GAAR Found to Apply to “Reverse Freeze” Transaction
On July 12, 2011, the Tax Court of Canada (TCC) released the long-awaited decision in Triad Gestco Ltd. v. The Queen, 2011 TCC 259. This is the TCC’s most recent decision concerning the application of the general anti-avoidance rule (GAAR). The case involved the use of a “reverse freeze” strategy in 2002, whereby the taxpayer created a capital loss by transferring shares with high cost base and low fair market value to a trust that was not “affiliated” with the taxpayer. The resulting capital loss was used to offset a capital gain realized earlier. The taxpayer lost.
In applying the three-step GAAR analysis, Justice Favreau concluded that the series of transactions comprising the “reverse freeze” was an avoidance transaction that gave rise to a tax benefit which was abusive. Of particular interest is Justice Favreau’s “abuse” analysis. As part of his analysis, Justice Favreau concluded that an amendment to the affiliated persons rules in 2004, which brought trusts within the scope of the relevant stop-loss rule, was “a clear indication” that the taxpayer had acted contrary to the object, spirit and purpose of the Income Tax Act (ITA) as it read in 2002. Justice Favreau reached this conclusion notwithstanding the TCC’s earlier caution against the use of subsequent amendments to interpret the earlier intention of Parliament (see Jabin Investments, 2001 DTC 1002 aff’d 2002 FCA 520).
Justice Favreau’s use of subsequent amendments to assist in the determination of the object, spirit and purpose of the ITA at an earlier point in time is cause for concern. How can a taxpayer plan his or her affairs with certainty if an amendment made years later can be given retroactive effect through the application of the GAAR? Surely such analysis undermines the need to
preserve the predictability, certainty and fairness for taxpayers demanded by the SCC in Canada Trustco (2005 SCC 54).
At the time of this posting, no decision had been made whether to appeal Justice Favreau’s decision to the Federal Court of Appeal (FCA). Hopefully the FCA will have the opportunity to consider the matter further.