Date: 19981124
Dockets: 97-1791-IT-G; 97-1793-IT-G
BETWEEN:
PETER J. SPEER, CRAIG G. BUSHELL,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
O'Connor, J.T.C.C.
[1] These appeals were heard on common evidence in Vancouver,
British Columbia, on October 26 and 27, 1998.
[2] Several witnesses were heard and numerous exhibits were
filed.
[3] The main issue is whether the Minister was correct in
assessing as fee income certain dividends which had been received
by Peter Speer in 1987 and by Craig Bushell's wife in
1988 on the ground that the amounts paid effectively represented
fees earned by Coopers & Lybrand ("Coopers"), of
which the two Appellants were Vancouver partners. There are
ancillary issues, namely, whether the Minister was statute barred
in reassessing; whether the Minister can raise the issue of
"sham" only at the late date of the Replies to the
Notices of Appeal when the original assessment was based solely
on subsection 56(2) of the Income Tax Act
("Act"); and whether the Minister can assess fee
income in 1989 in the exact same amounts as dividends which had
been reported and assessed as dividends in 1987 for
Mr. Speer and 1988 for Mrs. Bushell, there having been no
reassessments of either of them in respect of the said
dividends.
Background
[4] As these appeals revolve around the concept of
"refundable dividend tax on hand", I refer to the
following extracts from CCH Canadian Limited Reports, Vol. 4, p.
19039 et seq., which explain that concept.
One of the principles underlying the Income Tax Act is
the concept that integration should be achieved when most types
of income are received by a private corporation and then passed
on to an individual shareholder. Integration is achieved when the
total of tax payable by the private corporation and the resident
individual shareholder is the same as the tax that would have
been payable had the shareholder received the income directly.
The mechanics of achieving this result require four stages:
(1) a corporation is taxed on all types of investment income
(except dividends in certain situations);
(2) a portion of the tax paid by the corporation is refunded
under section 129 when it pays a dividend, to produce a net
effective tax rate on its investment income;
(3) the dividend is "grossed-up" in the hands of a
resident individual shareholder under subsection 82(1) to reflect
the premise that the corporation's tax on investment income
has been paid on the shareholder's behalf; and
(4) the shareholder is allowed to deduct a dividend tax credit
under section 121 to reflect the tax notionally "paid"
by the corporation on the shareholder's behalf.
Some of the most important provisions of the Income Tax
Act directed toward achieving this integration are those
dealing with the calculation of the refund of refundable dividend
tax on hand contained in section 129. As described below, one of
the most important aspects of refundable dividend tax on hand and
accordingly, the benefits of integration, is restricted to
private corporations which are Canadian-controlled.
...
It should be noted that under the present law, refundable
dividend tax on hand is accumulated in respect of Canadian and
foreign investment income only if the corporation qualifies as a
Canadian-controlled private corporation throughout the years in
which the income is earned. A private corporation is defined in
subsection 89(1) to be a corporation resident in Canada that is
not a public corporation as defined in subsection 89(1) and which
is not controlled directly or indirectly by one or more public
corporations. Under subsection 125(7), a Canadian-controlled
private corporation is defined to be a private corporation that
is not controlled directly or indirectly by non-residents, public
corporations (other than a prescribed venture capital
corporation) or a combination thereof.
If a corporation qualifies as a private corporation it will be
subject to the 33 1/3% tax on portfolio dividends imposed under
section 186 but will be entitled to a refund of this tax. It may
also be entitled to a refund of a portion of the tax paid on its
other investment income.
...
Income, other than income from an active business, can be
divided into two basic categories: (i) portfolio dividends and
(ii) other income including taxable capital gains, income
from property and income from a "specified investment
business". ... Portfolio dividends are those dividends
received by a private corporation which are subject to tax under
Part IV and the full amount of this tax may be refunded to the
private corporation as a result of the payment of taxable
dividends. Apart from the tax under Part IV, dividends between
Canadian corporations generally flow free of tax. The refundable
tax imposed by Part IV is designed to prevent an undue deferral
of tax when portfolio dividends are received by a private
corporation rather than directly by an individual shareholder.
