International Law

The Uncertain Demise of the Duke of Westminster: A Comment on Lipson v. Canada

By Soloman Lam

My colleague Julian Ho has already provided a succinct summary of last Thursday’s Supreme Court decision in Lipson v. Canada, 2009 SCC 1, so today I thought I’d comment briefly on the general anti-avoidance rule (GAAR), as provided by section 245 of the Income Tax Act (ITA). I confess that I’m disappointed by the majority’s reasons in Lipson because, as Julian pointed out, they fall short of resolving several pressing issues that arose out of Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54 (which, prior to Lipson, was the leading case on interpreting the GAAR). Specifically, the Court has failed to clarify what the parameters of the GAAR are and how the GAAR may coexist with tax law’s longstanding approach to statutory interpretation, which favours form over substance.

The purpose of the GAAR is to undo any transaction that, in effecting a tax benefit for the taxpayer, has unacceptably manipulated or exploited the rules of the ITA. Prior to the enactment of the GAAR in 1988, the government’s only available response to tax plans that were legal but overly aggressive was to enact specific anti-avoidance rules prohibiting a particular transaction from reoccurring. However, specific anti-avoidance rules have proven somewhat ineffective because they react against a transaction after the fact; they may also create loopholes which spawn further aggressive tax planning. The usefulness of the GAAR for the Canadian Revenue Agency is obvious: it is an umbrella rule that prohibits any abusive transaction or series of transactions that have not yet been contemplated by the ITA. Uncertainty arises, however, as to how a legitimate transaction is distinguished from an abusive one.

In Canada Trustco, the Court created a three-prong test with which to determine whether a transaction triggers the GAAR: (1) the transaction must produce a tax benefit to the taxpayer; (2) the transaction must be an avoidance transaction as defined in the ITA; and (3) the transaction must result in an abuse or misuse of the ITA provisions relied upon by the taxpayer. The third prong of the test is problematic because neither abuse nor misuse are defined. In Canada Trustco, the Court interpreted the two terms as having the same meaning. In establishing whether there has been an abuse or misuse of an ITA provision, a court must first determine what the purpose of that provision is, and then ask whether the taxpayer’s transaction (or series of transactions) frustrate that purpose.

The SCC has reasoned that, in order to find an abuse or misuse of an ITA provision, one first must define what the use of that provision is. Sounds reasonable, but this purposive approach subverts the Textual, Contextual and Purposive approach to statutory interpretation, by ignoring the everyday meaning behind the provision’s words and moving straight to a larger purposive analysis. The purposive approach is therefore inconsistent with tax law’s fundamental principle — as stated in Commissioners of Inland Revenue v. Duke of Westminster, [1936] A.C. 1 (H.L.) — that favours a textual reading of a provision above any contextual or purposive analysis. As stated in Duke of Westminster, a taxpayer has the right to order her affairs as she sees fit to minimize her tax payable. Deference to statutory text, rather than statutory purpose, allows a taxpayer certainty in tax planning. That certainty is removed when a provision’s underlying objectives, unwritten and unbeknownst to the average taxpayer, is allowed to override the provision’s clear wording on which the taxpayer relies.

Lipson leaves unclear how much the GAAR should be permitted to erode the Duke of Westminster rule. Furthermore, the Court fails to finesse the purposive approach to GAAR. While divining a legislative purpose is nothing new for the Court, a predictable interpretation is essential for taxpayers to plan their financial affairs. The majority’s reasons in Lipson, however, provide no guidelines on how to determine an ITA provision’s purpose, or how to choose between competing interpretations.

For example, the majority in Lipson held that s. 74.1(1) of the ITA, the property attribution rule for spouses, was an anti-avoidance rule designed “to prevent spouses from reducing tax by taking advantage of their non-arm’s length relationship when transferring property between themselves”; the appellant’s series of transactions therefore subverted this purpose by allowing income-splitting. In his dissent, however, Justice Binnie noted that that s. 74.1(1) only applied if spouses did not opt out of s. 73(1), the spousal rollover rule. Since Parliament in effect gave spouses a choice regarding property attribution, s. 74.1(1) was in fact not an anti-avoidance rule at all, but one that encouraged tax minimization. “Far from offending the ‘object, spirit or purpose’ of the spousal attribution rules, the taxpayer’s tax plan fulfilled them, or at a minimum did not abuse them.” Using a purposive approach to determining whether there’s been an abuse of an ITA provision produces uncertainty, since it is rarely clear what the true purpose behind a tax rule is.

Writing for the majority, Justice LeBel responds to Justice Binnie’s concerns by stating, “such uncertainty is inherent in all in all situations in which the law must be applied to unique facts.” Yet the Court has previously held that, in situations of genuine ambiguity over what an ITA provision means, there is a residual presumption in favour the taxpayer (Placer Dome Canada Ltd. v. Ontario, 2006 SCC 20). In Lipson, the majority did not consider whether Justice Binnie’s competing interpretation of s. 74.1(1) could bring genuine ambiguity to a provision’s purpose. Neither do they explain what steps must be followed to find a provision’s underlying purpose.

The majority’s decision in Lipson diminishes the importance of the Duke of Windsor method of interpreting the ITA. It imposes a purposive approach that was once only used after an examination of the provision’s words and context proved inconclusive. I agree with Justice Binnie’s view that “the application of the GAAR in these circumstances […] means paying lip service to the Duke of Westminster principle without taking seriously its role in promoting consistency, predictability and fairness in the tax system.” The majority’s reasons speak of the need to place limitations on the GAAR’s scope but refrain from providing any. It is therefore unclear what kind of aggressive tax plan could exploit the word and letter of the ITA and still withstand a challenge under the GAAR.

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Full post as published by The Court on January 14, 2009 (boomark / email).