A May 30 ruling from the Federal Court of Appeal has upheld a lower court decision in favour of a credit union that sought to deduct inter-corporate dividends: the dividends were paid to satisfy a regulatory requirement and the transfer could have been accomplished by other means that would have generated greater tax liability. The decision also considers the effect of the general anti-avoidance rule (GAAR) in the context of “avoidance transactions.”
The case — Canada v. Spruce Credit Union — affects at least 40 other credit unions in British Columbia, which had been waiting to hear whether or not they would be required to pay tax on the same kind of dividends paid to them. The tax dispute has been brewing since 2003, when B.C. financial authorities imposed new rules designed to ensure that sufficient deposit insurance would be available to cover the deposits of credit union members. That change required the transfer of funds from one deposit insurer, the Credit Union Deposit Insurance Corporation (CUDIC) to another, the Stabilization Central Credit Union of British Columbia (STAB).
A direct transfer from STAB to CUDIC would have resulted in tax liability on $83 million that STAB held as deposit insurance: these funds had been collected from member credit unions for many years as a result of annual assessments. A shortfall in the required deposit insurance as a result of taxes imposed on the transfer (to meet the new requirement) would have had to come out of the pockets of the member credit unions.
Instead, and after much consultation with the Financial Institutions Commission of B.C. (which had originally mandated the change), STAB transferred the funds to the individual member unions as inter-corporate dividends: such dividends are generally deductible under s. 112(1) of the ITA. These amounts were then paid to CUDIC under a new assessment levied by CUDIC on its members, completing the required transfer of funds from STAB to CUDIC.
The CRA took the position that the payment of the dividends was merely an attempt to avoid tax that would otherwise have been payable and disallowed the deduction claimed by Spruce Credit (and the other affected credit unions in B.C.).
The Tax Court of Canada held for the credit unions. On appeal to the Federal Court of Appeal, the Crown argued (among other things) that GAAR applied to disallow the transactions. Specifically, the Crown argued that the court should consider whether the objective of the transactions in question (the transfer from STAB to CUDIC) could have been completed in another way that did not carry the same tax implications.
But the Federal Court of Appeal disagreed, noting that there were some non-tax reasons for the dividend structure of the transactions and that: “the mere existence of an alternative transaction that would have resulted in greater tax implications is not sufficient to establish an avoidance transaction, and that individuals are permitted to order their affairs to minimize their tax liability in accordance with the Duke of Westminster principle [that taxpayers may arrange their affairs to minimize tax, so long as no laws are broken].”