FCA Overturns TCC in DAC Investments GAAR Decision
On Friday, February 20, 2026, the Federal Court of Appeal (FCA) released its decision in His Majesty the King v. Dac Investment Holdings Inc., 2026 FCA 35.[1] In its decision, the FCA overturned the decision of the Tax Court of Canada (TCC) finding that the general anti-avoidance rule (the GAAR) in the Income Tax Act(Canada) (the ITA) applied to the continuance of the Respondent in the British Virgin Islands (BVI) that resulted in the taxpayer no longer being a Canadian-controlled private corporation (CCPC) prior to a disposal of shares with an accrued gain. The continuance of DAC Investment Holdings Inc. (DAC) to the BVI was used as a means to circumvent anti-deferral measures, but was unlikely to result in an overall reduction of tax payable on the disposition of shares by the continued company once the proceeds were distributed to the shareholders. Although such planning was effectively curtailed by a legislative change in 2022, it was common sell-side tax planning by closely held Canadian vendors for M&A transactions where the purchaser was not a public or nonresident company. The result of the application of the GAAR is that the anti-deferral provisions that were rendered ineffective in the transaction were able to apply to the subsequent share sale by the taxpayer.
TCC Decision
In 2024 TCC 63, Justice D’Arcy conducted a GAAR analysis and assessed the object, spirit, and purpose of sections 123.3 and 123.4, as well as subsection 250(5.1) and the definitions of CCPC and Canadian corporation in the ITA. Justice D’Arcy rejected the Crown’s main argument that the object, spirit, and purpose of these provisions was to address tax deferral for all private corporations, not just CCPCs. In the view of the TCC, the object, spirit, and purpose was limited to CCPCs. It was the view of the TCC that anti-deferral measures were not abused because they produced the result Parliament intended. In that decision, the TCC noted, “[DAC] chose to move from one taxing regime with its pluses and minuses to another taxing regime with different pluses and minuses. . . . On the plus side, DAC avoided the application of section 123.3. On the minus side, DAC lost access to the favourable tax rate for business income, and refunds of a portion of the tax applicable to investment income when dividends are paid.” It also lost the benefit of certain tax rollover provisions and the tax deferral rules for corporate reorganizations.
FCA Decision
In the appeal by the Crown, two issues were raised:
- Does the object, spirit, and purpose of the anti-deferral measures extend to all private corporations whether they are CCPCs or not?
- If not, did the Tax Court err in concluding that the avoidance transactions were not abusive?
The FCA noted that issue b. alone was dispositive of the appeal and did not rule on issue a. In assessing the object, spirit, and purpose of anti-deferral measures in sections 123.3 and 123.4, and subsection 250(5.1) of the ITA, the FCA found the object, spirit, and purpose:
- section 123.3 is to reduce income tax deferral opportunities that individuals earning investment income directly might otherwise obtain by earning such income through a CCPC;
- Of section 123.4 is to foster international competitiveness for Canadian business but does not apply to already incentivized rates such as investment income of a CCPC, because (1) the investment income already has a preferential tax rate and (2) the exclusion preserves the fundamental principle that investment income should be taxed the same whether it is received directly or through a private corporation;
- Of subsection 250(5.1) is to make tax provisions fairer for corporations moving into or leaving Canada by way of continuance (where the FCA held that the TCC erred by not accurately setting out the object, spirit, and purpose of the subsection because it did not describe what results Parliament ).
The FCA then moved to the second stage of the abuse analysis. The FCA took a critical position of the TCC, noting, “[T]o put it starkly, the [TCC] suggests that Parliament intended that subsection 250(5.1) of the ITA may be used to circumvent anti-deferral measures that are a critical part of longstanding Canadian tax policy. The [TCC] supports its conclusion by noting that Parliament enacted certain provisions to facilitate movement from being a CCPC to a non-CCPC.” Further, the FCA noted that “although DAC may have theoretically been subject to minuses, this does not mean that this factor should be taken into account in the factually suffused abuse analysis. It is only relevant if the minuses were material to DAC.” The pluses and minuses noted by the TCC were an irrelevant factor in this case and the TCC erred by concluding that there was abuse on this basis.
As such, the TCC’s finding that there was no abuse of the anti-deferral measures was overturned. In addition, the FCA noted that the finding that there was no abuse of subsection 250(5.1) was owed no deference because the TCC did not correctly state the provision’s object, spirit, and purpose (as noted above). On this basis, the FCA held that there was an abuse of subsection 250(5.1). The object, spirit, and purpose of this provision was to make tax provisions fairer for corporations moving into or leaving Canada by way of continuance. DAC’s continuance fell outside of and frustrated this object, spirit, and purpose.
A&M Takeaways
Prior to the implementation of the “substantive CCPC regime” discussed below, this type of non-CCPC sell-side planning by closely held Canadian vendors for M&A transactions where the purchaser was not a public or nonresident company was commonplace. It provided vendors with the ability to obtain a significant tax deferral, as their investment income would not be subject to a combined corporate tax rate in the range of approximately 46% to 53% depending on the province (of which 30–2/3% would be refundable upon distribution to individual shareholders), and instead was taxed at a combined corporate tax rate of approximately 24% to 32% as a (although the overall tax payable once such income was fully distributed to individual shareholders remained generally the same as a result of tax integration).
The FCA’s decision was focused on the perceived abuse of the relevant provisions by the vendor, such that the impact on targets or buyers of targets from vendors who employed these structures is likely to be quite low, or unchanged altogether.
It would seem unlikely that the FCA’s decision will cause large shockwaves in respect of current transactions as the new “substantive CCPC regime” legislation introduced in the 2022 federal budget and ahead of the TCC’s decision effectively rendered this type of sell side planning ineffective. In August 2022 technical notes, the Department of Finance stated that under the new regime “investment income earned and distributed by corporations that are, in substance, CCPCs would be taxed in the same manner as CCPCs. This would ensure that private corporations cannot effectively opt out of CCPC status and inappropriately circumvent the existing anti-deferral rules applicable to CCPCs” [emphasis added]. As a result of the August 2022 legislative proposals and the now law “substantive CCPC” regime applying to taxation years that end on or after April 7, 2022, the higher investment income tax rate and refund mechanism applies to non-CCPCs that are controlled de facto by Canadian resident individuals, or would, if each share of the capital stock of a corporation that is owned by a Canadian resident individual were owned by a particular individual, be controlled by the particular individual.
It remains to be seen whether leave to Supreme Court of Canada (SCC) to further appeal this decision will be sought, and if so whether the SCC will grant it. We understand a significant number of similar cases were being held in abeyance pending the outcome of this “lead” case. The impact of this case may be more in relation to the impact of the FCA’s GAAR analysis and the use of the GAAR moving forward. Where the TCC took a restricted approach to GAAR’s application in their decision, the FCA again took a broader and more blunt approach following their decision in Dean’s Knight. Might this be a trend where there are perceived legislative gaps moving forward?
[1]Canada v. DAC Investment Holdings Inc., 2026 FCA 35 (CanLII), Federal Court of Appeal, February 20, 2026.
