Analysis of “Arm’s Length”

Volume No. 05-20

“CRA lost in its approach that any transactions that reduce taxes must be between non-arm’s length taxpayers.”

In the case of Brouillette, the principal issue that the Court had to determine was whether a purchaser and seller were dealing at arm’s length. If the taxpayer (seller) and the purchasing corporation were not dealing at arm’s length, section 84.1 of the Income Tax Act would apply and the disposition of the shares would be deemed a dividend received by the taxpayer, rather than a capital transaction. The Court also had to determine, if the dealings were at arm’s length, whether section 245 (GAAR) applied.

The basic facts were that the vendor wanted to sell his shares in a car dealership. The vendor and the purchaser shared the same tax advisors. The tax advisors recommended a plan that allowed the vendor to claim his capital gains exemption and the purchaser to use corporate funds to pay for the shares. The actual steps were fairly complicated and need not be considered here. The final result was that a corporation (“9017”) purchased the shares from Mr. Brouillette. Mr. Brouillette owned more than 50% of the votes of this company. The remaining shares were held by the purchaser There was, however, a shareholder’s agreement that limited Mr. Brouillette’s rights as well as an option by 9017 to purchase Mr. Brouillette’s remaining shares.

The CRA took the position that all of the transactions were done “in concert.” They also claimed that Mr. Brouillette had de facto control over all transactions throughout the process. The appellant gave evidence that steps were taken to minimize taxes and that at all times the parties were at arm’s length. None of the parties was related. Based on the facts, it seems obvious that a purchaser and a seller would try to accommodate each other, while always acting in their own best interests. It is common for the CRA to claim that, whenever a tax plan is beneficial and the parties are at arm’s length, they acted in concert. The Tax Court judge made it very clear that the interests of the purchaser and seller were totally separate. The Court held that Mr. Brouillette tried to sell at the best price he could get and the vendors tried to purchase at the lowest price for the shares of a business that they were seeking to operate.

The Court noted the irrelevance of the fact that the same financial advisors were used by both parties. Financial advisors are not the directing minds of the corporations that they advise. “They advise. They do not make the decisions.”

The Court stated that, since Mr. Brouillette was at arm’s length from 9017, section 84.1 could not apply. The judge also remarked that “when the evidence shows that the parties were dealing at arm’s length, the legal debate is closed” in referring to the possible applicability of section 245 (GAAR).

Perhaps the CRA will now accept that a business transaction entered into by arm’s length parties does not mean that the parties are acting in concert.


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