Tax planning for possible future events does not attract GAAR: MIL (Investments) S.A. v. The Queen (1).

Introduction

Jean-Raymond Boulle is a very lucky man who became a very rich man. In 1993, while he was a resident of Belize in Central America, (2) he began to acquire shares of Diamond Field Resources Ltd. (DFR), a public company incorporated in Canada and traded on the Toronto Stock Exchange. On March 10, 1993 he transferred those shares to MIL (Investments), a corporation that he had caused to be incorporated under the laws of the Cayman Islands and of which he was the sole shareholder. Before November 1994, DFR acquired, explored, and developed diamond properties. In November, 1994 DFR hit the Mother Lode--it discovered a major deposit of nickel, copper, and cobalt near Voisey's Bay, Labrador. From that point on DFR attracted the attention of mining companies from all over the world and its stock was the subject of huge price increases and much speculation.

While all of this was going on, Boulle took a number of steps to protect his own position. On June 28, 1995, MIL exchanged, under section 85.1 of the Income Tax Act of Canada (3) 703,000 DFR shares for 1,401,218 common shares of Inco: (4) Before June 28, 1995, MIL had held 3,252,273 common shares and Boulle had held 132,500 common shares of DFR representing 11.90 percent and 0.485 percent interest in that company respectively. After June 28, 1995, MIL held 2,549,273 and Boulle held 132,500 shares of DFR representing 9.332 percent and 0.485 percent interest in that company. The combined interest of MIL and Boulle was 9.817 percent.

Next, on July 17, 1995, Boulle caused MIL to be continued to Luxemburg. There was no dispute that at all material times thereafter MIL was a resident of Luxembourg.

Once MIL had acquired residence in Luxembourg, it began to dispose of some shares. Between August 14, 1995, and August 17, 1995, MIL disposed of the 1,401,218 common shares of Inco previously acquired on June 28, 1995 for proceeds of $65,466,895 (Canadian). MIL claimed an exemption from Canadian tax on the resulting capital gain of $64,982,713 (Canadian). MIL was not reassessed in Canada with respect to the gain.

On September 14, 1995, MIL disposed of 50,000 shares of DFR to three individuals for services rendered to the Holdcos. MIL reported proceeds of disposition of $4,525,000 (Canadian) and an ACB of $32,444 (Canadian) and claimed an exemption from Canadian tax on the resulting capital gain of $4,492,556 (Canadian). MIL was not reassessed in Canada with respect to the gain and did not pay tax in Luxembourg. In both cases, the exemption from tax was based on Article 13 of the Convention Between Canada and The Grand Duchy of Luxembourg for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital ("the Convention"). (5)

Were it not for the exchange of DFR shares by Boulle and MIL on June 28, 1995, MIL would not have been able to claim an exemption under Article 13 on the sale of DFR shares in September of 1995 since the combined ownership of Boulle and MIL in DFR would have been exceeded 10 percent. (6) Be that as it may, the Canada Revenue Agency (CRA) never challenged the exemption claimed by MIL in 1995 on this sale.

From the summer of 1995 into the spring of 1996, the shares of DFR continued to spiral up in value and the company was the subject of much take-over speculation. After a protracted series of offers and counter-offers, on May 22, 1996, the shareholders of DFR finally approved the acquisition of the outstanding shares of DFR by Inco to take effect on August 21, 1996.

MIL received proceeds of disposition in the amount of $427,475,645 (Canadian) for its DFR shares. This resulted in a capital gain of $425,853,942 (Canadian). MIL claimed an exemption on that gain, again under Article 13 of the Treaty. CRA denied that exemption and the heart of this case is whether CRA was entitled to deny MIL the exemption.

The Crown's attack was two-fold. First, it argued that the events starting in June 28, 1995, and ending with the disposition of the DFR shares on August 21, 1995, constituted a series of transactions that was the subject of the General Anti-Avoidance Rule (GAAR), with the result that MIL was not entitled to protection under the Convention. The second string to the Crown's bow was the argument that there is an inherent anti-avoidance rule in bilateral income tax conventions and the court should take notice of that rule and deny MIL the protection otherwise available under the Convention.

