lacobucci
J.:
The
principal
question
raised
by
this
appeal
is
whether
dividend
income,
paid
by
a
closely
held
family
corporation
to
a
non-arm’s
length
shareholder
who
has
not
contributed
to
or
participated
in
the
business
of
the
corporation,
in
this
case
Ruby
Neuman,
should
be
attributed
to
the
shareholder’s
spouse,
The
appellant
Melville
Neuman,
for
income
tax
purposes
in
accordance
with
s.
56(2)
of
the
Income
Tax
Act,
S.C.
1970-71-72,
c.
63
as
amended
(the
“ITA”).
I
conclude
that
s.
56(2)
does
not
apply
to
dividend
income
such
that
the
dividend
income
received
by
Ruby
Neuman
cannot
be
attributed
to
the
appellant
for
income
tax
purposes.
1.
Facts
The
appellant
was
at
all
material
times
a
lawyer
with
the
Firm
of
Neuman,
MacLean
in
Winnipeg.
The
appellant
and
his
partners
at
the
law
firm
each
owned
1,285.714
common
shares
in
Newmac
Services
(1973)
Ltd.(“Newmac”),
which
owned
commercial
property
in
downtown
Winnipeg,
including
the
offices
of
Neuman,
MacLean.
The
appellant
acted
as
secretary
of
Newmac.
The
appellant’s
wife.
Ruby
Neuman,
had
no
involvement
in
the
business
of
Newmac.
On
April
29,
1981,
the
appellant
incorporated
Melru
Ventures
Inc.
(“Melru”)
as
a
family
holding
company.
Rothstein
J.
of
the
Federal
Court,
Trial
Division
found
that
Melru
was
incorporated
for
tax
planning
and
income
splitting
purposes
and
that
it
had
no
other
independent
business
purpose
((1993),
[1994]
2
F.C.
154
(Fed.
T.D.),
at
p.
160).
The
capital
structure
of
Melru
provided
for
different
classes
of
shares
with
different
rights
and
privileges.
The
dividends
were
to
be
declared
at
the
sole
discretion
of
the
directors;
distributions
could
be
done
selectively
among
the
various
classes
of
shares.
The
rights
and
conditions
of
the
Class
“G”
and
“F”
shares
are
as
follows:
(a)
the
holders
of
Class
“G”
shares
shall
in
each
year,
in
the
discretion
of
the
directors,
be
entitled
out
of
any
or
all
profits
or
surplus
available
for
dividend
to
non-cumulative
dividends
at
such
rate
as
may
from
time
to
time
be
declared
on
any
such
shares
but
not
exceeding
the
equivalent
of
1%
per
annum
en
“redemption
price”
above
the
maximum
prime
bank
rates...
(e)
all
dividends
paid
or
declared
and
set
aside
for
payment
in
any
fiscal
year,
after
making
payments
on
Class
“G”
shares
and
preference
shares
of
dividends
declared
shall
be
paid
firstly
on
Class
“F”
shares
until
dividends
aggregating
16
per
share
on
the
Class
“F’
shares
then
outstanding
have
been
paid
and
then
any
additional
dividends
shall
be
set
aside
for
payment
on
common
shares
until
the
common
shares
then
outstanding
shall
have
received
1¢
per
share
and
any
additional
dividends
shall
be
paid
on
Class
“F”
shares
until
they
receive
that
fraction
of
profits
properly
available
for
payment
of
dividends
as
the
number
of
Class
“F”
shares
then
outstanding
bear
to
the
total
number
of
Class
“F’
shares
and
common
shares
then
outstanding
and
the
balance
shall
in
the
discretion
of
the
directors
be
paid
on
common
shares
or
set
aside
for
future
payment
on
common
shares
at
the
discretion
of
the
board
of
directors.
Pursuant
to
an
agreement
dated
April
29,
1981,
the
appellant
sold
his
shares
in
Newmac
to
Melru
for
1,285.714
Class
“G”
shares
of
Melru.
The
shares
were
sold
on
a
tax-deferred
basis
pursuant
to
s.
85(1)
of
the
ITA
and
they
were
described
as
having
a
fair
market
value
of
$120,000.
On
May
1,
1981,
a
meeting
of
the
first
director
was
held
at
which
the
appellant
was
appointed
president
and
Ruby
Neuman
was
appointed
secretary.
One
voting
common
share
of
Melru
was
issued
to
the
appellant
for
$1.
A
special
general
meeting
of
the
shareholders
was
held
that
same
day
at
which
the
appellant
resigned
as
first
director
and
was
elected
director
of
Melru
until
the
first
annual
meeting
of
the
corporation.
Ruby
Neuman
acted
as
secretary
at
this
meeting.
That
same
day
there
was
a
meeting
of
the
board
of
directors
which
the
appellant
chaired.
A
resolution
was
passed
authorizing
the
issue
of
1,285.714
Class
“G”
shares
to
the
appellant
in
accordance
with
the
agreement
of
sale.
A
second
resolution
was
passed
authorizing
the
issue
of
99
non-voting
Class
“F”
shares
to
Ruby
Neuman
at
$1.00
per
share.
The
first
annual
meeting
of
shareholders
was
held
on
August
12,
1982.
Ruby
Neuman
was
elected
sole
director
of
Melru
and
the
appellant
and
Ruby
Neuman
were
appointed
as
officers.
In
1982,
Melru
received
$20,000
in
dividends
on
the
Newmac
shares.
These
were
the
first
dividends
paid
on
the
Newmac
shares.
A
board
of
directors
meeting
was
held
on
September
8,
1982
at
which
time
Ruby
Neuman
declared
a
dividend
in
the
amount
of
$5,000
to
be
paid
on
the
Class
“G”
shares
and
another
dividend
of
$14,800
to
be
paid
on
the
Class
“F”
shares.
