Citation: 2012 TCC 80
Date: 20120321
Dockets: 2008-2139(IT)G, 2008-2129(IT)G,
2008-2118(IT)G, 2008-2121(IT)G
BETWEEN:
McCLARTY FAMILY TRUST,
JOEL McCLARTY,
BRAYDEN McCLARTY,
DEVON McLARTY,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Angers J.
[1]
The above appeals were
heard on common evidence. The Minister of National Revenue (the Minister)
reassessed the appellant McClarty Family Trust (MFT) for its taxation years
ending December 31, 2003 and December 31, 2004 on May 30, 2007. The Minister applied
section 245 of the Income Tax Act (ITA), called the general anti-avoidance
rule (GAAR), to certain transactions that are before this Court and disallowed
the capital gains reported by MFT, treating as dividends in the amount of
$47,999 for each of those taxation years the amounts so reported.
[2]
The Minister reassessed
the other three appellants' 2003 and 2004 taxation years on April 17, 2007 by
also applying the GAAR to the same transactions. The tax consequences are that
the Minister included in each appellant's income for each taxation year under
appeal the amount of $16,000 as other income or as dividends instead of as a
capital gain.
[3]
The issues are whether
section 245 of the Act applies to the transactions such that the capital
gains that were reported by MFT on the disposition of the 2003 and 2004 stock
dividend shares it received should be disallowed, whether the dispositions should
be treated as giving rise to dividends totalling $47,999 in each of MFT's
taxation years in question and whether the amount of $16,000 should be included
in the income of each of the three other appellants as other income or
dividends for each of the taxation years under appeal. In other words, the
Respondent is taking issue with the
result that Darrell McClarty was able to split his income with his children
despite the Act’s attempt to prevent this through the “Kiddie Tax” of
section 120.4. The relevant portions of section 120.4 read:
120.4(1) The definitions
in this subsection apply in this section.
"specified
individual", in relation to a taxation year, means an individual who
(a) had
not attained the age of 17 years before the year;
(b) at no
time in the year was non-resident; and
(c) has
a parent who is resident in Canada at any time in the year.
"split
income", of a specified individual for a taxation year, means the total of
all amounts (other than excluded amounts) each of which is
(a) an
amount required to be included in computing the individual’s income for the
year
(i) in respect of taxable dividends received by the individual in
respect of shares of the capital stock of a corporation (other than shares of a
class listed on a designated stock exchange or shares of the capital stock of a
mutual fund corporation), or
(b) [income
received from partnership]
(c) a
portion of an amount included because of the application of subsection 104(13)
or 105(2) in respect of a trust (other than a mutual fund trust) in computing
the individual’s income for the year, to the extent that the portion
(i) is not
included in an amount described in paragraph (a), and
(ii) can reasonably
be considered
(A) to be in respect of taxable dividends received in respect of
shares of the capital stock of a corporation (other than shares of a class
listed on a designated stock exchange or shares of the capital stock of a
mutual fund corporation),
(B) [shareholder
benefit]
(C) to be income derived from the provision of goods or services
by a partnership or trust to or in support of a business carried on by
(I) a person who is related to the individual at any time in the
year,
(II) a corporation of which a person who is related to the
individual is a specified shareholder at any time in the year, or
(III) a professional corporation of which a person related to the individual
is a shareholder at any time in the year.
(2) There shall be added to a specified individual’s tax
payable under this Part for a taxation year 29% of the individual’s split
income for the year.
[4]
In the alternative, the
respondent is asking the Court to determine whether MFT is deemed to have
received a dividend pursuant to subsection 84(3) of the Act in each of
its taxation years such that the amounts of $16,000 were properly included as
dividends in the income of each of the three individual appellants for each of
the taxation years under appeal.
[5]
The facts that led to
the transactions referred to above involve Mr. Darrell McClarty, who is
the central figure in these appeals. Although he is not the appellant, he is
the father of the three minor appellants as well as one of the trustees of MFT.
[6]
Darrell McClarty is a
professional engineer who specialized in geotechnical engineering, and later,
in information technology. Prior to the summer of 2001, he was employed with
Clifton Associates Ltd. in their information technology division known as
Envista. While there, he designed and marketed the Envista software called the
"accounting system for the environment".