GAAR

CRA's central thrust in its GAAR argument was that the June 28, 1995, exchange of DFR shares for shares of INCO was an avoidance transaction designed to take the overall group holdings of DFR below the 10-percent "bright line" test established in the Convention. Counsel for MIL argued that such a step was not even necessary since the Convention exempts "property (other than rental property) in which the business of the company, partnership, trust or estate was carried on" and that exemption would apply to the shares of DFR. The court did not rule on this point. Rather, it chose to accept the evidence of Boulle about his reasons for the exchange of share:

44] The first transaction was a sale of 703,000 DFR shares for 1,401,218 common shares of Inco whose value at that time was approximately $65 million dollars [Canadian]. The "roll-over" resulted in a deferral of Canadian tax until such time as MIL sold the Inco shares.

[45] In determining the primary purpose of any transaction the credibility of witnesses is extremely important. Throughout the hearing, I observed and assessed, on a continuous basis, Mr. Boulle's demeanor, his delivery, his constant unchanging colour, his facial expressions and the absence of fidgeting, nervous behaviour. I also listened carefully to all his responses, both to the questions of his own counsel and on cross-examination. I concluded that he was credible. Respondent's counsel said that he was not. He submitted that:

   ... the Appellant's suggestion that it sold the shares to pay
   off a line of credit is not plausible. At the time of the share
   exchange the amounts owing were a little over a million
   dollars in total. At that time, the value of the shares was
   approximately 65 million dollars. You're going to sell 65
   million dollars worth of shares to pay off a one million
   dollar line of credit?

[46] Mr. Boulle's evidence, which I accept, was that he wanted to pay off "over a million dollars of debt" and wanted to "get back to exploring and building mines in Africa." When, on cross-examination it was suggested to him that the credit line was not the main purpose he replied:

   I had no other income.., my whole well-being, if you want
   to call it fortune, was tied up in these shares.

[47] Mr. Boulle's rationale for exchanging DFR shares for Inco shares was that he would have been "conflicted" by taking cash, even if available, for his DFR shares at the time he exchanged them for Inco shares. That is consistent with the commercial reality that a co-chairman of the board and major shareholder of DFR would, by selling for cash, if available, give a negative signal to the stock market--especially given the normal securities' legislation requiring disclosure of an "insider" transaction.

And again:

[50] It is apparent from the evidence that the reason for the sale was to realize a gain on the sale of a small portion of his DFR shares. Mr. Boulle was a "paper millionaire" with financial burden, his entire wealth being held in non-liquid shares of DFR. There was always the possibility of a substantial diminution in the value of his investment which had risen inordinately quickly in value. The sale ensured him of financial security, a bona fide purpose, regardless of the success or failure of DFR. This is the "why" for each transaction in the series. The "how" of the series was the implementation of a complex plan formulated by Appellant's Canadian tax counsel.

[53] I find it clear that, despite the possibility of the DFR shares already being exempt under the Treaty, one of the "driving forces" of the transactions was the Appellant's desire to ensure the sale of its shares in a tax effective manner. I conclude, however, that the "how" is subordinate to the "why" of the sale.

The court's decision on this point is perhaps counter-intuitive. There was so much money floating around that Boulle could have satisfied his desire for financial security by selling shares without bringing his holdings of DFR just a fraction under 10 percent. Nevertheless, Justice Bell had the advantage of hearing Boulle's evidence under oath. In addition, he enjoys the benefit of the Supreme Court's observations in Canada Trustco that such findings of fact by the Tax Court should not be tampered with lightly on appeal.

The main assault on GAAR in this case came from another direction altogether. The Crown did not attempt to assess MIL on its profits on the sale of the exchanged Inco shares. Rather, it concentrated solely on the sale of DFR shares in 1996. In order to do this, it had to demonstrate that the 1996 sale was part of an extended "series" of events that included the alleged avoidance transaction in 1995, i.e., the exchange of DFR shares for Inco shares.