However, if the shareholder's marginal rate of tax on
dividends is more than 33 1/3%, the fact that the dividends are
received by a private corporation will result in some deferral of
tax as compared to a direct receipt of such dividends by the
shareholder. ...
Facts
[5] I find the most relevant facts to be as follows:
1. Coopers developed a plan with respect to refundable
dividend tax on hand (the "RDTOH Plan") whereby
companies with RDTOH balances could get tax refunds without
paying taxable dividends to existing shareholders.
2. Coopers in Vancouver facilitated such a transaction in
early 1987 and received fees for its work. It was decided to
expand the Plan later in 1987.
3. The Plan is best explained by quoting from Coopers'
memo of March 27, 1987 to All Tax Partners. That memo is at Tab 9
of Exhibit R-1 and reads as follows:
Date: March 27, 1987
To: All Tax Partners
From: Bruce Sinclair, Vancouver
Subject: GETTING A REFUND OF YOUR CLIENTS'
REFUNDABLE DIVIDEND TAX ON HAND
The Vancouver office has developed a plan that will be of
interest to private corporations having large RDTOH balances.
There is no requirement to pay taxable dividends to existing
shareholders. Interested private corporations will include
corporations that have realized large capital gains; corporations
that earn investment income in excess of the shareholders'
requirements for cash dividends; or corporations that have had
significant Part IV tax liabilities. In these circumstances, the
present value of the RDTOH may be low and the shareholders may
prefer entering into transactions today rather than waiting until
dividends would ultimately be paid in future years.
The transactions, which involve a client of the Vancouver
office, are designed to create a refund to the corporation of its
RDTOH for a relatively small cost – about 10% of the amount
of the tax refunded. The amount of this fee is such that it could
be recouped within a year or two by the private corporation
through re-investing the RDTOH refunded. The 50% increase in the
RDTOH of corporations on January 1, 1987 makes this type of
transaction more attractive than previously. Because of the fixed
costs associated with the plan, RDTOH of at least $150,000 -
$200,000 is required.
A brief outline of the essentials of the plan is attached.
The Vancouver office will bill our client for C & L services
provided and we propose to share the fee in the ratio of 70% to
the referring office and 30% to the Vancouver office.
Please call me if you have any clients that may be interested
in such a transaction and I will forward a document binder. We
will be asking anyone (including the clients' legal counsel)
outside the firm to sign secrecy agreements and we would request
that you contact the Vancouver office before discussing the plan
with specific parties. We will also attempt to centralize the
distribution of documents so as to preserve the value of this
plan.
"BRS"
BRS:de
cc: Bill Camden
David Steele
RDTOH PLAN
EXAMPLE – TO RECOVER $500,000 OF RDTOH
LOAN = $1,450,000
PREFERENCE SHARES
PUC = $1
REDEMPTION AMOUNT = $1,500,001
PURCHASE AMOUNT = $1,450,000
STEPS:
1. Subsidiary is newly incorporated for each transaction.
2. Shareholder lends $1,450,000 to Subsidiary, payable on
demand and secured by the preferred shares of Private Company
(see 3 below).
3. Subsidiary uses the proceeds of the loan to subscribe for
$1,450,000 of preferred shares of Private Company. The preferred
shares are non-voting and redeemable at the option of Private
Company. The paid-up capital is $1; the redemption amount is
$1,500,001. ...
4. When preferred shares are redeemed, a deemed dividend of
$1,500,000 arises in Private Company triggering a tax refund of
$1,500,000/3 = $500,000. The net cost to Private Company is
$1,500,001 - $1,450,000 = $50,001.
5. Subsidiary will receive the $1,500,000 deemed dividend free
of tax. Subsidiary has obtained independent legal advice to this
effect – Coopers & Lybrand will not opine since we have
acted as architects of the plan and stand to earn substantial
fees.
6. The issuance of high/low preference shares may cause some
difficulty for corporations incorporated federally or in certain
provinces. One solution might be continuation into B.C..
