Chief Justice Bowman of the Tax Court of Canada just does not like tax shelters much. He has released a number of decisions over the last few years in which he has ruled against taxpayers who purchased shelters of one kind or another. Makuz v. The Queen, 2006 TCC 263, is another recent example.
In Makuz, the appellants had invested in a partnership (CH1) that invested in a partnership (CA) that owned interests in Texas real estate. The taxpayers had invested amounts and then claimed losses that generated refunds in excess of the amount of their investments. The Minister refused to allow the losses on the grounds of “artificiality” and “sham”. The Minister also alleged that the taxpayers purchased the investment merely to acquire a tax write-off. The taxpayers responded “they were aware of the existence of the tax write-off but that their purpose was to acquire an investment in the real estate market in Texas” (¶8).
The Chief Justice refused to take the taxpayers’ statements of their subjective intentions at face value:
I will outline briefly the evidence of the appellants but I should preface the outline with the caveat that statements of subjective intention about the reasons for entering into a transaction are considerably less persuasive than the objective facts and circumstances surrounding the transaction. Without suggesting that there was any conscious dishonesty in a person’s statements of subjective intention, they tend to be unreliable because they are influenced by many extraneous factors. What actually happens is often a more reliable indication of a taxpayer’s purpose.
Chief Justice Bowman went on to find that, in fact, the taxpayers knew very little about the business and legal structure of their investments and that, though several of them were sophisticated real estate developers, they had invested in properties that had very slim prospects from a commercial perspective even without the benefit of hindsight. The Chief Justice concluded that, viewed objectively, the taxpayers likely were only concerned to acquire a tax loss (¶70).
What is the effect of such a finding? In Witkin v The Queen, 291 N.R. 300, 2002 FCA 174, a case that considered the same partnerships at issue in Makuz, the Federal Court of Appeal held that, without the requisite commercial intention, the taxpayers had not entered into a partnership and therefore they could not claim losses incurred by the partnership. Chief Justice Bowman in Makuz stated that he felt bound by this reasoning, but he went on to question it.
[74] Without the benefit of the decisions of the Federal Court of Appeal in Witkin and the Supreme Court of Canada in Backman [2001 SCC 10], I might have approached the issue somewhat differently by asking the question “Did the investment have any genuine commercial animus apart from utilizing the losses?” If it had none, as is the case here, I would have dismissed the appeal regardless of the vehicle used to make the investment. Here the creation of CH1 had as its purpose the extension of the time to March 31, 1988 in which the investors could gain access to the loss. CH1 invested in CA before the end of its 1987 taxation year. Then, after the end of CA’s 1987 taxation year the appellants bought into CH1. The rationale underlying the Witkin decision is that the loss of CA cannot flow through CH1 to the investors because of their purpose in investing in CH1. I am not sure what the result would have been if the investors, instead of investing in CH1, had invested directly in CA before the end of CA’s 1987 fiscal period. It is not legally accurate to say that one is “buying losses”. You cannot legally buy a loss, but you can buy your way into a position in which you hope to avail yourself of someone else’s loss and that is just what the appellants were doing. I know of no provision of the Income Tax Act that permits one to claim a loss when one’s only purpose in investing is, as a matter of commercial reality, to use someone else’s loss.
[75] I am dismissing the appeals on the basis of the reasoning of the Federal Court of Appeal in Witkin. Moreover I am of the view that one cannot avail oneself of losses that one has “purchased” in a transaction that has no credible genuine commercial motivation other than the utilization of losses that accrued when the partnership was composed of different persons.
Tax shelter buyer beware!