The
minutes
indicate
that
the
holder
of
the
common
shares
(i.e.,
the
appellant)
was
prepared
to
have
money
set
aside
for
future
payment
on
his
shares.
Ruby
Neuman
immediately
loaned
$14,800
to
the
appellant
and
she
received
in
return
a
demand
promissory
note
as
security.
Ruby
Neuman
died
in
1988.
The
loan
was
not
repaid.
Rothstein
J.
made
the
following
relevant
findings
of
fact
(at
pp.
160-61):
1.
The
dividends
declared
by
Ruby
Neuman
on
her
own
Class
“F”
shares
and
the
appellant’s
Class
“G”
shares
were
declared
pursuant
to
a
discretionary
dividend
clause
in
the
Articles
of
Incorporation
of
Melru.
The
dividends
of
$14,800
on
the
“F”
shares
and
$5,000
on
the
“G”
shares
were
arbitrary
numbers.
2.
Ruby
Neuman
made
no
contribution
to
Melru,
nor
did
she
assume
any
risks
for
the
company.
3.
The
appellant’s
evidence
was
that
when
his
wife
was
elected
director
of
Melru,
he
explained
to
her
the
duties
of
a
director,
that
directors
manage
the
corporation,
that
they
have
a
duty
to
the
corporation,
and
that
they
make
the
decisions.
The
appellant
said
that
he
made
recommendations
to
his
wife
which
she
accepted
but
that
the
decision
as
to
the
declaration
of
dividends
was
hers.
The
dividend
income
paid
to
Ruby
Neuman
in
1982
was
attributed
to
the
appellant
as
being
a
payment
or
transfer
of
property
made
pursuant
to
the
direction
of
or
with
the
concurrence
of
the
appellant
as
described
in
s.
56(2)
of
the
/TA
and
he
was
assessed
tax
on
this
income.
The
appellant
appealed
his
1982
assessment
to
the
Tax
Court
of
Canada
and
in
1992
the
assessment
was
vacated:
[1992]
2
C.T.C.
2074
(T.C.C.).
(Proceedings
had
been
delayed
pending
the
final
determination
in
McClurg
v.
Minister
of
National
Revenue,
[1990]
3
S.C.R.
1020
(S.C.C.).)
The
respondent
appealed
to
the
Federal
Court,
Trial
Division
without
success,
but
a
further
appeal
to
the
Federal
Court
of
Appeal
was
successful:
(1996),
[1997]
1
F.C.
79
(Fed.
C.A.).
2.
Judicial
History
A.
Tax
Court
of
Canada
Sarchuk
T.C.C.J.
allowed
the
appellant’s
appeal
and
referred
the
assessment
back
to
the
respondent
for
reconsideration
on
the
basis
that
the
dividend
income
received
by
Ruby
Neuman
was
not
to
be
included
in
the
appellant’s
income
under
s.
56(2).
In
reaching
this
conclusion,
he
relied
on
the
opinion
expressed
by
this
Court
in
McClurg
that
as
a
general
rule
s.
56(2)
does
not
apply
to
dividend
income.
Sarchuk
T.C.C.J.
acknowledged
Dickson
C.J.’s
obiter
dicta
in
McClurg
(at
p.
1054):
If
a
distinction
is
to
be
drawn
in
the
application
of
s.
56(2)
between
arm’s
length
and
non-arm’s
length
transactions,
it
should
be
made
between
the
exer-
else
of
a
discretionary
power
to
distribute
dividends
when
the
non-arm’s
length
shareholder
has
made
no
contribution
to
the
company
(in
which
case
s.
56(2)
may
be
applicable),
and
those
cases
in
which
a
legitimate
contribution
has
been
made.
However,
Sarchuk
T.C.C.J.
was
of
the
view
that
since
this
comment
was
obiter
he
was
not
bound
by
it.
In
his
opinion,
the
Court
had
left
open
the
question
of
the
applicability
of
s.
56(2)
to
non-arm’s
length
transactions
and
the
possibility
of
piercing
the
corporate
veil
to
stop
complex
tax
avoidance
schemes.
However,
the
case
at
bar,
in
his
view,
did
not
warrant
this
action.
Although
there
were
facts
that
would
support
the
attribution
of
the
income
back
to
the
appellant,
the
plan
could
not
be
described
as
a
“blatant
tax
avoidance
scheme”
(p.
2085).
B.
Federal
Court
of
Canada,
Trial
Division
Rothstein
J.
dismissed
the
appeal
from
the
decision
of
the
Tax
Court
on
the
grounds
that
s.
56(2)
was
not
designed
to
prevent
income
splitting
in
the
context
of
the
director-shareholder
relationship.
He
first
considered
whether
Ruby
Neuman,
in
declaring
the
dividend,
was
acting
under
the
direction
or
with
the
concurrence
of
the
appellant.
Rothstein
J.
said
he
was
“reluctant
to
presume
that
Ruby
Neuman
was
acting
pursuant
to
the
direction
of,
or
with
the
concurrence
of,
the
[appellant]
when
she,
as
director,
declared
dividends
on
behalf
of
Melru”
(p.
162).
Although
this
would
determine
l:he
appeal,
this
point
was
not
pressed
by
the
parties,
and
Rothstein
J.
did
not
decide
the
case
on
this
point.
Rothstein
J.
went
on
to
consider
this
Court’s
holding
in
McClurg-,
the
McClurg
decision
was
critical
to
the
outcome
of
the
case
at
bar
since
the
only
material
difference
between
the
facts,
in
Rothstein
J.’s
view,
is
that
Ruby
Neuman
made
no
contribution
to
Melru
while
Wilma
McClurg
did
make
contributions
to
the
corporation
from
which
she
received
dividend
income.
