Ovis Brooks v. Minister of National Revenue, 91 DTC 639, [1991] 1 CTC 2551 (TCC)

Teskey, T.C.J.:—The appellant appeals from reassessments for the years 1980 and 1981.

Issue

The issue is whether the appellant by causing Ovel Holdings Ltd. (Ovel") to issue shares to his children and spouse, thereby eroding his equity ownership from 100 per cent to 52 per cent was a deemed disposition of an economic interest in Ovel within the meaning of paragraph 245(2)(c) and subparagraph 69(1)(b)(i) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

Facts

The appellant is a 62-year-old merchant. He started his career with Canadian Tire in 1953 in shipping and receiving then progressed through many stages until he became a store manager and eventually a store owner. He took over ownership of the Timmins store in 1969 and has been the owner ever since. The franchise with Canadian Tire is personal to him and ceases on his death.

The franchise agreement gives Canadian Tire the usual rights to terminate the franchise if the owner does not follow company policy regarding pricing, purchasing and proper operation. In this case, this can be ignored. Canadian Tire also reserves the right to move the franchise from one location to another within the same general area. The holder of the franchise either takes the new location or has to abandon the area.

Ovis Brooks Ltd. "Ovis"), an Ontario company owned 70 per cent by the appellant and 30 per cent by his spouse, operated the business which was carried on in a shopping plaza at 29 Park Road, Timmins, Ontario.

When Ovis purchased the business in 1969, it received an assignment of an existing sublease for the store premises. The original sublease had a ten-year term expiring on August 31, 1976 and contained two five year renewals. In 1974, Ovis assigned the sublease to the appellant.

Ovel was incorporated in 1976 and only two shares were issued, one to the appellant and one to Ellen Brooks, his spouse. The company was used for the purposes of investing money in different enterprises. Prior to February 1, 1980 Ovel had nothing to do with Canadian Tire or the active business of the appellant. As of January 31, 1980, Ovel was in a loss position of approximately $82,000 and the shares were worthless. On this date the appellant obtained his spouse's share for nominal or no consideration.

On February 1, 1980, the appellant assigned the store sublease to Ovel. Ovel then gave a new sublease to Ovis for the store premises. The sublease held by Ovel had an annual rental of $24,000. The new sublease granted by Ovel to Ovis had an annual rental of three per cent of the annual sales of Ovis. The months of February, March, April and May 1980 produced a rental of $47,025 for a net cash gain to Ovel of $39,025.

When the appellant assigned the existing sublease on February 1, 1980, the consideration for the assignment was the issuance of one preferred share in Ovel to the appellant. The appellant and Ovel duly and timely filed an election under subsection 85(1) of the Act wherein each elected that the leasehold interest was to be treated as having proceeds of disposition equal to an agreed amount of $1.

On June 1, 1980, the following persons subscribed for and were issued common shares in the capital of Ovel in the numbers and for the consideration shown.

Thus, making the total issued common shares to be 100.

During the period January 30, 1980 to June 1, 1980, the appellant could not remember if his spouse had resigned from being a director of Ovel or not. The Court accepts the appellant's sworn statements that in all decisions he consulted with his wife and that all final decisions were a joint decision. The whole scheme, as described above, was the result of consultation between the appellant, his spouse, their lawyers and accountants. The events of the first six months of 1980 were all decided as one complete package and for the sole purpose of splitting income.

The respondent in assessing the appellant made the following two assumptions of fact:

—the fair market value of all of the common shares of Ovel at June 1, 1980 was not less than $200,000.00; therefore the fair market value of the 48% interest acquired by the Appellant’s spouse and children was not less than $98,000.00;

—the Appellant conferred a benefit upon Donald Brooks and Jeanne Parker upon the issuance of common shares by Ovel to them on June 1, 1980 of not less than $70,000.00 (being 35% of $200,000.00), which amount is deemed to be a payment to the Appellant and is deemed to be a disposition by way of a gift, resulting in a taxable capital gain to the Appellant during his 1980 taxation year of not less than $35,000.00.

The 13 shares issued to the appellant's spouse are not at issue. The appeal in regards to the 1981 reassessment is only for the purposes of adjusting the general averaging calculation, should the appellant be successful on the 1980 stock subscription issue.

