Federal Court of Appeal Decision in Gladwin Realty Corp. v Canada, 2020 FCA 142

On September 14, 2020, the Federal Court of Appeal (“FCA”) released its decision in Gladwin Realty Corp. v Canada, 2020 FCA 142. The FCA dismissed the taxpayer’s appeal and affirmed the Tax Court of Canada (“TCC”) holding that the General Anti-Avoidance Rule (“GAAR”) applied to the tax plan orchestrated by the taxpayer.

Background

Gladwin Realty Corporation Inc. (“Gladwin”), which was indirectly wholly-owned by a family through a holding company (“Shab Holdings”), carried on a commercial real estate business. In 2007, Gladwin sought to sell one of its properties (the “Property”) with an accrued gain and devised a plan that would allow Gladwin to distribute the full amount of the capital gain realized on the sale of the Property to the individual shareholders as a tax-free capital dividend. To achieve this result, Gladwin implemented a series of steps:

1.     The shareholders of Gladwin incorporated Gladwin GP Inc. (“GP Inc.”), and Gladwin and GP Inc. created a limited partnership, The Gladwin Limited Partnership (“Gladwin LP”);

2.     Gladwin transferred the Property to Gladwin LP on a rollover basis pursuant to subsection 97(2) of the Income Tax Act (all further references are to the Income Tax Act);

3.     Gladwin LP sold the Property to a third party on August 8, 2007 and realized a capital gain of $23,346,822;

4.     Gladwin LP loaned to Shab Holdings $24,463,142, roughly the amount of the proceeds from the sale of the Property;

5.     To avoid refundable tax on investment income under section 123.3, Gladwin gave up its CCPC status by continuing in the British Virgin Islands;

6.     Gladwin LP distributed $24,647,301 to Gladwin on September 28, 2007. As a result, Gladwin’s adjusted cost base (“ACB”) in the Gladwin LP partnership interest became negative by an amount of $24,311,654. Consequently, on October 1, 2007 (the day after Gladwin LP’s fiscal period), Gladwin realized a capital gain of $24,311,654 (the negative ACB) pursuant to subsection 40(3.1), half of which was added to Gladwin’s capital dividend account (“CDA”);

7.     On October 1, 2007 (the day after Gladwin LP’s fiscal period), the capital gain of $23,642,822 realized on the disposition of the Property was allocated to Gladwin, half of which was added to Gladwin’s CDA. Additionally, the ACB of Gladwin’s partnership interest in Gladwin LP was increased to $24,352,695;

8.     Gladwin declared and paid a capital dividend to Shab Holdings in the amount of $23,829,237 (i.e., the full amount of its CDA);

9.     A year later, Gladwin elected under subsection 40(3.12) to realize a capital loss equal to the deemed gain resulting from the negative ACB under subsection 40(3.1).