598606 Ontario Ltd. v. The Queen, 93 DTC 142, [1993] 1 CTC 2001 (TCC)

Sarchuk, T.C.CJ.:—The appeal of 598606 Ontario Ltd. [1] is from an assessment for its 1986 taxation year by which the Minister of National Revenue assessed the appellant in the amount of $99,380.51, being the Part VII tax owing together with interest thereon and denying the Part VII tax refund claimed by the appellant.

The Minister’s assessment was made on the basis that Omnibus Computer Graphics Inc. (Omnibus) [2] failed to designate a share-purchase tax credit (SPTC) in the amount of $80,000 in favour of the appellant by filing prescribed Form T-2110 with the Minister as and when required and accordingly the appellant's Part VII refund is "nil" within the meaning of subsection 192(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

At the commencement of the hearing counsel for the appellant tendered in evidence an application record filed with the Ontario Court (General Division) in an action taken by the appellant against Omnibus (Exhibit A-1). Specific reference was made to the affidavit of James Donald Wiley (“Wiley”) which formed part of the record and to the documents appended thereto as exhibits. Both counsel advised the Court that the facts set out in the affidavit, excepting those contained in paragraph 17, were not in dispute. Counsel for the appellant also adduced evidence from Wiley and from Mark F. Jefferson ("Jefferson"), a member of the firm of accountants retained by the appellant. On the basis of this document, the admissions made by the Minister in his reply to notice of appeal and the testimony of Wiley and Jefferson the facts which gave rise to these proceedings can be briefly stated.

The appellant is a taxable Canadian corporation, as that term is defined in the Act. It was a single purpose company incorporated to make a substantial investment in Omnibus structured so as to take advantage of certain provisions in Part VII of the Act. These provisions create a share-purchase tax credit system the mechanism of which was summarized thus in paragraph 6 of Wiley's affidavit:

(i) Where a taxable Canadian corporation is entitled to investment tax credits which it cannot or does not choose to use, it may issue "qualified shares" (most commonly fully participating common shares) to purchasers who are the first registered holders of such shares and are not brokers or dealers in securities. Under these circumstances the issuing corporation may designate an amount in respect of the shares up to 25 per cent of the entire consideration for which the shares were issued as a share-purchase tax credit.

(ii) The designation is made by filing with Revenue Canada, Taxation a prescribed Form T-2110 setting out the shares in respect of which the designation is made and the amount of the tax credit.

(iii) The corporation delivers to the shareholder a prescribed Form T-2111 which evidences the shareholder's entitlement to the share-purchase tax credit.

(iv) The corporation files a Part VII tax return for its taxation year in which the designated flow-through tax credit is shown as a tax liability, offset by the investment tax credit to which the corporation is entitled.

(v) A corporate shareholder which receives a share-purchase tax credit may, in turn, designate qualified shares issued to its own shareholders as entitled to flow- through of the credit. In this case, the corporate shareholder would file a Part VII tax return showing a tax liability for the tax credit flow-through to its shareholders, off-set by the tax credit that had been flowed-through to the corporation.

It was understood that this step-by-step process would be followed to the point where the appellant's shareholders would ultimately benefit from the flow-out of tax credits. The evidence indicates that certain steps were taken while others were not.

As at March 29, 1985 the appellant was a shareholder in Omnibus and held a debenture issued by it (the Omnibus debenture) securing the principal amount of $600,000 convertible prior to March 29, 1987 into 444,444 common shares of Omnibus. Under the terms of this debenture, if it was converted on or before December 31, 1986, Omnibus was obligated to issue the “ qualifying shares" and in compliance with subsection 192(4) of the Act designate an amount in respect of those shares not exceeding 25 per cent of the consideration upon which they were issued to a maximum of $80,000 as the SPTC. It was further required to deliver to the appellant the prescribed designation Form T-2110 and the executed Form T-2111 evidencing the appellant's entitlement to such SPTC (Exhibit A-1, Tab 5, pages 9-10).

In similar fashion the shareholders of the appellant, as at March 29, 1985, held debentures (the "Omnivest debentures") issued by the appellant securing the total principal amount of $600,000 convertible at any time prior to March 29, 1987 into 444,000 common shares of the appellant (the "Omnivest shares"). These debentures provided that if they were converted on or before December 31, 1986 the appellant was to issue the qualifying shares and to designate an amount pursuant to the provisions of subsection 192(4) of the Act.

On or about June 27, 1986 the appellant converted the full amount of the Omnibus debenture. Thus, according to the terms of the debenture, Omnibus was obligated to designate the amount of $80,000 as an SPTC to be flowed out to the appellant. There is, however, no evidence that the requisite designation was ever made or filed with the Minister by Omnibus.