The only evidence called by the appellant concerning the Minister's Assumption of value was the introduction of the financial statement of Ovel for the year ending May 31, 1980 with the 1979 comparison, which showed a net gain of $39,025 for four months.

Taking into consideration the lease term and the one remaining five year renewal period the assignment of lease would produce a total net value of approximately $700,000 to Ovel. Taking into consideration that the franchise could be lost in the event of the appellant's death or misbehaviour or Canadian Tire's desire to relocate in Timmins, there is no evidence before the Court to warrant a change in the value of Ovel as of June 1, 1980 (particularly in light of the excellent sales the store was producing and the long outstanding and good relationship the appellant had with Canadian Tire). If anything, the value set by Revenue Canada of $200,000 is low. The Court therefore finds that Ovel on June 1, 1980 had a value of $200,000.

As a result of the appellant's actions, (both personally and as a director of Ovel), his 100 per cent ownership in Ovel worth $200,000 went to 52 per cent ownership worth $104,000 and his two children’s ownership combined together from an outlay of $35 went from nil to 35 per cent ownership worth $70,000.

Analysis

The appellant relies quite heavily on the Federal Court of Appeal decision of Jim McClurg v. M.N.R., [1988] 1 C.T.C. 75;88 D.T.C. 6047. Her Majesty the Queen after losing in the Federal Court of Appeal appealed to the Supreme Court of Canada. The Supreme Court of Canada in a 4/3 decision rendered on December 20, 1990 dismissed the appeal.

The relevant facts in McClurg, supra, is that McClurg and his partner were owners of one class of common shares with voting rights and their wives held another class of common shares without voting rights. The articles of incorporation provided that each class could receive dividends exclusive of the other classes. Dividends were declared on the common shares held by the spouses for three consecutive years while none were declared on the voting common shares held by McClurg and his partner. The Minister had reassessed the appellant on the basis that the dividends should have been attributed equally to all the common shares no matter what class. The Minister therein relied on subsection 56(2) which provided as follows:

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.

Subsection 245(2) of the Act is found in Part XVI under the general heading "Tax Evasion" with the subheading of Indirect Payment or Transfers''. The operative words of this subsection for the purposes of this appeal read as follows:

2. Where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatever is that a person confers a benefit on a taxpayer, that person shall be deemed to have made a payment to the taxpayer equal to the amount of the benefit conferred notwithstanding the form or legal effect of the transactions or that one or more other persons were also parties thereto; and, whether or not there was an intention to avoid or evade taxes under this Act, the payment shall, depending upon the circumstances, be

(a) . . .

(b) . . .

(c) deemed to be a disposition by way of gift.

This can be paraphrased to read as follows:

Where the result of a transaction of any kind is that a person confers a benefit on a taxpayer, that person shall be deemed to have made a payment to the taxpayer equal to the amount of the benefit notwithstanding that one or more parties were also parties thereto; and the deemed payment shall be deemed to be a disposition by way of gift.

The respondent relies heavily on the Exchequer Court decision of M.N.R. v. Dufresne, [1967] C.T.C. 153; 67 D.T.C. 5105. The taxpayer therein held 164 shares of a company, his wife one and his five children held three each for a total of 15 shares. Twice the company offered to each of its shareholders the right to purchase five new shares for each share held at a purchase price of $100 a share. The original shares prior to the stock option each had a value of $1,421.47. Both times the children exercised the options and neither the taxpayer nor his spouse exercised their options. In the end, the taxpayer still had his original 164 common shares and the children's shareholdings had gone from 15 to 360 common shares. Thus, the taxpayer's shares had fallen from a value of $243,044 to $78,560. The children’s shareholdings went from a value of $21,315 to $199,400.

This case dealt with gift tax under the then section 137 of the Act which read as follows:

(2) Where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatsoever is that a person confers a benefit on a taxpayer, that person shall be deemed to have made a payment to the taxpayer equal to the amount of the benefit conferred notwithstanding the form or legal effect of the transactions or that one or more other persons were also parties thereto; and, whether or not there was an intention to avoid or evade taxes under this Act, the payment shall, depending upon the circumstances, be

(c) deemed to be a disposition by way of gift to which part IV applies.

The old subsection 137(2) and this new subsection 245(2) are similar but not identical. Mr. Justice Jackett as he then was said at page 154 (D.T.C. 5105):

The question raised by the appeal relates to the acquisition, on two separate occasions, by each of the respondent's five children of shares in a company in which the respondent was the controlling shareholder in circumstances which resulted in the children having an interest in the capital stock of the company, relative of that of the respondent, that was greater than the interest that they had, relative to his, prior to such acquisition.

