When it comes to the tax system, no one — taxpayers, their advisors and even the Canada Revenue Agency — likes uncertainty. On the other hand, it’s equally important that the tax system be fair and not subject to the abuse that can arise as a result of overly fancy footwork.

So, it’s disappointing that the most recent court rulings on the general anti-avoidance rule, potentially the most powerful weapon in the CRA’s arsenal, leave so much in doubt when it comes to advising clients on what they can and can’t do.

The issue has provoked a somewhat tortured debate among tax professionals following the Supreme Court of Canada’s long-awaited January decision in Lipson v. Canada. Those professionals were relieved about one of the main issues in the case, the use of mortgage swaps to create deductible interest. But the court’s views on GAAR, while receiving less attention at the time, may subsequently turn out to be the sleeper tax problem of the next few years.That’s because the 4-3 split decision presents opposing — and confusing — views on how the rule should be applied.

On this point, there is clearly much frustration among those required to give opinions about the viability of tax structures. “GAAR is in limbo,” says William Innes, counsel with Fraser Milner Casgrain LLP in Toronto. “It is extremely difficult for tax professionals and practitioners to read much into the entrails of the Lipson case.”

Adds Innes, with a degree of understatement: “There were obviously some basic philosophical differences among the judges.”

Accountant Heather Evans, a tax partner with Deloitte & Touche LLP in Toronto, echoes that thought: “The analysis of the majority on the specifics of why there was a misuse or abuse [of the Income Tax Act] was not as robust as we would have liked to have seen.”

The failure to send a clear message about GAAR could affect, in ways that can’t be predicted, everything from the use of the attribution rules (which govern transfers between non-arm’s-length individuals, such as spouses) to innovative products such as the so-called “10/8” loans being offered by some insurance companies to clients with business interests (see the guest column on page 38 of our February 2009 issue). That product relies heavily on creating deductible loan interest in conjunction with life insurance policies. CRA officials stated late last year that they intend to take a close look at some of these products, with a view to possibly disallowing them under GAAR.

GAAR was introduced more than two decades ago to give the CRA a general tool for challenging tax plans that the CRA may consider “abusive.” The idea was to cover situations that the drafters of the ITA may not have contemplated. Incorporating such a rule also keeps a statute that is already extremely intricate from veering too far in the direction of complexity. GAAR essentially states that when a taxpayer has structured transactions to receive a tax benefit in a way that isn’t consistent with the spirit or intent of the tax law, the transaction can be found to be “abusive.”

But with such vague wording, the problem then becomes: in what situations should it apply?

Indeed, in the years since the introduction of GAAR, it has often been difficult for tax advisors and taxpayers to know with a comfortable degree of certainty if a series of transactions will run afoul of GAAR or not. Over the past few years, that uncertainty has moved up through the courts, leading to several important decisions from the SCC.

The judgments in Canada Trustco Mortgage Co. v. Canada and Mathew v. Canada (known as Kaulius), both released in 2005, appeared to go a long way toward setting out basic principles for how the GAAR could be understood and applied. Canada Trustco, in particular, included an often-cited direction from Chief Justice Beverley McLachlin that when applying GAAR, the first task is to identify the “object, spirit and purpose” of the disputed section of the ITA. It is also crucial, the court said in that case, that GAAR be applied with the objectives of “consistency, predictability and fairness.” The court also cautioned that the CRA may not use GAAR to make rulings that would have the effect of rewriting tax law.

@page_break@Given this state of affairs, the Lipson case was awaited with considerable anticipation by the tax-planning community. But, ironically, in the view of many lawyers and accountants, the best news about the judgment — released a long nine months after it was heard — is that its influence may end up being rather muted. That is due to a number of factors: the court was deeply split on the GAAR issue, with the panel’s reigning commercial law expert, Justice Ian Binnie, giving a strongly worded dissent that was opposed to the views of the majority on GAAR, which was contained in the judgment of Justice Louis LeBel. A second dissent (a somewhat unusual situation) was delivered by Justice Marshall Rothstein.

In addition, the views of the court’s most influential member, the chief justice, are not known, as she was required to stand aside in order to achieve an odd-numbered panel. (There was a vacancy on the court at the time.)

Lipson involved a couple, Earl and Jordanna Lipson, who made a series of transactions while in the process of buying a home that, in effect, swapped mortgage debt for business debt. What makes the case unusual is that the couple devised a way of applying the attribution rules that resulted in lowering their taxes — in this case, by allowing the higher-income husband to deduct the mortgage interest from his income, even though the wife had actually taken out the business loan.

Attribution rules, of course, are intended to prevent income-splitting and when applied, typically increase an individual’s tax liability. The majority were clearly very uncomfortable with the Lipsons’ use of the attribution regime and concluded that when it was linked with the mortgage swap, the strategy amounted to abuse of the tax system. Therefore, the SCC majority ruled, GAAR should apply.

Binnie, however, asserted that the majority had failed to understand the true intent of the attribution regime — in his view, the rules that govern transfers, including both income and losses, between non-arm’s-length parties — and that the purpose of the rule had thus not been frustrated. He went on to state that GAAR has the potential to be a “weapon” that, unless interpreted with great care, could have a “widespread, serious and unpredictable effect on legitimate tax planning.”

As a result of what appears to be “two solitudes” when it comes to interpreting GAAR, many experts are now saying that Lipson has indeed introduced a higher degree of uncertainty into the understanding of the rule. “The majority’s decision is somewhat difficult to fathom,” Innes says. “The majority seemed to acknowledge the Duke of Westminster principle [that a taxpayer can arrange his or her affairs in order to minimize taxes owed], while at the same time taking a very expansionist view of the role of the judiciary in interpreting the GAAR.”

Notes Edward Rowe, a partner with Blake Cassels & Graydon LLP in Calgary: “It will simply be more difficult for tax advisors to provide certainty in opinions as to whether a particular tax structure or approach does or does not run afoul of GAAR because of Lipson.”

A commentary on the case written by other Blake lawyers goes even further, suggesting that in future, courts may be engaged in little more than a “judicial smell test” when trying to arrive at the “object and spirit” of tax laws as required by the Canada Trustco case.

The second dissenting opinion seems to muddy the waters even further. In Rothstein’s view, there was another anti-avoidance section in the ITA that specifically addresses the way that the Lipsons used the attribution rules. As a result, there was no need to invoke GAAR, Rothstein concluded. But because the CRA did not rely on that rule, it could not be applied by the court. Rothstein, therefore, would have dismissed the CRA’s claim against the Lipsons.

“The implicit premise of Roth-stein’s argument,” says Innes, “is that if the Crown won’t or can’t prove harm using a specific anti-avoidance rule, why should the Crown be able to pursue it under the broader, vaguer GAAR?”

Some experts also believe that the decision in Lipson cuts both ways and that, given Binnie’s strongly worded dissent and the absence of the chief justice, the CRA may well tread rather lightly when it comes to using GAAR to disallow a taxpayer’s claim.

“The CRA came pretty close to losing Lipson,” Evans says. “It’s not necessarily emboldened by the decision.” IE