On or about July 29, 1986 the shareholders of the appellant converted their Omnivest debentures, thus entitling the shareholders by the terms of the Omnivest debenture, to SPTC to be flowed out from the appellant in the aggregate amount of $80,000. In August 1986, on the instructions of the appellant's Board of Directors, Jefferson prepared the share-purchase tax credit designation Form T-2110 in respect of that amount. On August 29, 1986, the appellant filed the form with the Minister as required. Subsequent to that filing Jefferson prepared Form T-2111 supplementary slips for distribution to the appellant’s shareholders.

In April 1987 when Jefferson began to prepare the appellant's Part VII tax return he discovered that the Omnibus designation and the appropriate supplementary slips were not at hand. He contacted Omnibus’ solicitor and accountants and learned that nothing was available to indicate whether it had filed the necessary designation. Notwithstanding the absence of these documents Jefferson prepared the appellant's return. It was filed on June 30, 1987 and reported Part VII tax payable of $80,000 in respect of the Omnivest shares for which the designation had been filed and claimed an offsetting Part VII refund of $80,000 in respect of the Omnibus shares purchased. He says he acted on the assumption that it was necessary to do so since the appellant had itself taken the next step in the process, i.e., flowing out an SPTC to its shareholders.

By notice of assessment dated January 31, 1989 the Minister assessed the appellant for its 1986 taxation year on the grounds that the Minister had not received a designation in respect of the Omnibus shares and denied to the appellant the SPTC which would have offset the appellant's Part VII tax liability.

Mr. Wiley was the president and a director of the appellant. He was also, at the relevant time, a director of Omnibus. Since the position of the appellant is premised to some extent on the conduct of others beyond its control, reference should be made to Wiley’s testimony as to the state of Omnibus’ business in 1987 and to the circumstances which he believes led to the failure of Omnibus to file the required designation. Wiley said Omnibus was a successful computer graphics firm which by the end of 1986 had improved the value of its stock and was a good investment. However this changed in February 1987 when it became involved in the acquisition of several companies and required more cash flow than expected. Suddenly the business "turned around", the bank began making demands and the managerial situation became chaotic. A majority shareholder stepped in, became involved in the day-to-day operations and ultimately took over. In Wiley's view the directors lost control at that point of time, were no longer listened to and this led to his resignation in March or April of 1987. From that point of time he received little information regarding Omnibus’ affairs although he was aware that a short time after the bank "foreclosed on it" and that as of the summer of 1987 Omnibus was, for all practical purposes, not functioning. He believed there were insufficient assets to warrant bankruptcy proceedings and what there was, was sold. Wiley who signed the designation with respect to the Omnivest shares said he was not aware at the time that the appellant had not received the requisite forms from Omnibus. Indeed he had no knowledge whether Omnibus had prepared the necessary forms and designations nor did he make any effort to ensure that they were obtained prior to the appellant proceeding to designate its shares. He said only that he believed that the appellant's accountant, Jefferson, may have done so. It was not until receipt of the assessment that Wiley made calls to Omnibus’ attorneys inquiring about the documentation and was given to understand that they would search for it. These inquiries produced no results.

Appellant's position

Counsel for the appellant submits that the SPTC mechanism under Part VII is a product of government economic policy designed to encourage or induce a taxpayer to undertake a specific activity which would not otherwise be undertaken but for the inducement. In this case the legislation was directed towards assisting small or medium size businesses to raise equity to finance new investment projects with the concurrent objective of increasing production and employment. To encourage investment the government held out inducements by way of tax credits to make such an investment more attractive. This objective, counsel noted, was clearly stated in the budget speech delivered by the Minister of Finance on April 19, 1983 and in the Budget Papers— Supplementary Information dated April 19, 1983.

Counsel argues that the appellant did exactly what the government intended. The appellant complied with every requirement imposed upon it by the Act both as a precondition to obtaining the SPTC and in turn flowing it out to its shareholders. Relying upon Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305 and O'Brien Estate v. M.N.R., [1991] 2 C.T.C. 2747, 91 D.T.C. 1349 (T.C.C.), he submits that the statute should not be interpreted in a manner which would defeat “the object and spirit" of the relevant provisions by reason of technical filing deficiencies not of the appellant's doing nor in its control. To do otherwise would create an unjust enrichment for the Minister since it is apparent that had the appropriate designations been filed by Omnibus no tax would have been required of any of the parties.