And at pages 160-62 (D.T.C. 5109):

In my view, the appeal has to be decided by answering the question whether it has been established that the "result" of one or more "transactions" is that the respondent, in one or both of the years in question, conferred a" benefit” on each of his children within the meaning of those words in section 137(2). If he did, he is deemed to have made a payment to each of the children equal to the amount of the benefit; and that payment, in the circumstances of this case, is deemed to be a "disposition by way of gift to which part IV applies.

Furthermore, it does not matter whether persons other than the respondent and his children were parties to the transactions. It is not surprising that Parliament inserted this latter clause because, in the nature of things, it is to be anticipated that, where a person makes arrangements to confer a benefit on another by a series of transactions, it will frequently be so arranged that the person granting the benefit will be a party to the first transaction and the person benefited will be a party to the last transaction, but third parties will be the other parties to those transactions and possibly to intervening transactions.

In my view they were, because, in my view, the word "transaction" or "opération" is used in the widest possible sense as meaning any act having operative effect in relation to a business or property. However, I do not need to reach a concluded opinion on that question to conclude, as I do, that the "result" I have described was the result of a "transaction".

The resolution granting the "rights" was, it is true, passed by the Board of Directors; and the respondent was only one director and had in the proceedings of the Board only one vote.

The sequence of events bears all the earmarks of a series of company transactions that had been arranged in advance by the major shareholder and father, after taking appropriate professional advice, with a view to achieving the result of increasing the children’s proportions in the ownership of the stock of the company.

Moreover, the benefit, if it was one, was an increase in the proportions of the children almost entirely at the expense of a decrease in the respondent's.

There is no doubt in my mind that, if the result of the transaction was a benefit to the children, it was conferred on them by the respondent.

The Dufresne case, supra, was followed by three Federal Court-Trial Division judgments namely:

Boardman v. The Queen, [1986] 1 C.T.C. 103; 85 D.T.C.5628;

Perrault v. The Queen, [1976] C.T.C. 65; 76 D.T.C. 6021;

Levine Estate v. M.N.R., [1973] C.T.C. 219; 73 D.T.C. 5182.

The Exchequer Court of Canada in the Craddock v. M.N.R., [1968] C.T.C. 379; 68 D.T.C. 5254 concluded that subsection 137(2) (the old gift tax section) of the Act (as it then was) in any such case is not dependent upon or connected with any other section or sections in Part I of the Act. The Craddock case was appealed to the Supreme Court of Canada and the appeal was dismissed. The Court therein did not make any comment concerning whether paragraph 137(a) was a stand alone section or not.

This Court is satisfied that subsection 56(2) is much narrower than subsection 245(2) and therefore the decisions interpreting subsection 56(2) are not authority for interpreting subsection 245(2). The Court is assisted in this opin- ion by the fact that Strayer, J. in his reasons for judgment in Boardman, supra, relied heavily on Dufresne, supra, when he interpreted subsection 245(2) yet one year later when he delivered his judgment in McClurg, [1986] 1 C.T.C. 355; 86 D.T.C. 6128 when dealing with subsection 56(2), he did not quote Dufresne nor refer to the wording of subsection 245(2). Neither the Supreme Court of Canada nor the Federal Court of Appeal in McClurg referred to subsection 245(2) or the cases dealing with this subsection.

The respondent in his reply to the notice of appeal pleaded paragraph 245(2)(c) and subparagraph 69(1)(b)(ii) as it then was and did not plead nor rely upon subsection 56(2).

This Court is satisfied that the actions of the appellant fall within the clear language of subsection 245(2) and therefore he is deemed to have made a disposition by way of gift to his two children. Then subparagraph 69(1)(b)(ii) as it then was deems that the disposition was at fair market value. This subparagraph can be paraphrased to read:

Where a taxpayer has been deemed to have disposed of anything by way of a gift, he shall be further deemed to have received income equal to the fair market value of the deemed gift.

This Court is satisfied that paragraph 245(2)(c) a deeming provision stands on its own and that subsection 56(2) is not relevant to these appeals.

Decision

For the above reasons, the appeals are dismissed.

Appeals dismissed.