[7]
He became unhappy,
though, with the existing operations at Clifton
and sought to purchase the Envista division from Clifton
in a management buyout. The discussions with Clifton did not go very far and, as
a result, he resigned his position with Clifton
on June 15, 2001. His departure made many ripples. A few days after his
departure, Derin Hildebrandt, another Clifton employee also
resigned. That led to a meeting with the president of Clifton
to discuss the situation and particularly the need for Mr. McClarty to return
and stabilize Clifton's operations. It was at that meeting that
Darrell McClarty was shown a draft statement of claim for an action by Clifton
against McClarty and told that this is what would happen if he did not return to
Clifton.
[8]
Shortly thereafter, two
other Clifton employees left, namely, Colin Denison and
Catherine Marisi. The four of them got in contact with Cameco Corporation
(Cameco) and were invited to bid on the development of a system to monitor employees'
exposure to radiation at its mines. Projectline Solutions Inc. (PSI) was
therefore incorporated on August 24, 2001 under the laws of Saskatchewan for the purpose of submitting the bid. Darrell
McClarty held 31 common shares and the other three held 23 common shares
each.
[9]
PSI did develop
products for Cameco in the fall of 2001 and won a further contract in August
2002 despite competition from Clifton's Envista division. PSI's success was,
according to Mr. McClarty, due to the fact that it proposed developing new
software from the ground up for Cameco's purposes while Envista's proposal was
to simply deploy the Envista software then operating at Cameco's MacArthur River
site across Cameco's entire operation. During all that time, letters were being
exchanged by Clifton's and PSI's lawyers with respect to
various disputes.
[10]
It was in August or
early September 2002 that Darrell McClarty met with his accountant to discuss
incorporating a holding company. He was referred to Evan Shoforost. They
discussed the best method for structuring PSI. They needed basic accounting services
for PSI and protection from creditors as Mr. McClarty was still concerned about
potential legal actions by Clifton and also concerned about potential
liability related to the systems they created, as errors could occur. It was
agreed that the existing structure — with the four shareholders holding shares
personally — should be replaced with holding and management companies as well
as family trusts. As a result, McClarty Professional Services Inc. (MPSI) was
incorporated under the laws of Saskatchewan on October 7, 2002.
[11]
Darrell McClarty held
100% of the Class A voting shares of MPSI while MFT held 100% of the Class B
non-voting shares. MPSI then subscribed for 31 Class A shares in PSI.
[12]
The other shareholders
replaced their Class A shares with their own class of voting shares in the same
proportion as their original shareholdings, namely, 23 Class B shares, 23
Class C shares and 23 Class D shares. When Catherine Marisi left PSI in 2009, her
shares were redeemed by PSI and the shareholdings were a 31-23-23.
[13]
MFT was settled by
Vaughan McClarty, Darrell McClarty's father, on September 27, 2002 with a gold
coin. Darrell McClarty and his wife, Karen, were the trustees. The
beneficiaries were Darrell McClarty, Karen McClarty and their children Devon,
Joel and Brayden, the other three appellants. All three were minors at the
time.
[14]
Finally, 101051392
Saskatchewan Ltd. (101 SK) was incorporated on December 17, 2003,
with Darrell McClarty as sole shareholder and director. According to Darrell
McClarty, the purpose of 101 SK was to capture future investments and facilitate
the creditor protection scheme.
[15]
The transactions at
issue began on September 30, 2003 when MPSI declared a stock dividend on its
Class B common shares held by MFT (stock dividend shares). The stock dividend consisted
of 48,000 Class E non-voting preferred shares of MPSI with a paid-up capital
and an adjusted cost base of $1 and a redemption price of $1 per share. MFT then
sold the stock dividend shares (Class E) to Darrell McClarty on the same
day for $48,000 payable by means of a demand promissory note at a 0% rate of interest,
but which was to become 10% once payment was demanded.
[16]
That transaction
resulted in a capital gain for MFT of $47,999. MFT distributed this capital
gain to the three minor beneficiaries, $15,999 each payable by issuing to each
a demand promissory note with the same interest terms as Darrell McClarty's
promissory note. That resulted in a taxable capital gain of $7,999 for each
minor beneficiary, which was declared in their respective tax returns.
[17]
On the same day, namely,
September 30, 2003, Darrell McClarty paid $48,000 to MPSI in repayment of
previous shareholder loans and advances. MPSI then paid $48,000 to MFT as a
shareholder loan. MFT in turn made a loan to Darrell McClarty, which is called the
trustee loan. Darrell McClarty then paid a second sum of $48,000 to MPSI in
repayment of other shareholder loans.
