On May 9, 2024, the Tax Court of Canada (TCC) released its judgement on DAC Investment Holdings Inc. v. the King. The TCC held that the general anti-avoidance rule (GAAR) did not apply to a Canadian-controlled private corporation (CCPC) that continued to the British Virgin Islands (BVI) to avoid CCPC status before recognizing a significant capital gain.
It is important to note that the transactions undertaken in this case to avoid the tax regime ordinarily applicable to the investment income of a CCPC should now be captured by new substantive CCPC (SCCPC) rules that are contained within Bill C-59, which is currently before Parliament. However, despite a likely appeal, this judgment will have ramifications for numerous taxpayers who undertook similar transactions prior to the effective date of the SCCPC regime.
DAC Investment Holdings Inc. (DAC) was a CCPC until April 29, 2015, when it transferred its jurisdiction to BVI. In doing so, it ceased to be a CCPC under the Income Tax Act (Act). Under Canadian tax law, CCPCs receive different (often preferential) tax treatment. For example, CCPCs qualify for enhanced investment tax credits for scientific research and experimental development and benefit from being subject to a shorter reassessment period by the Canada Revenue Agency. However, to promote integration between individuals and Canadian corporations, CCPCs are subject to a refundable tax and are not eligible for a general rate reduction on investment income.
After continuing to the BVI, DAC no longer qualified as a CCPC under the Act because it was deemed to be incorporated in the place of its continuance. It maintained its central management and control in Canada and therefore was subject to the tax regime applicable to corporations that are not CCPCs but are resident of Canada. Once it achieved this status, DAC sold shares of another company, Soberlink Inc. (Soberlink), and realized a large capital gain.
The Minister of National Revenue (Minister) applied the GAAR to this series of transactions on the basis that DAC circumvented the regime applicable to CCPC’s investment income by continuing abroad. The Minister sought to tax DAC as if it were a CCPC following the continuance.
Generally, for the Minister to apply GAAR to a transaction and supplant a new tax consequence, (i) there must be a tax benefit, (ii) the transaction must be an avoidance transaction and (iii) the avoidance transaction must be abusive.
The only issue at trial was whether the avoidance transactions were abusive. This required the TCC to determine the object, spirit, and purpose (OSP) of each provision that was relied on to obtain the tax benefit and examine whether the avoidance transactions defeated or frustrated the OSP of the provisions at issue.
In this case, those provisions related to:
The TCC held that the OSP of the definition of CCPC is to enumerate specific criteria chosen by Parliament to be afforded such status. Similarly, the OSP of the definition of a Canadian corporation is to set out the specific criteria that must be satisfied before a corporation is considered for the purposes of the Act to be a Canadian corporation. The TCC stated that these definitions provide a dividing line between those corporations that are taxed under the specific regime for CCPCs and those corporations that are not taxed under this regime.
The TCC disagreed with the Minister’s characterization of the OSP for these definitions. The Minister submitted the OSP of the definitions for CCPC and Canadian corporation was to ensure that private corporations directly or indirectly controlled in any manner whatever by Canadian residents are subject to the anti-deferral regime applicable to the investment income of CCPCs.
The Act normally levies a refundable tax on a CCPC’s passive income. This tax is later refunded to the corporation when it pays out a dividend to its shareholders.
The TCC stated the goal of this temporary tax is to ensure CCPCs are not used as tax-deferral vehicles for Canadian residents who earn investment income. The same tax outcome should result regardless of whether such investments are held individually or through a CCPC.
The TCC found that this provision was not frustrated by the transactions at issue. Following the continuance, the provisions of the Act applicable to CCPCs no longer applied to DAC, as Parliament intended.
The Act allows the reduction of a corporation’s general tax rate by 13% in certain circumstances.
The Minister submitted that this provision is aimed at excluding a CCPC’s investment income from the general corporate tax rate. The TCC disagreed, stating the provision’s rationale was to lower the general corporate tax rate such that the highest non-refundable corporate tax rate levied under the Act is 15%. The TCC held that DAC did not abuse this provision because the provision operated as intended: lowering DAC’s tax rate on income that was not eligible for special tax preferences.
The corporate continuance provisions apply when a Canadian-incorporated corporation continues to a different jurisdiction (or vice versa). Upon continuation, it deems the corporation to have been incorporated in the new jurisdiction.
The Minister submitted that the OSP of this provision is to not allow an individual resident of Canada who controls a private corporation to circumvent the regime applicable to CCPC investment income. The TCC disagreed. The TCC considered that this deeming rule ensures that various provisions in the Act that refer to place of incorporation, such as the definition of Canadian corporation, produce the results intended by Parliament following a taxpayer’s departure.
The TCC held that once DAC continued in the BVI, its place of continuance was equated with its place of incorporation, which allowed numerous other provisions of the Act to operate as Parliament intended. The fact that it remained a resident of Canada (through central mind and management) did not frustrate the OSP of this provision.
The TCC held that DAC’s continuance to the BVI prior to selling its Soberlink shares was not abusive of the Act’s provisions related to taxing investment income of a CCPC. Parliament intended to have different regimes apply to CCPCs and non-CCPCs.
It is anticipated the Minister will appeal this decision to the Federal Court of Appeal (FCA). Regardless, this decision comes as a relief to taxpayers who have engaged in similar transactions. At the appeal, the FCA will review whether the TCC’s conclusions were legally correct.
