Citation: 2010 TCC 71
Date: 20100204
Docket: 2008-1724(IT)G
BETWEEN:
LESLIE EMORY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Woods J.
[1] This appeal relates to the arm's-length deeming rules
in section 84.1 of the Income Tax Act.
[2] In 2002, the appellant, Leslie Emory, sold shares in
the capital of Sona Computer Inc. (“Sona”) for cash proceeds of $400,000. The
purchaser was 1514488 Ontario Inc. (“Ontario Inc.”).
[3] The gain from the sale was reported by the appellant as
a capital gain which was eligible for the capital gains exemption.
[4] In a reassessment for the 2002 taxation year, the
Minister of National Revenue considered that section 84.1 of the Act applied
to the disposition. As a result, the Minister included $492,387 in the
appellant’s income as a taxable dividend.
[5] Ms. Emory appeals from this assessment as well as
consequential assessments for the 2003 and 2004 taxation years.
[6] The main issue is whether section 84.1 applies to the
disposition of the shares of Sona. There are also incidental issues with
respect to the 2003 and 2004 taxation years that are relevant if the appellant is
successful on the main issue.
Background facts
[7] The relevant facts, which are not in dispute, are set
out as assumptions in the reply. They are reproduced below. Corporate
organization charts which were prepared by the appellant’s counsel are reproduced
in an appendix.
Minister’s
assumptions
a)
on March 24, 1992, Sona Computer Inc. (Sona) was incorporated;
b)
in July 2001, Leslie Emory (Emory) and Xuening Chen (Chen) held 20 and
55 common shares of Soma [sic], respectively, which represented all of the
issued and outstanding shares of the corporation;
c)
on February 23, 2000, Foxwise Technologies Inc. (Foxwise) was
incorporated;
d)
in July 2001, Emory, Chen and Sam Damm held 24, 25 and 51 common shares
of Foxwise, respectively, which represented all of the issued and outstanding
shares of the corporation;
e)
on June 2, 2002, 1514488 Ontario Inc. (Ontario Inc.) was incorporated;
f)
at all material times, Emory and Chen held 5 and 95 common shares of Ontario
Inc., respectively, which represented all of the issued and outstanding common
shares of the corporation;
g)
on September 3, 2002, Emory and Chen disposed of their shares of Sona
and Foxwise to Ontario Inc.;
h)
on September 3, 2002, Emory received as consideration for her shares of
Sona and Foxwise an amount of $400,000;
i)
Emory’s adjusted cost base of her shares of Sona and Foxwise was $2,000
and $24, respectively;
j)
the portion of the consideration of $400,000 attributable to the shares
of Foxwise was nominal;
k)
on September 3, 2002, Chen received as consideration for his shares of
Sona and Foxwise, 1100 Special Shares of Ontario Inc. by way of “rollover”
pursuant to section 85 of the Income Tax Act;
l)
on September 3, 2002, Ontario Inc. held all of the issued and
outstanding shares of Soma [sic];
m)
on September 3, 2002, Ontario Inc. held 49 of the 100 issued and
outstanding common shares of Foxwise;
n)
on September 25, 2002, Sona declared and paid a dividend of $400,000 to
Ontario Inc.; and
o)
at all relevant times, Emory, Chen, Soma, Foxwise and Ontario Inc, were
Canadian residents.
The issue
[8] The primary question is whether Ms. Emory and Ontario
Inc. were not dealing at arm’s length for the purposes of section 84.1 of the Act.
[9] The respondent suggests that they were not dealing at arm’s
length. The argument is founded not on the ordinary meaning of the term “arm’s
length,” but on the extended meaning that is applicable for purposes of s.
84.1.
[10] The
appeal relates to the disposition of shares in Sona and Foxwise. I do not
propose to discuss the Foxwise shares in these reasons since the parties agree that their value was nominal.
Legislative scheme
[11] The general purpose of section 84.1 is described in a Department
of Finance technical note, as follows:
Section 84.1
is an anti-avoidance rule designed to prevent the removal of taxable corporate
surplus as a tax-free return of capital through a non-arm’s length transfer of
shares by an individual resident in Canada to a corporation.