[18]
On December 31, 2003,
Darrell McClarty sold the Class E shares he held in MPSI to 101 SK in
return for a $48,000 promissory note without interest. On the same day, MPSI
redeemed the stock dividend (Class E) shares at a redemption price of $1 per
share, or $48,000. 101 SK received a deemed dividend as a result of the
redemption, however, there was no tax payable on the transaction since the
deemed dividend was received from a taxable Canadian corporation (see section 112
of the ITA).
[19]
Still on the same day,
101 SK paid $48,000 to Darrell McClarty. There is a dispute here between
the parties as to what Darrell McClarty actually repaid with the $48,000 he
received from 101 SK. The respondent alleges that he repaid the promissory
note issued to MFT with respect to the stock dividend share sale that I
referred to earlier as the trustee loan while the appellant contends that the
payment at that stage represented the repayment of a separate trustee loan. In
any event, both parties are in agreement that on December 31, 2004, Darrell
McClarty had $104,400.37 in outstanding promissory notes owed to the MFT and
that the MFT had outstanding promissory notes in the amount of $96,000 owed to
the minor beneficiaries.
[20]
To complete the
December 31, 2003 transactions, MFT paid $48,000 to MPSI in satisfaction of the
shareholder loan it had received from MPSI on September 30, 2003, and MPSI paid
$48,000 to Darrell McClarty as repayment of another shareholder loan.
[21]
The 2004 transactions
proceeded in much the same way as the 2003 transactions except for certain
differences. On September 30, 2004, MPSI issued to MFT a stock dividend on the
Class B non-voting shares consisting of 48,000 Class E shares with a
paid-up capital, an adjusted cost base and a redemption price of $1 per share. This
resulted in a deemed dividend of $1 to MFT. MFT then sold the Class E shares to
Darrell McClarty for $48,000 and Darrel McClarty issued to MFT a promissory note
for that amount. MFT again distributed the capital gain equally among each of
the three minor beneficiaries, who received an amount of $15,999 each,
resulting in a taxable gain of $7,999 each. They declared this amount in their
tax returns.
[22]
Unlike what had
occurred in 2003, on September 30, 2004, MFT then paid $36,500 to MPSI in
repayment of a shareholder loan and $11,500 to Darrell McClarty as a trustee
loan. Darrell McClarty then paid the $11,500 to MPSI in repayment of a
shareholder loan.
[23]
On December 31, 2004,
Darrell McClarty issued a promissory note to MFT in the amount of $56,400,
indicating this represented the total net cash advances in 2004. On that same
day, Darrell McClarty sold the Class E shares to 101 SK for $48,000. 101 SK
again received a deemed dividend of $47,999 and claimed the corresponding
dividend deduction.
[24]
Also on that date, 101 SK
transferred the sum of $48,000 to Darrell McClarty in satisfaction of its
promissory note with respect to the purchase of Class E shares. Darrell McClarty
then transferred that amount to MFT as partial payment of its promissory note
of $56,000. The last step on December 31, 2004 was for MPSI to repay PSI the
amount of $48,000.
[25]
As a result of these
transactions and as said earlier, MFT had outstanding promissory notes owing to
the three minor beneficiaries of $32,000 each. Darrell McClarty had
outstanding promissory notes owing to MFT of $104,400.37 ($48,000 for 2003 +
$48,000 for 2004 + $8,400 in cash advances). The accounts of the remaining
companies offset each other.
The GAAR Analysis
[26]
I will deal first with
whether the GAAR can be used to recharacterize the capital gain received by
MFT. There is no dispute between the parties that the framework laid down by the
Supreme Court of Canada in Canada Trustco Mortgage Co. v. The Queen,
2005 SCC 54, is to be used. That case predates the Supreme Court's decision in Copthorne
Holdings Ltd. v. The Queen, 2011 SCC 63. The guidelines set forth at
paragraph 66 of Canada Trustco, supra, are as follows:
The approach to s. 245
of the Income Tax Act may be summarized as follows.
1. Three requirements
must be established to permit application of the GAAR:
(1) A tax benefit resulting from a transaction or part of a series of transactions (s. 245(1) and (2));
(2) that the
transaction is an avoidance transaction in the sense
that it cannot be said to have been reasonably undertaken or arranged primarily
for a bona fide purpose other than to obtain a tax
benefit; and
(3) that there was abusive tax avoidance in the sense that it cannot be
reasonably concluded that a tax benefit would be consistent with the object,
spirit or purpose of the provisions relied upon by the taxpayer.