Applying
McClurg,
Rothstein
J.
concluded
that
the
declaration
of
dividends
pursuant
to
the
discretionary
dividend
clause
was
valid
and
he
then
went
on
to
consider
the
tax
law
issue.
Rothstein
J.
noted
that
in
McClurg
Dickson
C.J.
recognized
two
prerequisites
to
the
application
of
s.
56(2):
that
the
dividend
income
would
otherwise
have
been
obtained
by
the
reassessed
taxpayer,
and
that
the
payment
must
be
a
“benefit”
for
which
there
was
no
adequate
consideration.
Dickson
C.J.
concluded
that
s.
56(2)
did
not
generally
apply
to
dividends
since
the
reassessed
taxpayer
would
not
have
received
the
money
if
it
had
not
been
paid
to
the
shareholder
because
it
would
have
been
retained
as
earnings
by
the
company.
Dickson
C.J.
also
concluded
that,
on
the
facts
in
McClurg,
the
dividend
income
received
by
Wilma
McClurg
was
consideration
for
the
significant
contribution
which
she
made
to
the
corporation;
the
dividend
received
by
her
was
not,
therefore,
a
“benefit”.
Rothstein
J.
concluded
that
Dickson
C.J.
had
not
intended
to
dispose
of
the
McClurg
case
on
the
basis
of
Wilma
McClurg’s
contributions
to
the
corporation;
rather,
his
comments
about
her
contributions
were
intended
to
address
the
third
precondition
to
the
application
of
s.
56(2)
articulated
in
the
provision
itself,
i.e.,
was
the
money
“for
the
benefit
of
the
taxpayer
or
as
a
benefit
that
the
taxpayer
desired
to
have
conferred
on
the
other
person”?
Rothstein
J.
proceeded
to
consider
Dickson
C.J.’s
suggested
exception
to
the
general
rule
that
s.
56(2)
does
not
apply
to
dividend
income.
Rothstein
J.
recognized
that
this
Court
did
not
determine
in
McClurg
whether
a
distinction
can
be
made
between
non-arm’s
length
and
arm’s
length
transactions
because
in
McClurg
the
recipient
of
the
dividend
made
a
legitimate
contribution
to
the
company;
therefore
the
dividend
did
not
constitute
a
benefit
to
Wilma
McClurg
and
s.
56(2)
could
not
apply
for
that
reason.
The
problem
faced
by
Rothstein
J.
was
whether,
on
the
facts
before
him,
where
Ruby
Neuman
had
made
no
contribution
to
the
company
and
the
receipt
of
the
dividend
was
thus
a
“benefit”
to
her,
a
distinction
must
be
drawn
between
non-arm’s
length
and
arm’s
length
transactions.
He
concluded,
relying
on
Urie
J.’s
ruling
in
the
Federal
Court
of
Appeal
in
McClurg
v.
Minister
of
National
Revenue
(1987),
[1988]
2
F.C.
356
(Fed.
C.A.)
(which
ruling
had
not
been
overturned
by
the
reasons
of
Dickson
C.J.),
that
there
is
nothing
in
s.
56(2)
which
contemplates
a
distinction
between
non-arm’s
length
and
arm’s
length
transactions.
Rothstein
J.
noted
that
this
Court
found,
in
more
general
terms,
that
there
was
no
distinction
between
arm’s
length
and
non-arm’s
length
transactions
(Stubart
Investments
Ltd.
v.
R.,
[1984]
1
S.C.R.
536
(S.C.C.)).
Having
found
that
a
distinction
cannot
be
drawn
between
non-arm’s
length
and
arm’s
length
transactions
in
the
application
of
s.
56(2),
Rothstein
J.
decided
that
he
need
not
consider
whether
a
dividend
payment
is
a
benefit
for
the
purposes
of
s.
56(2)
where
the
recipient
did
not
make
a
contribution
to
the
corporation.
Rothstein
J.
noted
that
there
is
nothing
in
the
ITA
which
suggests
an
overall
intention
to
prevent
income
splitting;
an
income
splitting
transaction
must
actually
violate
a
section
of
the
/7A
in
order
for
the
Minister
to
challenge
it.
In
the
absence
of
sham,
and
with
all
corporate
formalities
having
been
observed,
Rothstein
J.
held
that
the
transaction
was
valid
and
he
dismissed
the
appeal.
C.
Federal
Court
of
Appeal
The
Federal
Court
of
Appeal
allowed
the
respondent’s
appeal
and
held
that
the
appellant
was
taxable
on
the
dividend
income
received
by
Ruby
Neuman.
The
court
held
that
the
dictum
of
Dickson
C.J.
in
McClurg
regarding
the
possible
application
of
s.
56(2)
in
non-arm’s
length
transactions
was
binding
on
the
Trial
Division.
The
court
relied,
in
reaching
its
conclusion,
on
the
fact
that
the
incorporation
of
Melru
and
the
declaration
of
the
dividend
to
Ruby
Neuman
had
no
bona
fide
business
purpose
and
lacked
commercial
reality.
In
reaching
its
conclusion,
the
court
essentially
pierced
the
corporate
veil.
The
court
was
of
the
view
that
the
respondent
had
satisfied
the
four
elements
necessary
to
invoke
s.
56(2):
(1)
payment
or
transfer
made
to
a
person
other
than
the
taxpayer;
(2)
made
at
the
direction
of
or
with
the
concurrence
of
the
taxpayer;
(3)
for
the
taxpayer’s
benefit;
and
(4)
the
payment
would
have
otherwise
been
included
in
the
taxpayer’s
income.
More
specifically,
the
court
found
that
Ruby
Neuman
was
acting
with
the
concurrence
of
the
appellant
when
she
declared
the
dividends.
