Bodrug Estate v. The Queen, 90 DTC 6521, [1990] 2 CTC 324 (FCTD), aff'd 91 DTC 5621 (FCA)

McNair, J.: —This action is an appeal by the plaintiffs as personal representatives of the deceased taxpayer, Evan Wesley George Bodrug, from an income tax reassessment for the 1980 taxation year, whereby the Minister of National Revenue determined that damages awards of $2,247,500 and $200,000 for which the deceased was adjudged liable in a lawsuit did not form part of the adjusted cost base of certain shares of stock. No evidence was adduced at trial. Counsel for the parties went to some pains to prepare and submit an agreed statement of facts which, despite its length, I deem advisable to reproduce hereunder:

Agreed Statement of Facts

The parties hereto by their respective solicitors hereby admit the documents contained in the Book of Documents which is filed herewith and also admit the following facts, provided that such admissions are made for the purpose of this action only and may not be used against either party on any other occasion or by any other person:

A. Statement of Facts

1. The Plaintiffs are the legal representatives of one Evan Wesley George Bodrug, (hereinafter referred to as "the Deceased") who was killed in a plane crash on January 10, 1980.

2. At all material times and before his death, the Deceased was an individual resident in Canada who owned the control block of shares in Canadian Hidrogas Resources Ltd. (hereinafter referred to as "Hidrogas").

3. In 1973 Mr. Noah Cohen (hereinafter referred to as "Cohen") entered into an employment contract with Hidrogas; and in connection therewith, Cohen's company, NIR Oil Ltd. (hereinafter referred to as "NIR"), was granted the option to purchase 340,000 shares of Hidrogas from the Deceased at a price of 65 cents per share. True copies of the aforesaid Employment Contract and Option Agreement appear in the Book of Documents at tabs 1 and 2 respectively.

4. In 1975, due to unhappy differences between the Deceased and Cohen, the latter terminated his employment with Hidrogas.

5. In December 1976, after 30,000 of the aforesaid shares had been acquired by NIR from the Deceased at the price of 65 cents per share, the Deceased delivered a letter to Cohen which purported to cancel his agreement for the sale of the remaining 310,000 Hidrogas shares to NIR.

6. In response to such purported cancellation, legal action was commenced against the Deceased in the Supreme Court of Alberta, Trial Division whereby NIR sought specific performance of the aforesaid option agreement pursuant to which NIR claimed the right to purchase a further 310,000 Hidrogas shares from the Deceased at the price of 65 cents per share. In that action NIR obtained a court order pursuant to which certificates for the 310,000 shares in question were deposited with the Court by the Deceased pending the outcome of the litigation. Copies of the Statement of Claim and Statement of Defence in such action appear in the Book of Documents at tabs 3 and 4 respectively.

7. In August, 1979 when Hidrogas shares were trading on the Toronto Stock Exchange at approximately $7 per share, the parties to the aforesaid litigation settled their claims and executed Minutes of Settlement dated August 21, 1979 (hereinafter referred to as the "Settlement Agreement") pursuant to which, inter alia :

(a) the Deceased agreed to pay NIR the sum of $1,320,000 in consideration for the latter releasing and surrendering all rights it had by virtue of the aforesaid option agreement.

(b) the said sum of $1,320,000 was required to be paid by the Deceased as follows:

(i) $660,000 on or before August 31,1979

(ii) $660,000 on or before February 29, 1980

(c) upon payment of the first $660,000 instalment as aforesaid, the Deceased became entitled to receive 110,000 of the Hidrogas shares which had been deposited with the Court.

(d) the certificates for the remaining 200,000 Hidrogas shares which had been deposited with the Court were endorsed in blank and delivered to NIR's solicitors to be held in trust for delivery to the Deceased upon payment of the second $660,000 instalment as aforesaid.

(e) the Deceased had the right to accelerate delivery to him of the remaining 200,000 Hidrogas shares by paying NIR's solicitors the sum of $165,000 or multiples thereof prior to February 29, 1980 in which case NIR's solicitors were required to deliver 50,000 shares to the Deceased or multiples thereof depending upon the amount so paid.

