Supreme Court of Canada's Decision in Lipson

Earl and Jordanna Lipson were a married couple.  On April 24, 1994, they entered into an agreement of purchase and sale to purchase a personal residence for $750,000 with a $50,000 deposit.  On August 27, 1994, the Lipsons signed a letter addressed to their solicitor stating that the Bank of Montreal was lending them $562,500 on September 1, 1994 to place a mortgage on the new property.

On August 31, 1994, the following transactions occurred:

1. Jordanna borrowed $562,500 from the bank;
2. Earl transferred 20 and 5/6^th shares of Lipson Family Investments Limited to Jordanna for $562,500, which was the fair market value of the shares;
3. Jordanna gave Earl a cheque for $562,500 as payment for the shares;
4. Earl forwarded the funds to the solicitor handling the purchase of the property.

On September 1, 1994, the following transactions occurred:

1. the Transfer/Deed of Land, showing Earl and Jordanna as joint tenants, was registered;
2. the Charge/Mortgage of Land was registered;
3. the solicitor used the funds received from Earl on August 31, 1994 to pay $562,500 towards the purchase price of the property;
4. the bank advanced $562,500 to the solicitor as proceeds from the mortgage on the property;
5. the solicitor used the $562,500 proceeds from the mortgage to repay Jordanna's loan.

Earl did not elect not to have subsection 73(1) of the Income Tax Act apply to the transfer of the shares to Jordanna.   The Lipsons claim entitlement to the following tax consequences as a result:

1. the shares are deemed to have been sold by Earl for proceeds equal to his adjusted cost base ("ACB") of the shares and to have been acquired by Jordanna at the same ACB so that no taxable gain or loss would arise until the shares were sold by Jordanna; and
2. any income or loss from the shares computed in the hands of Jordanna is deemed to be that of the Earl under subsection 74.1(1) of the Act.

The Lipsons claim that the steps they take should effectively result in the mortgage interest becoming deductible.

The Minister argued that the GAAR should apply to nullify the deductbility of the interest expenses on the mortgage.  For the GAAR to apply, three factors must be present: (i) there must be an identifiable tax benefit; (ii) an avoidance transaction engaged in by the taxpayer; and (iii) it must be reasonable to consider that the transaction or series of transactions amounts to a "misuse" or "abuse" of the Income Tax Act (and/or related instruments).

The majority judgment of the Supreme Court of Canada, authored by LeBel J. (joined by Fish, Abella, and Charron JJ.), held that the Lipsons had engaged in an avoidance transaction that constituted a misuse or abuse of the attribution rules under the GAAR, largely along the lines I advocated for in my earlier blog posting--that the transactions constituted a misuse or abuse of the 74.1(1) attribution provision.

In the first of two dissenting judgments, Binnie J. (joined by Deschamps J.) held that the object or spirit of the attribution rules was not violated.  At para. 80, he states that, "In my respectful view, what LeBel J. believes s. 74.1(1) is designed to prevent is actually a reasonable statement of what 74.1(1) seeks to permit.  This case, as my colleague appears to acknowledge at para. 32, is not about income splitting.  The taxpayer's evident purpose was to postpone capital gains tax on the transfer of property to the wife while in the meantime allowing any 'income or loss[es]' to be attributed to himself."

It seems that one source of the difference between the majority and Binnie J. is that the majority assumes that the dividend policy of the family holding company was subject to the direction (or at least the influence) of the Lipsons, as was assumed by Bowman CJTC at the Tax Court of Canada.  Binnie J. at para. 82 wants to preserve this as an open issue, stating that, "Whether or not the appellant suffers a loss or gains additional income in any particular taxation year depends on the fluctuating amount of the dividends.  There was no evidence about the dividend practice or policy of Holdco."

The second dissenting judgment by Rothstein J. disagrees with the judgments of both LeBel J. and Binnie J.  Justice Rothstein focuses on the specific anti-avoidance rule, 74.5(11), arguing that since the GAAR is regarded as a provision of last resort, the application of any specific anti-avoidance rules should be ruled out before the GAAR is applied.  In Rothstein J.'s view, because 74.5(11) would have precluded the tax benefit realized by the Lipsons, the GAAR ought not to apply.  At para. 103, he states that, "By not addressing s. 74.5(11), Binnie J.'s reasons leave the inaccurate impression that because the GAAR did not apply in this case, nothing in the Act prevented the attribution of the net loss to Mr. Lipson."

Rothstein J.'s judgment contains a rebuke of the way in which the Minsiter's case was presented from the outset.  At para. 118 he states, "In my view, the parties cannot avoid the proper application of the Act by conceding or asserting that the relevant provision [subsection 74.5(11)] does not apply.  It is not open to this Court to assist the Minister by allowing him to ignore the applicable specific anti-avoidance rule and instead rely on the GAAR."

In light of the reasons given in the three judgments, the 4-3 final tally is perhaps a little misleading.  It appears that the outcome might have been 7-0 in favour of the government if two things had been done differently.  First, if at trial in the agreed statement of facts there had been evidence showing the extent to which the Lipsons controlled the dividends paid by the family holding company, Binnie J.'s concern in para. 82 would have been addressed.  Second, Rothstein J.'s concern that subsection 74.5(11) precluded application of the GAAR could have been effectively addressed at trial as well.