The
court
also
held
that
the
payment
of
the
dividend
was
“for
the
benefit
of
the
taxpayer”
as
required
by
s.
56(2).
The
appellant
benefited
through
a
reduction
in
his
own
tax
liability;
he
benefited
a
second
time
by
having
his
wife
lend
him
the
money
interest-free.
In
addition,
the
court
found
that
the
property
would
have
been
included
in
the
appellant’s
income
had
it
been
received
by
him
and
not
Ruby
Neuman
by
operation
of
ss.
12(1
)(/)
and
82(1)
of
the
ITA.
Next
the
court
had
to
deal
with
this
Court’s
ruling
in
McClurg
that
s.
56(2)
does
not
generally
apply
to
dividend
income
because
the
reassessed
taxpayer
would
not
have
received
that
money
had
it
not
been
paid
to
the
shareholder.
In
order
to
overcome
that
general
rule,
the
court
invoked
the
exception
to
the
rule
recognized
by
Dickson
C.J.
in
obiter
in
McClurg:
that
where
a
non-arm’s
length
shareholder
does
not
make
a
legitimate
contribution
to
the
corporation,
a
person
who
directed
or
concurred
in
the
payment
of
a
dividend
to
that
shareholder
could
be
assessed
for
taxes
on
the
amount
of
the
dividend
under
s.
56(2).
The
court
concluded
(at
p.
Ill)
that
the
recognition
by
Dickson
C.J.
of
this
possible
exception
to
the
rule
is
binding
on
courts
as
it
represents
the
“considered
opinion
of
a
majority”
of
the
Supreme
Court
of
Canada.
The
court
then
found
that
the
facts
before
them
Fit
within
the
exception
detailed
in
McClurg.
Unlike
Wilma
McClurg,
Ruby
Neuman
had
made
no
contribution
to
Melru,
a
company
which
was
incorporated
solely
for
tax
planning
and
income
splitting
purposes.
The
court
found
that
applying
s.
56(2)
“would
not
be
contrary
to
the
commercial
reality
of
the
declaration
of
the
dividend
to
Ruby
Neuman,
since
there
was
none”
(p.
105).
The
appellant
argued
that
the
court
should
apply
Outerbridge
Estate
v.
Canada
(1990),
[1991]
1
F.C.
585
(Fed.
C.A.),
which
stands
for
the
proposition
that
there
is
a
fifth
precondition
to
the
application
of
s.
56(2)
which
requires
proof
that
the
payee
would
not
be
subject
to
tax
on
the
dividend
income.
The
court
declined
to
find
that
there
was
a
fifth
precondition
to
the
application
of
s.56(2).
As
a
result,
the
Federal
Court
of
Appeal
allowed
the
appeal
and
affirmed
the
Minister’s
assessment
attributing
the
dividend
income
received
by
Ruby
Neuman
to
the
appellant.
3.
Issues
The
central
question
raised
by
this
appeal
is
whether
the
dividend
income
received
by
Ruby
Neuman
should
be
attributed
to
the
appellant
for
tax
purposes
under
s.
56(2)
of
the
ITA.
Section
56(2)
provides:
56...
(2)
A
payment
or
transfer
of
property
made
pursuant
to
the
direction
of,
or
with
the
concurrence
of,
a
taxpayer
to
some
other
person
for
the
benefit
of
the
taxpayer
or
as
a
benefit
that
the
taxpayer
desired
to
have
conferred
on
the
other
person
shall
be
included
in
computing
the
taxpayer’s
income
to
the
extent
that
it
would
be
if
the
payment
or
transfer
had
been
made
to
him.
In
order
for
s.
56(2)
to
apply,
four
preconditions,
each
of
which
is
detailed
in
the
language
of
the
s.
56(2)
itself,
must
be
present:
(1)
the
payment
must
be
to
a
person
other
than
the
reassessed
taxpayer;
(2)
the
allocation
must
be
at
the
direction
or
with
the
concurrence
of
the
reassessed
taxpayer;
(3)
the
payment
must
be
for
the
benefit
of
the
reassessed
taxpayer
or
for
the
benefit
of
another
person
whom
the
reassessed
taxpayer
wished
to
benefit;
and
(4)
the
payment
would
have
been
included
in
the
reassessed
taxpayer’s
income
if
it
had
been
received
by
him
or
her.
I
agree
that
these
four
prerequisites
to
attribution
are
an
appropriate
analytical
framework
for
the
interpretation
of
s.
56(2)
(see
Cattanach
J.
in
both
Murphy
v.
R.
(1980),
80
D.T.C.
6314
(Fed.
T.D.),
at
pp.
6317-18,
and
in
Fraser
Cos.
v.
R.
(1981),
81
D.T.C.
5051
(Fed.
T.D.),
at
p.
5058).
Because
I
conclude
that
s.
56(2)
does
not
apply
to
dividend
income
since
dividend
income,
by
its
very
nature,
cannot
satisfy
the
fourth
precondition
absent
a
sham
or
other
subterfuge,
it
is
not
necessary
to
discuss
the
other
three
prerequisites
to
the
application
of
s.
56(2).
4.
Analysis
A.
Introduction.
As
the
judicial
history
of
this
appeal
reveals,
the
interpretation
of
this
Court’s
majority
decision
in
McClurg
lies
at
the
heart
of
the
present
case.
This
Court
held
in
McClurg
that
generally
s.
56(2)
will
not
apply
to
dividend
income.
However,
Dickson
C.J.
suggested
in
obiter
in
McClurg
that
s.
56(2)
may
apply
where
dividend
income
is
distributed
through
the
exercise
of
a
discretionary
power
to
a
non-arm’s
length
shareholder
who
has
made
no
legitimate
contribution
to
the
company
(at
p.
1054).
