University of Toronto Law School Faculty Blog

Copthorne Holdings and the Future of the GAAR: January 6, 2012

On December 16, 2011, the Supreme Court of Canada released its much-anticipated decision in Copthorne Holdings Ltd. v. Canada, in which the Court considered the General Anti-Avoidance Rule (GAAR) for the fourth time.

In contrast to its previous GAAR decision in Lipson, the Court arrived at a unanimous decision in Copthorne, applying the GAAR to a number of transactions designed to preserve paid-up capital and redeem shares on a tax-free basis. In order to review the decision and its implications, the University of British Columbia’s National Centre for Business Law and the University of Toronto Faculty of Law are co-sponsoring a symposium on Copthorne Holdings Ltd. and the Future of the GAAR, which will be held at the University of Toronto Faculty of Law on the afternoon of Friday, January 6, 2012. 

Confirmed speakers include Ben Alarie (U of T Law), Hon. Donald G.H. Bowman (FMC Law and former Chief Justice of the Tax Court of Canada), Mark Brender (Osler), Robert Couzin (Couzin Taylor), David Duff (UBC Law), Tim Edgar (Osgoode Hall Law School), Phil Jolie (Canada Revenue Agency), and Deen Olsen (Department of Justice). Space is quite limited. Please go to http://www.copthorne.ca for registration information.

Prof. Ben Alarie: Price Discrimination in Income Taxation

I have posted a draft of a new working paper on SSRN. It is entitled, "Price Discrimination in Income Taxation: Defending Half-Hearted Anti-Avoidance" and is available for download now. Here is the abstract:

Governments throughout the developed world worry incessantly about the implications of sophisticated tax planning for their tax revenues. And yet the same governments routinely stop short of doing all that they can legally do to combat tax avoidance. Why? One response is that a thick conception of the rule of law constrains governments to adopt only certain kinds of responses to tax avoidance. Another response is that inherent structural limitations in tax administrative capacity or features of the political economy environment constrain the available responses to a subset of those that are possible de jure. Even considered jointly, however, the rule of law and political economy explanations do not provide an adequate account of the observed behavior of governments in the context of anti-avoidance. The main inadequacy is that the accounts fail to provide an explanation of the circumstances that will give rise to aggressive measures countering tax avoidance. 

This paper introduces the “integrated price discrimination” account of income taxation. The integrated price discrimination account provides an original and superior explanation of lax anti-avoidance. An advantage of the integrated price discrimination account is that it better explains the observed practice of most developed countries. Another advantage of the price discrimination account is that it does not require that governments adopt this counter-intuitive approach consciously; it could simply be an unintentional byproduct of decisions taken for different reasons. Several policy implications of the intregrated price discrimination account are addressed.

Prof. Ben Alarie on taxwiki.ca

An important experiment is beginning in documenting the administration and content of Canadian income tax law.  The experiment is called taxwiki.ca.  What is this experiment, and why is it necessary?

The Office of the Auditor General recently pointed out that there is insufficient accurate guidance being provided to Canadian taxpayers by the Canada Revenue Agency (CRA).  To support this claim, the Auditor General's report highlighted that the interpretation bulletins issued by the CRA are accessed frequently by Canadians (1.5 million times from April 2008 to March 2009) and that, “Most tax auditors and many tax practitioners told us that they begin their research into a legislative interpretation question with Income Tax Interpretation Bulletins as their source of guidance.” 

Obviously, then, the bulletins are an important source of tax information for taxpayers and their advisers.

Ben Alarie: Supreme Court of Canada's Decision in Lipson

Earlier today the Supreme Court of Canada released its judgment in the Lipson case (about which I blogged earlier here).  The Court was sharply divided, 4-3, in favour of dismissing the taxpayer's appeal from the decision of the Federal Court of Appeal.

The Lipsons engaged in a series of transactions over two days in 1994 in which they made use of various rules, including the spousal rollover rule (section 73), the spousal attribution rule (section 74.1), and the back-to-back loans rule (subsection 20(3)), to transform what would otherwise have been non-deductible mortgage interest under paragraph 20(1)(c) into, they argue, deductible interest under paragraph 20(1)(c).

The facts are as follows...

Ben Alarie - Tax-Free Savings Accounts

I've posted a new paper on SSRN that analyzes the new "tax-free savings accounts" that are soon to be available in Canada (they will be coming to a financial institution near you in January).  You may recall having seen one (or more) of the now ubiquitous advertisements for the accounts.  Here's the abstract of the paper:

Tax-free savings accounts ("TFSAs") will be available in Canada in January 2009. A TFSA is a "tax prepaid" or "yield-exempt" investment account that does not provide any deduction for contributions and allows for tax-free compounding of investment returns in addition to tax-free withdrawals at any time. This article examines the theory surrounding TFSAs, briefly outlines the empirical evidence from the UK and the US with similar accounts, and identifies the consequences that are likely to emerge with the advent of TFSAs in the existing Canadian tax system. TFSAs can be expected to generate some modest new savings by Canadians with low and middle incomes and to give rise to asset shifting from taxable investments to TFSAs by those who have savings that are currently held outside of tax-advantaged accounts. The analysis suggests that the TFSA regime should probably be regarded ambivalently from the perspectives of efficiency and equity on account of having a small effect on savings and investment behaviour that will come at the cost of significant forgone tax revenue.