Undoubtedly other solutions exist. This problem will have to be
explored on a province by province basis.
...
4. The flow of dividends from the RDTOH companies down to the
subsidiaries of the public companies, then down to the public
companies, namely Pinetree Software Canada Ltd.
("Pinetree") and Eastern Mines Ltd. and to AH Three
Holdings Ltd. ("AH Three") and AG Fourteen
Holdings Ltd. ("AG Fourteen") and then from these last
two mentioned companies to their shareholders, namely Coopers
partners or investment vehicles of partners or family members of
partners or family trusts (collectively "Coopers
partners") is shown on the following diagram which is, with
minor corrections and clarifications, based on Schedule I to the
Replies to the Notice of Appeal. Although these two appeals only
relate to the amounts paid to Peter Speer and Mrs. Bushell, the
diagram, as well as the dividends paid, as detailed below, cover
all amounts paid to Coopers partners. This approach was adopted
by the Respondent because many other Coopers partners have been
assessed in the same manner as Peter Speer and Mrs.
Bushell.
RDTOH
Strip
Companies
$170,000 $226,859 $123,352 $1,308,578
Subsidiaries
of
Public
Companies
$62,500 $62,500 $141,500 $147,500
$340,000 $574,289 $80,000
$314,289
Not directly relevant to
these appeals
$15,630 $242,265 $90,979 $86,857
$194,508
$70,335 $60,022 $74,508
$58,584
Coopers Vancouver Non Tax Partners Coopers Vancouver Tax
Partners
5. The actual dividends paid to Peter J. Speer, to
Craig G. Bushell's wife and to other Coopers
partners is shown below and is based on Schedule III to the
Replies.
DIVIDENDS PAID
December 23, 1987 AG Fourteen Holdings Ltd. declared the
following taxable dividends:
Class A Common $60,000 C.L. Friesen, in Trust
Class B Common $80,700 Rodney B. Johnston
Class C Common $26,904 Yolande A. Proctor
Class C Common $26,904 S.C. Sinclair, in Trust
Total $194,508
December 23, 1987 AH Three holdings declared the following
taxable dividends:
Class A Common $15,630 Judith Bowles
Class D Common $15,630 W.J. Dawson Family Trust
Class E Common $15,630 June F. Fairchild
Class G Common $7,815 Hazel Halliday
Class H Common $7,815 Catriona Halliday
Class I Common $7,815 Maureen Fane
Class K Common $15,630 Pauline Kay
Class L Common $15,630 Doreen A. Lilley
Class M Common $15,630 M.A. Linsley Family Trust
Class P Common $15,630 Janet Paterson
Class R Common $15,630 M.G. Larsen
Class S Common $15,630 Donna M. Shultz
Class T Common $15,630 K. Powroznik, in Trust
Class V Common $7,815 Robert E. Sinclair
Class W Common $7,815 Susan M. Sinclair
Class X Common $15,630 P.J. Speer
Class Y Common $15,630 L. Marie Stanley
Class Z Common $15,630 Doris Wanless
Total $242,265
January 13, 1988 AG Fourteen Holdings Ltd. declared the
following taxable dividends;
Class A Common $20,700 C.L. Friesen, in Trust
Class C Common $26,904 Yolande Proctor
Class D Common $26,904 S.C. Sinclair, in Trust
Total $74,508
January 13, 1988 AH Three Holdings declared the following
dividends:
Class C Common $15,630 Liz Byrd
Class I Common $7,815 Maureen Fane
Class N Common $15,630 C.G. Bushell's
wife
Class O Common $15,630 300169 B.C. Ltd.
Class U Common $15,630 D.R. Eddy, in Trust
Total $70,335
March 31, 1988 AG Fourteen Holdings declared the following
taxable dividends:
Class A Common $1,200 C.L. Friesen, in Trust
Class B Common $1,200 Rodney B. Johnston
Class C Common $28,092 Yolande A. Proctor
Class D Common $28,092 S.C. Sinclair, in Trust
Total $58,584
6. The said March 27, 1987 memo refers to a cost to the RDTOH
companies of 10% of the tax refund (said 10% to be divided 50/50
between the subsidiaries of the public companies and Coopers).
