GAAR DOES NOT APPLY TO SOPHISTICATED TAX PLAN INVOLVING LOSS-STREAMING

MMV Capital Partners Inc. v. The Queen 2020 TCC 82

Decision Here

Summary

The Tax Court of Canada found that the GAAR did not apply in this case.

MMV Capital Partners Inc. (“MMV”), was reassessed under section 245, the general anti-avoidance rule (the “GAAR”), of the Income Tax Act, RSC 1985, c.1, as amended (the “Act”). The Minister of National Revenue (the “Minister”) disallowed non-capital losses totaling $23,444,775 (the “losses”) deducted over the 2011-2015 taxation years. MMV appealed to the Tax Court of Canada (“TCC”).  The TCC allowed MMV’s appeal.

Background

This case is ultimately about a corporation’s ability to deduct non-capital losses accrued during the course of a prior business against income from a new business.  The salient facts are below.

MMV (previously NCI) was incorporated in 2001 and went into receivership in 2009.  It was involved in VOIP applications to service providers. Subsequent to its receivership, MMV ceased carrying on its original business and, as of that time, was not carrying on any business. After the sale of its assets, MMV’s only remaining assets were nominal moveable assets and certain accrued losses: unused non-capital losses, net capital losses, scientific research, and experimental development expenditures, plus certain investment tax credits. These losses were the subject matter of the appeal.

MMV was then subject to a series of corporate reorganizational transactions, including share consolidations[1]; the creation of new corporate entities[2]; a change in name to MMV Capital Partners Inc.; and subsequent share subscriptions to the newly incorporated entity (773)[3].

The ownership structure of MMV had then changed. Two critical facts are that the newly incorporated entity (773) did not own a sufficient number of shares which would have allowed it to elect by itself MMV’s board of directors, and MMVF and its affiliates alone did not acquire voting control of MMV.

MMV then purchased a portfolio of loans and related assets from MMVF and MMV further purchased a portfolio of loans and related assets from MMV Finance.

Following the Acquisition

Following the acquisition of the portfolio, MMV carried on a venture lending business, servicing the existing portfolio of loans and entering into new financing arrangements.  This was referred to as the ‘new business’ in the decision.

It is critical to note that despite all of the corporate reorganizational steps, there was no de jure change in control.  MMVF did not gain de jure control of MMV.

For its 2011 to 2015 taxation years, MMV applied non-capital losses totaling $23,444,775 from prior years to reduce its taxable income under Part I of the Act in various amounts during each year from 2011 to 2015, until the losses were extinguished.

By notices of reassessment dated June 8, 2016, the Minister reassessed MMV’s 2011 to 2015 taxation years to disallow the deductions that MMV claimed in respect of the applied non-capital losses.

Position of Parties

The issue under appeal involved the loss streaming rules contained in section 111 of the Act. MMV argued that the applicable loss trading prohibition was not engaged and the losses should be deductible.  The reasoning was that the deduction of losses by corporations from other business is permitted unless the acquisition of de jure control has been attained by another person or group of persons and that the test to determine de jure control is a bright-line test.

Crown’s Argument

The Crown argued the de jure, “bright-line” acquisition of control test is a “proxy” for control.  In the Crown’s view, referencing the de jure test was simply not determinative; a purposive analysis of its existence demonstrated that the deduction of losses from an entirely different business, with dramatically different beneficiaries earning revenue from a disparate business undertaking, abuses, frustrates and runs contrary to the rationale of subsection 111(5), the loss streaming rule.[4] Ultimately, the Crown argued that MMV’s loss transactions circumvented the application of section 111(5) in a manner that frustrated its object, spirit, and purpose. The use of the old business losses to shelter income from the new business was not consistent with the object, spirit and purpose of subsection 111(5) and the loss streaming rules in the Act.

Elements of GAAR

The GAAR has three critical elements necessary for its application: the taxpayer must

(1) have realized a tax benefit;

(2) have undertaken a transaction or series of transactions which contain at least one avoidance transaction; and

(3) within the transactions yielding the tax benefit misused a section or abused the Act as a whole.

As is usually the case in GAAR appeals, there was no dispute that MMV realized a tax benefit and that a transaction or series of transactions constituted an avoidance transaction.  The only true issue was whether there was misuse or abuse of the provision at issue.

The TCC acknowledged that the Act embodies a policy against loss trading between unrelated corporations. It is a long-standing policy that effectively precludes one corporate entity from accessing the tax attributes, such as losses, of another corporate entity (subject to finite exceptions).

Ultimate Findings

It seemed clear from the factual matrix that MMVF acquired de facto control of MMV by acquiring a significant economic interest in or influence over MMV. But de jure control had not been acquired by MMVF. The Court relied on the reasoning in Duha Printers[5] to conclude that subsection 111(5) contemplates de jure control rather than de facto control.  Further, in finding no abuse, the Court relied on the reasoning of Deans Knight[6] to find that a change in management, business activity, assets, liabilities, and name are not markers of a change of effective control of a corporation.  The Court was not convinced by the Crown that subsection 111(5) had been abused.  The appeal was thus allowed.

Takeaway

It is important to keep in mind that section 256.1 of the Act was added in 2013 specifically to deal with continued corporate loss trading where de jure control is not acquired. Section 256.1 deems an acquisition of de jure control when the following conditions are met: (i) a person or group of persons has acquired shares in the capital stock of a corporation having a fair market value exceeding 75% of the total fair market value of all of the shares in the capital stock of the corporation; (ii) control of the corporation (i.e., de jure control) is not thereby acquired; and (iii) it is reasonable to conclude that one of the main reasons that control was not acquired was to avoid the application of certain enumerated provisions in the Act, including subsection 111(5).

[1] At the time of receivership, MMV had outstanding 9,890,394 common shares and 317,042,039 preferred shares, held by 78 different shareholders. At a special meeting of MMV’s shareholders in 2010, the shareholders voted to consolidate all of MMV’s common shares at a 13,000,000:1 ratio. Following the consolidation, only 18 common shares of MMV remained outstanding.

[2] 7733704 Canada Inc. (“773”) was incorporated under the CBCA and subscribed for 17 common shares in MMV. 773 is a wholly-owned subsidiary of MMV Financial (MMVF). A series of resolutions left many Board members of MMVF to become officers of MMV.

[3] 773 then subscribed for 100,000 non-voting common shares in MMV at an aggregate subscription price of $1,000, and MMV entered into a revolving credit facility with MMVF for a total principal amount of US$75 million. All non-voting common shares were held by 773.

[4]MMV Capital Partners Inc. v. The Queen 2020 TCC 82, at para. 45.

[5] 1998] 1 SCR 795, [1998] 3 CTC 303 at paragraph 35 [Duha SCC].

[6] 2019 TCC 76 [Deans Knight].

By Amit Ummat
Ummat Tax Law
(905)336-8924