(f) in the event of the failure by the Deceased to pay all or any portion of the second $660,000 instalment on or before February 29, 1980, NIR's solicitors were required to deliver all the Hidrogas shares remaining in their possession to NIR or its nominee.

(g) Cohen and NIR agreed to sell all their previously acquired shares of Hidrogas; being approximately 25,000 in number, to the Deceased for the price of $7 per share, which amount was paid on or before August 31, 1979.

A true copy of the Settlement Agreement appears in the Book of Documents at Tab 5.

8. At the time the Settlement Agreement was executed, Cohen was unaware that there was an impending takeover bid with respect to the shares of Hidrogas. In connection with such takeover bid, the Deceased entered into an agreement on August 23, 1979 with the offeror, Stratfield Investments Ltd. (hereinafter referred to as "Stratfield"), a subsidiary of Norcen Energy Resources Ltd., pursuant to which the Deceased agreed to sell all of his shares in Hidrogas to Stratfield at a price of $15.50 per share, the same price at which Stratfield agreed to make the tender offer to all the other shareholders of Hidrogas. The closing of such purchase and sale of the Deceased's shares in Hidrogas occurred after the Deceased's death on January 18, 1980 in accordance with the provisions of the aforesaid agreement.

9. Cohen became aware of the Stratfield tender offer for the shares of Hidrogas shortly after the execution of the Settlement Agreement but nevertheless proceeded to complete the settlement arrangements embodied therein. Such arrangements were completed in early 1980 when payment of the second $660,000 instalment referred to in subparagraph 7(b) above was made.

10. In December of 1979, Cohen and NIR brought an action against the Deceased for damages and alleged that they would not have executed the Settlement Agreement had they known, as did the Deceased, that at the time of such execution there was an impending takeover bid with respect to the shares of Hidrogas. In this regard, Cohen and NIR based their cause of action at common law, alleging active concealment of the material fact amounting to fraudulent misrepresentation. Moreover, Cohen and NIR also asserted that the Deceased was liable pursuant to the insider trading provisions of the Companies Act of Alberta and the Securities Act of Alberta. True copies of the Amended Statement of Claim and Statement of Defence in such action appear in the Book of Documents at Tab 6 and 7 respectively.

11. The aforesaid action came to trial before the Court of Queen's Bench of Alberta in May of 1983, and NIR and Cohen were awarded damages in the amount of $2,247,500 and $200,000 respectively. In his reasons for judgment dated June 22, 1983, a true copy of which appears in the Book of Documents at Tab 8, Mr. Justice D.C. McDonald held that the action of NIR and Cohen failed in so far as it was based on common law fraudulent misrepresentation. However, his Lordship held that the action succeeded on the basis of s. 112(1) of the Securities Act of Alberta which provided as follows:

Every insider of a corporation or associate or affiliate of such insider, who, in connection with a transaction relating to the capital securities of the corporation, makes use of any specific confidential information for his own benefit or advantage that, if generally known, might reasonably be expected to affect materially the value of such securities, is liable to compensate any person or company for any direct loss suffered by such person or company as a result of such transaction, unless such information was known or ought reasonably to have been known to such person or company at the time of such transaction and is also accountable to the corporation for any direct benefit or advantage received or receivable by such insider, associate or affiliate, as the case may be, as a result of such transaction.

It was argued on behalf of the Deceased's Estate that the settlement embodied in the Settlement Agreement was not a “transaction relating to the capital securities” of Hidrogas within the meaning of this provision. In this regard, it was argued that neither NIR or Cohen owned the 310,000 Hidrogas shares in question and that at best NIR only had the right to purchase such shares from the Deceased at a price of 65 cents per share. Even that right had been in dispute by the Deceased and accordingly it was argued that the $1,320,000 paid by the Deceased to NIR pursuant to the aforesaid Settlement Agreement should be regarded as a payment made to settle a law suit rather than a payment in connection with a “transaction” relating to Hidrogas shares. Such argument was unsuccessful at trial.

12. The Plaintiffs appealed to the Court of Appeal of Alberta from the aforesaid decision of Mr. Justice McDonald which appeal was unanimously dismissed. A true copy of the reasons for judgment delivered by Mr. Justice McDermid in this matter appear in the Book of Documents at Tab 9.

