Hollinger Inc. v. R., 99 DTC 5500, [1999] 4 CTC 61 (FCA)

Létourneau J.A. (Rothstein J.A. concurring):

This is an appeal from a decision of Bowman T.C.C.J. which upheld an ingenious scheme devised by the respondent whereby through a series of planned transactions, executed over a very short span of time (November 5, 1986 to December 22, 1986), it acquired worthless shares of a U.S. based subsidiary, (Coseka Resources (U.S.A.) Ltd.) “Coseka U.S.”, of a Canadian company (Coseka Resources Ltd.) “Coseka”. By reason of the high Adjusted Cost Base of the shares which the respondent acquired and the negligible amount for which it disposed of the shares, it realised a substantial capital loss which offset substantial capital gains of its own.

Asa matter of fact, in filing its 1986 tax return, the respondent claimed a capital loss of $113,723,980 and an allowable capital loss of $56,861,990. The amount of the capital loss was based on the Adjusted Cost Base of approximately 52% of the Coseka U.S. shares it had acquired ($113,724,000) minus the proceeds of the disposition of these worthless shares, i.e., $20.00. The Minister of National Revenue (Minister) disallowed the respondent’s loss claim on the sole basis of subsection 55(1) of the Income Tax Act (Act) which existed at the time as an anti-avoidance provision applicable to capital losses and gains. It read:

55. (1) Avoidance. - For the purposes of this subdivision, where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatever is that a taxpayer has disposed of property under circumstances such that he may reasonably be considered to have artificially or unduly

(a) reduced the amount of his gain from the disposition,

(b) created a loss from the disposition, or

(c) increased the amount of his loss from the disposition,

the taxpayer’s gain or loss, as the case may be, from the disposition of the property shall be computed as if such reduction, creation or increase, as the case may be, had not occurred.

Subsection 55(1) was repealed in September 1988 and then replaced by subsection 245(1) (which itself has now been replaced) which sought to attain the same objective, but was broader in scope and had a significantly different wording:

245. (1) Artificial transactions. - In computing income for the purpose of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

The respondent appealed the decision of the Minister to the Tax Court of Canada. In his reply to the respondent’s Notice of Appeal, the Minister raised for the first time a new argument which has now, before us, become the chief argument, thereby relegating the initial subsection 55(1) reassessment to the role of subsidiary argument.

Basically, the Minister now argues that, for the purposes of subsection 85(4) and paragraph 53(1)(f-1) of the Act, the Coseka U.S. shares (the loss shares) bought by the respondent were no longer capital property as the loss shares had no value as an investment to anyone. To the Minister, they were neither a source of income themselves nor a part of an income-producing structure of another source of income. They were incapable of producing income and they were sold only as carriers of a tax loss.

Moreover, as Coseka had been promoting the sale of its losses, this, according to the Minister, amounted to a clear and positive act indicating a change of intention regarding the purpose for which the shares were held by Coseka. They were no longer held as an investment and, consequently, they did not qualify as capital property. Relying upon the decision of the House of Lords in Bishop (Inspector of Taxes) v. Finsbury Securities Ltd.', [1] he submitted in his Memorandum of Fact and Law that the loss shares that were the subject of the transactions were neither capital nor stock-in-trade because the whole transaction stood outside the ambit of the taxpayer’s business and was a purely artificial device remote from trade to secure a tax advantage.

A brief description of the scheme whereby the respondent acquired the loss shares is necessary for a proper understanding of the arguments made by the parties. The main features of that scheme were usefully and succinctly described by the learned Tax Court judge and I am content to reproduce this excerpt from pages 2 and 3 of his decision:

The Coseka U.S. shares had only a nominal value. If Coseka sold those shares it would have sustained a capital loss equal, roughly, to its Adjusted Cost Base (ACB). This loss would have been of no value to it because it had no capital gains against which the loss could be offset. Therefore a means had to be found whereby the potential loss could be turned to account.

Hollinger had ample capital gains and so the following series of steps was devised and implemented to enable Hollinger to utilize Coseka’s potential losses. Counsel for the respondent described the steps as “preordained” and indeed they were. They were orchestrated by the appellant’s solicitors.

l. Coseka caused 346045 Alberta Limited (“346045”) to be incorporated of which it held all the shares.

