer elected under subsection 73(1) to exempt the Sold Shares from the application of that provision. Consequently, the Taxpayer sold the Sold Shares to his Spouse for proceeds equal to the FMV of the Sold Shares, which was $985,728. Because the Sold Shares had an ACB of $1,242, the Taxpayer realized a capital gain of $984,486 on which he was taxed.

Prior to the application of subsection 47(1) of the ITA, the tax attributes of the Spouse’s Shares were as follows:

However, because the Gifted Shares and Sold Shares were identical property, subsection 47(1) of the ITA deemed the Shares to all have the same ACB by the application of the averaging rule, regardless of how the Shares were transferred. The tax attributes of the Spouse’s Shares therefore became as follows:

Accordingly, the sale of the Gifted Shares and the Sold Shares by the Spouse to the third-party investors resulted in a capital gain of $900,745 calculated as follows:

Because the Gifted Shares were previously transferred from the Taxpayer to his Spouse, the capital gain realized by the Spouse on the disposition of the Gifted Shares was deemed, pursuant to subsection 74.2(1) of the ITA, to be realized by the Taxpayer and not his Spouse. The capital gain realized by the Spouse on the disposition of the Sold Shares would have also been deemed, pursuant to subsection 74.2(1), to be realized by the Taxpayer and not his Spouse except that, pursuant to subsection 74.5(1), subsection 74.2(1) does not apply to the Sold Shares because the Taxpayer received consideration equal to FMV in exchange for the shares (i.e., the Promissory Note). Accordingly, the capital gain of $450,373 realized on the Sold Shares was not deemed to be realized by the Taxpayer but instead remained taxable in the Spouse’s hands. The Taxpayer and his Spouse then each claimed the capital gains deduction under subsection 110.6(2.1) of the ITA.

By reassessment issued on October 13, 2017, the Minister sought to apply the GAAR to attribute the entire capital gain realized by his Spouse to the Taxpayer.

Issues and Decision

For the GAAR to apply, three requirements must be established:

1. There was a tax benefit resulting from a transaction or part of a series of transactions (subsections 245(1) and (2));
2. The transaction is an avoidance transaction in the sense that it cannot be said to have been reasonably undertaken or arranged primarily for a bona fide purpose other than to obtain a tax benefit (subsection 245(3)); and
3. There was abusive tax avoidance in the sense that it cannot be reasonably concluded that a tax benefit would be consistent with the object, spirit or purpose of the provisions relied upon by the taxpayer.

The burden is on the Taxpayer to refute (1) and (2) and on the Minister to establish (3). Because a tax benefit was conceded by the Taxpayer, only (2) and (3) were issues before the Court.

Avoidance Transaction

The Court found that a series of transactions was carried out on June 25, 2009 that consisted of the following individual transactions:

1. transfer of the Gifted Shares by the Taxpayer to his Spouse;
2. transfer of the Sold Shares by the Taxpayer to his Spouse; and
3. sale of the Gifted Shares and Sold Shares by the Spouse to the third-party investors.

The Court determined that transaction (3) was clearly not an avoidance transaction because its main purpose was to make a profit from the sale of shares and to bring new partners into Créaform. The Court did not make a determination with regards to transaction (1) because certain contradictions in the testimony of the Taxpayer and his Spouse made the main purpose of the transaction unclear. However, the Court held that it did not need to make a determination with regards to transaction (1) because it determined that transaction (2) was an avoidance transaction and only one transaction needs to be an avoidance transaction for the second GAAR requirement to be met.

The Court held that the Taxpayer did not demonstrate that transaction (2) was reasonably undertaken or arranged primarily for a non-tax purpose. Instead, the Court held that the Spouse acted only as an intermediary and received no benefit from transaction (2). The proceeds the Spouse received from the sale of the Sold Shares to the third-party investors was used fully to repay the Promissory Note. If not for the application of subsection 47(1), the election under subsection 73(1) and the attribution to the Taxpayer pursuant to section 74.2, the Taxpayer and his Spouse would have received no benefit from transaction (2).

Abusive Tax Avoidance

The Court held that the Minister established that there was abusive tax avoidance on the basis of Gervais c. Canada, 2018 DTC 5006 (FCA) (“Gervais”).

The facts in Gervais were essentially the same as in the Taxpayer’s case; virtually the same series of transactions was undertaken that resulted in essentially the same tax consequences (i.e., the splitting of a capital gain between the taxpayer and his spouse due to the averaging rule in subsection 47(1) of the ITA). The only differences between Gervais and the Taxpayer’s case were that, in Gervais, there was a reorganization of capital at the beginning of the series of transactions; only the spouse benefitted from the capital gains deduction in subsection 110.6(2.1); the proportion of shares donated versus the shares sold was different; and the series of transactions was carried out over several days rather than just one. The Court held that these differences were altogether minor and did not distinguish the Taxpayer’s case from Gervais. Accordingly, the Court held that the reasoning in Gervais applied to the Taxpayer’s case and because the Court in Gervais held that there was abusive tax avoidance, the same conclusion applied to the Taxpayer’s case as well.

Conclusion

The Taxpayer undertook a series of transactions virtually identical to the series of transactions in Gervais which resulted in essentially the same tax consequences as Gervais, which included the application of the GAAR to attribute the taxable capital gain realized by his Spouse to the Taxpayer.