2.
The burden is on the taxpayer to refute
(1) and (2), and on the Minister to establish (3).
3.
If the existence of abusive tax
avoidance is unclear, the benefit of the doubt goes to the taxpayer.
4.
The courts proceed by conducting a
unified textual, contextual and purposive analysis of the provisions giving
rise to the tax benefit in order to determine why they were put in place and
why the benefit was conferred. The goal is to arrive at a purposive
interpretation that is harmonious with the provisions of the Act that confer
the tax benefit, read in the context of the whole Act.
5.
Whether the transactions were motivated
by any economic, commercial, family or other non-tax purpose may form part of
the factual context that the courts may consider in the analysis of abusive tax
avoidance allegations under s. 245(4). However, any finding in this respect would
form only one part of the underlying facts of a case, and would be insufficient
by itself to establish abusive tax avoidance. The central issue is the proper
interpretation of the relevant provisions in light of their context and
purpose.
6.
Abusive tax avoidance may be found
where the relationships and transactions as expressed in the relevant
documentation lack a proper basis relative to the object, spirit or purpose of
the provisions that are purported to confer the tax benefit, or where they are
wholly dissimilar to the relationships or transactions that are contemplated by
the provisions.
7.
Where the Tax Court judge has proceeded
on a proper construction of the provisions of the Income
Tax Act and on findings supported by the evidence, appellate tribunals
should not interfere, absent a palpable and overriding error.
Tax Benefit
[27]
The first requirement that
must be met in order to recharacterize the transaction under the GAAR has been
conceded by the appellants in that there is a tax benefit resulting from the
transactions.
Is the transaction an avoidance
transaction?
[28]
With regard to the second
requirement, the appellants argue that the transactions at issue were
undertaken primarily to place Darrell McClarty beyond the reach of creditors by
putting demand promissory notes in the hands of MFT. The respondent counters
with the argument that the alleged bona fide purpose is not supported by
a reasonable assessment of the facts and circumstances of the transactions in
that the creditor-proofing was ineffective, the documentation reveals a
circular flow to the transactions, and the transactions were in fact an
off-the-shelf tax plan.
[29]
In Canada Trustco,
supra, at paragraph 29, the Supreme Court of Canada has provided
guidance for examining whether there was a bona fide purpose:
. . . this is a factual inquiry. The
taxpayer cannot avoid the application of the GAAR by merely stating that the
transaction was undertaken or arranged primarily for a non-tax purpose. The Tax
Court judge must weigh the evidence to determine whether it is reasonable to
conclude that the transaction was not undertaken or arranged primarily for a
non-tax purpose. The determination invokes reasonableness, suggesting that the
possibility of different interpretations of the events must be objectively
considered.
[30]
In other words, there
must be "an objective assessment of the relative importance of the driving
forces of the transaction" (see paragraph 28 of Canada Trustco).
Rothstein J.A., as he then was, in OSFC Holdings Ltd. v. The Queen,
2001 FCA 260, at paragraph 46, stated that the time to be considered in making
that assessment is the time the transaction was undertaken and not some later time
with the benefit of hindsight.
[31]
A large part of Darrell
McClarty's testimony was centred on his fears after leaving Clifton and his position with Envista. Shortly after he left,
others began to leave Envista as well and became his associates. He met with
Wayne Clifton, the president of Clifton, who stressed the importance of his returning
to Envista and clearly indicated that there could be significant legal
consequences if he did not. Darrell McClarty was shown a draft statement of
claim alleging that he had conspired to directly damage Envista's business and
had stolen Envista's intellectual property. That statement of claim was not
issued but it was used as a threat.
[32]
The statement of claim
was not put in evidence at trial, but there were other documents which
corroborated its existence, in addition to Darrell McClarty's testimony and
that of his lawyer at the time, Bill Warren. There is a letter from Bill Warren
as solicitor for Darrell McClarty stating that he was in possession of the draft
statement of claim and warning of its potentially libellous nature. Another letter,
in response, from Cory J. Furman of the firm Furman & Kallio, solicitors for
Clifton Associates Ltd, confirms that the draft statement of claim had not been
issued or distributed. There is also an e-mail from Paulette Popadynec of the
Saskatchewan Labour Board to Darrell McClarty indicating that there would be no
payment of remaining holiday pay since Clifton
was commencing legal action.