The memo also refers to a split in the fees between the referring
office of Coopers and the Vancouver office, namely 70% for the
referring office and 30% for the Vancouver office. Further,
Coopers' letter to Pinetree dated May 4, 1987 (Tab 5 of
Exhibit R-1) which was agreed to by Pinetree, indicates a fee was
to be paid to Coopers.
7. From April 22, 1987 to May 26, 1987 Coopers wrote to RDTOH
companies outlining Coopers' involvement asking that the
transaction be completed in confidence and advising that the fees
earned by Coopers would be borne by the public companies or their
subsidiaries – see Tabs 25 to 29 of Exhibit R-1.
8. The RDTOH companies were advised that Coopers would be
receiving fees from the subsidiaries of the public companies,
said subsidiaries being AH Six Holdings Ltd. ("AH
Six"), Quinstar Developments Ltd. ("Quinstar") and
AG Nineteen Holdings Ltd. ("AG Nineteen"). These
subsidiaries were incorporated in April and May of 1987 and were
controlled by the public companies.
9. The amounts received by the subsidiaries matched the
amounts proposed to be charged as fees in the March 27, 1987
memo. For example, as stated in paragraph 4(bb) of the
Replies,
bb) On June 16, 1987, AH6 entered into an RDTOH transaction
involving the purchase of preferred shares for $7,330,000 which
were redeemed immediately after their purchase by the issuer
company G.R. Dawson Holdings Ltd. for an amount of $7,500,000
resulting in a net gain to AH6 (after legal expenses) of
$170,000.
Applying these figures to step 4 of the RDTOH Plan quoted
above on page 6, the deemed dividend in the Private Company is
$7,500,000, the tax refund is $7,500,000/3 = $2,500,000. The net
cost to the Private Company is $7,500,000 - $7,330,000 =
$170,000.
10. All of the shares of AH Three and AG Fourteen (the
"Coopers companies") were owned by Coopers partners.
The amounts paid out by AH Six, Quinstar and AG Nineteen to
the Coopers companies were, for all intents and purposes, exactly
the same amounts as paid to the subsidiaries of the public
companies. In other words, the so-called cost or premium of 10%
mentioned above was split 50-50 between the Coopers companies and
the subsidiaries. None of the companies in the chain paid Coopers
any fees in respect of the RDTOH Plan. The obvious advantages of
the Plan are that dividend income is taxed at a rate lower than
fee income and in some cases Coopers partners would achieve
income splits.
11. The amount paid by AH Three to Peter Speer was taken into
account in determining his share of profits earned from Coopers.
The amount paid by AH Three to Mrs. Bushell was taken into
account in determining Craig Bushell's share of profits
earned from Coopers. Both Peter Speer and Craig Bushell were
required to make a 10% capital contribution to Coopers in respect
of the dividends paid.
12. The legal relationships are not at issue. In other words,
the companies shown on Schedule I were validly incorporated, the
requisite resolutions of directors declaring dividends were
adopted and were technically correct. Both Peter Speer and Mrs.
Bushell (through a family trust of which she was the sole
beneficiary) acquired shares in the Coopers companies in each
case at a cost of $100.00.
13. Neither of the Appellants were officers or directors of
any of the companies but other Coopers' partners were
directors of the Coopers companies.
14. When the RDTOH Plan was presented to the partners, several
partners raised objections to Coopers participating by way of
fees because it was beyond the business of Coopers and might
raise liability insurance problems and further it was quite
possibly contrary to the British Columbia Institute of Chartered
Accountants' Rules against contingency fees. Thus, Coopers
received no fees but through the Coopers companies, Coopers
partners received dividends. There is no doubt that at one point
in time it was contemplated that fees would be paid to Coopers,
however the evidence of Peter Walton, on behalf of the RDTOH
companies and Michael Iannacone, on behalf of AG Nineteen and
Quinstar, was that there was no agreement as to fees and no
professional advice was provided by Coopers. The companies
involved received opinions from professionals other than
Coopers.
