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When CRA Does Not Like the Results, GAAR Is Applied

Subject: GAAR, 84(2), 84.1 Number: 07-05 Date: 3/2/2007

The CRA will use GAAR to overcome a decision they do not like

The recent case of McMullen (2007 TCC 16) shows how the CRA will use GAAR as a last ditch effort to overcome a decision that they do not like. In this case, a plan was implemented to divide a business. The two arm’s length shareholders wanted to go in different directions and steps were taken to allow each shareholder to operate in a different location and to carry on future business in that location. The entire transaction was made tax-free by using the capital gains exemption and the inter-corporate tax-free dividend provisions in section 112 of the Income Tax Act. The CRA attempted to apply subsections 84(2), 84.1(1) or section 245 (GAAR) to make the transactions taxable.

The CRA argued either that one of the parties received assets on the wind-up or that the transaction was not at arm’s length. If neither of these arguments applied, they claimed that the GAAR provisions should apply. The CRA continues to claim that unrelated persons are not at arm’s length when they complete a transaction that is beneficial to both. The Court, in this case, referred to a 1997 case (McNichol) in which the Tax Court Judge said:

“…buyer and seller do not act in concert simply because the agreement which they seek to achieve can be expected to benefit both.”

The CRA has difficulty with this concept. In this case, the two shareholders tried to find the most tax efficient way to achieve a legitimate business result, i.e. dividing the business.

The Tax Court decided that the parties were at arm’s length. The Court also decided that the provisions of GAAR did not apply, as there was no abuse of any section of the Income Tax Act. The Court made it clear that all of the provisions of the Income Tax Act were properly complied with and that they were used as they were meant to be used.

The Court several times referred to the fact that the intent of these transactions was to separate the assets of the business and not to avoid taxes or to obtain a tax benefit. The fact that these transactions had a business purpose seems to have been an important factor in the decision of the Court.

As always, when there is a legitimate business transaction and the provisions of the Income Tax Act are properly complied with, it is difficult for the CRA to be successful in their claim to apply GAAR.

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