[33]
In addition, Clifton
through its solicitors, MacPherson Leslie & Tyerman, sent letters to the
Comision Interinstitucional de la Cuenca Hidrografica del Canal de Panama and
the Canadian International Development Agency to alert those agencies to the
fact that Darrell McClarty and Derin Hildebrandt, through a company named Can
Global, were "holding themselves out as having the authority to license,
sell, use, apply or otherwise market the Envista software and that they are
representatives of Envista".
[34]
These documents and the
evidence of Darrell McClarty clearly indicate that Darrell McClarty was under
threat of legal action upon leaving Clifton in 2001. The
threat of legal action remained as Envista and Clifton
continued thereafter to be competitors of PSI until Envista ceased operations
around 2005-2006. During that time of direct competition with Envista and Clifton, the situation, as summarized by Darrell McClarty in
his testimony, was that they were concerned that entering into contracts for developing
systems where they had done so before could be grounds for lawsuits and could
give rise to continuing legal problems with Clifton.
[35]
The respondent's position
is mainly centred on the argument that the creditor-proofing was ineffective.
The respondent argues that, regardless of what was done, Darrell McClarty would
be personally liable as a director of MPSI for issuing dividends which rendered
MPSI insolvent. They cited Evan Shoforost's statement in his paper given at the
2002 Prairie Provinces Tax Conference (Canadian Tax Foundation), at
page 7, where he stated that professionals cannot shield themselves from liability
for professional negligence but can do so with respect to liability in other
contexts, such as employer liability. The Crown relies on section 40 and
subsection 113(2) of the Saskatchewan's The Business Corporations Act (SBCA),
which reads follows:
40 A corporation shall not declare or pay a dividend if there are
reasonable grounds for believing that:
(a)
the corporation is, or would after the payment
be, unable to pay its liabilities as they become due; or
(b)
the realizable value of the corporation's assets
would thereby be less than the aggregate of its liabilities and stated capital
of all classes.
113(2) Directors of a corporation who vote for or consent to a
resolution authorizing:
. . .
(c)
a payment of a dividend contrary to section 40;
. . .
are jointly and severally liable to restore to the corporation any
amounts so distributed or paid and not otherwise recovered by the corporation.
[36]
The respondent did not
state how this would nullify the plan for providing protection from creditors in
this case. Given the fact that most of the evidence regarding the creditor-proofing
is centred on the fear of a lawsuit by Clifton
and Associates, it raises the question whether paragraph 40(a) of the SBCA
would apply in a situation involving future creditors who will only establish the
existence of a debt when a judgment is issued. Paragraph 40(a) of the SBCA
applies where a corporation is unable to pay its liabilities as they become
due. It is not entirely clear whether contingent creditors can rely upon paragraph
40(a) of the SBCA. In Devry v. Atwood's Furniture Showrooms Ltd.,
[2000] O.J. 4283 (QL), at paragraphs 26 and 27, the Ontario Superior Court of
Justice held that contingent judgment creditors could not rely upon the
equivalent provision of Ontario's Business Corporations Act (OBCA).
[37]
The respondent also
cited Justice Archambault of this Court, who held in Gestion Yvan Drouin Inc.
v. Canada, [2000] T.C.J. No. 872 (QL), 2001 DTC 72, at paragraph 71:
. . . according to legislation governing corporations . . . the
directors of a corporation cannot declare dividends that would cause the
corporation to be unable to meet its debts. If the directors declared and paid
a dividend in violation of the corporation's obligation toward its creditors,
they would be held liable for the amounts owed to those creditors. Remedies
could also be had against the shareholders for reimbursement of the dividends.
. . .
[38]
That case revolved
around subsection 160(1) of the ITA and its application and not the Canada
Business Corporations Act. His statement prior to ruling that the
subsection 160(1) assessment could not be upheld was obiter dictum. In
addition, the statement was made in the context of a tax debt, which becomes
due on the balance due date and is not contingent upon first obtaining
judgment.
[39]
I do not believe that
section 40 of the SBCA applies here. The desire to creditor-proof is
based on Darrell McClarty's fear of potential legal action by Clifton. MPSI, as far as the evidence shows, did not issue
dividends greater than its retained earnings. Since Clifton
was at best a contingent judgment creditor, that contingent debt would not be
required to be on MPSI's balance sheet for the purposes of conducting the
insolvency test prior to issuing the dividends. The situation could have been
different, though, if there had been ongoing litigation, but there was none here.