Submissions of the Appellants
[6] Counsel for the Appellants submits that since the
dividends in issue were reported in the 1987 and 1988 tax returns
respectively for Mr. Speer and Mrs. Bushell, and since they
were taxed as such and have not been reassessed the Minister
cannot subsequently decide to tax the same amounts as fee income.
He states that if the Minister can succeed in doing so then tax
will have been paid twice with respect to the same amounts.
[7] Counsel submits further that as the dividends were paid in
1987 and 1988 the same amounts cannot be taxed in the 1989 year.
Moreover the actual reassessment in 1993 is statute barred
– i.e., too late. Also none of the Coopers partners in
Victoria who were shareholders of Nordic Investments Ltd. or
partners in Edmonton who were either shareholders or whose
spouses or family trusts owned shares in C & L Edmonton
Limited were reassessed. He adds that of greater significance is
the fact that none of the corporations who issued the dividends
received by AH Three or AG Fourteen were reassessed. Counsel
argues further that the Minister cannot raise the issue of
"sham" and even if he can, there was no sham. He adds
that the basis of the assessment is subsection 56(2) of the
Act in that the Minister concluded that the Appellants
directed or concurred in a payment being made by AH Six, Quinstar
and AG Nineteen to the Coopers companies, which would otherwise
have been made by way of fees to the Appellants and other Coopers
partners and that this position is untenable because the
Appellants were incapable legally of directing or concurring in
any issuance of dividends by AH Six, Quinstar or AG Nineteen.
[8] He refers to the decision of the Supreme Court of Canada
in Neuman v. M.N.R., unreported, File 25565, judgment
dated May 21, 1998, which determined conclusively that subsection
56(2) cannot apply to dividends since as dividends come from
retained earnings of a corporation, if dividends are not issued
funds remain in the corporation and the shareholders have no
right to require the payment of the dividend.
[9] Counsel adds further that there was no clear proof of any
agreement to pay fees to Coopers and that the letter to Pinetree,
dated May 4, 1987, refers to a fee but does not refer to any
amount or to any of the terms and conditions related to the
payment of that fee.
Submissions of the Respondent
[10] The submissions of the Respondent are best summarized by
quoting from pages 7 and following of Respondent's
counsel's written argument.
1. It is the Respondent's submission that the case before
the Court is one of a simple case of constructive receipt, for
which subsection 56(2) was designed to prevent. Cattanach, J., of
the Federal Court Trial Division in Murphy v. R., [1980]
C.T.C. 386 stated the purpose of subsection 56(2) as follows (Tab
3, para.38):
Subsection 56(2) is to impute receipt of income to the
taxpayer that was diverted at his instance to some one else. It
is to cover cases where the taxpayer seeks to avoid the receipt
of what in his hands would be income by arranging to transfer
that amount to some other person he wishes to benefit or for his
own benefit in doing so. Apart from any moral satisfaction the
practical benefit to the taxpayer is the reduction in his income
tax.
2. Where a taxpayer had rights to a sum which would be taxable
in his hands and he arranges for those sums to be received by
another, subsection 56(2) has been applied to bring the sums back
into his income. see Sims v. MN.R. (Tab 7), McClain
Industries of Canada v. R. (Tab 8), George D. Adams v.
M.N.R. (Tab 9).
3. Coopers were entitled to fees resulting from their
development of and work on the RDTOH Plan. They were entitled to
these fees from the public companies. Instead of being paid these
fees, Coopers, as creditor to the public companies, directed the
public companies to pay the fees to AH3 and AG14. The public
companies then had the Subsidiaries which they controlled pay the
amounts owed to Coopers to AH3 and AG14. The amounts would then
flow as dividends to either the partner or a family member. The
practical effect of this is that what was professional fees has
been converted into dividend income in the partners hands or
dividend income in the hands of a family member who presumably
would be either non-taxable or taxed at a lower rate than
the partner.
4. The relevant portions of subsection 56(2) of the Income
Tax Act reads as follows:
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 the taxpayer.