2. Coseka caused 353380 Alberta Ltd. (“353380”) to be incorporated. Its shares were all owned by 346045.

3. Coseka entered into a written option agreement with an arm’s length company, 341063 Alberta Ltd. (“341063”) whereby in consideration of $15,000 it gave 341063 an option exercisable prior to December 30, 1986 to purchase all of the issued and outstanding 2,050 common, 240 preferred, 150 preferred series B and 1,396 preferred series C shares of Coseka U.S. for a purchase price of $0.01 per share.

4. 341063 was owned by Phelps Drilling International Limited (“Phelps”), which was owned to the extent of 24% by Bramalea Limited. Bramalea was a 68% shareholder of Coseka.

5. By an agreement of purchase and sale dated November 24, 1986, which followed substantially a letter of intent of November 7, 1986, the appellant agreed to purchase from Coseka the 10 issued and outstanding shares of 346045 for $4,000,000 with a closing time of 2:00 p.m. on December 16, 1986.

6. In that agreement, Coseka warranted that at closing the only assets of 346045 were the shares of 353380, and that 353380’s only assets would be 1,068 common, 125 preferred, 79 preferred series B, and 728 preferred series C shares of Coseka U.S. (about 52% of all of its issued and outstanding shares) which were subject to the option to 341063.

7. In the agreement there was a condition that the appellant would satisfy itself that the ACB of the Coseka U.S. shares held by 353380 was at least $100,000,000.

8. The Coseka U.S. shares had been pledged and hypothecated to the Royal Bank of Canada. The bank released them on December 9, 1986 in consideration of Coseka’s agreement to pay it one-half of the net amount received by Coseka for the shares of 346045 as well as one half of the amount received under a similar transaction with Westbridge Capital Corporation relating to the rest of the shares of Coseka U.S.

9. On December 12, 1986 Coseka sold and transferred to 353380 the 1,068 common, 125 preferred, 79 preferred series B and 728 preferred series C, shares of Coseka U.S. referred to in paragraph 6. 353380 acknowledged that the shares were subject to the option to 341063 and entered into a similar option agreement with 341063.

10. On December 18, 1986, 346045 was dissolved and its shares of 353380 were transferred to the appellant. The certificate of dissolution of 346045 is dated December 18, 1986. Following the dissolution of 346045, the Appellant caused 353350 to be dissolved and its assets, which consisted of approximately 52% of the issued shares of Coseka U.S., were transferred to the appellant.

l 1. On December 19, 1986, 341063 gave notice to the appellant that it was

exercising its option to purchase the Coseka U.S. shares and on December 22, 1986, the Appellant sold them to 341063 for $20.00.

It is undisputed that the whole scheme had no business purpose and was set up only to gain a tax advantage under the Act. However, no sham was involved as there were a series of transactions legally binding and culminating in the acquisition of the loss shares by the respondent.

The learned Tax Court Judge allowed the respondent’s appeal. However, on the evidence that was available to him, he reduced the Adjusted Cost Base of the shares to $92,000,000. This finding is not in dispute before US.

He also ruled that the shares had not ceased to be capital property because of Coseka’s decision to sell an unproductive investment. Furthermore, he dismissed the Minister’s argument based on paragraphs 85(4)(b) and 53( 1 )(/'. 1 ) of the Act as he was of the view that these paragraphs did not apply in the circumstances since Coseka owned no shares of the corporation to which the property was disposed.

It is against this factual and legal background that this appeal stands to be decided.

The respondent raised two preliminary issues in its Memorandum and, at the hearing, it was agreed that it would be convenient that these two issues be argued first. The Court reserved its decision and I shall dispose of them now.

The preliminary issues raised by the respondent

The respondent submitted that, in view of the decision of the Supreme Court of Canada in the Continental Bank case [2] , the appellant was not entitled to raise for the first time before the Tax Court an argument which, in effect, after the limitation period for reassessing had expired, completely changed the basis of its earlier reassessment of the taxpayer.

In addition, it submitted that, with respect to the anti-avoidance provision contained in subsection 55(1) of the Act, this panel was bound by the earlier decision of this Court in the Nova case [3] . Not to follow the stare decisis rule and the principle of judicial comity would, according to the respondent, create nothing less than a judicial lottery whereby one could expect different decisions from this Court depending upon the composition of its panels from time to time.