The court first explained its understanding of the meaning of "series" in this context:

[64] In paragraph 26 of Canada Trustco the Supreme Court of Canada said:

   Section 248(10) extends the meaning of "series of transactions"
   to include "related transactions or events completed
   in contemplation of the series." The Federal Court of
   Appeal held, at para. 36 of OSFC, that this occurs where
   the parties to the transaction "knew of the ... series, such
   that it could be said that they took it into account when
   deciding to complete the transaction." We would elaborate
   that "in contemplation" is read not In the sense of actual
   knowledge but in the broader sense of "because of"
   or "in relation to" the series. The phrase can be applied to
   events either before or after the basic avoidance transaction
   found under s.245(3).

[65] There must be a strong nexus between transactions in order for them to be included in a series of transactions. In broadening the word "contemplation" to be read in the sense of "because of" or "in relation to the series," the Supreme Court cannot have meant mere possibility, which would include an extreme degree of remoteness. Otherwise, legitimate tax planning would be jeopardized, thereby running afoul of that Court's clearly expressed goals of achieving "consistency, predictability and fairness." [Emphasis added]

The court reviewed the evidence of Boulle and his associates and concluded that there was no pre-ordained strategy to sell DFR to anyone. The company struggled to maintain its independence and was probably not pushed strongly in the direction of sale until the unexpected death of its Executive Vice President (a renowned expert who was charged with developing the mine) in late 1995. What is more, Boulle's holdings were not sufficient to either block a take-over bid or to force the acceptance of such a bid. He was simply one (albeit large) shareholder among a number of others. Accordingly, the court concluded:

[69] Accordingly, having found that, at the time of the Series, DFR had no desire of allowing itself to be sold to any buyer, I conclude that the Sale cannot be included in that series because of a mere possibility of a future potential sale of any shares.

The Inherent Treaty Abuse Doctrine

Having failed to persuade the court to apply GAAR to the transactions, the Crown argued that there was an inherent treaty abuse doctrine that the court should apply to set aside the relief claimed under the Convention. The court summarized the Crown's argument, as follows:

[76] The [Crown] presented the alternative written argument that:

Even if the GAAR does not apply to deny the treaty benefit in this case, it is still possible to deny the treaty based on the anti-abuse rule inherent within the Treaty itself.

[77] In order to establish an "inherent rule" the Minister presented an expert from Luxembourg, Professor Alain Steichen ("Steichen"). He was qualified as an expert in Luxembourg tax law and income tax treaties to which Luxembourg is a party and also as an expert on international law as it applies to income tax treaties to which Luxembourg is a party.

[78] Steichen's inherent anti-abuse test is that a specific treaty benefit may be denied in situations where both Canadian and Luxembourg domestic anti-avoidance rules would deny that benefit. In order to establish his opinion that Luxembourg law would apply to deny the Appellant a treaty benefit, Steichen was asked by the Minister to review the "reversed scenario" in which MIL continued into Canada from the Cayman Islands in order to use the Treaty.[12]

[79] Before the Treaty benefit could be denied under Steichen's test it would have to be established that both Canadian and Luxembourg domestic anti-avoidance rules would apply in the circumstances. Even if Steichen's test is accepted, the inherent anti-abuse rule could not be applied without first finding the existence of an abusive avoidance transaction in Canada.

The court was not very impressed by this line of argument:

[85] In Crown Forest, Justice Iacobucci of the Supreme Court of Canada endorsed the use of the OECD commentary writing:

In order to help illustrate and illuminate the intention of the parties to the Canada-United States Income Tax Convention (1980) articles 31 and 32 of the Vienna Convention on the Law of Treaties indicate that reference may be made to these types of extrinsic materials when interpreting international documents such as tax convention....

Of high persuasive value in terms of defining the parameters of the Canada-United States Income Tax Convention (1980) is the OECD model double-taxation convention on income and on capital. As noted by the Court of Appeal it served as the basis for the Canada-United States Income Tax Convention and also has world wide recognition as a basic document of record in the negotiation, application and interpretation of multilateral or bilateral conventions.

