Aggressive Tax Planning Schemes, Specially Those Designed By Third Parties, Will Annoy CRA – Canada v. Microbjo Properties Inc.

Introduction – When Tax Planning Crosses the Line: Lessons from Microbjo Properties

The case of Canada v. Microbjo Properties Inc. 2023 FCA 157 deals with tax avoidance, third-party liability, and the limits of tax planning under Canadian tax law. The Federal Court of Appeal was asked to decide whether certain corporations could be held responsible for unpaid tax debts through a series of transactions designed to reduce or eliminate tax liability.

At the heart of the case was section 160(1) of the Income Tax Act, which allows the government to recover unpaid taxes from a person who is not acting at arm’s length and receives property from a taxpayer debtor without adequate consideration. The Court ultimately allowed the CRA’s appeal in part, finding that liability existed, but only to a limited extent.

Facts of the Case in Canada v. Microbjo Properties Inc.

The respondents were corporations that indirectly owned farmland in Ontario. They agreed to sell the land, which would generate significant taxable income—approximately $17 million.

Before the sale was completed, a third-party company, Wilshire Technology Corporation (WTC), proposed a plan. The plan aimed to reduce or avoid the tax liability arising from the sale. The structure involved transferring assets into newly created subsidiaries and then selling those subsidiaries to WTC.

Under the arrangement:

• The subsidiaries held cash from the land sale and the related tax liability.
• WTC agreed to purchase the shares of the subsidiaries at a price that ignored the tax liability.
• The parties agreed to split the amount that would otherwise have been paid as tax.

The respondents received a financial benefit, while WTC retained a larger share and moved funds offshore. The tax liability was never paid.

The CRA issued reassessments against the taxpayers under section 160(1) of the Income Tax Act, making them liable for the subsidiaries’ unpaid tax debts.

At the Tax Court of Canada, the skilled Canadian tax litigation lawyers for the taxpayers challenged the CRA reassessments and were successful. The Tax Court judge found that there had been a transfer of property, structured as a two-step movement of cash through a third party (WTC).

The Tax Court concluded that the taxpayers were dealing at arm’s length with WTC at the time of the transfer, as each party acted in pursuit of its own independent economic interests.

As a result, the requirements of section 160 were not met, and the provision could not apply.

The Tax Court also proceeded to consider the General Anti-Avoidance Rule (GAAR) on an alternative basis. It rejected the application of GAAR, finding that the CRA had not established a relevant tax benefit, an avoidance transaction, or abusive tax avoidance.

The Tax Court therefore allowed the taxpayers’ appeals and vacated the CRA’s reassessments in their entirety.

Issues Before the Federal Court of Appeal in Canada v. Microbjo Properties Inc.

The Federal Court of Appeal had to determine three key issues:

1. Whether there was a “transfer of property” under section 160(1).
2. Whether the parties were dealing at arm’s length.
3. Whether the General Anti-Avoidance Rule (GAAR) could apply to recover the full tax amount.

Decision of the Federal Court of Appeal in Canada v. Microbjo Properties Inc.

The Federal Court of Appeal overturned part of the Tax Court’s decision. It found that:

• A transfer of property did occur.
• The parties were not dealing at arm’s length.
• The respondents were liable under section 160(1), but only up to the benefit received.

However, the Court rejected the CRA’s attempt to recover the full unpaid tax amount through GAAR.

Analysis of the Federal Court of Appeal’s Reasoning in Canada v. Microbjo Properties Inc.

1. Transfer of Property

The Federal Court of Appeal confirmed that subsection 160(1) applies broadly. A transfer does not need to be direct; it can occur through a series of steps. In this case, the Court accepted that the funds moved from the subsidiaries to WTC and then to the respondents, which constituted a transfer.

The respondents argued that no real transfer occurred because the cash was replaced by a receivable. The Court rejected this argument, finding that the supposed receivable was not genuine.

2. Arm’s Length Relationship

This was the most important issue. The Tax Court had originally found that the parties acted independently and therefore dealt at arm’s length.

The Federal Court of Appeal disagreed. It emphasized that an arm’s length relationship requires real economic tension between parties acting in separate interests.

