First TCC Loss-Trading Case Applying Deans Knight

On December 27, 2023, the Tax Court of Canada (“TCC”) released its decision for Madison Pacific Properties Inc. v. The King.[1] This is the first loss trading case in the TCC that applied the Supreme Court of Canada’s precedent-setting decision in Deans Knight Income Corp. v. Canada.[2] The TCC found that the use of non-voting shares abused subsection 111(4) of the Income Tax Act (“ITA”) and that the general anti-avoidance rule (“GAAR”) accordingly applied to deny the use of net capital losses.

Facts

The Appellant, Madison Pacific Properties Inc.[3] (“MPP”), was a publicly traded company engaged in the business of mining. As of December 31, 1997, MPP had accumulated $9,688,703 in non-capital losses and $72,718,480 in capital losses. Madison Venture Corporation (“Madison”) and Vanac Development Corp. (“Vanac”), two corporations that were initially at arm’s length with each other and with MPP, each held a portfolio of rental properties.

Through a series of transactions[4] described below, Madison and Vanac accessed MPP’s losses from its mining business to offset income from Madison and Vanac’s real estate businesses:

1. A syndicate – which included (i) Vanac, (ii) a wholly-owned subsidiary of Madison, and (iii) a corporation that was controlled directly or indirectly by the Chair of the Board of Directors of MPP and also owned 6.02% of the shares in MPP at the time – loaned $2.7 million to MPP.
2. MPP spun its mining business out to a subsidiary, 3396061 Canada Inc. (“New Mining Co.”).
3. MPP amended its share capital to create three new classes of shares: Class A Preferred shares, Class B voting shares, and Class C non-voting shares.
4. MPP’s existing shareholders exchanged their old common shares of MPP for Class A Preferred and Class B voting shares of MPP. The Class A Preferred shares were then further exchanged for common shares of New Mining Co.
5. New Mining Co. amalgamated with a subsidiary of a different public mining company, Imperial Metals Corporation, to form Amalco. MPP’s shareholders then exchanged their shares in Amalco for shares of Imperial Metals Corporation, allowing them to continue holding an interest in the mining business.
6. Amalco repaid the syndicate loan from the first step.
7. Madison and Vanac sold MPP various real estate assets in exchange for MPP assuming various liabilities and a mix of Class B voting and Class C non-voting shares of MPP. The Class B voting shares were priced the same as the Class C non-voting shares.
8. MPP was granted various options by Vanac to acquire properties from Vanac in the future.
9. Madison sold additional real estate to MPP in exchange for a mix of Class B voting and Class C non-voting shares. Madison also subscribed for additional Class C non-voting shares. As a result of these two transactions, Madison and Vanac held an equal number of Class B voting shares and Class C non-voting shares in MPP.  

As a result of the above series of transactions, Madison and Vanac each held 23.28% of the Class B voting shares and 50% of the Class C non-voting shares of MPP. Together, Madison and Vanac held only 46.56% of the voting shares of MPP despite owning 92.82% of the total equity of MPP.

MPP used non-capital loss carryforwards and net capital loss carryforwards from its mining activities to reduce its income and capital gains from its real estate business for several years. The Minister of National Revenue (“Minister”) denied the use of the net capital loss carryforwards in MPP’s 2009, 2011, and 2013 taxation years (“Disputed Tax Years”).