[12] The mischief at which the provision is aimed was
discussed in greater detail by Peter S. Bowen in “The Effect of the June 22,
1992 Notice of Ways and Means Motion on Certain Corporate Reorganizations,”
(1992), vol. 40, no. 5 Canadian Tax Journal 1218-33, at 1214:
In its present form, section 84.1 is primarily intended to prevent an
individual from using the capital gains exemption (or any pre-1972 increase in
value) to withdraw cash in excess of the paid-up capital of the shares, on a
tax-free basis, from a corporation. For example, consider an individual who
owns all of the shares of a corporation (Opco). The shares have a fair market
value of $100,000 but have only a nominal paid-up capital and adjusted cost
base. Assume that this individual has not yet used her capital gains exemption,
and is not restricted by any cumulative net investment loss. Ordinarily, the
individual would withdraw cash from the corporation by way of a dividend, which
would be taxed in her hands. But for the existence of section 84.1, the individual
could withdraw cash on a tax-free basis by undertaking a simple reorganization.
For instance, the individual could transfer the subject shares to a holding
corporation (Holdco) in exchange for a debt equal to the fair market value of
the shares. The resulting gain would be sheltered by the capital gains
exemption. The two corporations could subsequently amalgamate, and the debt
could be paid by the amalgamated company. Alternatively, Opco could pay a
tax-free dividend to Holdco to finance repayment of the debt. In either case,
$100,000 would have been withdrawn from Opco at no tax cost. Paragraph 84.1(1)(b)
acts in such circumstances to deem a dividend to have been paid to the
individual, and thus prevents the removal of the surplus. The deemed dividend,
in this case, is calculated as the excess of the debt received over the greater
of the paid-up capital and adjusted cost base of the subject shares.
[13] The general requirements for the application of
section 84.1 are set out at the beginning of subsection 84.1(1). Among other
requirements, there must be a non-arm’s length relationship between the taxpayer
who disposed of the shares and the corporation that acquired them.
[14] The relevant part of s. 84.1(1) reads:
Where after May 22, 1985 a taxpayer
resident in Canada (other than a corporation) disposes of shares that
are capital property of the taxpayer (in this section referred to as the
“subject shares”) of any class of the capital stock of a corporation resident
in Canada (in this section referred to as the “subject corporation”) to
another corporation (in this section referred to as the “purchaser
corporation”) with which the taxpayer does not deal at arm’s length and,
immediately after the disposition, the subject corporation would be connected (within
the meaning assigned by subsection 186(4) if the references therein to “payer
corporation” and to “particular corporation” were read as “subject corporation”
and “purchaser corporation” respectively) with the purchaser corporation,
[…]
(Emphasis added)
Analysis
[15] It is the submission of the respondent that Ms. Emory
and Ontario Inc. do not deal at arm’s length by virtue of a set of deeming
rules in section 84.1. For the reasons below, I agree with this submission.
[16] The result follows from the interplay between paragraphs
84.1(2)(b) and (2.2)(b), (c) and (d) of the Act.
[17] I begin the analysis with paragraph 84.1(2)(b).
It provides:
(2) For the purposes
of this section,
[…]
(b) in respect
of any disposition described in subsection (1) by a taxpayer of shares of the
capital stock of a subject corporation to a purchaser corporation, the taxpayer
shall, for greater certainty, be deemed not to deal at arm’s length with the
purchaser corporation if the taxpayer
(i) was, immediately before the disposition, one of a group of
fewer than 6 persons that controlled the subject corporation, and
(ii) was, immediately after the
disposition, one of a group of fewer than 6 persons that controlled the
purchaser corporation, each member of which was a member of the group referred
to in subparagraph (i);
[18] Pursuant to this provision, Ms. Emory is deemed not to
deal at arm’s length with Ontario Inc. if:
(a)
immediately before the
disposition, Ms. Emory was one of a group of fewer than six persons that
controlled Sona, and
(b)
immediately after the disposition,
Ms. Emory was one of a group of fewer than six persons that controlled Ontario
Inc., and each member of this group was a member of the group described in (a).
[19] Were it not for other deeming provisions, neither of
the above requirements would be satisfied because Ms. Emory would not be part
of a group that controlled either Sona or Ontario Inc. There are two reasons
for this.
[20] First, it is not suggested that Ms. Emory acted in
concert with the other shareholder, Mr. Chen, in controlling either Sona or
Ontario Inc. This is a necessary requirement in order to find that a group
controls a corporation: Silicon Graphics Ltd. v. The Queen, 2002 FCA
260, 2002 DTC 7112, at para 36.
[21] Second, Mr. Chen alone controlled Sona and Ontario
Inc. This would preclude Ms. Emory from being part of a group that controlled
these corporations: Southside Car Market Ltd. v. The Queen, 82 DTC 6179
(FCTD).
[22] The principles
from Silicon Graphics and Southside Car Market have been statutorily
overridden for purposes of s. 84.1.