The Continental Bank issue

The Minister’s reassessment pursuant to subsection 55(1) was based on the assumption that the loss shares acquired by the respondent were capital property throughout, but that the respondent’s conduct was abusive in that it artificially or unduly increased its loss from the disposition of that property. It is clear from the Minister’s reply to the respondent’s Notice of Appeal that the Minister assumed that the Adjusted Cost Base of the loss shares was transferred by Coseka [4] . In addition, subsection 55(1) applied only to capital losses and capital gains and the assessor who caused the reassessment to be issued confirmed in his testimony that he treated the loss shares as capital property [5] .

The position now taken by the appellant that the loss shares were not capital property is obviously a revocation of its prior unsuccessful assumption. From the evidence before us and before the Tax Court judge, it is impossible, however, to determine whether the limitation period for reassessing had expired when this new basis was first raised by the Minister. We know that a Notice of Reassessment was issued on February 4, 1993, but the record does not reveal when the original assessment of the respondent was made from which to calculate the four-year limitation period.

On the other hand, the Minister did raise for the first time on September 12, 1994, in his Reply to the respondent’s Notice of Appeal, that Coseka did not hold the loss shares as capital property on December 12, 1986 [6] and that the transfer of these shares to the second subsidiary company (353380 Alberta Ltd.) on that date was not a transfer of capital property [7] . Instead, he submitted that the loss shares had become trading assets utilized by Coseka in a business operation or venture of profit-making by which it intended to sell for gain its tax loss. Thus, the issue was as early as September 1994 before the Tax Court and it is still impossible to establish whether by then the limitation period for reassessment had expired. Because the limitation date is not in evidence, I am of the view that the Continental Bank of Canada principle relied upon by the respondent, namely that the Crown is not permitted to advance a new basis for reassessment after the limitation period has expired, cannot be applied in this instance.

However, counsel for the respondent contended that the Continental Bank of Canada decision of the Supreme Court stands for more. In his view, it also determined the procedure to be followed when a new basis for reassessment is being advanced. Under the existing law at the time, if the Minister was entitled to change the basis of the reassessment within the limitation period, counsel claimed, he could only do that formally by either issuing a new reassessment or amending the existing reassessment. Consequently, the mere pleading of such new basis in the Reply is not sufficient to validly raise the issue and prevent the limitation period from expiring. He relied to sustain his claim upon the following passage from Bastarache J. [8] :

The Crown is not permitted to advance a new basis for reassessment after the limitation period has expired.

With respect, I do not read this statement of Bastarache J. as imposing a formal procedure or a procedural restriction of the kind suggested by the respondent.

First, the quoted passage refers to the Crown, not the Minister. Had Bastarache J. mentioned the Minister, it could have been a possible indication that he had in mind the procedure of reassessment itself. Second, it speaks of “advancing a new basis for reassessment”, thereby referring to the Crown’s actual practice of advancing a new argument in its pleadings in support of the assessment [9] . Indeed, immediately after his statement, Bastarache J. refers with approval to the case of R. v. McLeod^ [10] in which the Crown was refused leave to amend its pleadings to advance a new basis for reassessment because the limitation period had expired. While Collier J. in McLeod refused the amendment on account of the expiry of the limitation period, he never questioned the Crown’s right to make new assumptions at trial or advance a new argument in support of the assessment.

It is obvious at pages 367-368 of his reasons that what Bastarache J. is concerned with is the possible unfairness to the taxpayer when notification of the new basis, whatever form it may take, is either inadequate or given too late and, as a result, the taxpayer is not afforded a proper opportunity to respond:

p. 367 Taxpayers must know the basis upon which they are being assessed so that they may advance the proper evidence to challenge the assessment.

p. 368 To allow the appellant to proceed without the benefit of findings of fact made at trial would require this Court to become a court of first instance with regard to the new claim.

I am comforted in this view by the recent legislative amendment in Bill C-72 brought to section 152 of the Act to overrule the decision of the Supreme Court in Continental Bank of Canada on this point. Subsection 152(9) assented to on June 17, 1999 allows for an alternative argument in support of an assessment to be advanced at any time after the normal reassessment period, subject to a discretion given to the Court to refuse it if prejudice could result to the taxpayer from the late change. The subsection reads:

s. 63.1(2) Section 152 of the Act is amended by adding the following after subsection (8):

(9) The Minister may advance an alternative argument in support of an assessment at any time after the normal reassessment period unless, on an appeal under this Act

(a) there is relevant evidence that the taxpayer is no longer able to adduce without the leave of the court; and

(b) it is not appropriate in the circumstances for the court to order that the evidence be adduced.

