https://decisions.fca-caf.gc.ca/fca-caf/decisions/en/item/235963/index.do
Univar Holdco Canada ULC v The Queen (October 13, 2017 – 2017 FCA 207, Pelletier, Webb (author), Near JJ. A.)
Note: This guest blog was prepared by Josh Kumar, one of the bright young stars at Thorsteinssons. Thanks Josh.
Précis: This case dealt with the application of the general anti-avoidance rule (the “GAAR”) to certain transactions that would otherwise allow a non-resident person, immediately following an arm’s length acquisition of control of a Canadian corporation, to extract surplus from that corporation (which had accumulated prior to its acquisition of control) without triggering a dividend under section 212.1 of the Income Tax Act (the “Act”).
In 2007 Univar NV was a Netherlands public company that carried on a global business of acquiring chemicals in bulk and then processing and repackaging them for sale. It carried on business in several countries, including Canada. A UK corporation, CVC Capital Properties (“CVC”), made an offer to acquire Univar NV and after receiving the required approvals, ultimately acquired 99.4% of the shares of Univar NV.
Univar Canada Ltd. (“Univar Canada”) was a member of the Univar NV corporate group. Univar Canada was of interest to CVC because it had accumulated a significant surplus. At the time that CVC acquired Univar NV, all of the shares of Univar Canada were held by Univar North American Corporation, an American company (“UNAC”). The adjusted cost base (“ACB”) of the shares of Univar Canada was $10,000, the paid-up capital (“PUC”) was approximately $911,729 and the fair market value was approximately $889M.
After the acquisition, CVC undertook a reorganization in order to distribute Univar Canada’s surplus out of Canada without attracting withholding tax. To increase the ACB of Univar Canada, UNAC amalgamated with its American parent. The cost of Univar Canada’s shares to the amalgamated US corporation was increased to FMV and the capital gain of $889M was exempt in Canada by the Canada-US Treaty.
In order to increase cross-border PUC, two new holding companies were formed. The first was UHI, a US subsidiary of Univar NV and the second was UHC (the Appellant), a Canadian subsidiary of UHI. Univar NV then undertook a number of transactions to capitalize UHC with debt and shares, with the resulting aggregate tax attributes for such debt and shares equal to Univar Canada’s FMV. At the end, the FMV of Univar Canada could be distributed out of Canada through UHC without attracting Part XIII withholding tax.
To summarize, the amount of the note payable from the Canadian company to its American parent and the PUC of the shares of the Canadian company held by the American company before and after the transactions were:
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Note Payable:
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$0
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$589,262,400
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PUC:
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$911,729
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$302,436,000
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The parties relied on Article XIII of the Canada-US Treaty to exempt from Canadian taxation the capital gain arising as part of the transactions, and on the exception contained in subsection 212.1(4) of the Act to avoid the deemed dividend that would otherwise arise under ss. 212.1(1). As part of the transactions, the corporate group was reorganized so that the conditions of subsection 212.1(4) of the Act were satisfied in that the US shareholder of Univar Canada was owned by the Appellant, immediately before the shares of Univar Canada were transferred to the Appellant.
Generally, section 212.1 was enacted to prevent a non-resident shareholder from indirectly extracting surplus in a Canadian corporation, and avoiding Part XIII withholding tax, in the course of a non-arm’s length transaction. The exception in ss. 212.1(4) previously provided (i.e. before Budget 2016 was implemented) that section 212.1 did not apply to a share disposition if the purchaser corporation controlled the non-resident vendor immediately before the disposition.
The GAAR issue focused on the structuring of the transactions to satisfy the conditions of subsection 212.1(4). There was no dispute that the transactions included a series that resulted in a tax benefit or that there was an avoidance transaction. The sole issue was whether there was a misuse or abuse of section 212.1, given that the parties complied with the technical requirements of ss. 212.1(4).
Tax Court’s Decision
The Tax Court found that GAAR applied to the transaction. Justice Valerie Miller agreed with the Crown that the “purpose of section 212.1 is to prevent non-resident shareholders from reorganizing their Canadian resident corporations so that they can convert dividend distributions that would ordinarily be subject to non-resident withholding tax under Part XIII into tax-free capital gains.”
However, identifying the specific purpose of the exception in ss. 212.1(4) appeared illusive. The trial judge referred to limited material in this respect and noted that no explanatory notes accompanied subsection (4) upon its enactment.
Although the appeal was heard in June 2015, the trial judge cited a March 2016 proposed amendment to ss. 212.1(4) as support for her finding that GAAR applied. She relied on the 2002 FCA case, Water's Edge Village Estates (Phase II) Ltd. v The Queen, for the proposition that such subsequent amendment was relevant in the GAAR analysis.
