Birchcliff Energy Ltd. v. R. - TCC: Loss trading plan subject to GAAR

Birchcliff Energy Ltd. v. R. - TCC:  Loss trading plan subject to GAAR

Birchcliff Energy Ltd. v. The Queen (October 1, 2015 – 2015 TCC, 232, Hogan J.).

Précis:   This decision involved a very complex tax plan designed to trade in the losses of a predecessor corporation of the taxpayer:

[1]             The present case is an appeal from a reassessment made by the Minister of National Revenue (the “Minister”) for the 2006 taxation year of Birchcliff Energy Ltd. (the “Appellant”). The genesis of this appeal is a dispute regarding the disallowance by the Minister of a deduction of $16,226,489 of non-capital losses claimed by the Appellant for its 2006 taxation year in the circumstances described below. The losses were incurred by a predecessor corporation, Veracel Inc. (“Veracel”), which was amalgamated with Birchcliff Energy Ltd. (“Birchcliff”) to form the Appellant as the last step of a complex series of transactions (the “Amalgamation Transactions”) implemented pursuant to the terms of a court‑sanctioned plan of arrangement.

The key to the plan was to “seed” shares of Veracel to an unrelated group of new investors (the “New Investors”) who held the shares upon the amalgamation of Veracel and Birchcliff briefly in order to avoid the application of the change of control rule found in 256(7)(b)(iii) of the Income Tax Act (the “Act”) dealing with so-called “reverse takeovers”.  CRA denied Birchcliff’s bid to utilize Veracel’s losses in its 2006 taxation year.

The Tax Court rejected the Crown’s arguments that the issuance of shares to the New Investors was a sham.  The Court also rejected the concept that the New Investors were a “group of persons” who acquired control of Veracel immediately prior to the amalgamation.  The Court did however accept the Crown’s argument that GAAR applied to the transaction and dismissed the appeal with costs.

Decision:   The evidence was that this structure was specifically designed to permit trading in the Veracel losses:

[7]             The Respondent points out that there is no dispute that Veracel was a dormant corporation that had accumulated a large amount of non-capital losses, scientific research and experimental development expenses and investment tax credits (the “Tax Attributes”) from the Medical Business that it had previously carried on. The evidence shows that Veracel sent out a request for proposals to sell its Tax Attributes for the benefit of its existing shareholders. The Respondent contends that in early 2004 David Tonken and his partner, Greg Matthews, were engaged as advisors to Veracel to market the Tax Attributes.

[8]             David Tonken and Greg Matthews were the managing directors of Cavalon Capital Partners Ltd. (“Cavalon”). The Respondent states that Cavalon was in the business of the monetization of tax losses.

[9]             David Tonken sought out potential partners in a transaction with Veracel who might be interested in acquiring Veracel’s Tax Attributes. He brokered an initial transaction with Emerging Equities Inc. (“EEI”), which ultimately fell through. David Tonken then contacted Jim Surbey, the vice-president of corporate development and corporate secretary of Birchcliff, to inform him of Veracel’s Tax Attributes and Veracel’s willingness to make the Tax Attributes available to a profitable company.

[10]        Birchcliff, the other predecessor corporation in the amalgamation, was a public entity that had entered into an agreement to purchase the Devon Properties. At that time, it was already on a successful path in establishing its oil and gas business. Prior to the amalgamation, Birchcliff had obtained a commitment for financing for the Devon Properties acquisition in the form, inter alia, of the Bridge Loan. Birchcliff did not intend to draw on the Bridge Loan. The plan was to raise equity rather than draw on the Bridge Loan, or to use the proceeds from the equity financing to repay the Bridge Loan if the Devon acquisition was closed prior to completion of the equity financing.

[Footnote omitted]

The Court rejected the Crown’s “sham” argument:

[53]        In the case at bar, the New Investors were promised that they would receive Class B shares of Veracel for their subscription receipts and that these Class B shares would become shares of the Appellant following the amalgamation of Birchcliff and Veracel. This is what happened. The brevity of the share ownership does not negate the fact that the New Investors became shareholders of Veracel.

[54]        Furthermore, I respectfully disagree with the Respondent’s suggestion that the shares were never issued. The documentary evidence clearly shows that the Class B shares were to be issued as consideration for the acquisition of the subscription receipts by the investors. Susan Mak, the assistant manager of client services at Olympia, the subscription receipt agent for Veracel, testified that Olympia received the funds realized from the sale of the subscription receipts. She confirmed that Olympia received the certificate for 34,000,000 Class B shares of Veracel in trust for the New Investors. She further confirmed that Olympia received instructions to exchange the certificate representing 34,000,000 Class B shares of Veracel for 34,000,000 common shares of the Appellant following the amalgamation. Her cross-examination did not reveal any inconsistencies or contradictions with her evidence in chief.

[55]        Considering the evidence as a whole, I am satisfied that the Class B shares were effectively issued and their existence cannot be ignored under the legal doctrine of sham.

The Court also rejected the Crown’s argument that the New Investors as a group acquired control of Veracel immediately prior to the amalgamation:

[61]        In the case at hand, there is no evidence to show that the New Investors knew each other or had a plan to control the corporation together. I infer that the New Investors entered into the Subscription Agreement and granted a proxy to Jeff Tonken or Jim Surbey to vote their shares in favour of the plan, if required, because it appealed to their individual self-interest. I surmise that they did so without discussing the matter with the other investors. Therefore, I agree with the Appellant’s submission that the grant of the proxy in these circumstances is insufficient to demonstrate a common connection between the New Investors, and I find that the New Investors did not constitute a “group of persons” that acquired control of Veracel.

However the Court did find that GAAR applied to the transaction:

[111]   In contrast, in the instant case, the New Investors were not shareholders of Veracel at the commencement of the series of transactions. They were made transient shareholders of Veracel for the sole purpose of artificially complying with the Majority Voting Interest Test mandated in clause 256(7)(b)(iii)(B). In addition, the Veracel Transactions were painstakingly planned before they were implemented. They were carried out in rapid sequential order. The New Investors became shareholders of Veracel literally for the briefest time. The financing was “seeded” into Veracel to circumvent the application of the deeming rule in subparagraph 256(7)(b)(iii) by an attempt to qualify the transactions under the exception found in clause 256(7)(b)(iii)(B) in a manner which does harm to the object, spirit and purpose of that exception. While tax planning does not necessarily bring into play the GAAR, this is a case where the proverbial elastic was stretched beyond its breaking point.

[112]   Subsection 245(2) empowers the Minister to determine the tax consequences that are reasonable in the circumstances in order to deny a tax benefit. As noted, the Veracel Transactions were planned so as to fit within the exception provided for in clause 256(7)(b)(iii)(B). As a result, in my opinion the issue of the Class B shares by Veracel should be ignored, resulting in an acquisition of control of Veracel upon the amalgamation of Veracel and Birchcliff. In this context, the reasonable tax consequence that flows from the application of the GAAR is that the Loss Streaming Restrictions apply to prevent the Appellant from using Veracel’s Tax Attributes.

As a result the appeal was dismissed, with costs.