The amendment has no application in the present proceedings because it was not in force when the matter was argued before the Tax Court [11] . But it is indicative of the philosophy that ought to prevail in these matters. It would introduce an unnecessary measure of formalism, unwarranted by the decision of the Supreme Court and the subsequent amendment to section 152, if we were to require that proper notification to the taxpayer of an alternative argument in support of an assessment can only be achieved by the ministerial issuance of a new reassessment. This is not to say that the Minister may change the amount of an assessment in pleadings, but only that arguments in support of an assessment can be made in pleadings, even if not included in a notice of reassessment. Changing the amount of an assessment in pleadings is tantamount to the Minister appealing his own assessment, an avenue which has been clearly rejected by the Courts [12] .

In conclusion, I think the preliminary objection of the respondent grounded on the Continental Bank of Canada case has no merit in this instance and, accordingly, the appellant was entitled to argue, as it did before the Tax Court, the new basis advanced in its Reply. The respondent was fully and timely informed of it and had ample time to prepare as the hearing of the appeal took place more than three and a half years later. All the relevant evidence was before the Tax Court judge. Not only was there no objection made by the respondent at the time, but submissions were made to the judge by both parties with respect to the new basis for reassessment. The Tax Court judge dealt with the issue on its merits and the appellant’s ground of appeal relating to that aspect of the Tax Court judge’s decision is properly before us. I shall deal with it after consideration of the second preliminary objection.

The Nova case and the applicability of the doctrine of stare decisis and judicial comity

Before the Tax Court as well as before us, counsel for the appellant sought to distinguish the facts of the present case from the facts of the Nova case [13] . He forcefully argued that, unlike in Nova, the solicitors for the respondent were instrumental in initiating, orchestrating, directing and implementing the transactions. I carefully reviewed the decision of this Court in Nova where the transactions executed to transfer the loss to Nova were similar to those in the present instance. In that case, the majority concluded that the loss on disposition claimed by Nova had come about purely by operation of the provisions of the Act and that Nova had done nothing which influenced the proceeds of disposition in the transactions or increased the Adjusted Cost Base of the shares [14] .

There is no doubt that, in the present instance, the respondent through its solicitors was active in aiding and abetting the transactions completed or caused to be completed by Coseka. Counsel for the appellant perhaps is right in asserting that there was a greater involvement of the taxpayer here than in the Nova case. But I agree with the Tax Court judge that the respondent’s involvement “did nothing to create or increase the inherent loss or the loss ultimately sustained. That loss existed independently of the [respondent], and its solicitors’ activities were directed to ensuring that the formal steps necessary to implement the specific rules laid down by Parliament were followed” [15] . To use the words of our colleague McDonald J.A. in the Nova case, the respondent “cannot be punished for taking full advantage of the operation of the Act while it so existed” [16] and, in my view, there is even less ground to be punished if a party actually ensures that the requirements of the Act are fully complied with, so as to allow some particular provisions of the Act to operate as they are intended to.

In view of the conclusion that I have come to on capital property infra, the facts of this case are not distinguishable from those of the Nova case. In these circumstances, both the doctrine of stare decisis, premised on the need for certainty in the law [17] , and that of judicial comity require that we follow the judicial precedent established in the Nova case. The appellant has been unable to point out in that case any overriding error or failure to consider relevant legislation or binding authorities which, in the interest of justice, would either require or justify us departing from the interpretation previously given by this Court to subsection 55(1) of the Act.

I am now left to determine whether or not the loss shares were capital property in the hands of Coseka and its subsidiary company 353380 Alberta Ltd.

Whether or not the loss shares were capital property throughout the transactions

As previously mentioned, counsel for the appellant relies upon the Bishop (Inspector of Taxes) case, a 1966 decision of the House of Lords, to contend that, in the present instance, the loss shares acquired by the respondent were neither capital property nor stock-in-trade.

In the Bishop (Inspector of Taxes) case, Finsbury Securities Ltd. (Finsbury), a company which carried on the trade of dealing in shares and securities, entered into some 15 sets of transactions with other companies which amounted to “forward stripping operations” whereby Finsbury acquired from these companies’ preference shares carrying special rights. Under the scheme devised to avoid payment of taxes, the preference shares would have to be kept for a period of five years while the available profits of the companies would be distributed as dividends on these shares with the result that the value of the shares would diminish year by year to a nominal value.

