Aggressive tax planning is permissible and the general anti-avoidance rule (GAAR) should not be invoked to bridge legislative gaps in the Income Tax Act (ITA), the Tax Court of Canada has ruled.
Specifically, recent amendments to the “kiddie tax” were reviewed by the court, with the decision concluding that the taxpayer’s avoidance scheme in this case did not contravene that section.
The May decision in Gwartz v. The Queen deals with a complex strategy set up by a dentist to split income with his minor children. The series of transactions attacked by the Canada Revenue Agency involved stripping surplus value out of a private corporation, converting the value to capital gains and distributing those gains to the dentist’s two children. While the children paid tax on the gains, those taxes would have been higher if the amounts had been paid out as dividends.
In holding for the taxpayer’s children, Justice Robert Hogan referred to a series of principles frequently discussed in these types of cases.
Specifically, Justice Hogan noted that:
1) Tax planning is not inherently abusive.
“[A] taxpayer who chooses a course of action that minimizes his or her tax liability will not necessarily have engaged in abusive tax avoidance for the purposes of subsection 245(4) [GAAR]” the decisions says.
2) Gap filling and the GAAR.
“Abusive tax avoidance cannot be found to exist if a taxpayer can only be said to have abused some broad policy that is not itself grounded in the provisions of the ITA,” the decision says.
3) Is there a policy in the ITA against surplus stripping?
Justice Hogan referred to a number of judgments which have held that there is no express policy in the ITA that prohibits surplus stripping and that this practice is not necessarily abusive tax avoidance under GAAR.
4) Is there a policy in the ITA against income splitting?
The decision concludes that there is no such general policy and indeed there may be incentives created by the legislation.
States the decision: “The ITA levies an income tax on individuals at marginal tax rates that increase as taxable income increases. Unlike the U.S. personal income tax system, where married couples can file joint tax returns, the Canadian income tax system requires that couples and their children file individual tax returns in which each family member’s tax liability generally depends on that member’s individual circumstances. The increasing marginal tax rates and the choice of the individual as the basic taxable unit create incentives for taxpayers to split their income with their family members.”