GENERAL ANTI AVOIDANCE RULE – GAAR

General Anti Avoidance Rule - GAAR - CRA Loses Catch-All Case

Wednesday, October 26, 2005 from The Globe and Mail.

The Supreme Court of Canada can boast of many achievements in its hallowed 130-year history, but last week it did the impossible. It managed to stir up excitement over the subject of tax law. In a decision being hailed as a major victory for Corporate Canada, the country's highest court effectively sanctioned the well-worn practice of tax avoidance, saying transactions structured to minimize what is owed to Caesar, as it were, don't per se constitute a breach of the law.

The closely watched decision was one of two rulings handed down last Wednesday that marked the high court's first test of the infamous general anti-avoidance rule, or GAAR. Enacted in 1988, the rule was intended as a catch-all to close loopholes in the Income Tax Act, forcing taxpayers to honour the spirit of the law, even in cases where no specific statute prevents them from structuring a sweeter deal.

"It's an extremely important case," said Alan Wheable, senior vice-president of taxation for Toronto-Dominion Bank, whose Canada Trustco Mortgage Co. subsidiary prevailed in the case after a bitter three-year battle with the federal government. "I think it's reassuring to both regular taxpayers and the government, because I think it indicates that the government can't do whatever it wants [even though] there are definite limits on taxpayers." The case in question turned on a complex sale-leaseback transaction set up in 1996 by Canada Trustco with the help of two partners at Toronto-based law firm McMillan Binch Mendelsohn LLP, Vern Kakoschke and Michael Templeton. The mortgage lender purchased $120-million worth of tractor trailers from a U.S. company, Transamerica Leasing Inc., and then leased back the trailers to Transamerica, enabling Canada Trustco to claim a capital cost allowance -- essentially a tax break for equipment depreciation -- on the trailers for the 1997 taxation year.

For the most part, the arrangement was run of the mill. In fact, it's common for capital-intensive industries such as airlines and trucking companies to finance equipment by having deep-pocketed financial institutions buy the planes and trucks at the outset and then lease them over time to minimize capital outlay. But this deal had a twist. Instead of setting up regular instalment payments, the parties arranged for Transamerica to prepay the lease in a lump sum through a circuitous route that included an intermediary company registered in the United Kingdom. That's when the government pounced. It argued Canada Trustco, by getting its money back right away, had not acquired title to the trailers and was avoiding the risk associated with leaseback arrangements. But the financial institution fought back, hiring a team of lawyers at Osler Hoskin & Harcourt LLP, led by litigators Al Meghji and Gerald Grenon and tax partner Monica Biringer, and won its case. The government appealed, but again Canada Trustco prevailed.

Supreme Court of Canada Rules Against CCRA and GAAR

Determined to close a loophole some lawyers say could cost Ottawa tens of millions of dollars annually from future arrangements, it took the GAAR case up to the Supreme Court. But the high court sided unanimously with Canada Trustco, reasoning the deal was not an abuse of law.

The case has electrified legal experts versed in the arcana of accrued revenues and tax-loss carry forwards. So excited were the tax gnomes in March, on the day the Supreme Court heard arguments, that more than 200 from across the country descended on the Ottawa courtroom, forcing staffers to hastily set up a second room with a video screen to accommodate the overflow. "I looked behind me and I was stunned to see that it was completely packed," Oslers' Mr. Meghji said. Evy Moskowitz, a senior partner with Moskowitz & Meredith LLP, a Toronto law firm affiliated with accounting giant KPMG LLP, said the decision offers greater taxplanning certainty to Canadians considering transactions that aren't explicitly covered by existing law -- not just in the leasing arena but in all business and personal income tax arrangements."I think generally this is a good decision for taxpayers," she said. "The onus is on the CRA [Canada Revenue Agency] to show that what you are doing is abusive, and if the CRA cannot show that, then the taxpayer wins."  

The case is particularly significant for businesses, however, because companies for years have endured the prospect of reassessments whenever their savvy deal advisers waded into uncharted legal waters with aggressive tax-paring structures. Indeed, tax lawyers, along with their counterparts in competition law, have become key players in cross-border mergers and acquisitions, where the tax fallout often can make or break a deal. "It is a very significant tax case," Mr. Meghji said. "It gives corporations direction on when tax avoidance becomes abusive tax avoidance." Accolades for Mr. Meghji and his colleagues have been pouring in from the corporate world as a result. "There's been almost universal praise for the team at Oslers that argued this," said David Powell, president and chief executive officer of the Canadian Finance & Leasing Association, which represents about 235 financial institutions with more than $100-billion in leasing deals. Lawyers say the Canada Trustco case is bound to bring new status to the arcane field of tax law. "It's been a lot of fun watching this case go all the way to the top and holding your breath," said Mr. Kakoschke of McMillan Binch Mendelsohn. "It's been exciting."

Comments:

The General Anti Avoidance Rule, known as GAAR, has been a wild-card threat against aggresive offshore planning that is compliant with current statutes, by implying CCRA could rule against such plans that are not clearly dealt with in law. These case law precedents allow greater certainty and are a welcome relief to excessive taxation powers. Although not as important to the Tax-Free Loan Program, because it is clearly onside with regulations, it offers some comfort that GAAR will not be effective in discouraging use of the Program.