The question of law which was submitted to the House of Lords by way of Stated Case was whether the commissioners erred in law when they held that the shares were part of the stock-in-trade of Finsbury. However, at page 108 of the decision, Lord Morris of Borth-Y-Gest defined instead the question to be answered as one which required the Court to determine whether the transactions entered into by Finsbury should be regarded as trading transactions of a kind undertaken by a dealer in shares and securities.

The Crown submitted that the shares were capital assets and were not stock-in-trade or trading assets because Finsbury had acquired them for five years as part of the capital structure of its company from which an income could be earned. Finsbury argued on the contrary that the shares had been acquired as part of their stock-in-trade.

His Lordship expressly found that neither argument raised by the parties was correct. Rather, he concluded that the one transaction that he had examined which was typical of the others, on its particular facts, was not, within the definition of section 526 of the British Income Tax Act, 1952, an adventure or concern in the nature of trade at all, but was a wholly artificial device remote from trade to secure a tax advantage.

With respect, I do not read the conclusion reached by his Lordship as a finding that the preference shares were neither capital nor stock-in-trade. His conclusion related not to the shares, but to the transactions themselves which he found to be lacking the ordinary features of the trade of share dealing. In other words, he answered in the negative the question that he had defined at page 108, that is to say that the transactions should not be regarded as trading transactions of a kind undertaken by a dealer in shares and securities which, because of the definition of trade in section 526, included every adventure or concern in the nature of trade. Consequently, the shares were not acquired by Finsbury for the purpose of dealing with them and were not part of its trading business.

To accept the appellant’s submission in the present instance that the loss shares were neither capital nor inventory would first require that we not follow the decision of the Supreme Court of Canada in Friesen v. /?. [18] and then would lead to an unfortunate and undesirable result.

In Friesen, Major J. for a unanimous Court on this point [19] ruled that the Act creates a simple system which recognizes only two broad categories of property: inventory or capital property. Under the Act, the characterization of an item of property is linked to the type of income that such property will produce, i.e., business income or capital gain.

The proposal of the appellant would create an undefined and elusive third category of property not contemplated by the Act and unrelated to the type of income or sources of revenues envisaged by the Act. It is not clear on what basis then the profits resulting from the disposition of the shares could be taxed in the hands of the seller or the losses deducted. It would create in the Act an unwarranted vacuum as well as uncertainty with respect to the characterization of items of property. Counsel for the appellant has been unable to explain what these loss shares would become or what status they would have if we were to accede to his submission and find that they were neither capital nor inventory property. In my view, the position advanced by the appellant is untenable and the characterization of the loss shares stands to be decided by reference to the two income-related categories established by the Act.

In this respect, the Tax Court judge correctly found that the shares owned by Coseka were a capital asset, the sale of which would have normally given rise to a capital gain or a capital loss. As it turned out, the shares were a bad investment. I agree with the learned judge that Coseka’s decision to sell their bad investment on terms as favourable as possible did not change the nature of that investment or of its use. I would reject the appellant’s submission that the shares were not capital property throughout the transactions.

Like my colleagues in the Nova case, I am disturbed by the fact that a corporation, such as the respondent, was able to repatriate losses in the amount of 92 millions incurred in the United States and thereby reduce its Canadian tax liability. However, as Desjardins J.A. pointed out in the Nova case, we are concerned here with the legality of the transaction, not its morality. I am bound by the law which existed at the time and which allowed for this kind of transaction.

For these reasons, I would dismiss the appeal with costs.

Isaac C.J. (concurring in the result):

I have had the advantage of reading the reasons for judgment that Mr. Justice Létourneau proposes to deliver in this appeal.

Like Mr. Justice Létourneau, I have reached the conclusion that this appeal should be dismissed; but, I do so for three reasons: first, for the reasons given by Marceau J.A. in his lament in Nova Corp. of Alberta v. R. [1] *; secondly, for reasons of judicial comity; and, thirdly and most importantly, because paragraph 55(1)(c) of the Income Tax Act has been repealed and replaced by provisions which prohibit the conduct that the appellant and others engaged in in the transactions described in the reasons of Mr. Justice Létourneau.

I would, therefore, dismiss the appeal with costs.

Appeal dismissed.