[86] The Respondent presented the 2003 revisions to the OECD commentary as support for the existence of an inherent anti-abuse rule in tax treaties. Article 31(1)(c) of the Vienna Convention states "there shall be taken into account, together with the context, any relevant rules of international law applicable in the relations between the parties." I interpret that to mean that one can only consult the OECD commentary in existence at the time the Treaty was negotiated without reference to subsequent revisions. The Respondent's own expert on cross-examination agreed that subsequent revisions should be ignored:

Q. First, I understand that using the commentaries that came out in 2003 to the OECD Convention, the Article 1 commentaries, I think we both agree that trying to apply those commentaries to interpret a treaty that was put in place in 1989 is nonsense. Would you agree with that?

A. That is correct.

[87] Overall, I found Steichen's opinion and testimony not substantively convincing. In particular, in light of the OECD commentary and the decision by Canada and Luxembourg not to include an explicit reference to anti-avoidance rules in their carefully negotiated Treaty, I find there is no ambiguity in the Treaty permitting it to be construed as containing an inherent anti-abuse rule. Simply put, the "ordinary meaning" of the Treaty allowing the Appellant to claim the exemption must be respected.

CONCLUSIONS

If the MIL decision is upheld on appeal, which is likely because it is a carefully written and thoroughly-analyzed decision, it will provide very important future guidance for tax planners on two vital points:

1. Tax planning against possible future contingencies will not attract the operation of GAAR. There must be a high (or, indeed, possibly very high) likelihood that the event in question will transpire before the antecedent planning can be seen as part of a extended "series" possibly subject to GAAR. If this proves to be correct then it will greatly enhance the flexibility available to tax planners and correspondingly curtail the application of GAAR.

2. The decision rules out an inherent treaty abuse doctrine. A treaty must be construed in accordance with its clear meaning unless there is a specific anti-avoidance rule contained in the treaty. This conclusion should provide considerably more certainty in cross-border transactions and will likely come as a welcome relief to Canada's treaty partners. 2006 D.T.C. 3307 (T.C.C.).

(1.) 2006 D.T.C. 3307 (T.C.C.).

(2.) He subsequently became a resident of Monaco.

(3.) R.S.C. 1985, c. 1 (5th Supp.).

(4.) Appendix A to MIL Reasons for Judgment, Partial Agreed Statement of Facts, para. 9.

(5.) Article 13 provides, in part:

1. Gains derived by a resident of a Contracting State from the alienation of immovable property situated in the other Contracting State may be taxed in that other State ...

4. Gains derived by a resident of a Contracting State from the alienation of:

(a) shares forming part of a substantial interest in the capital stock of a company which is a resident of the other Contracting State the value of which shares is derived principally from immovable property situated in that other State; or

(b) an interest in a partnership, trust or estate, the value of which is derived principally from immovable property situated in that other State, may be taxed in that other State. For the purposes of this paragraph, the term "immovable property" ... does not include property (other than rental property) in which the business of the company, partnership, trust or estate was carried on; and a substantial interest exists when the resident and persons related thereto own 10 per cent or more of the shares of any class of the capital stock of a company.

(5.) Gains from the alienation of any property, other than that mentioned in paragraphs I to 4 shall be taxable only in the Contracting State of which the alienator is a resident.

(6.) The provisions of paragraph 5 shall not affect the right of either of the Contracting States to levy, according to its law, a tax on gains from the alienation of any property derived by an individual who is a resident of the other Contracting State and has been a resident of the first-mentioned State at any time during the six years immediately preceding the alienation of the property. Subject, that is, to the argument that the immovable property in question was a place where the business of DFR was carried on.

William I. Innes is counsel to Fraser Milner Casgrain LLP in Toronto, where he practices in the areas of tax litigation, taxation, and estates and trusts. He is a graduate of the University of New Brunswick (LL. B.) and Osgoode Hall Law School at York University (LL.M.), and is a member of the Editorial Board of the Canadian Tax Journal and Canadian Tax Reporter. He may be reached at [e-mail].