13. In filing the Deceased's terminal tax return for the 1980 taxation year, the Plaintiffs reported a deemed disposition of 1,075,787 Hidrogas shares which resulted in a capital gain of $13,991,742 calculated as follows:

capital gain in respect of 968,600 Hidrogas

shares owned by the Deceased at the date of

death which were acquired prior to December

31,1971

proceeds of disposition (i.e. $14.25 per share

which was a bid price on the Toronto Stock

Exchange on the date of death)	$13,802,550.00
less adjusted cost base of such shares
determined in accordance with subsection
26(7) of the Income Tax Application Rules,
1971, (i.e. $1.25 per share was used as the
valuation day value)	$ 1,210,750.00
valuation day value)
	$12,591,800.00 $12,591,800.00
capital gain in respect of 107,187 Hidrogas
shares owned by the Deceased at the date of
death which were acquired after December 31,
1971.
proceeds of disposition (i.e. $14.25 per
share)	$1,527,414.75
less adjusted cost base of such shares	$	127,472.74
		1,399,942.01 $ 1,399,942.01
	$ 1,399,942.01
		$13,991,742.01

Included in the 968,600 "pre-1972" Hidrogas shares owned by the Deceased at the date of death were the 310,000 shares which were the subject of the Settlement Agreement and no recognition, for capital gains purposes, was given to the $1,320,000 paid by the Deceased to NIR with respect to such shares. Such filing position was taken so as not to prejudice the Plaintiff's argument in the Cohen law suit to the effect that the arrangements embodied in the Settlement Agreement did not constitute a “transaction relating to the capital securities" of Hidrogas within the meaning of s. 112(1) of the Securities Act but rather should be regarded as arrangements implemented to settle a law suit. Similarly, the 25,000 Hidrogas shares acquired by the Deceased from Cohen pursuant to the Settlement Agreement were not included in the "post-1972 pool” of Hidrogas shares owned by the Deceased at the date of his death.

14. As indicated in paragraph 13 above, a valuation day value of $1.25 per share was utilized for the purposes of determining the capital gain realized by the Deceased in connection with the deemed disposition of the "pre-1972 pool” of Hidrogas shares owned by him at the date of his death. The question of the appropriate valuation day value of the Hidrogas shares arose in an appeal by the Deceased in connection with his 1972 and 1973 taxation years. The Tax Appeal Board dismissed the Deceased's appeal by the Deceased in connection with his 1972 and 1973 taxation years. The Tax Appeal Board dismissed the Deceased's appeal and held that the valuation day value of 72 cents per share utilized by the Minister in his assessment was appropriate (see [1979] C.T.C. 2593; 79 D.T.C. 551). The Deceased commenced an appeal to the Federal Court from this decision, which appeal was allowed with assessments for the taxation years in question being referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the adjusted cost base of all shares of Hidrogas disposed of by the Deceased in such taxation years, being the fair market value thereof as at Valuation Day, December 22, 1971, was an amount of 97 cents per share.

16. In reassessing the Plaintiffs in respect of the Deceased's 1980 taxation year, notice of which is dated January 31, 1985, the Minister of National Revenue assessed additional tax in the amount of $1,463.15 together with interest in the amount of $677.78. A true copy of the said Notice of Reassessment appears in the Book of Documents at Tab 10.

17. The Plaintiffs duly filed a Notice of Objection to the said reassessment for the purposes of recalculating the capital gain originally reported by them in respect of the deemed disposition by the Deceased of the Hidrogas shares owned by him immediately prior to his death so as to reflect:

(a) the payment by the Deceased of $1,320,000 to NIR pursuant to the Settlement Agreement in respect of 310,000 Hidrogas shares which were included in the deemed disposition;

(b) the failure to report in the deemed disposition the 25,000 Hidrogas shares which the Deceased acquired from Cohen for an aggregate purchase price of $175,000 pursuant to the Settlement Agreement;

(c) the resolution of the issue as to the valuation day value of the Hidrogas

shares in question owned by the Deceased on December 31, 1971; and

(d) the liability for damages to NIR and Cohen incurred by the Deceased in the amounts of $2,247,500 and $200,000 respectively by virtue of the Deceased's use of specific confidential information for his own benefit in connection with the negotiation of the Settlement Agreement.

