J.K. Read Engineering Ltd. – TCC: Interest on GAAR assessment starts to run when tax incurred, not when GAAR assessed

Bill Innes on Current Tax Cases


J.K. Read Engingeering Ltd. v. The Queen (October 21, 2014 – 2014 TCC 309) is an interesting decision where counsel made the ingenious, albeit ultimately unsuccessful, argument that in the case of a GAAR assessment interest should only run from the date that the Minister assesses on the basis of GAAR, not from the date of the transactions in question.

[1] These appeals concern the calculation of arrears interest in the context of the application of the general anti-avoidance rule (the “GAAR”). The Appellants implemented a series of transactions (the “Transactions”) resulting in capital losses used to offset capital gains realized by J.K. Read Engineering Ltd. (“Read”) and J.M. Hutton Engineering Ltd. (“Hutton”) earlier in their 2007 taxation year. Read and Hutton produced their income tax returns for the 2007 taxation year on the basis that the Transactions gave rise to a nil tax liability.

[2] In 2011, the Appellants were reassessed by the Minister of National Revenue (the “Minister”). The Minister found the steps taken by the Appellants to be abusive avoidance transactions and, as a result, applied the GAAR to disallow the capital losses claimed by Read and Hutton in their 2007 tax returns.

[3] The Appellants do not dispute the application of the GAAR or the resulting tax liability. What is in dispute, however, is the date on which the liability arose and from which interest began to accrue thereon.

[4] The Appellants argue that subsection 245(7) of the Income Tax Act (the “Act”) requires the Minister to issue a notice of assessment based on the GAAR before section 245 can be applied to redetermine the tax consequence of abusive avoidance transactions. The essence of the Appellants’ position is that the capital losses purportedly created as a result of the implementation of the Transactions continue to offset the capital gains realized by Read and Hutton up until the date that the Minister assessed the Appellants on the basis of the GAAR (the “GAAR Assessments”). According to the Appellants, interest began to accrue only from the date of the GAAR Assessments, which is the moment in time GAAR tax liability is said to arise.

[5] The Respondent does not see it quite the same way. According to the Respondent, the GAAR applies without the intervention of the Minister. Consequently, the Appellants had unpaid income tax as of their respective balance-due dates, on which arrears interest began to accrue.

[7] Because the Appellants acknowledge that the GAAR applies to disallow the capital losses claimed by Hutton and Read, it is sufficient for me to observe that the Appellants used high-low preferred shares to create capital losses, employing a strategy similar to that used by the appellants in three recent appeals. In those appeals, the Federal Court of Appeal (the “FCA”) found that the GAAR applied, describing the capital losses as artificial such that they could not be used to offset the capital gain of each of the appellants.

[Footnotes omitted]

The appellants relied upon an interpretation of the Tax Court decision in Copthorne Holdings (2007 TCC 481, affirmed in 2009 FCA 163, affirmed in 2011 SCC 63). In this case the Tax Court rejected that interpretation:

[17] In light of the above, did the Court arrive at a contradictory decision in Copthorne? I do not believe so. Subsection 215(6) of the Act is a charging provision that makes the payer liable for the payee’s tax if the payer fails to deduct or withhold at the time of payment tax that is payable by the payee. In contrast, subsection 227(8) of the Act is a penalty provision. A due diligence defence can be mounted against the latter but not the former. In my opinion, Campbell J. struck out the subsection 227(8) penalty assessed against Copthorne because, in the circumstances, she found that Copthorne had acted diligently with respect to its withholding obligations under section 215 of the Act.

B. What is the proper interpretation of subsection 245(7) of the Act?

[18] As noted above, the Appellants’ position is also based on subsection 245(7) of the Act, which reads as follows:
Notwithstanding any other provision of this Act, the tax consequences to any person, following the application of this section, shall only be determined through a notice of assessment, reassessment, additional assessment or determination pursuant to subsection 152(1.11) involving the application of this section.

[19] The Appellants submit that this provision precludes all taxpayers from self‑assessing tax consequences under the GAAR.

[20] According to the Appellants, taxpayers should not be liable for interest before an assessment based on the GAAR is issued if they cannot self-assess under the GAAR. While, in Copthorne, Campbell J. appears to endorse the interpretation against self‑assessment put forward by the appellants, I note that her decision to strike out the penalty was not appealed by the Respondent. In contrast, her conclusion that Copthorne was liable for the Part XIII tax of its non-resident shareholder was affirmed on appeal by the FCA and the Supreme Court of Canada (the “SCC”).

[Footnote omitted]

The court examined the language of the statute and found that it did not support the appellants’ submissions:

[37] Even if I was inclined to endorse the Appellants’ view of subsection 245(7), the language of that subsection is unhelpful to their position. The key words are “the tax consequences to any person [according to the Appellants, Hutton or Engineering], following the application of this section, shall only be determined through a notice of assessment” (emphasis added).

[38] The Oxford English Dictionary (online) defines the term “following” as meaning “[t]hat follows or moves after another”, “[t]hat comes after or next in order or in time; succeeding, subsequent, ensuing”, or “[a]s a sequel to, in succession to (an event), after”. Similarly, that term is defined in the Merriam‑Webster English Dictionary as signifying “being next in order or time” or “listed or shown next”.

[39] These definitions clearly indicate that the notice of assessment does not trigger the application of the GAAR, but is rather subsequent to it. This view is supported by a plain interpretation of the French version of the provision:

245(7) Malgré les autres dispositions de la présente loi, les attributs fiscaux d’une personne, par suite de l’application du présent article, ne peuvent être déterminés que par avis de cotisation, de nouvelle cotisation ou de cotisation supplémentaire ou que par avis d’un montant déterminé en application du paragraphe 152(1.11), compte tenu du présent article.

[Emphasis added.]

[40] The Nouveau Petit Robert considers “par suite de” to be synonymous with “à cause de” or “en conséquence de”. In the Larousse, it is defined as meaning “en raison de”. These synonyms unequivocally point towards a determination that an application of the GAAR must precede the notice of assessment.

[41] In light of both the English and French definitions above, it cannot be said that the tax liability pursuant to the GAAR is incurred as of the date of the notice of assessment.

[Footnotes omitted]

In the result the appeals were dismissed with, by prior agreement, one set of costs.

Comment: It is likely that this case will find its way to the Federal Court of Appeal. While the appellants’ argument has a certain intellectual attraction, i.e., interest should not run unless and until the Minister takes the affirmative step of recharacterizing the transaction(s) under GAAR, it also seems to run contrary to the grain of years of accepted tax jurisprudence that interest runs from the taxation years in question, not the date of the assessment or reassessment. If the decision is appealed it will be interesting to see what the Federal Court of Appeal makes of it.