In Budget 2016, the Department of Finance amended ss. 212.1(4) such that the exception would no longer apply to the transactions undertaken by Univar going forward. In the Explanatory Notes to such amendment, the government said that it was currently challenging the perceived misuse of ss. 212.1(4) in the Courts, in part a reference to this appeal, and also said that such amendment merely clarified the original intended scope of the provision,
Transactions that misuse subsection 212.1(4) are currently being challenged by the Government under existing provisions of the Income Tax Act, including the general anti-avoidance rule; these challenges will continue with respect to transactions that occurred prior to Budget Day. This measure is intended to promote certainty and clarify the intended scope of the existing exception.
Such language in the explanatory notes is obviously self-serving as the Univar decision was under reserve. Furthermore, it is difficult, if not impossible, for Parliament in 2016 to comment on the original intention of the Parliament that enacted ss. 212.1(4) in 1978. On this point, the Supreme Court of Canada in United States of America v Dynar, [1997] 2 SCR 462, cautioned against using subsequent legislative amendments to ascertain the intent of the enacting Parliament.
The Tax Court also dismissed Univar’s argument that an alternative structure would have achieved the same tax result whereby the purchaser could have fully capitalized a Canadian acquisition corporation. Citing Friedberg, the trial judge quickly dismissed this argument saying that “the Appellant did not implement this alternative structure and in tax law, form matters.”
The sole issue on appeal was whether the avoidance transaction undertaken by the Appellant was abusive under the GAAR.
Decision: The FCA allowed the appeal and found that GAAR did not apply. In doing so, the FCA clarified the role of subsequent legislative amendments and of alternative transaction comparators in the GAAR context.
Key to the finding that GAAR did not apply was the fact that s. 212.1 was not intended to apply to an arm’s length sale, such as the arm’s length acquisition by CVC in the case at hand,
[16] … Notably, [section 212.1] does not apply if the shares of the Canadian corporation are sold to an arm’s length purchaser. As a result, a non-resident person who owns shares of a Canadian corporation with an accumulated surplus can sell the shares to any Canadian corporation with which the vendor deals at arm’s length and realize a capital gain. If there is an exemption under an applicable tax treaty for the capital gain that would arise on the sale of the shares, the vendor would not be required to pay any tax in Canada in relation to the transaction. Therefore, the vendor could indirectly extract the surplus accumulated in a Canadian corporation by selling the shares to an arm’s length purchaser.
The FCA reframed the purpose of section 212.1, stating that its purpose was not to prevent the removal from Canada, by an arm’s length purchaser of a Canadian corporation, of any surplus that such Canadian corporation had accumulated prior to the acquisition of control. As the transactions did not frustrate this purpose, since they were part of the genuine arm’s length sale of Univar Canada, GAAR did not apply.
In regard to the alternative structure that could have been implemented, the FCA said that “these alternative transactions are a relevant factor in determining whether or not there has been an abuse of the provisions of the ITA. If the taxpayer can illustrate that there are other transactions that could have achieved the same result without triggering any tax, then, in my view, this would be a relevant consideration in determining whether or not the avoidance transaction is abusive.” The Appellant demonstrated that such alternative transactions would have achieved the same result. The FCA observed that it was difficult to see how GAAR would apply to the alternative transactions, as it was clear that such alternative structure did not frustrate the purpose of section 212.1.
As for subsequent legislative amendments, the FCA did not mention Dynar but disagreed with the Tax Court’s interpretation of Waters Edge, saying the case did not support the proposition that subsequent amendments to the Act will necessarily reinforce that transactions caught by the amendments would be abusive before such amendments are enacted.
The Court noted that the amendments were written approximately nine years after the transactions at issue. Since the transactions did not frustrate the purpose of section 212.1 as it was written during the relevant time, the 2016 amendments could not be used to make a finding that the avoidance transaction was abusive.
The FCA concluded by noting that Copthorne required the Minister to clearly demonstrate that the transactions at issue were an abuse of the Act. The Minister failed to demonstrate that the removal of surplus in an arm’s length transaction, which accumulated prior to the acquisition of control, was abusive and therefore GAAR did not apply.
The Court of Appeal’s decision provides clarity for the roles that subsequent legislative amendments and comparisons to alternative transactions play in a GAAR analysis. The FCA’s approach reinforces the principle that GAAR is an extreme measure that should only be used as a last resort. The Minister must clearly identify and demonstrate an abuse of the Act, as it was written during the transactions at issue. Courts should be cautious in identifying the original purpose of legislation via subsequent amendments and explanatory notes. In this case, it was obvious that Parliament was responding directly to the pending Univar decision, and similar appeals awaiting the decision, when it drafted the 2016 amendments.
Further, the ability to introduce alternative transactions and structures is welcome in the GAAR context. While form matters in tax law, the exact opposite is true with the GAAR. Although form is complied with, the GAAR can nonetheless apply to a set of transactions.
Therefore, it is reasonable for a taxpayer in defending a GAAR assessment to point to alternative transactions that would achieve the same result. If the Minister could then not demonstrate how the GAAR would apply to that separate set of transactions, it is difficult to see how the Act was misused or abused. It will be interesting to see how this aspect develops in the GAAR caselaw going forward, given that analogous transactions are now another tool for taxpayers to employ in challenging the Minister’s use of the GAAR.