A true copy of the said Notice of Objection appears in the Book of Documents at Tab 11.

18. Upon considering the aforesaid Notice of Objection, the Minister of National Revenue further reassessed the Plaintiffs in respect of the Deceased's 1980 taxation year; and inter alia, made the following adjustments to the capital gain originally reported by the Plaintiffs in respect of the Deceased's deemed disposition of the Hidrogas shares owned by him immediately prior to his death:

(a) $356,250 was added to the proceeds of disposition originally reported by the Plaintiff which amount was added in respect of Hidrogas shares acquired by the Deceased from Cohen pursuant to the Settlement Agreement (i.e. 25,000 shares at $14.25 per share);

(b) $271,208 was deducted from the adjusted cost base originally reported by the Plaintiffs in respect of the 968,600 Hidrogas shares owned by the Deceased prior to December 31,1971 in order to reflect the revised valuation day value of such shares.

i.e. Previous V-Day value reported 968,600 shares at $1.25

per share	$1,210,750.00
less revised V-Day value allowed 968,600 shares at .97
per share	939,542.00
	$ 271,208.00

(c) $175,000 was added to the adjusted cost base originally reported by the Plaintiffs to reflect the amount paid by the Deceased to Cohen pursuant to the Settlement Agreement (i.e. 25,000 shares at $7.00 per share);

(d) $1,320,000 was added to the adjusted cost base originally reported by the Plaintiffs to reflect the amount paid by the Deceased to NIR pursuant to the Settlement Agreement.

19. In reassessing the Plaintiffs in the manner referred to in paragraph 18 above, notice of which reassessment is dated December 29, 1986, the Minister of National Revenue determined that the amounts of $2,247,500 and $2000,000 [sic] paid by the plaintiffs as damages to NIR and Cohen respectively as a result of the decision of the Alberta Court of Queen's Bench was not a cost to the Deceased of acquiring shares and therefore did not form part of the adjusted cost base of Hidrogas shares to the Deceased. A true copy of the said Notice of Reassessment appears in the Book of Documents at Tab 12.

The only issue on this appeal is whether the Minister was correct in determining that the damages awards paid by the plaintiffs to NIR and Cohen did not form part of the adjusted cost base of Hidrogas shares to the deceased. Counsel for the plaintiffs advanced a number of arguments challenging the Minister’s reassessment. Firstly, he concentrated on the definition of the terms "cost" and "capital cost", which he submitted were synonymous, and urged that I give those expressions a broad interpretation. He cited numerous cases and referred to various Revenue Canada publications in support of his conten tion that the "cost" or “capital cost" of an asset is not restricted to the actual purchase price paid therefor. In counsel's submission, the decision of the Federal Court of Appeal in The Queen v. Stirling, [1985] 1 C.T.C. 275; 85 D.T.C. 5199, should not be regarded as restricting the broad ambit otherwise afforded the term "cost", inasmuch as the observations of Pratte, J. have to be viewed in light of the particular facts of that case.

Plaintiffs’ counsel referred to the decisions of the Supreme Court of Canada in M.N.R. v. Dominion Natural Gas Ltd., [1941] S.C.R. 19; [1940-41] C.T.C. 155, and British Columbia Power Corp. v. M.N.R., [1968] S.C.R. 17; [1967] C.T.C. 406, arguing that these cases stand as authority for the proposition that expenses incurred to "preserve" or "protect" a capital asset or one's legal title thereto should be regarded as outlays on account of capital rather than currently deductible expenses. While those decisions make no specific reference to the expenses in question as comprising part of the cost of the assets which the taxpayer was attempting to preserve or protect, it was his contention that such a result was necessarily implicit. Plaintiffs' counsel further contended that there was no difference for tax purposes between the sum of $1,320,000 paid by the deceased to NIR pursuant to the settlement agreement and the amounts paid by the plaintiffs as damages to NIR and Cohen. In his submission, the Minister’s determination that the former amount formed part of the adjusted cost base of the Hidrogas shares inevitably led to the conclusion that the damages awards in question should be regarded similarly as an additional component of that adjusted cost base.