The
Federal
Court
of
Appeal
felt
bound
by
the
potential
exception
articulated
by
Dickson
C.J.
in
obiter
since
the
facts
in
the
present
case
were
similar
to
the
facts
in
Me-
Clurg
with
the
only
material
difference
being
that
Ruby
Neuman,
unlike
Wilma
McClurg.,
had
not
made
any
contribution
to
the
corporation.
A
large
part
of
my
analysis
will
involve
a
review
of
the
holdings
in
McClurg.
Before
I
turn
to
McClurg,
however,
I
wish
to
make
some
observations
to
place
the
present
debate
into
its
proper
perspective.
First,
s.
56(2)
strives
to
prevent
tax
avoidance
through
income
splitting;
however,
it
is
a
specific
tax
avoidance
provision
and
not
a
general
provision
against
income
splitting.
In
fact,
“there
is
no
general
scheme
to
prevent
income
splitting”
in
the
ITA
(V.
Krishna
and
J.
A.
VanDuzer,
“Corporate
Share
Capital
Structures
and
Income
Splitting:
McClurg
v.
Canada”
(1992-93),
21
Can.
Bus.
L.J.
335,
at
p.
367).
Section
56(2)
can
only
operate
to
prevent
income
splitting
where
the
four
preconditions
lo
its
application
are
specifically
met.
Second,
this
case
concerns
income
received
by
Ruby
Neuman
during
the
1982
taxation
year
at
which
time
the
ITA
did
not
provide
specific
guidelines
to
deal
with
corporate
structures
designed
for
the
purposes
of
income
splitting
and
tax
minimization.
Professor
V.
Krishna,
in
an
article
entitled
“Share
Capital
Structure
of
Closely-Held
Private
Corporations”
(1996),
7
Can.
Curr.
Tax.
7,
at
p.
9,
made
the
following
comment
with
respect
to
income
splitting
in
the
corporate
context:
Except
when
specifically
curtailed
by
the
Income
Tax
Act
(for
example,
by
the
attribution
rules),
income
splitting
per
se
is
not
a
sanctioned
arrangement.
Thus,
corporate
structures
that
facilitate
income
splitting
in
private
companies
should
not
be
penalized
without
clear
statutory
language
and
intent.
[Emphasis
added.]
Parliament
has
since
fashioned
legislation
to
regulate
corporate
income
splitting
(s.
74.4
of
the
ITA,
introduced
in
1985),
but
this
legislation
does
not
apply
to
the
present
appeal.
Third,
this
appeal
is
limited
to
the
interpretation
and
application
of
s.
56(2)
of
the
/TA;
the
appeal
is
not
based
on
the
general
anti-avoidance
rule
set
out
in
s.
245
of
the
ITA
(“GAAR”).
GAAR
came
into
force
on
September
13,1988
and
it
applies
only
to
transactions
entered
into
on
or
after
that
date.
Fourth,
the
respondent
has
not
argued
that
the
appellant
was
involved
in
a
sham
or
an
artificial
transaction
and
this
was
acknowledged
by
counsel
for
the
respondent
during
the
hearing.
Finally,
it
is
important
to
remember
that
this
Court
held
unanimously
in
Stubart,
supra,
at
p.
575,
that
a
transaction
should
not
be
disregarded
for
tax
purposes
because
it
has
no
independent
or
bona
fide
business
purpose
(Estey
J.
wrote
for
himself
and
Beetz
and
McIntyre
JJ,;
Wilson
J.
wrote
concurring
reasons
for
herself
and
Ritchie
J.).
Thus,
taxpayers
can
arrange
their
affairs
in
a
particular
way
for
the
sole
purpose
of
deliberately
availing
themselves
of
tax
reduction
devices
in
the
/TA.
Estey
J.
rejected
the
suggestion
that
a
distinction
must
be
drawn
between
non-arm’s
length
and
arm’s
length
transactions
in
the
application
of
this
principle
(at
pp.
570-72).
According
to
Stubart,
therefore,
non-arm’s
length
arrangements
can
also
be
created
for
the
sole
purpose
of
taking
advantage
of
tax
reduction
devices.
With
these
points
in
mind,
I
now
turn
to
the
decision
of
the
Court
in
McClurg.
B.
McClurg
McClurg
involved
a
taxpayer
and
business
associate
who
were
the
sole
directors
of
a
corporation
which
they
had
set
up
and
in
which
they
and
their
wives
were
shareholders.
The
corporation
operated
an
International
Harvester
truck
dealership.
The
capital
structure
of
the
corporation
provided
for
three
classes
of
shares
with
different
rights
and
privileges:
Class
A
shares
were
common,
voting
and
participating
shares;
Class
B
shares
were
common,
non-voting
and
participating
where
so
authorized
by
the
directors;
and
Class
C
shares
were
preferred
non-voting
shares.
The
dividends
were
to
be
declared
at
the
sole
discretion
of
the
directors;
distributions
could
be
done
selectively
among
the
three
classes
of
shares.
Essentially,
the
capital
structure
was
designed
to
permit
income
splitting.
Jim
McClurg
and
his
associate
held
class
A
and
C
shares
whereas
their
wives
held
class
B
shares.
In
1978,
1979,
and
1980
the
wives
of
the
directors
each
received
$100/share
on
their
Class
B
shares:
$
10,000/year.
These
were
the
only
dividends
declared
in
those
years.
Wilma
McClurg
made
legitimate
contributions
to
the
business.
She
exposed
herself
to
extensive
liability
by
assisting
in
the
financing
of
the
business.
She
also
worked
as
an
administrative
assistant,
drove
a
truck
when
necessary,
and
generally
fulfilled
needs
as
they
arose.
