October 07, 2011

Her Majesty the Queen (Appellant) v. Hollinger Inc. (Respondent)

99 DTC 5500
Federal Court of Appeal
July 22, 1999

(Court File No. A-564-98.)

Avoidance — Deductions — Capital losses — In a complex series of transactions taking place between November 5, 1986 to December 22, 1986, the corporate taxpayer acquiring worthless shares of another corporation with a high ACB — Taxpayer disposing of such shares at a negligible amount — Whether taxpayer entitled to deduct the resulting capital loss against substantial capital gains of its own — Whether such deduction unduly or artificially reducing taxpayer’s income — Whether the said worthless shares not capital property or inventory for purposes of subsection 85(4) and paragraph 53(1)(f.1) of the Act — Income Tax Act, R.S.C. 1985 (5th Supp.), c. 1, as amended, ss. 40(2)(e), 53(1)(f.1), 53(1)(f.2), 55(1), 85(4)(a), 85(4)(b), 88(1)(a), 88(1)(c) and 152(9).

In a complex series of transactions taking place between November 5, 1986 to December 22, 1986, the corporate taxpayer acquired from a Canadian corporation (“Coseka”) worthless shares of one of its U.S.-based subsidiaries (“the loss shares”). Such shares had a high ACB. The taxpayer disposed of them at a negligible amount, realizing a substantial capital loss to offset against substantial capital gains of its own. In reassessing the taxpayer for 1986, the Minister disallowed the taxpayer’s deduction of the said capital loss under the avoidance provisions of subsection 55(1) of the Act as they then read. The Tax Court of Canada allowed the taxpayer’s appeal in part (98 DTC 1913), but adjusted its ACB of the loss shares downward. The Tax Court concluded, inter alia: (a) that the taxpayer itself had done nothing to create or increase the loss ultimately sustained by it, even though the transaction had no commercial purpose; and (b) that the loss shares had not ceased to be capital property because of Coseka’s decision to sell an unproductive investment. The Tax Court judge also observed that the transaction was not a sham, but that transactions of this type had virtually been eliminated by the tax legislation that had subsequently been introduced. The Crown appealed to the Federal Court of Appeal. The Crown relied on Bishop v. Finsbury Securities Limited, [1966] 3 All E.R. 105, arguing, inter alia, that the loss shares were neither capital property (for purposes of subsection 85(4) and paragraph 53(1)(f.1) of the Act) nor stock-in-trade, because the whole transaction stood outside the ambit of the taxpayer’s business, and was a purely artificial device remote from trade to secure a tax advantage.

Held: The Crown’s appeal was dismissed. The taxpayer raised two preliminary issues. The first was a submission that, in view of the decision of the Supreme Court of Canada in Continental Bank v. The Queen (98 DTC 6501), the Minister was not entitled to raise, for the first time before the Tax Court, an argument that completely changed the basis of the earlier reassessment against taxpayer after the limitation period for reassessing had expired. The second preliminary issue raised by the taxpayer involved an argument that the Court was bound by the earlier decision of the Federal Court of Appeal in The Queen v. Nova Corporation of Alberta (97 DTC 5229) concerning the anti-avoidance provision in subsection 55(1) of the Act. On the first preliminary issue, the Minister’s reassessment under subsection 55(1) of the Act had been based on the assumption that the loss shares were capital property throughout, but that the taxpayer’s conduct had been abusive, in that it had artificially or unduly increased its loss from the disposition of those shares. The position now being taken by the Minister was that the loss shares were not capital property. This was obviously a revocation of its prior unsuccessful assumption. From the evidence, however, it was impossible to determine whether the limitation period for reassessing had expired when this new basis was first raised by the Minister. Nor could the Minister be heard to argue that, as a result of the Continental Bank decision, the only way in which the Minister could change the basis of the reassessment would be formally by issuing a new reassessment, or by amending the existing one (neither of which happened here). Hence the taxpayer’s first preliminary objection grounded on the Continental Bank case was without merit. The Minister was therefore entitled to argue, as it did before the Tax Court, the new basis advanced in its Reply. As for the second preliminary issue, the Tax Court judge was correct in concluding that the taxpayer had done nothing to create or increase the loss that it ultimately sustained. And in the Nova case, McDonald, J.A. concluded that the taxpayer in that case could not be punished for taking full advantage of the operation of the Act while it so existed. Accordingly, in view of the conclusion, infra, concerning the Minister’s capital property argument, the facts of this case were not distinguishable from those of the Nova case. As for that capital property argument (based on the Bishop case), adopting it would require that the decision of the Supreme Court of Canada in Friesen v. The Queen not be followed. That decision involved a finding that the Act creates a simple system recognizing only two broad categories of property: inventory or capital property. The Minister’s argument would create an undefined and elusive third category of property not contemplated by the Act, and unrelated to the type of income or sources of revenues envisaged by the Act. Hence the argument was untenable. In light of all of the foregoing, the taxpayer, albeit regrettably, was entitled to the capital loss deduction that it had claimed. The issue here was the legality of the transaction, not its morality. The Minister was ordered to reassess accordingly.