[40]
Regarding the argument
that the documentation reveals an entirely circular flow to the transactions,
the respondent put a lot of emphasis on the determination whether the payments of
$48,000 from Darrell McClarty to MFT represented the repayment of the
promissory note with respect to the stock dividend share sale or of the
outstanding trustee loan. The appellants argued that the trustee loans were
repaid pointing to two separate promissory notes issued in 2003 and 2004 and to
a memo prepared by one Michelle Mack, who worked for MPSI's accounting firm in
which she sets out the plan for the transactions and refers to the repayment of
the $48,000 that was loaned to Darrell McClarty by MFT.
[41]
The respondent countered
by referring to two other memos prepared by Michelle Mack explaining all the
steps in the transactions, particularly step 6, where it says that Darrell
McClarty repaid MFT's promissory note with $48,000 cash, and she refers to step
2 which describes to the sale of the stock dividend shares. The appellants
answered by stating that Michelle Mack had mistakenly left that out of the
instructions given to Bill Warren, Darrell McClarty's solicitor.
[42]
Other documents, such
as MFT's general ledger, were referred to in trying to determine whether it was
the promissory notes relating to the sale of shares that were repaid or those relating
to the trustee loan. I do not believe that it is necessary for me to make a
finding as to which promissory note the $48,000 actually repaid. The money
received by Darrell McClarty on the share redemption was used to repay an
outstanding debt owed to MFT. Both parties have agreed that Darrell McClarty
had outstanding promissory notes of approximately $104,000 at the end of 2004.
[43]
The last submission by
the respondent in support of the position that there was no bona fide
purpose is that the overall plan was put in place by Evan Shoforost, who
created the off-the-shelf plan. On cross-examination, he acknowledged that
every tax plan starts out as generic, and then one would look at the fact
situation to see if there are bona fide business reasons for utilizing
some of the generic plan's content. I believe that there were bona fide
business reasons in this case. It is clear from the evidence that Darrell
McClarty was under the threat of legal action upon leaving Clifton and beginning to compete directly with that
corporation. There was a bona fide non-tax purpose for undertaking the
transactions in question.
[44]
The respondent
submitted that at least one of the transactions in the series was not
undertaken for a bona fide non-tax purpose. In oral submissions, the
respondent referred to the declaration of stock dividends in both years at
issue and the sale of those shares to Darrell McClarty as supporting that point
of view.
[45]
The appellants
submitted that the transfer of wealth in order to provide protection from
creditors without attracting the significant tax costs that would have been
incurred by the payment of a dividend to MFT is a valid, bona fide
non-tax purpose under the ITA.
[46]
The stock dividend declared
in both years at issue resulted in a shift of the value of assets from MPSI to
MFT. This is consistent with the creditor-proofing strategy. Darrell McClarty's
assets in MPSI were partially reduced for the benefit of MFT and, once
redeemed, the assets will be entirely out of the hands of MPSI and
Darrell McClarty. I do not find that transaction to be an avoidance
transaction. As argued by the appellants, if MPSI had paid a dividend to MFT,
allocated the income to the minor beneficiaries by way of a promissory note,
and loaned the funds to Darrell McClarty, some creditor protection could have
been achieved but it would have been less effective because of the higher tax
rate on the dividend to the minor beneficiaries, and it would have resulted in
less funds being available to establish the debt between MFT and the minor
beneficiaries.
[47]
In Canada Trustco,
supra, the Supreme Court of Canada stated, at paragraph 30:
. . . It is useful to consider what
will not suffice to establish an avoidance transaction under s. 245(3). The
Explanatory Notes state, at p. 464:
Subsection 245(3) does not permit
the "recharacterization" of a transaction for the purposes of
determining whether or not it is an avoidance transaction. In other words, it
does not permit a transaction to be considered to be an avoidance transaction
because some alternative transaction that might have achieved an equivalent
result would have resulted in higher taxes.
[48]
According to the
Explanatory Notes referred to in the above excerpt, Parliament recognized the
Duke of Westminster principle that tax planning with the objective of attracting
the least possible tax is a legitimate and accepted part of Canadian tax law.
[49]
The other transaction referred
to by the respondent is the sale of the 48,000 class "E" shares to
Darrell McClarty by MFT. The appellants argued that the purpose of that
transaction was to create the debt between Darrell McClarty and MFT in order to
protect some of the equity of MPSI and PSI should trouble arise, while allowing
Darrell McClarty to use the funds personally to continue to grow the business.