The
Minister
reassessed
Jim
McClurg’s
income
for
1978
to
1980
on
the
basis
that
$8000
of
the
$10,000
in
dividends
paid
to
his
wife
each
year
was
attributable
to
him
through
the
operation
of
s.
56(2).
The
Minister
also
challenged
the
validity
of
the
discretionary
dividend
provision.
(i)
The
ratio
in
McClurg.
Dickson
C.J.,
writing
for
himself
and
Sopinka,
Gonthier
and
Cory
JJ.
(Wilson,
La
Forest
and
L’
Heureux-Dube
J
J.
in
dissent)
first:
dealt
with
the
issue
of
whether
the
discretionary
dividend
provision
was
valid
as
a
matter
of
corporate
law;
he
concluded
that
it
was.
He
then
turned
to
the
tax
issue
and
he
held
that
the
dividend
income
paid
to
Wilma
McClurg
was
not
attributable
to
her
husband
for
income
tax
purposes
through
the
operation
of
s.
56(2).
This
Court
concluded
that,
as
a
general
rule.
s.
56(2)
does
not
apply
to
dividend
income
since,
until
a
dividend
is
declared,
the
profits
belong
to
the
corporation
as
retained
earnings.
The
declaration
of
a
dividend
cannot
be
said,
therefore,
to
be
a
diversion
of
a
benefit
which
the
taxpayer
would
have
otherwise
received
(at
p.
1052).
Dickson
C.J.
explained
the
ruling
as
follows
(at
p.
1052):
While
it
is
always
open
to
the
courts
to
“pierce
the
corporate
veil”
in
order
to
prevent
parties
from
benefitting
from
increasingly
complex
and
intricate
tax
avoidance
techniques,
in
my
view
a
dividend
payment
does
not
fall
within
the
scope
of
s.
56(2).
The
purpose
of
s.
56(2)
is
to
ensure
that
payments
which
otherwise
would
have
been
received
by
the
taxpayer
are
not
diverted
to
a
third
party
as
an
anti-avoidance
technique.
This
purpose
is
not
frustrated
because,
in
the
corporate
law
context,
until
a
dividend
is
declared,
the
profits
belong
to
a
corporation
as
a
juridical
person:
[B.
Welling,
Corporate
Law
in
Canada
(1984),
at
pp.
609-10].
Had
a
dividend
not
been
declared
and
paid
to
a
third
party,
it
would
not
otherwise
have
been
received
by
the
taxpayer.
Rather,
the
amount
simply
would
have
been
retained
as
earnings
by
the
company.
Consequently,
as
a
general
rule,
a
dividend
payment
cannot
reasonably
be
considered
a
benefit
diverted
from
a
taxpayer
to
a
third
party
within
the
contemplation
of
s.
56(2).
[Emphasis
added.]
Although
not
explicitly
stated,
Dickson
C.J.’s
preceding
comments
concern
the
fourth
precondition
to
the
application
of
s.
56(2):
that
the
payment
would
have
been
included
in
the
reassessed
taxpayer’s
income
if
it
had
been
received
by
him
or
her.
In
essence,
dividend
income
does
not
satisfy
this
prerequisite
to
attribution
since
the
reassessed
taxpayer
would
not
have
received
the
income
had
it
not
been
paid
to
the
shareholder.
In
effect,
this
Court
implicitly
interpreted
the
fourth
precondition
to
include
an
entitlement
requirement;
entitlement
is
used
in
the
sense
that
the
reassessed
taxpayer
would
have
otherwise
received
the
payments
in
dispute.
This
was
correctly
noted
by
Rothstein
J.
at
the
Federal
Court,
Trial
Division
in
similar
terms
where
he
acknowledged
that
Dickson
C.J.C.
qualified
the
application
of
s.
56(2)
by
requiring
that
the
payment
in
issue
“would
otherwise
have
been
obtained
by
the
reassessed
taxpayer”
(p.
164).
An
entitlement
requirement
in
the
sense
I
have
described
is
consistent
with
the
stated
purpose
of
s.
56(2),
which
is
to
capture
and
attribute
to
the
reassessed
taxpayer
“receipts
which
he
or
she
otherwise
would
have
obtained”
(McClurg,
at
p.
1051).
Dividend
income
cannot
pass
the
fourth
test
because
the
dividend,
if
not
paid
to
a
shareholder,
remains
with
the
corporation
as
retained
earnings;
the
reassessed
taxpayer,
as
either
director
or
shareholder
of
the
corporation,
has
no
entitlement
to
the
money.
This
is
the
only
interpretation
which
makes
sense
and
which
avoids
absurdity
in
the
application
of
s.
56(2),
as
noted
by
Dickson
C.J.
(alp.
1053):
...but
for
the
declaration
(and
allocation),
the
dividend
would
remain
part
of
the
retained
earnings
of
the
company.
That
cannot
legitimately
be
considered
as
within
the
parameters
of
the
legislative
intent
of
s.
56(2).
If
this
Court
were
to
find
otherwise,
corporate
directors
potentially
could
be
found
liable
for
the
tax
consequences
of
any
declaration
of
dividends
made
to
a
third
party....this
would
be
an
unrealistic
interpretation
of
the
subsection
consistent
with
neither
its
object
nor
its
spirit.
It
would
violate
fundamental
principles
of
corporate
law
and
the
realities
of
commercial
practice
and
would
“overshoot”
the
legislative
purpose
of
the
section.
I
note
that
the
decision
in
Outerbridge
Estate,
supra,
which
was
rendered
shortly
before
this
Court’s
ruling
in
McClurg,
appears
to
challenge
the
view
that
where
a
taxpayer
is
not
entitled
to
a
payment
that
payment
cannot
be
attributed
to
him
or
her
under
s.
56(2).
Outerbridge
Estate,
however,
did
not
involve
the
attribution
of
dividend
income.
