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Published: August 15, 2023

Last Updated: August 15, 2023

Introduction Deans Knight GAAR decision

The highlight of the Supreme Court of Canada’s (“SCC”) decision in this case is that merely following the letter of the law is insufficient. Deans Knight Income Corporation (“Deans Knight”), the taxpayer and appellant in this case, devised a plan which even the Canada Revenue Agency (“CRA”) agreed did not violate the text of subsection 111(5) of the Income Tax Act (“ITA”). This provision is a Specific Anti Avoidance Rule (“SAAR”) that prevents a corporation’s losses from transferring to other corporations under certain circumstances. According to the Majority of the SCC, what the taxpayer’s plan did violate was the object and spirit of subsection 111(5). The taxpayer’s actions were thus deemed to be an abusive transaction captured by the General Anti Avoidance Rule (“GAAR”) contained in section 245 of the ITA.

Background – The Deans Knight tax Plan

Deans Knight was a struggling public company with unused non‑capital losses, scientific research and development tax expenditures, and investment tax credits (“Tax Benefits”). Due to Deans Knight’s financial difficulties, the company partnered with Matco Capital Ltd. (“Matco”) through an investment agreement executed on May 9th, 2008, that would use the Tax Benefits.

The Taxpayer moved assets to the newly formed parent company, Newco. Following this, Matco bought $3 million in convertible debenture issued by Deans Knight. This debenture would allow Matco to later convert the debenture into 35% of voting shares and non-voting shares, totaling 79% equity in Deans Knight. Matco would then have a year to find a business opportunity that would give new business income for Deans Knight to use up the Tax Benefits.

This setup was meant to prevent the ‘de jure’ control of Deans Knight by Matco, which would have led to the Tax Benefits being disallowed by subsection 111(5). De jure control occurs when one party through its shareholdings can elect the majority of the board of directors. Though structured to avoid de jure control, the agreement also barred Deans Knight from certain actions, such as issuing shares, without Matco’s consent during Matco’s search for a new income source. The agreement, however, did not require that Newco to sell its remaining shares in Deans Knight to Matco.

Matco, however, would arrange for an Initial Public Offering (“IPO”) of Deans Knight in March 2009, and funds from the IPO were used to purchase corporate debt securities. Immediately prior to the IPO, Matco converted the debenture it held into shares of Deans Knight. Then in April 2009, Matco would buy the remaining shares that Newco held for $800,000 per the investment agreement. The Tax Benefits were then used to lower taxes on the earnings from the bonds during 2009 to 2012. In 2014, however, Deans Knight’s use of the Tax Benefits was reassessed and disallowed by the CRA.

Timeline of the Deans Knight GAAR Case

In 2014, the Canadian tax litigation lawyer for Deans Knight appealed the reassessment to the Tax Court of Canada (“TCC”). The taxpayer won the case at the TCC; however, the CRA appealed the decision to the Federal Court of Appeal (“FCA”), which overturned the’ tax court’s ruling. The FCA found that the taxpayer’s actions were abusive and denied the tax benefits from the plan. Subsequently, Deans Knight appealed this decision to the SCC.

The SCC Deans Knight GAAR Decision

In a 7-to-1 split decision, the SCC ruled in favor of the CRA. The majority agreed with the FCA that the taxpayer’s actions were abusive tax avoidance. In applying the GAAR, the Majority found that the taxpayer’s actions were against the object and spirit of subsection 111(5) of the ITA, even though they were within the letter of the law. Justice Côté dissented, arguing that the taxpayer’s actions did not amount to abusive tax avoidance. She believed that the Majority’s interpretation of subsection 111(5) and the GAAR was a departure from Parliament’s intent, which is a crucial factor in a GAAR analysis.

Understanding the GAAR

The GAAR is a tool for tax authorities to prevent abuse of the tax system that may not be captured by the letter of the law but goes against the object and spirit of the law. The current test to determine if a transaction falls under the GAAR involves a three-step process that is a result of previous Supreme Court of Canada decisions, that asks whether: (1) there was a tax benefit; (2) the transaction giving rise to the tax benefit was an avoidance transaction; and (3) the avoidance transaction was abusive. If the answer is affirmative for all three steps, the GAAR is invoked to deny the tax benefit in question. (For further information on the GAAR see our previous article)

The Divide between Majority and Dissent Regarding the GAAR

Both the Majority and Dissent agreed on the first two steps of the GAAR analysis. There was a tax benefit that the taxpayer received from using the Tax Benefits. They also concurred that the plan was an avoidance transaction, resulting in the use of the Tax Benefits. However, where the Dissent disagreed with the Majority was in determining whether this plan could be classified as abusive.

