In E Hamelin, “Surplus Stripping: A New Approach?” 18:4 Tax for the Owner-Manager (October 18, 2018), the author notes that the Court in Pomerleau v R, 2018 FCA 129 seemed to treat the one-half portion of a capital gain that is “tax free” as an amount that is untaxed for the purposes of a section 84.1 purpose analysis. Mr Hamelin writes
Will this new approach have an impact on the surplus-stripping operations currently accepted by the tax authorities or validated by the courts that involve, directly or indirectly, capital gains? Examples include two-step pipeline transactions, either post mortem or inter vivos, for the purpose of distributing a corporation’s surplus through the realization of a taxable capital gain (sale of shares to an individual to trigger a taxable capital gain before a subsequent sale to a corporation), and gains such as those realized in Gwartz v. The Queen (2013 TCC 86).
In Pomerleau c R, 2016 CCI 228, the Tax Court applied GAAR to a series of transactions that used the stop loss rule in 40(3.6) to create basis not caught by the PUC grind in 84.1, which in turn allowed the taxpayer to extract corporate surplus tax-free.
In “GAAR: Abuse of Section 84.1” Tax for the Owner-Manager 17:1 (January 2017), Eric Hamelin writes:
In Gwartz, the TCC refused to apply GAAR to transactions designed to distribute corporate surplus as capital gains, thereby circumventing the limitations of the kiddie tax provisions in section 120.4. However, the TCC may apply GAAR in an appropriate case to avoid an abuse of section 84.1, as it did in this decision and in Descarries, a similar case in which the CGD was indirectly used to shelter surplus distributions. If one adds to this approach the de facto arm’s-length relationship established (within the meaning of section 84.1) in Poulin v. The Queen (2016 TCC 154, under appeal) and the application of subsection 84(2) by the FCA to a surplus distribution in MacDonald (2013 FCA 110), there is good reason to act cautiously when a shareholder purports to receive distributions of corporate surplus on a tax-free basis.
In Quinco Financial Inc v R, 2016 TCC 190, Justice Bocock held that interest on a GAAR assessment accrues from the balance due date, just like any other assessment. His Honour, however, in obiter, also stated that a taxpayer has an obligation to self-assess under the GAAR!
Jennifer Flood (“Must a Taxpayer Self-Assess Under GAAR?” Canadian Tax Highlights 24:11 (Nov 2016)) isn’t impressed:
Underlying the TCC comments in Quinco is an uncontroversial notion: a taxpayer that engages in a tax-avoidance transaction is well aware that GAAR may apply, and this taxpayer, in undertaking the transaction, assumes the risk that an interest charge will be imposed if GAAR applies. The accrual of interest from the balance-due day for the year is in all likelihood an intended and reasonable consequence of GAAR. However, it is far from clear that Parliament intended a taxpayer to self-assess under GAAR and to be subject to unlimited reassessment periods and penalties for failing to self-assess in the manner that the CRA ultimately decides was most appropriate. Respectfully, self-assessment under GAAR raises a quagmire of interrelated problems under the Act, and this suggests that the issue of self-assessment is one best left for Parliament.
Apparently the decision is under appeal.