In
Outerbridge
Estate,
the
majority
shareholder
in
an
investment
company
caused
the
corporation
to
sell
some
of
its
shares
to
his
son-in-law,
who
was
also
a
shareholder
in
the
corporation,
for
a
price
of
$100
per
share.
The
Minister
calculated
the
fair
market
value
of
the
shares
at
approximately
$1,000
per
share
and
reassessed
the
majority
shareholder
under
s.
56(2)
by
adding
as
income
the
difference
between
what
the
son-in-law
paid
for
the
shares
and
their
market
value.
Marceau
J.A.,
writing
for
the
court,
held
that
the
fact
that
the
taxpayer
had
no
direct
entitlement
to
the
shares
did
not
preclude
attribution
since
there
was
no
indication
that
s.
56(2)
was
intended
to
be
so
confined.
Marceau
J.A.
concluded
(at
p.
593)
that:
[w]hen
the
doctrine
of
“constructive
receipt”
is
not
clearly
involved,
because
the
taxpayer
had
no
entitlement
to
the
payment
being
made
or
the
property
being
transferred,
it
is
fair
to
infer
that
subsection
56(2)
may
receive
application
only
if
the
benefit
conferred
is
not
directly
taxable
in
the
hands
of
the
transferee.
[Emphasis
added.]
Marceau
J.A.
distinguished
the
Federal
Court
of
Appeal’s
ruling
in
McClurg
where
Urie
J.
held
that
s.
56(2)
does
not
apply
to
dividend
income,
which
holding
was
affirmed
by
this
Court,
as
follows
(at
pp.
591-92):
[t]he
McClurg
decision
was
concerned
with
a
declaration
of
dividend
in
accordance
(in
the
views
of
the
majority)
with
the
powers
conferred
by
the
share
structure
of
the
corporation)
and
I
do
not
see
it
as
having
authority
beyond
the
particular
type
of
situation
with
which
it
was
dealing.
I
agree
with
Marceau
J.A.:
Outerbridge
Estate
concerned
the
conferral
of
a
benefit
which
was
not
in
the
form
of
dividend
income.
The
application
of
s.
56(2)
to
non-dividend
income
was
not
before
this
Court
in
McClurg
and
it
is
not
before
this
Court
in
the
present
case.
But
the
entitlement
requirement
implicitly
read
into
the
fourth
precondition
of
s.
56(2)
in
McClurg
clearly
applies
to
dividend
income.
I
conclude
that,
unless
a
reassessed
taxpayer
had
a
preexisting
entitlement
to
the
dividend
income
paid
to
the
shareholder
of
a
corporation,
the
fourth
precondition
cannot
be
satisfied
and
consequently
s.
56(2)
cannot
operate
to
attribute
the
dividend
income
to
that
taxpayer
for
income
tax
purposes.
(ii)
The
obiter
dicta
in
McClurg
and
the
exception
to
the
general
rule.
The
finding
that
dividend
income
cannot
satisfy
the
fourth
precondition
to
the
application
of
s.
56(2),
as
modified
by
the
implicit
entitlement
requirement,
was
dispositive
of
the
McClurg
case.
La
Forest
J.
agreed
with
the
majority’s
conclusion
that
bona
fide
dividend
income
does
not
fall
within
the
scope
of
s.
56(2).
However,
he
dissented
on
the
finding
under
corporate
law
that
the
discretionary
dividend
clause
was
valid;
therefore
the
dividend
income
at
issue
in
McClurg
was
not,
in
his
view,
bona
fide
and
s.
56(2)
applied
(see
p.
1073).
Despite
these
conclusions,
Dickson
C.J.
went
on
to
consider
the
third
precondition,
that
the
payment
must
be
for
the
benefit
of
the
reassessed
taxpayer
or
for
the
benefit
of
another
person
whom
the
reassessed
taxpayer
wished
to
benefit,
and
in
so
doing,
he
qualified
his
earlier
interpretation
of
the
fourth
precondition.
In
his
view,
Wilma
McClurg’s
receipt
of
the
funds
was
not
a
“benefit”
as
required
by
s.
56(2)
(the
third
precondition)
since
her
contributions
to
the
corporate
enterprise
could
be
described
as
a
“legitimate
quid
pro
quo
and
were
not
simply
an
attempt
to
avoid
the
payment
of
taxes”
(p.
1054).
Since
Wilma
McClurg
had
made
legitimate
contributions
to
the
corporation,
the
application
of
s.
56(2)
“would
be
contrary
to
the
commercial
reality
of
this
particular
transaction”
(
p.
1053).
Dickson
C.J.
seemed
to
be
of
the
view
that
the
character
of
a
shareholder’s
dividend
income
is
to
be
determined
by
that
shareholder’s
level
of
contribution
to
the
corporation.
This
approach
ignores
the
fundamental
nature
of
dividends;
a
dividend
is
a
payment
which
is
related
by
way
of
entitlement
to
one’s
capital
or
share
interest
in
the
corporation
and
not
to
any
other
consideration.
Thus,
the
quantum
of
one’s
contribution
to
a
company,
and
any
dividends
received
from
that
corporation,
are
mutually
independent
of
one
another.
La
Forest
J.
made
the
same
observation
in
his
dissenting
reasons
in
McClurg(at
p.
1073):
With
respect,
this
fact
is
irrelevant
to
the
issue
before
us.
To
relate
dividend
receipts
to
the
amount
of
effort
expended
by
the
recipient
on
behalf
of
the
payor
corporation
is
to
misconstrue
the
nature
of
a
dividend.
As
discussed
earlier,
a
dividend
is
received
by
virtue
of
ownership
of
thecapital
stock
of
a
corporation.