5. From the wording of subsection 56(2), four ingredients must
be present for there to be taxability under the subsection:
a) there must be a payment or transfer of property to a person
other than the reassessed taxpayer;
b) the payment or transfer must be pursuant to the direction
of or with the concurrence of the reassessed taxpayer;
c) the payment or transfer must be for the benefit of the
reassessed taxpayer or for the benefit of another person whom the
reassessed taxpayer wished to benefit; and
d) the payment or transfer would have been included in the
reassessed taxpayer's income if it had been received by him
or her.
George A. Murphy v. Her Majesty the Queen, 80 DTC 6314
(F.C.T.D.)
Melville Neuman v. Her Majesty the Queen, unreported,
op cit.
6. In our case, the amounts paid by the Subsidiaries to AH3
and AG14 as set out in Schedule I of the Reply were payments or
transfers of property to a person other than the Appellants.
These payments were for the benefit of the Appellants (in that
they reduced their income tax) and for the benefit of persons
related to the Appellants (in that the amounts were redirected to
corporations in which their family members were shareholders).
These amounts would have been included in the Appellant's
income if received by them as their share of the income of the
Coopers partnership.
7. In addition to the above four criteria, an additional
criteria was added by the Supreme Court of Canada's decisions
in McClurg and Neuman. This is that the reassessed
taxpayer had an entitlement to, or would otherwise have received,
the payments in dispute.
8. As stated, it is the Respondent's submission in our
case that the amounts paid by the Subsidiaries to AH3 and AG14
were fees owing to Coopers for their development and work on the
RDTOH plan and that the Appellants, as partners in Coopers, had
an entitlement to those fees, and concurred in the redirection of
those fees to companies in which they or their family members
were shareholders.
9. If it should be found that the amounts paid by the
Subsidiaries to AH3 and AG14 were in fact dividends, the
Respondent concedes that the appeals should be allowed as the
Appellants would not have any pre-existing entitlement to
these dividends as they were not shareholders in the
Subsidiaries. As was determined in Neuman, subsection
56(2) would have no application because the dividends, if not
paid, would be retained as earnings by the company.
10. The two issues therefore are whether Coopers & Lybrand
had an entitlement to fees from the RDTOH plan and whether the
amounts paid to AH3 and AG14 by the Subsidiaries were in fact
fees and not dividends.
11. The Respondent submits that the letter dated May 4, 1987
from Coopers to Pinetree (Tab 5 of Exhibit R-1) clearly
establishes an agreement to pay a fee as it was signed
"accepted and agreed" by a director of Pinetree. This
alone would establish an entitlement to a fee by Coopers.
However, the following evidence provides further support for a
fee entitlement:
a) the nationally distributed Coopers interoffice memo dated
March 27, 1987 which was written to inform the various
Coopers offices of the RDTOH plan and to get referrals of RDTOH
companies makes several references to fees:
i) refers to a 10% fee to be charged;
ii) proposes a split of this fee between the referring office
and Vancouver office of Coopers;
iii) refers to the earning of "substantial fees" by
Coopers as a reason why Coopers cannot give an opinion to the
Subsidiaries as to the tax-free receipt of the dividend
from the RDTOH companies;
iv) advises referring offices on the contents of any
engagement letters stating that "it is very important that
the referring office notify its clients in writing that Coopers
& Lybrand will be receiving fees from the public company or
Subsidiary";
v) advises that the "fees" will definitely not be
refunded should the RDTOH plan not work.
b) a letter [Tab 10 of Exhibit R-1] from Coopers to Randy
Zien, a lawyer at the law firm Ladner Downs and legal advisor to
one of the RDTOH companies, stated that "Coopers &
Lybrand is acting on behalf of its client, Pinetree Software
Canada Ltd., and will be paid a fee for services rendered on its
behalf.";
c) letters from Coopers to the RDTOH companies state "the
fees earned by Coopers & Lybrand will be borne by our client
in this transaction, the purchaser of the redeemable preferred
shares.";
d) as well, as Coopers developed this Plan, it would be
reasonable that they would seek financial compensation for use of
the Plan. Mr. Majeau himself referred to a proprietary right to
the RDTOH Plan.