Minister's position

The Minister relies on subsections 192(2), 192(4) and 192(8) of the Act and contends that failure by Omnibus to designate an SPTC by filing the prescribed Form 1-2110 leads automatically to the failure of the appellant's case. Counsel referred to the decision of the Tax Court of Canada in United Equities Ltd. v. M.N.R., [1989] 2 C.T.C. 2171, 89 D.T.C. 391 which, he argues, supports the Minister's position. (Reversed in the Federal Court-Trial Division by MacKay, J. in [1992] 2 C.T.C. 213, 92 D.T.C. 6572.) He also contends that there was an obligation on the appellant, beyond the mere acquisition of the shares of Omnibus, to exercise due diligence to be in the position to believe that Omnibus would not evade its obligations under Part VII. That was not done. He noted that there were common directors and that Mr. Wiley as president of the appellant and a director of Omnibus could have taken timely action prior to the failure of Omnibus in 1987, which occurred well after the date of the conversion of the Omnibus debenture and the time specifically set out in that agreement for both the filing of the designation with the Minister and the production of the designation to the appellant.

Conclusions

Two preliminary comments.

First as to the appellants contention that the object and spirit of the relevant provisions should not be defeated by technical filing deficiencies not within its control. I do not believe that the plea of due diligence or impossibility is tenable on the facts established before me. The terms and conditions of the Omnibus debenture provided that if the debenture was converted into shares on or before December 31, 1986 Omnibus was obliged to comply with the provisions of subsection 192(4). The appellant converted the Omnibus debenture on June 27,1986. That triggered Omnibus’ contractual obligations to the appellant including the issuing of the shares, the delivery of a duly completed and executed Form T-2110 and, most importantly, the filing of the prescribed designation form with the Minister on or before the last day of the month immediately following the month in which the qualifying shares were issued. [3] Wiley was a director at the time the Omnibus debenture was executed and had reviewed its terms. I am satisfied that he, and the appellant were aware, albeit in general terms, that in order for the appellant to obtain the tax benefit it was first necessary for Omnibus to make and file the requisite designation. It was open to the appellant to have taken the simple step of inquiring of Omnibus or of the Minister to determine whether that had been done and upon discovering that fact to have enforced its right to the production of the designation. That was not done.

Second, regarding the reference made by counsel for the respondent to the decision of the Tax Court of Canada in United Equities. That judgment no longer stands and in any event the issue determined therein is substantially distinguishable. The plaintiff in that case had appealed from reassessment of income tax made by the Minister of National Revenue who had disallowed a scientific research tax credit (SRTC) claimed for its 1984 taxation year. MacKay, J. described the circumstances as follows:

The essential facts are not in dispute. On May 31, 1984, Acadia Saw Mills Ltd. ("the company”), in consideration of the payment of $200,000. by United Equities, issued a debenture in the amount of $114,000. to the plaintiff in accord with an agreement dated May 28, 1984. Under the agreement between the company and the plaintiff, the Company was to designate the purchase price, $200,000., for the purposes of a scientific research and experimental development tax credit (SRTC) pursuant to section 127.3 and Part VIII of the Act. . . . By inadvertence, the solicitor of the company, who had completed the documents required to be filed to permit the designation of the SRTC, did not file those documents within the prescribed times.

[Emphasis added.]

The solicitor for the company, who had neglected to file the designation form and the information forms, first realized his mistake when, following an enquiry from a local officer of Revenue Canada on October 17, 1985, he discovered the Original forms still in his file. After finding the original forms the solicitor wrote that same day to Revenue Canada at its Halifax office forwarding the original forms 72113, T2114 summary and form 12114 supplementary, noting that "Due to an oversight on my part, these documents were not forwarded to Revenue Canada as required”.

Then on December 23, 1985 the solicitor received from the company a letter dated November 18, 1985 addressed to Acadia Saw Mills from Revenue Canada Taxation in Ottawa, signed on behalf of D. Dexter of the Part VII, VIII Tax Group. By that letter, form T2113, the SRTC designation form, was returned to the company with the statement that it should have been filed under subsection 194(4) of the Act not later than June 30, 1984. That letter also noted that subsection 194(7) provided for late filing of the designation if the prescribed information return T2114 summary is filed by the end of February in the year following the issue of the debt obligation and the penalty provided in subsection 194(8) is both calculated and remitted. The letter also noted that no remittance of the penalty “appears to have been made" with the designation forwarded on October 17 and “ consequently, the designation in question cannot be considered to be filed as a valid designation in accordance with subsection 194(7) as the applicable penalty of $8,000 has not been remitted”. Finally, the letter stated:

The enclosed T2113, will be accepted as filed on the original filing date if it is resubmitted with the applicable penalty payment within 30 days of the mailing of this letter. Failure to submit the requested penalty payment with the enclosed T2113 will result in an invalid designation and the disallowance of the tax credits claimed by investors.