It
is
a
fundamental
principle
of
corporate
law
that
a
dividend
is
a
return
on
capital
which
attaches
to
a
share,
and
is
in
no
way
dependent
on
the
conduct
of
a
particular
shareholder.
[Emphasis
added].
Dickson
C.J.’s
finding
that
Wilma
McClurg’s
contributions
to
the
corporation
resulted
in
the
dividend
being
consideration
for
her
efforts
rather
than
a
“benefit”
as
required
by
s.
56(2)
opened
the
door
to
his
obiter
comments
which
have
led
to
some
confusion
(at
p.
1054):
In
my
opinion,
if
a
distinction
is
to
be
drawn
in
the
application
of
s.
56(2)
between
arm’s
length
and
non-arm’s
length
transactions,
it
should
be
made
between
the
exercise
of
a
discretionary
power
to
distribute
dividends
when
the
non-arm’s
length
shareholder
has
made
no
contribution
to
the
company
(in
which
case
s.
56(2)
may
be
applicable),
and
those
cases
in
which
a
legitimate
contribution
has
been
made.
Dickson
C.J.
is
suggesting,
it
would
seem,
that
where
a
non-arm’s
length
shareholder
receives
a
dividend
from
a
corporation
to
which
he
or
she
has
made
no
contribution
(the
dividend
income
therefore
constituting
a
“benefit”
for
the
purposes
of
s.
56(2)
in
Dickson
C.J.’s
view),
precondition
four,
interpreted
by
him
to
include
an
entitlement
requirement,
is
automatically
considered
satisfied,
or
need
not
be
satisfied,
with
the
result
that
s.
56(2)
applies.
In
my
view,
it
is
wrong
to
suggest
that
there
may
be
an
exception
to
the
rule
that
s.
56(2)
does
not
apply
to
dividend
income
where
the
recipient
of
the
dividend
income
in
a
non-arm’s
length
transaction
has
not
made
a
“legitimate
contribution”
to
the
corporation.
In
so
stating,
I
assume,
of
course,
that
proper
consideration
was
given
for
the
shares
when
issued.
I
am
not
aware
of
any
principle
of
corporate
law
that
requires
in
addition
that
a
so-
called
“legitimate
contribution”
be
made
by
a
shareholder
to
entitle
him
or
her
to
dividend
income
and
it
is
well
accepted
that
tax
law
embraces
corporate
law
principles
unless
such
principles
are
specifically
set
aside
by
the
taxing
statute.
Furthermore,
there
is
no
principled
basis
upon
which
this
distinction
can
be
drawn;
the
fact
that
a
company
is
closely
held
or
that
no
contribution
is
made
to
the
company
by
a
shareholder
benefiting
from
a
dividend
in
no
way
changes
the
underlying
nature
of
a
dividend.
Neither
the
fact
that
the
transaction
is
non-arm’s
length
nor
the
fact
that
the
shareholder
has
not
contributed
to
the
corporation
serves
to
overcome
the
conclusion
that
dividend
income
cannot
satisfy
the
fourth
precondition
to
attribution
under
s.
56(2).
Moreover,
the
obiter
comments
raise
the
difficult
task
of
determining
what
constitutes
a
legitimate
contribution.
What
will
be
the
criteria
upon
which
one
can
ascertain
with
any
degree
of
precision
or
certainty
that
a
contribution
is
legitimate?
Finally,
the
requirement
of
a
legitimate
contribution
is
in
some
ways
an
attempt
to
invite
a
review
of
the
transactions
in
issue
in
accordance
with
the
doctrines
of
sham
or
artificiality.
Implicit
in
the
distinction
between
nonarm’s
length
and
arm’s
length
transactions
is
the
assumption
that
non-arm’s
length
transactions
lend
themselves
to
the
creation
of
corporate
structures
which
exist
for
the
sole
purpose
of
avoiding
tax
and
therefore
should
be
caught
by
s.
56(2).
However,
as
mentioned
above,
taxpayers
are
entitled
to
arrange
their
affairs
for
the
sole
purpose
of
achieving
a
favourable
position
regarding
taxation
and
no
distinction
is
to
be
made
in
the
application
of
this
principle
between
arm’s
length
and
non-arm’s
length
transactions
(see
Stubart,
supra).
The
ITA
has
many
specific
anti-avoidance
provisions
and
rules
governing
the
treatment
of
non-arm’s
length
transactions.
We
should
not
be
quick
to
embellish
the
provision
at
issue
here
when
it
is
open
for
the
legislator
to
be
precise
and
specific
with
respect
to
any
mischief
to
be
avoided.
To
summarize,
it
is
inappropriate
to
consider
the
contributions
of
a
shareholder
to
a
corporation
when
determining
whether
s.
56(2)
applies.
Dividends
are
paid
to
shareholders
as
a
return
on
their
investment
in
the
corporation.
Since
the
distribution
of
the
dividend
is
not
determined
by
the
quantum
of
a
shareholder’s
contribution
to
the
corporation,
it
would
be
illogical
to
use
contribution
as
the
criterion
that
determines
when
dividend
income
will
be
subject
to
s.
56(2).
The
same
principles
apply
in
the
context
of
both
non-arm’s
length
relationships
such
as
often
exist
between
small
closely
held
corporations
and
their
shareholders,
and
arm’s
length
relationships
such
as
exist
between
publicly
held
corporations
and
their
shareholders.
5.
Conclusion
For
the
foregoing
reasons,
s.
56(2)
does
not
apply
to
the
dividend
income
received
by
Ruby
Neuman.
The
appeal
is
therefore
allowed,
the
decision
of
the
Federal
Court
of
Appeal
is
reversed,
and
that
portion
of
the
respondent’s
assessment
which
attributes
the
dividend
income
received
by
Ruby
Neuman
to
the
appellant
is
set
aside
with
costs
throughout.
Appeal
allowed.