Canada Trust Co.: GAAR and Canada

The supreme court of Canada had the opportunity to interpret the GAAR provisions in 2005 in two companion cases namely, Mathew v. Canada [2005] SCC 55 and The Queen v. Canada Trustco Mortgage Company [2005] SCC 54. In this post I shall discuss the Trustco case and in a subsequent post I shall discuss the recent ruling of the Canadian Supreme Court in Lipson v. Canada [2009] SCC 1 which interprets Trustco.


In Trustco the court laid down a three step test for invoking the GAAR provisons embodied u/s 245 of the Canadian Income Tax Act. These three steps can be simply put as under:

1. Whether there is a “tax benefit” arising from a “transaction” u/s 245(1) and 245(2)?

2. Whether the “transaction” is an “avoidance transaction” as under s. 245(3) i.e. the transaction is not being arranged primarily for bona fide purpose other than to obtain tax benefit?

3. Whether the avoidance transaction is abusive as u/s 245(4)

The court noted that all the three ingredients as stated above needs to be fulfilled before invoking the GAAR provisions. However, the question arises as to what is a tax benefit? What qualifies as an avoidance transaction? When is an avoidance transaction abusive? These questions are critical in understanding the scope and ambit of the GAAR provisions u/s 245.

Tax Benefit

A plain reading of S. 245(1) suggests that a “tax benefit” is one which leads to a “reduction, avoidance or deferral of tax” or “an increase in a refund of tax or other amount” paid under the Act. It seems fairly clear that the amount of “tax benefit” is inconsequential for the purposes of s. 245(1). In Trustco the court noted that inorder to determine whether there arises a “tax benefit” in a given transaction, the “alternative arrangement approach” can also be adopted. Simply put, suppose to achieve a desired business purpose, an enterprise has the option to adopt two distinct models say A and B. Now assume the enterprise adopts model B. Subsequently on a closer scrutiny it is found that if the enterprise had adopted model A instead of model B its tax incidence would have been higher. In such a case the enterprise can be said to have obtained a “tax benefit” as per the “alternative arrangement approach” test.

Avoidance Transaction

In my earlier post I had discussed avoidance transaction u/s 245(3) and stated that GAAR provisions are not attracted in a case where the transaction “may reasonably be considered to have been made for bona fide purposes”. The investigation u/s 245(3) proceeds on the assumption that a transaction can have both tax and non tax purpose. In trustco the court held that a transaction is deemed to be an “avoidance transaction” if its “primary purpose” is to obtain tax benefit (this is contrary to the “only purpose” approach as asserted in my previous post). It would be safe to conclude that this is the correct interpretation of S. 245(3).The ruling of the court also suggests that S. 245(3) is similar to “main purpose” test under the Indian Direct Tax Code.

Abusive Tax Avoidance

The scheme of the GAAR provisions suggests that an avoidance transaction can only be disregarded if it is abusive. In trustco the court stated that what amounts to an abusive tax avoidance is a mixed question of law and fact. In essence the court stated that if a transaction defeats the object and spirit of any of the provisions of the Income Tax Act read as a whole then it would qualify as an “abusive tax avoidance” transaction.

Burden of Proof

S. 114 of the Indian Direct Tax Code presumes that a transaction is undertaken for the “main purposes” of obtaining a tax benefit i.e. the burden of proof lies with the taxpayer to show otherwise. However, the case is slightly different under the Canadian GAAR provisions. In trustco the court noted that for test (1) and (2) the burden lies on the taxpayer whereas for test (3) the burden lies on the department/minister. Simply put, the taxpayer has to show that (a) there is no tax benefit obtained and (b) the transaction was not contemplated primarily for tax purposes. Whereas the department has to prove that the transaction was an abusive tax avoidance transaction i.e. if the existence of abusive tax avoidance is unclear the benefit of the doubt goes to the taxpayer. The Canadian GAAR provisions seems to be fairly well balanced in terms of the burden of both the parties unlike the DTC.


An overall reading of Trustco suggests that:

1. The objective of the GAAR provisions is to draw a line between legitimate tax minimization and abusive tax avoidance and to this extent the principles enunciated in Westminister are not wholly dead.

2. The GAAR provisions under the DTC are far wider than its Canadian counter part, in the sense that the DTC does not require an inquiry as to whether a tax avoidance is abusive or not. Once it is shown under the DTC that the “main purpose” of the transaction is to obtain a tax benefit, the transaction can be disregarded.

3. The GAAR provisions under the DTC are tilted in favour of the department as opposed to the Canadian provisions, which is fairly well balanced.