Discussions and correspondence between the plaintiff, the solicitor and officials of Revenue Canada followed. On January 27, 1986 the solicitor wrote resubmitting the original Form T-2113 and enclosing a cheque in the amount of the penalty. The cheque was cashed by Revenue Canada and receipt of the Form T-2113 was acknowledged by letter dated February 10, 1986 which noted that the letter and an enclosed stamped copy of the form were an acknowledgement of receipt of the designation form and should not be regarded as confirmation that the designation was valid.

The issue in United Equities was stated by MacKay, J. as follows:

While the parties state the issue in this case in different terms, those terms relate to their differing perceptions of the construction or interpretation of subsection 194(7) in this case. For the plaintiff it is argued that timely filing of information returns is not a condition precedent to late filing of a designation where the Minister has given notice that a designation has not been made under subsection 194(4) and the designation and payment of the penalty prescribed is made on or before 90 days after mailing of the notice. Further, the letter of November 18, 1985 constitutes notice and the company having filed the designation and paid the penalty within 90 days of the date of that letter has met the requirements of the exception clause in subsection 194(7). For the defendant it is argued that timely filing of information returns is a condition precedent to any late filing of the designation, but if the Court concludes otherwise, the letter of November 18 does not constitute a notice by the Minister within subsection 194(7).

MacKay, J. concluded that:

Since, following notice mailed on behalf of the Minister, the company filed its designation and paid a penalty, previously estimated by Revenue Canada in the letter of November 18 and not disputed as being an appropriate penalty at trial, all before 90 days from November 18, 1985, that designation qualifies as valid, though filed late, by reason of subsection 194(7).

and allowed the plaintiff's action.

The issue before me is markedly different. I must determine the effect upon the appellant of the failure on the part of Omnibus to make and file the requisite designation. For the following reasons I have concluded that such failure deprives the appellant of its entitlement to the SPTC.

Part VII and section 127.2 of the Act [4] provide a mechanism by which a corporation unable to use investment tax credits earned is permitted to attract investors in its equity capital by making those investment tax credits available to the investors. In this manner the latter are able to secure a credit against tax payable as provided in section 127.2 of the Act. There is no dispute that the legislative provisions in issue have a substantial economic policy element.

In the present appeal the appellant seeks to create in its hands a sharepurchase tax credit as provided in section 127.2 of the Act. Such a credit is deductible in computing the appellants tax otherwise payable under Part I of the Act. To be entitled to that benefit the appellant must come within the parameters of the relevant legislative provisions. These provisions can only be read to mean the following: an investor will obtain an SPTC only where an amount is designated by the issuer in respect of the SPTC instrument acquired pursuant to subsection 192(4) of the Act. A designation will be effective only if the issuer files the prescribed form (T-2110) within the time prescribed including the late filing period. [5] Such filing is fundamental to the investor's entitlement to an SPTC. A designation is not made for the purposes of Part VII and section 127.2 of the Act until the prescribed form is filed.

Counsel for the appellant has argued that the relevant provisions should be interpreted in accordance with the "object and spirit of the enactment" and not so as to permit an administrative requirement to thwart the substantive purpose of the legislation. I am satisfied that the making and the filing of a designation is more than a mere administrative requirement. The submission of counsel for the appellant that the substantive purpose of the relevant provisions are negated by requiring issuer to provide the Minister with the designation does not withstand close scrutiny. The relevant provisions provide for the creation of the SPTC and impose a refundable tax on the corporation which creates such a tax credit. The designation therefore has substantive purposes: to put the Minister on notice of the designating corporation's tax liability and of the investor's claim to an SPTC; to ensure there exists a qualifying share as described in subsection 192(4) and, to enable the Minister to satisfy himself that the provisions of subsection 192(11) are complied with. [6] In my view the designation is a logical as well as statutory precondition to the acquisition of a tax credit.

In Stubart Investments, supra, the Supreme Court modified the strict interpretation rule for the construction of taxation statutes. It is important to note the precise words that Estey, J. adopted in defining the appropriate approach at page 578 (C.T.C. 316, D.T.C. 6323):

While not directing his observations exclusively to taxing statutes, the learned author of Construction of Statutes, 2nd ed., (1983), at page 87, E.A. Dreidger, put the modern rule succinctly:

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

The conclusion I have reached does not offend the object and spirit of the enactment.

The appeal is dismissed.

Appeal dismissed.