[50]
The circumstances
surrounding the transactions at issue involve the threat of legal action that Darrell
McClarty was faced with upon leaving Clifton in 2001. What
triggered the entire series of transactions was the desire to protect the
assets of MPSI in anticipation of that threat. When the stock dividend was
issued, an asset was transferred from MPSI to MFT such that Darrell McClarty’s
assets in MPSI were partially eroded to the benefit of MFT.
[51]
It could be argued that
the sales of the shares by MFT to Darrell McClarty followed by the subsequent
sales to 101 SK were done basically to lessen the tax consequences of the
creditor-proofing plan, but those transactions would never have occurred in the
absence of the need to protect MPSI’s assets. They were an integral part of the
strategy to protect those assets. As stated in Canada Trustco, supra,
if there are both tax and non‑tax purposes to a transaction, it must be
determined whether it was reasonable to conclude that the non‑tax purpose
was primary. If so, the GAAR cannot be applied to deny the tax benefit.
[52]
To hold that the sale
of the shares should be considered an avoidance transaction because some
alternative transaction may have achieved a similar result but with higher
taxes would, in my opinion, be inconsistent with the Supreme Court’s comments
in Canada Trustco and the Explanatory notes relating to section 245
of the ITA.
[53]
It is my opinion that
every single transaction constituting the series was made with a bona fide
purpose other than to obtain the tax benefit. The intention of protecting the
assets was the primary motivating element behind each transaction. As for
Darrell McClarty personally, he is going to be taxed the same way when the
funds are be extracted from 101 SK as he would be if the money was taken
out of MPSI.
[54]
Having concluded that
we do not have here an avoidance transaction arising from the series of
transactions, there is no need to continue the analysis and determine whether there
was an abusive tax avoidance.
[55]
There is a definite gap
that was left by Parliament in enacting section 120.4 of the ITA. I
subscribe to my colleague Justice Paris' statement in Landrus v. The Queen,
2008 TCC 274, that, as noted by former Chief Justice Bowman, it is
inappropriate for the Minister to use the GAAR to fill the gaps left by
Parliament. Justice Paris said the following at paragraph 124:
The Minister is therefore using the
GAAR in this case to fill in the gaps left by Parliament in subsection 85(5.1).
This is an inappropriate use of the GAAR, as noted by Bowman A.C.J. in Geransky v. The Queen:
. . . The Income
Tax Act is a statute that is remarkable
for its specificity and replete with anti-avoidance provisions designed to
counteract specific perceived abuses. Where a taxpayer applies those provisions
and manages to avoid the pitfalls the Minister cannot say "Because you
have avoided the shoals and traps of the Act and
have not carried out your commercial transaction in a manner that maximizes
your tax, I will use GAAR to fill in any gaps not covered by the multitude of
specific anti-avoidance provisions".
Does subsection 84(3) apply to the
circumstances of this case?
[56]
The other issue is
whether the appellants MFT is deemed to have received a dividend from MPSI
pursuant to subsection 84(3) of the Act in each of its taxation years
ending December 31, 2003 and December 31, 2004 notwithstanding the fact that 101
SK held the shares. If that is the case, the amounts of $16,000 were properly
included as dividends in the income of each of the minor beneficiaries of the
trust for each of their 2003 and 2004 taxation years.
[57]
The respondent relies
on the decision of this Court in RMM Canadian Enterprises Inc. v. R.,
[1998] 1 C.T.C. 2300, for the proposition that the wording “in any manner
whatever” found in subsections 84(2) and 84(3) is to be interpreted broadly
such that a person who did not hold shares immediately prior to the redemption
falls within the scope of the words “each person” in subsection 84(3). In other
words, a redemption in any manner whatever is not an instantaneous event but
can be extended to include multi-step redemptions.
[58]
The appellants, on the
other hand, submit that all the transactions at issue clearly demonstrate that
each and every one was real and legally effective and had economic substance.
MFT did not own the 2003 stock dividend shares and the 2004 stock dividend
shares at the time of the redemption of those shares by MPSI. It was 101 SK
that owned them pursuant to a legally effective share purchase agreement
between 101 SK and Darrell McClarty. The appellants submit that subsection
84(3) operated as intended with regard to legally effective transactions when
MPSI redeemed the 2003 and 2004 stock dividend shares.
[59]
The purpose of section
84 of the ITA, in general terms, is to deem certain events that are not payments
of dividends in corporate law to be payments of dividends for tax purposes.