[23] The relevant provisions, paragraphs 84.1(2.2)(b),
(c) and (d), read:
(2.2) For the purpose of paragraph (2)(b),
[…]
(b) a group of
persons in respect of a corporation means any 2 or more persons each of whom
owns shares of the capital stock of the corporation;
(c) a
corporation that is controlled by one or more members of a particular group of
persons in respect of that corporation is considered to be controlled by that
group of persons; and
(d) a
corporation may be controlled by a person or a particular group of persons even
though the corporation is also controlled or deemed to be controlled by another
person or group of persons.
[24] As a result of the application of these provisions, Ms.
Emory and Mr. Chen are considered to be a group that: (1) controlled Sona
immediately before the disposition, and (2) controlled Ontario Inc. immediately
after the disposition. The analysis is set out below.
[25] First, Ms. Emory and Mr. Chen are considered to be a
group of persons in respect of Sona and Ontario Inc. at the relevant times: s.
84.1(2.2)(b).
[26] Second, Sona and Ontario Inc. were controlled by this
group: s. 84.1(2.2)(c) and (d). In particular, Sona and Ontario
Inc. were each controlled by Mr. Chen at the relevant times because he owned
more than 50 percent of the voting shares of these corporations. In this
circumstance, the group of persons that includes Mr. Chen, namely Ms. Emory and
Mr. Chen, are considered to have controlled Sona and Ontario Inc.
[27] Accordingly,
the necessary conditions of s. 84.1(2)(b) are satisfied so that Ms. Emory is deemed not to deal at arm’s length with
Ontario Inc.
[28] Counsel for the appellant acknowledges that the plain
meaning of the relevant provisions produces this result. However, he suggests
that the plain meaning does not reflect the object and spirit of the
legislation and that a purposive interpretation is more appropriate.
[29] First, counsel suggests that subparagraphs 84.1(2)(b)(i)
and (ii) are meaningless if the plain meaning is given to s. 84.1(2.2)(b).
[30] The analysis above shows the fallacy of this argument.
Subparagraphs 84.1(2)(b)(i) and (ii) are not meaningless. Paragraph
84.1(2)(b) provides the framework for the expansion of the meaning of
the term “arm’s length.”
[31] Second, counsel suggests that this interpretation can
lead to absurd and repugnant results because it disregards the actual facts
concerning lack of control.
[32] I can understand why counsel would suggest that these
rules could have inappropriate results. For many years, commentators have noted
that section 84.1 is a trap for the unwary. See, for example, the article by
Peter Bowen referred to above. However, Parliament has clearly provided for
this result, presumably in order to limit the potential for abuse.
[33] Third, counsel suggests that this interpretation
conflicts with public positions taken by the Minister. It is suggested that the
Minister has acknowledged that a common link or interest between members of the
group is required: 1995 Revenue Canada Roundtable, at 52:10 and Interpretation
Bulletin IT-302R3, para. 3.
[34] With respect, I am not satisfied that these
commentaries were intended to apply to the legislative provisions that are relevant
in this appeal.
[35] Fourth, it is suggested that a plain meaning
interpretation is inconsistent with case law such as Silicon Graphics.
It is suggested that there is no appreciable difference between the statutory
provisions at issue here and in Silicon Graphics.
[36] I reject
this submission. The statutory provision
that was relevant in Silicon Graphics was the definition of “Canadian-controlled
private corporation” in subsection 125(7) of the Act. It did not contain
deeming rules similar to those at issue here.
[37] Further, counsel submits that this interpretation renders the
word “particular” in s. 84.1(2.2)(c) meaningless.
[38] I also disagree with this submission. The word
“particular” in s. 84.1(2.2)(c) is necessary because a corporation with several
shareholders could have many “groups” for purposes of the analysis. It is
necessary to specify which particular group is to be considered for purposes of
s. 84.1(2.2)(c).
[39] Finally, counsel submits that the plain meaning
interpretation is counter to the purpose of s. 84.1.
[40] I also
disagree with this submission. It is clear that section 84.1 is an
anti-avoidance provision that is designed to prevent the tax-free extraction of
corporate surplus. It is also clear, though, that the provision could
potentially overreach its anti-avoidance objective in certain cases. This
result was clearly intended by Parliament, in my view.
[41] It is perhaps worth mentioning that section 84.1 would
not have applied to the disposition by the appellant of shares of Sona if the
appellant had not owned any shares in Ontario Inc. The fact that the appellant owned
a small number of shares in Ontario Inc. has unfortunately resulted in the
application of this section.
Disposition
[42] The appeal with respect to assessments for the 2002, 2003
and 2004 taxation years is dismissed. The respondent is entitled to costs.
Signed at Ottawa, Canada this 4th
day of February 2010.
“J. M. Woods”
Appendix
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