12. Taken as a whole, the Respondent submits the documents
evidence a clear entitlement to fees on the part of Coopers for
its development of and facilitation of the RDTOH plan.
13. Not only does the evidence indicate that a fee was earned
by Coopers, the Respondent submits that the evidence also
indicates that the amounts that were paid to AG14 and AH3 were in
fact payment of the fees owing to Coopers and were not
dividends:
a) the only financial benefit derived out of the Plan by
anyone at Coopers were the amounts that flowed first from the
Subsidiaries to AG14 and AH3 and then from AH3 and AG14 to the
partners and family members of the partners of Coopers. If
Coopers had an entitlement to a fee, and since no fee was paid to
Coopers directly, it would be reasonable to assume that the
amounts flowing from AG14 and AH3 were in payment of the fees
owing to Coopers;
b) the March 27 memo from Coopers which was distributed
nationally proposed exploiting the RDTOH Plan by charging a fee
equal to 10% of the dividend refunds. This was the proposal in
March. As it turned out, the amounts received by the Subsidiaries
from the RDTOH companies, which were to be distributed between
the public companies and the Coopers Companies, were consistent
with the proposed 10% fee to be paid;
c) the amounts paid out to Coopers & Lybrand (Edmonton)
Ltd. and Nordic Investments Ltd., which represent investment
vehicles by the Edmonton and Victoria partners of Coopers
respectively, exactly matched the proposed fee split arrangement
between referring offices and the Vancouver office as set out in
the national Coopers memo dated March 27, 1987;
d) the amounts paid out to the public companies and LD134
exactly matched the amounts paid out to the Coopers
Companies;
e) as with the Appellants share of partnership income for the
year, the Appellant was required to make a 10% capital
contribution with respect to the amounts received from AH3.
Therefore, at least for purposes of this holdback, the amounts
from AH3 were treated as if they were partnership income of the
Appellants.
14. As a dividend is received by virtue of ownership of the
capital stock of a corporation and not to any other consideration
(see Neuman Tab 2 para.57), the amounts received by AG14
and AH3 from the Subsidiaries did not have the characteristics of
a dividend and in substance were amounts in payment of the fees
owing to Coopers for developing the RDTOH Plan.
15. It is trite law that the substance of a payment is to
govern over its form. Courts have in the past considered the
nature of a payment made by a corporation allegedly made as
dividend payments and have found the payments were not, because
of their nature, in substance dividends. see Charles A.
Guenette v. M.N.R. (Tab 4), Katherine Irene German v.
M.N.R. (Tab 5), United Color and Chemicals Ltd. v.
M.N.R. (Tab 6).
16. In summary the Respondent submits that the evidence
indicates that, contrary to the Appellants position, the proposed
charging of a fee by Coopers as set out in the March 27, 1987
memo was carried out and fees were earned by Coopers for their
development of the RDTOH Plan. As well, the evidence indicates
that the amounts that were paid to AG14 and AH3 were in payment
of the fees earned by Coopers and as such they were not in
substance dividends but rather represented professional fees
earned by Coopers. The redirecting of these fees to AG14 and AH3
is clearly a situation subsection 56(2) was meant to address.
Analysis and Decision
[11] In my opinion there was no sham. The companies were
validly incorporated and the declarations of dividends were
validly made. Shares in AH Three and AG Fourteen were
validly acquired. There was no attempt to disguise the
true nature of the relationships between the companies and their
shareholders nor of the dividends being paid. Having found there
was no sham I will not address whether the Minister was barred
from raising that issue.
[12] The Supreme Court of Canada in Neuman made it
clear that subsection 56(2) does not apply to dividends.
Admittedly, there is a close relationship between the amount of
the dividends and the amount of the fees that might otherwise
have been charged. However the Coopers partners were free to take
advantage of the provisions of the Act and to structure
the transactions in such a manner that dividends would be paid
and not fees. Moreover, there was no specific agreement as to
fees. Dividends have been validly declared and paid and moreover
the Minister has already assessed the amounts in question as
dividends in 1987 for Mr. Speer and 1988 for Mrs. Bushell. The
following extracts from the decision of the Supreme Court in
Neuman are relevant:
34 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
McClurg with the only material difference being that Ruby Neuman,
unlike Wilma McClurg., had not made any contribution to the
corporation.
