Gwartz: Subsequent Legislative Amendments and GAAR

Gwartz v. The Queen (2013 TCC 86) reiterates that GAAR does not necessarily apply to tax plans established before the legislative amendment of a section. In Gwartz, Forest Hill Dental Management Inc. (FHDM) acted on behalf of Dr. G's dental practice. The Gwartz-Ludwig Family Trust held all the common shares in FHDM. In 2003 and 2005, FHDM paid a high redemption value and low paid-up capital stock dividend. In 2003, 2004, and 2005, the trust sold 75,000 shares to Dr. G in exchange for a promissory note. In 2005, Dr. G sold his 225,000 shares to a company owned by his wife (Spouseco) before they were redeemed by the trust. The note issued to Spouseco against the deemed dividend was used to reimburse the note held in favour of Dr. G. Dr. G then extinguished the note in favour of the trust. In 2003 and 2004, the trust allocated the capital gains to Dr. and Mrs. G. In 2005, the trust divided the capital gains between Dr. and Mrs. G's minor children. In 2011, section 120.4 was amended so that it applied to certain capital gains. The CRA issued a notice of assessment to the children wherein the capital gains were recharacterized as dividends subject to a tax on split income (the kiddie tax).

The judge primarily considered the following issue: Can a transaction be characterized as abusive if the legislative provision that was wilfully avoided was subsequently amended? He referred to three judgments in which a similar issue was raised. In Water's Edge Village Estates (Phase II ) Ltd. (2002 FCA 291), the provision (before being amended) created a loophole used to abusively circumvent Parliament's true purpose. The CRA effectively used the amendment to demonstrate the taxpayer's original abusive intent. In Triad Gestco Ltd. (2012 FCA 258) and 1207192 Ontario Limited (2012 FCA 259), however, the court concluded that the provisions subject to avoidance were not directed at the essence of the transactions that were put into place.

According to the judge in Gwartz, those decisions demonstrate that a subsequent amendment to a section that would have effectively defeated a tax-avoidance strategy challenged under GAAR does not necessarily indicate that the strategy is abusive. The amendment is only one of the relevant aspects to be considered when ascertaining the object and the spirit of the provision. In certain cases, a subsequent amendment may suggest that the provision's object and spirit were circumvented by a loophole strategy; in others, it may suggest that Parliament changed its mind and now intends to prevent something that was not initially intended to be captured by the provision. In this case, since section 120.4 was drafted in simple terms, it was clear that the purpose of the pre-amendment section 120.4 was not to prevent capital gains splitting, and therefore GAAR did not apply.

Alexandre Blouin
Groupe FEC, Quebec City

Jean-René Sénéchal
PricewaterhouseCoopers LLP, Quebec City

Canadian Tax Focus
Volume 3, Number 3, August 2013
©2013, Canadian Tax Foundation