GAAR – Using Attribution to the Taxpayer’s Benefit

“Using attribution to your benefit is not GAAR.”

In the recent case of Overs (2006 TCC 26), the taxpayer’s deductions for carrying charges and interest expense were denied by CRA pursuant to the GAAR rules in section 245 of the Income Tax Act.

The taxpayer’s loan from his company had to be repaid to avoid the income inclusion rules of subsection 15(2). In order to repay the loan, the following transactions occurred:

  1. The taxpayer’s wife borrowed $2.3 million from the Bank of Montreal.
  2. The taxpayer’s company provided a guarantee to the bank for the loan and a pledge of cash collateral in the amount of $2.3 million.
  3. The taxpayer’s wife purchased shares of the taxpayer’s company from the taxpayer for an amount approximately equal to the loan outstanding.
  4. The taxpayer used the proceeds from the sale of the shares to repay the shareholder loan.

When the taxpayer filed his tax return, he did not elect out of provisions of subsection 73(1),so that the transaction between the taxpayer and his wife took place at cost, and not at fair market value. The taxpayer took the position that he could deduct the interest expense paid by his wife, pursuant to subsection 74.1(1). This subsection provides that any transfers to a spouse that are not at fair market value will result in the attribution of any income or loss from the property that was transferred. The net result was that the taxpayer did not have an income inclusion in respect of the shareholder loan and he could deduct the interest that his wife paid on the funds ultimately used to repay the shareholder loan.

The CRA did not challenge the fact that all of the provisions noted above had been properly applied. They did, however, attempt to apply the GAAR rules. The Tax Court followed the guidance given in the Canada Trustco case by the Supreme Court of Canada, wherein the Court first looked at whether there was a tax benefit, then whether there was an avoidance transaction and finally whether the avoidance transaction was abusive. The Court concluded that there clearly was a tax benefit, since the taxpayer deducted an amount that reduced his taxes. The Court concluded that there were no avoidance transactions, since each of the sections involved were properly applied, so there could not be avoidance transactions when the rules in subsections 15(2), 73(1) and 74.1(1) were properly followed. The Court then considered whether there was abusive tax avoidance. The Court concluded that there was no abusive tax avoidance, even if a higher Court were to determine that there was an avoidance transaction.

This decision offers the possibility of interesting tax planning, when a client has to repay a shareholder loan. The client’s spouhse can borrow, and use the funds to purchase shares of the client’s company. The client can then use the proceeds of the share sale to repay the shareholder loan.

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The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

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Cadesky Tax