35 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 to its application are
specifically met.
36 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.
37 Third, this appeal is limited to the interpretation
and application of s. 56(2) of the ITA; 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.
38 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.
39 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
ITA. 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.
...
63 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 non-arm'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.
64 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.
[13] The facts (a) that fees were paid to Coopers on the first
transaction in early 1987; (b) that correspondence and memos
refer to fees or costs; (c) that the splits of 50/50 and 70/30
described above were in effect achieved; and (d) that the
dividends paid to Coopers partners were taken into account in
dividing partnership profits and fixing capital contributions
certainly indicate that the amounts of the dividends were
related to the amounts of the fees that might otherwise
have been charged but in my opinion that is not sufficient to
change dividends, validly and legally declared by companies,
validly incorporated and organized, into fees. It is noteworthy
that the dividends declared by the RDTOH companies and by the
subsidiaries of the public companies were paid prior to the
enactment of subsection 129(1.2), an anti-avoidance provision
apparently aimed at transactions of the nature in question. This
subsection is discussed in IT-243R4 as follows:
6. Subsection 129(1.2) provides an anti-avoidance rule which
prevents a corporation from structuring arrangements in order to
obtain a dividend refund without the related shareholder tax
being paid. For example, a private corporation with RDTOH may
seek to issue shares with a high redemption price but low paid-up
capital to a tax-exempt entity or other corporation that receives
ordinary dividends on a non-taxable basis and obtain a dividend
refund on the subsequent share redemption. Subsection 129(1.2) is
designed to stop these types of arrangements by deeming a
dividend not to be a taxable dividend and denying a dividend
refund in respect of that dividend where the following
circumstances exist:
the dividend is paid on a share of a corporation;
the share (or a substituted share) was acquired by the holder
in a transaction or as part of a series of transactions; and
one of the main purposes of the transaction or the series of
transactions was to obtain a dividend refund.
Subsection 129(1.2) applies to dividends paid after 4 p.m.
Eastern Daylight Saving Time, September 25, 1987 to a person who
is exempt from tax or is a corporation other than a private
corporation, and to all dividends paid after November 27, 1987
where the circumstances described above exist.
[14] As to the issue of whether the Minister could in 1993
assess the 1989 taxation year it is helpful to quote the
following from the Replies to understand the Minister's
position:
oo) had the fees been paid directly to the Appellant and the
Partners, instead of being paid to AH3 and AG14 and then as
Dividends to the Other Persons, the amounts would have been
taxable to the Appellant and the Partners as income of the
Coopers Operating Partnership;
pp) the Coopers Operating Partnership had a year end of
April 3 and was a member of the Coopers Partnership with a
year end of January 31.
qq) as a result the income in respect of the fees earned in
the year ending April 3, 1988 (from fees received in the form of
dividends in May and June, 1987) are income to the Coopers
Partnership in the year ending January 31, 1989;
In my view it is a considerable stretch to conclude that
because of the varying year ends of Coopers and the Coopers
Operating Partnership, the Minister could assess in 1993
dividends actually paid and assessed to tax in 1987 and 1988.
Moreover, in my opinion, if any recharacterization of the
dividends was to be done (and in my view it should not), what
Coopers in effect did was to charge a consideration for the use
of the Plan, i.e., a consideration for the use of intellectual
property not fee income. That consideration was clearly received
in 1987 and 1988 and cannot be assessed in 1993 as income
received in 1989.
[15] I have reviewed all the authorities submitted by counsel
for the Respondent but find that none of them have convinced me
to arrive at conclusions other than those stated above.
[16] Consequently the appeals are allowed with costs and the
reassessments in issue are vacated.
Signed at Ottawa, Canada this 24th day of November
1998.
"T.P. O'Connor"
J.T.C.C.
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