Plaintiffs’ counsel also made the point that the provisions of the Alberta securities legislation under which the deceased was found liable were purely compensatory in nature with the result that the damages awards were not tantamount to a penalty levied against the deceased. Hence, it would be unjustifiable in the present case to apply that line of judicial authority which prohibits the deduction of penalties from income on the grounds of public policy. He cited Imperial Oil Ltd. v. M.N.R., [1947] C.T.C. 353; 47 D.T.C. 1090 (Ex. Ct.), as a case which precluded any argument that compensatory damage awards and settlement payments are somehow unique in the sense that they cannot be treated as legitimate expenses of doing business. He pointed also to Sunshine Mining Co. v. The Queen, [1975] C.T.C. 223; 75 D.T.C. 5126 (F.C.T.D.), as an example of a case where a damage award was characterized as a capital expenditure. Referring to a number of other cases, plaintiffs’ counsel advanced the proposition that in determining whether damages awards are taxable in the hands of recipients the courts have consistently applied the principle that the receipt of compensation by way of damages is a neutral matter and that it is necessary to ascertain the true nature and quality of the awards for the purpose of determining the appropriate tax treatment applicable thereto. He contended that in the circumstances of the present case the true nature and quality of the damages awards in question was:

the additional cost of obtaining the release of NIR's rights under the Option Agreement and also the additional cost of acquiring approximately 25,000 Hidrogas shares from NIR and Cohen.

Finally, plaintiffs’ counsel argued that the liability of the deceased was created by the latter's actions in 1979, and that the absence of any determination of the quantum of liability until after disposition of the subject shares did not bar that liability from being regarded as part of the cost of the shares.

Counsel for the defendant submitted there were four reasons which precluded the plaintiffs from claiming the damages awards as part of the adjusted cost base of the Hidrogas shares. Firstly, she argued that the damages payments were made subsequent to the taxation year in issue and could not be deducted in 1980, in accordance with the matching principles of the Income Tax Act, R.S.C. 1952, c. 148 (am S.C. 1970-71-72, c. 63) (the "Act"). Secondly, counsel referred to the source concept of income and submitted that by reason of the deemed disposition of the Hidrogas shares in 1980, it could not be argued plausibly that those shares provided a source or possibility of earning income. She next pointed to the wording of subparagraph 40(1)(a)(i) of the Act for the proposition that the adjusted cost base to a taxpayer must be determined immediately before the disposition of property, and that such disposition occurred in 1980 in the present case. Finally, defendant's counsel submitted that even under the most liberal interpretation of the word "cost" there was no authority for extending the definition of that term to cover expenses incurred subsequent to the date of disposition of property.

The general provision governing the computation of capital gains is subparagraph 40(1)(a)(i) of the Act, which reads as follows:

40.(1) Except as otherwise expressly provided in this Part

(a) a taxpayer's gain for a taxation year from the disposition of any property is the amount, if any, by which

(i) if the property was disposed of in the year, the amount, if any, by which his proceeds of disposition exceeds the aggregate of the adjusted cost base to him of the property immediately before the disposition and any outlays and expenses to the extent that they were made or incurred by him for the purpose of making the disposition, . . .

There is no suggestion that the Hidrogas shares constituted depreciable property. Thus, their adjusted cost base to the deceased falls to be determined under subparagraph 54(a)(ii), which reads:

54. In this subdivision,

(a) "adjusted cost base" to a taxpayer of any property at any time means, except as otherwise provided, . . .

(ii) in any other case, the cost to the taxpayer of the property adjusted, as of that time, in accordance with section 53, . . .

Counsel were agreed that none of the provisions of section 53 of the Act applied in the circumstances of the present case. The question therefore is simply this: Can the damages awards in question properly be considered part of the "cost to the taxpayer" of the Hidrogas shares?

In Stirling, supra, Pratte, J.A., rendering the judgment of the Federal Court of Appeal from the bench, interpreted the word "cost" in relation to the computation of capital gains as follows at page 276 (D.T.C. 5200):

The only issue on this appeal is whether the Trial Division was right in holding that, in computing his capital gain from the disposition of gold bullion, the respondent could deduct, as part of his cost, interest on the unpaid portion of the price of the bullion and safekeeping charges that he had incurred in respect of the period during which he had held the bullion.