To assess if an avoidance transaction is abusive, one must ascertain the object, spirit, and purpose of the relevant provisions, then compare the transaction’s results against these. The Majority argued that this assessment must be formulated as a “description of [the provision’s] rationale.” This entails examining not only the provision’s text but also the context and purpose behind its creation, as shown by intrinsic and extrinsic evidence.

In this case, the relevant provision was subsection 111(5). The key difference between the Majority and Dissent’s understanding of the provision’s rationale was the inclusion of control. The Majority contended that the underlying rationale of the section was to “prevent corporations from being acquired by unrelated parties to deduct their unused losses against income from another business for the benefit of new shareholders.” Acquiring another corporation has been determined by the de jure control test, a test long interpreted as intended by Parliament. However, the Majority argued that this test does not fully reflect the rationale and that a broader examination of factors could be used to determine whether control changed. Based on these factors, the Majority concluded that control had indeed changed, and the investment structure to avoid de jure control amounted to an abuse of the provision.

Conversely, the Dissent held that broadening the test contradicted principles of statutory interpretation. The relevant principle was that courts cannot override Parliamentary intent when interpreting provisions. The Dissent accused the Majority of violating this principle by disregarding Parliament’s intent regarding the triggering event for subsection 111(5), which was the test for de jure control. The Majority’s disregard for the test was a departure from legislative intent. Furthermore, the Dissent argued that any gaps left by the de jure control test were likely intentional on Parliament’s part, and relying on such gaps should not be considered abusive.

Discussion – Effect on tax law

The Dissent in this case voiced the concerns of many top Canadian tax professionals that the delicate balance between legitimate tax avoidance by taxpayers and the integrity of the income tax system is tilting towards the latter. The Majority’s decision expands the scope of the GAAR in favor of the CRA in several ways. Firstly, they overrode an established test in a SAAR in favor of a new ‘ad hoc’ approach that is less predictable for taxpayers. Secondly, the inability to rely on specific legal standards chosen by Parliament will complicate the interpretation of legislative intent for taxpayers. Thirdly, they clarified that the GAAR applies not only to unforeseen tax strategies but also to tax strategies for which Parliament has already drafted provisions. This decision also comes at a time when legislative changes are further shifting the balance away from taxpayers, such as through the adoption of new reporting requirements.

Pro Tax Tips – Reading versus Understanding Tax Law

The most important lesson from this case is that solely focusing on the text of the law is insufficient. To effectively prepare and present compelling arguments in tax law, reading the provision alone does not suffice. A more holistic comprehension of the provision and its associated rationale is essential. Experienced Canadian tax lawyers meet this high standard set by the SCC and serve as valuable resources for understanding ITA provisions for tax planning or litigation.


How important is it to understand the spirit of tax laws as a taxpayer?

Understanding the spirit of tax laws is crucial for any tax planning by Canadian taxpayers. Simply following the letter of the law might not prevent potential issues, as demonstrated in this case. Understanding the intention behind tax provisions is essential to ensure compliance and avoid unintended consequences. Thus, successful tax planning requires a holistic comprehension of not only the provisions but also the broader context and purpose behind their creation. This understanding, demonstrated by top tax lawyers, is instrumental in navigating the complexities of tax law.

How does this case affect my approach to tax planning and how can I ensure my tax planning is effective considering the outcome of this case?

This case highlights that focusing solely on technical compliance might not protect taxpayers from challenges. Taxpayers should consider the broader context and intent of tax laws in their planning. A more comprehensive understanding of the law can help avoid situations where their actions, even if within the literal text, might be deemed abusive or against the law’s spirit. Given the complexities revealed by this case, seeking professional advice is paramount. Experienced Canadian tax lawyers can provide insights into the nuances of tax provisions, helping you navigate potential pitfalls.


This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the articles. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.


"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."

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