Here, the Court found that:

• The parties were splitting money that was effectively destined for taxes.
• The structure was dictated entirely by WTC.
• The respondents followed the plan without questioning it.

Because the parties were not using their own money and did not bear real risk, the Court concluded that true independence was lacking.

3. Fair Market Value and Liability

Under subsection 160(1), liability is limited to the benefit received.

The Court accepted that the respondents gained approximately $600,000 from the transaction. Therefore, liability was limited to that amount, not the full tax debt of $1.3 million.

4. The GAAR Argument

The CRA argued that GAAR should apply to recover the remaining unpaid tax.

The Court rejected this argument. It found that:

• The respondents believed the tax plan would work.
• There was no clear intention to abuse the law.

Since GAAR requires proof of abusive tax avoidance, it could not be applied in this case.

Significance of the Case of Canada v. Microbjo Properties Inc.

This decision of the Federal Court of Appeal in Canada v. Microbjo Properties Inc. is important for several reasons:

• It reinforces that subsection 160(1) is a powerful tool for tax collection.
• It clarifies that “arm’s length” is not just about formal independence, but also about real economic behaviour.
• It confirms that liability under section 160(1) is limited to the actual benefit received.

The case also highlights the risks of participating in aggressive tax planning schemes, especially those designed by third parties.

Conclusion: Not Knowing the Plan Will Not Always Protect You from Taxes

Canada v. Microbjo Properties Inc. shows how courts look beyond the surface of transactions to determine their true nature. Even though the respondents may not have fully understood the scheme, the Court still held them responsible for the benefit they received.

Overall, the case strikes a balance between protecting the tax system and ensuring that taxpayers are not unfairly penalized beyond their actual gain.

Pro Tax Tip: Arm’s Length Transactions Require Real Independence

Simply dealing with an unrelated party does not mean a transaction is at arm’s length. The Court in this case of Canada v. Microbjo Properties Inc. made it clear that true arm’s length dealings require independent interests, real negotiation, and genuine risk. If one party controls the entire structure or dictates all terms, the relationship may not be considered arm’s length.

This can have serious tax consequences. In situations where the tax act requires an arm’s length relationship, you should ensure that your transactions reflect real commercial bargaining and that both parties act independently. Our leading Canadian tax lawyers can help you assess your structures for potential flaws or red flags, including ensuring compliance with arm’s length requirements where mandated by law.

Frequently Asked Questions (FAQs):

What is the purpose of the arm’s length test?

The purpose of the arm’s length test is to ensure that transactions reflect normal business dealings between independent parties. The test helps confirm whether the terms of a deal are fair and influenced by real market forces. When parties act at arm’s length, there is usually tension between them, as each side tries to get the best outcome. This protects the tax system from manipulation. In contrast, when parties cooperate to achieve a shared goal—such as avoiding tax—the transaction may not reflect genuine commercial reality and may trigger tax liability.

What is the standard of review when an extricable question of law lies within a set of facts?

When an extricable question of law is identified within a set of facts, the standard of review for that question is correctness. This means that an appellate court does not defer to the lower court’s decision and instead determines the correct legal answer on its own. As a general rule, questions of law are subject to correctness review, whereas findings of fact—or mixed fact and law—attract the more deferential standard of palpable and overriding error. Accordingly, where a legal issue can be cleanly separated from the facts, the appellate court may fully reassess it and substitute its own interpretation. Where no such separation is possible, the palpable and overriding error standard applies.

Can labelling a transaction as a “loan” prevent it from being treated as a transfer of property for the purposes of section 160(1) of the Income Tax Act?

No. Simply labelling a transaction as a “loan” does not preclude it from being characterized as a transfer of property for the purposes of section 160(1). The Court in Canada v. Microbjo Properties Inc. made it clear that what matters is the substance of the transaction, not the label used. In that case, the taxpayers argued that the funds were replaced by a loan, meaning no transfer occurred. However, the Court found that there was no credible evidence of a real obligation to repay, and key individuals, who ought to have direct knowledge of the transaction, could not confirm that the loan truly existed. As a result, the Court concluded that the so-called loan was not genuine and treated the movement of funds as a transfer.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.