In deciding that those interest and charges could be deducted, the learned trial judge did not rely on any provision of the Income Tax Act but, rather, on what, in his view, would have been the intention of Parliament had it given consideration to that question. We cannot agree with that approach.

In trying to support that judgment, counsel for the respondent argued in substance that capital gain should be computed according to the same rules as income from a business or property. That argument, while attractive, does not find any support in the Income Tax Act which provides special rules for the computation of capital gain. Under those rules, as they are found in subparagraph 40(1)(c)(i) and section 54, the interest and safekeeping charges here in question could be deductible only if they were part of the cost of the bullion. In our opinion, they were not. As we understand it, the word "cost" in those sections means the price that the taxpayer gave up in order to get the asset; it does not include any expense that he may have incurred in order to put himself in a position to pay that price or to keep the property afterwards.

[Emphasis added.]

I have no problem with the submission of counsel for the plaintiffs that the cost of an asset is not restricted to the actual purchase price paid therefor. It seems clear that the cost of property may include brokerage fees, legal fees, commissions and other expenses incurred in connection with the acquisition of the property. In my view, the decision in Stirling does not necessarily restrict such an extended definition of the term “cost”. However, I am of the opinion that it is clear authority for the proposition that the cost of an asset for the purposes of capital gains computation is limited to the costs of acquisition of that asset or, as Pratte, J. put it, "the price that the taxpayer gave up in order to get the asset".

In the present case, I am unable to see how the damages awards in question could possibly be regarded as part of the acquisition costs of the Hidrogas shares to the deceased. The deceased was found liable for those damages as a result of his use of confidential information relating to the Hidrogas shares. His title to those shares was not in issue in the action brought by Cohen and NIR. In their amended statement of claim, the plaintiffs sought only damages, and made no claim for specific performance. Whether the deceased's liability and the award of damages were fixed in 1979, or in 1983 or 1985 when the judgments of the Alberta Court of Queen's Bench and the Court of Appeal were rendered, is immaterial. The entire lawsuit having nothing to do with the deceased's title to the shares per se, it is my opinion that the damages for which the deceased was adjudged liable cannot be regarded as part of the price he had to give up in order to get the shares. The decisions in Dominion Natural Gas and British Columbia Power, supra, dealing with the deduction of legal expenses incurred in preserving capital assets or title thereto, in my view, have no bearing in the circumstances of the present case.

It follows, therefore, that I am unable to accept the submission of plaintiffs’ counsel that the sum of $1,320,000 paid by the deceased to NIR pursuant to the settlement agreement and the damages awards should be treated similarly for income tax purposes. In my opinion, these two payments are entirely dissimilar in nature. The payment of $1,320,000 by the deceased to NIR formed one of the conditions of the settlement agreement dated August 21, 1979 and was made in consideration for the release and surrender by NIR of all of its rights under the option agreement of 1973. In essence, the deceased paid this sum to regain his rights to the Hidrogas shares and, presumably on that basis, the Minister saw fit to increase the latter's adjusted cost base accordingly. The damages, on the other hand, were paid by the plaintiffs to satisfy a personal judgment against the deceased, and I cannot see that their tax treatment is in any way affected by the Minister's addition of the $1,320,000 to the adjusted cost base of the shares.

In light of my findings, it is unnecessary for me to consider whether the damages awards could be regarded as a penalty levied against the deceased and whether their addition to the adjusted cost base of the shares might perhaps be precluded on that basis. Nor need I address the issue of the date on which the deceased's liability and the quantum thereof were determined. I am inclined to the view that the liability and consequent damages were not established definitively until the judgment of the Court of Appeal of Alberta upholding the trial judge's decision finding the deceased guilty of insider trading and awarding damages accordingly. The judgment of the appellate court was pronounced on May 1, 1985, more than five years after the deemed disposition of the Hidrogas shares on January 10, 1980. As I see it, the damages awards could not be considered part of the price the deceased had to pay to obtain those shares by any stretch of the imagination. In any event, my finding that the plaintiffs’ damages payments were unrelated to the deceased's acquisition of the shares suffices to dispose of the matter.

In the result, the plaintiffs’ appeal must be dismissed with costs.

Appeal dismissed.