The paper is entitled, Assessing Tax-Free Savings Accounts: Promises and Pressures. As this work is still preliminary, I welcome any comments or suggestions you may have.

Earl Lipson, et al. v. Her Majesty the Queen, et al.

The Supreme Court of Canada will hear an appeal tomorrow in a case called Lipson v. Canada.  The appeal may prove to be a significant test of the efficacy of the so-called "general anti-avoidance rule" (the "GAAR") in combatting what is perceived to be abusive tax avoidance.

The Lipsons engaged in a series of transactions over two days in 1994 in which they made use of various rules, including the spousal rollover rule (section 73), the spousal attribution rule (section 74.1), and the back-to-back loans rule (subsection 20(3)), to transform what would otherwise have been non-deductible mortgage interest under paragraph 20(1)(c) into, they argue, deductible interest under paragraph 20(1)(c). 

The Lipsons have lost previously at the Tax Court of Canada and at the Federal Court of Appeal.  It is not at all obvious, however, that the Lipsons will lose at the Supreme Court of Canada.

Collectivizing Rights; Privatizing Taxation: The Unarticulated Function of Copyright Collectives

The recent proposal from the Songwriters Association of Canada to fully legalize peer-to-peer file sharing of music by adding a $5 monthly charge to the cost of Internet access (and similar proposals floating south of the border) has brought renewed attention in the role of levies and tariffs collected by copyright collectives in Canada.  I am now beginning a research project that looks at the broader implications of the expansion of collective administration of copyrights and the use of levies and tariffs.  Since the topic is current, I thought I'd use the blog not only for sharing some of my initial thoughts, but hopefully, to solicit some ideas that will help me to shape them.  Therefore, I'm posting below the description of the project and the questions  it seeks to answer.  Comments on or off the blog will be highly appreciated.  Here it is:

Income Trusts and the Diversified Investor

This commentary was first published in the Financial Post on November 9, 2006.

With the surprise announcement last week by the Conservative government that distributions by income trusts would no longer be exempt from corporate-level taxation, investors in income trusts have suffered material losses to those investments.

Interestingly, investors with diversified portfolios of Canadian equities would have hardly noticed a difference in their wealth and are probably wondering what all the fuss is about.

While the TSX composite index suffered a substantial loss on the day immediately following the government's announcement, it has already made up most, if not all, of those losses. Since the announcement, then, the TSX Income Trust Index has underperformed the broader TSX Composite Index by approximately 10%. Even taking into account the current yield disparity in the two indexes (approximately 9% for the Income Trust Index and 2% for the TSX Composite Index), the TSX Composite Index still comes out ahead of the Income Trust Index by approximately 3%.

While investors in income trusts have been handsomely rewarded over the past few years, so have investors in the TSX Composite Index, who have been rewarded with double-digit returns over the last five years, without even taking into account dividends. The subsequent divergence in performance in the two sectors has revealed what should have been obvious from the beginning: that investors in the trust sector were taking on greater risk than investors in the broader securities market.

Part of the risk that investors were taking on by investing in the income trust sector was regulatory risk: the risk that Canada would cease preferential taxation of income trusts. Part of the risk was ordinary business risk: while older income trusts represented stable companies with stable and predictable cash flows, over the last eighteen months many income trusts were formed out of otherwise marginal businesses in order to take advantage of retail investors' focus on yield. This obsession with yield has now come home to hurt many retail Canadian investors who invested in income trusts on the assumption that they represented a "safe" source of income, especially in a low interest-rate environment in which it was difficult to earn more than 3% or 4% on fixed-income securities.

Far from being low-risk, income trusts were a riskier than the overall market for at least three reasons. The first was lack of diversification, since income-trusts represented only approximately 10% of the TSX Composite Index on a weighted basis. The second was regulatory risk. Regardless of official representations to the contrary, as more and more Canadian corporations adopted the income trust structure for tax reasons, the pressure to clamp down in order to preserve the integrity of the corporate tax system would have only increased. The third was ordinary business risk. As more and more issuers converted to the income trust structure for tax reasons, the relative quality of the issuers declined, increasing the risk in the sector.

More about income trusts

Two commonly invoked reasons for the new tax on income trust distributions are: (1) to ensure fairness (indeed, the government introduced the new tax as the centrepiece of a "Tax Fairness Plan"); and (2) to prevent impairment of the "competitiveness and productivity" of the Canadian economy that would result from greater recourse to the income trust structure by Canadian companies.

In this online opinion article, I take issue with these justifications for the new tax.

Income Trusts Changes

The Minister of Finance announced last week changes to the taxation of income trusts that will take effect in 2011 for existing income trusts.  The following op-ed appeared in the National Post this past weekend addressing the changes.