Under subsection 84(3), all amounts paid by a corporation resident in Canada on a redemption of any class of shares that exceeds
the paid‑up capital of those shares are taxed as dividends. Such a
redemption of its own shares “in any manner whatever” by a corporation resident
in Canada results in the corporation being deemed to
have paid, and the shareholders being deemed to have received, a dividend.
[60]
The respondent’s
argument is based on a decision interpreting the wording of subsection 84(2) of
the Act. I reproduce below for comparison both subsections 84(3).
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84(3) Where at any time after December
31, 1977 a corporation resident in Canada has redeemed, acquired or
cancelled in any manner whatever (otherwise than by way of a
transaction described in subsection 84(2)) any of the shares of any class of
its capital stock,
(a) the corporation shall be
deemed to have paid at that time a dividend on a separate class of shares
comprising the shares so redeemed, acquired or cancelled equal to the amount,
if any, by which the amount paid by the corporation on the redemption,
acquisition or cancellation, as the case may be, of those shares exceeds the
paid-up capital in respect of those shares immediately before that time; and
(b) a dividend shall be deemed
to have been received at that time by each person who held any of the
shares of that separate class at that time equal to that portion
of the amount of the excess determined under paragraph 84(3)(a) that the number of those shares
held by the person immediately before that time is of the total number of
shares of that separate class that the corporation has redeemed, acquired or
cancelled, at that time.
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84(2) Where funds or property of a
corporation resident in Canada have at any time after March 31, 1977 been distributed
or otherwise appropriated in any manner whatever to or for the benefit
of the shareholders of any class of shares in its capital stock, on the
winding-up, discontinuance or reorganization of its business, the corporation
shall be deemed to have paid at that time a dividend on the shares of that
class equal to the amount, if any, by which
(a) the amount or value of the
funds or property distributed or appropriated, as the case may be,
exceeds
(b) the amount, if any, by
which the paid-up capital in respect of the shares of that class is reduced
on the distribution or appropriation, as the case may be,
and a dividend
shall be deemed to have been received at that time by each person who held
any of the issued shares at that time equal to that proportion of the
amount of the excess that the number of the shares of that class held by the
person immediately before that time is of the number of the issued shares of
that class outstanding immediately before that time.
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[61]
RMM (supra) stands for the proposition
that the expression “in any manner whatever” is to be interpreted broadly. In
applying subsection 84(2) to the facts of that case Judge Bowman (as he then
was) focused on the wording of the subsection and specifically said at
paragraph 22:
The words “distributed or otherwise appropriated in any manner
whatever on the winding-up, discontinuance or reorganization of its
business” are words of the widest import, and cover a large variety of ways in
which corporate funds can end up in a shareholder’s hands. See Minister of
National Revenue (supra); Smythe v. Minister of National Revenue (1969),
69 D.T.C. 5361 (S.C.C.). They were unquestionably received on the
winding-up or discontinuance of EL’s business and it is impossible to say that
the funds that found their way into EC’s hands were not on any realistic view
of the matter EL’s funds, notwithstanding the brief intervention of the bank
and RMM [footnote omitted].
[62]
The issue in RMM
was centred on the determination of how and why the funds in question found
their way into EC’s hands when in reality they were the funds of EL. That
determination requires, with regard to the appropriation, an analysis as to how
those funds found their way into the shareholder’s hands, and the phrase
"in any manner whatever" covers many situations that give rise to the
application of that subsection.
[63]
Subsection 84(3), on
the other hand, refers to a corporation that has acquired, cancelled or
redeemed some of its shares in any manner whatever. That wording would warrant
an analysis of how the shares in question were actually redeemed, acquired or
cancelled in that the method of redemption, acquisition or cancellation could
have an impact on who the actual persons are who hold the shares. The manner in
which each person who holds the redeemed, acquired or cancelled shares came to
be in possession of the shares is not what needs to be determined under
subsection 84(3).
[64]
This is particularly so
in this present fact situation where none of the transactions are fictitious or
lacking in economic substance. I agree with the appellants that each and every
transaction at issue was legally effective and that subsection 84(3) operated
as intended when MPSI redeemed the 2003 and 2004 stock dividend shares. The share
redemptions in this case is the result of a single event.
[65]
Even if I were to look
into the method by which the shares were redeemed, I would need to view the
transactions as many steps in the process of redemption, acquisition or
cancellation, which I do not believe to be the case here. The steps in this
case were undertaken for a bona fide reason and I do not believe that, in
these circumstances, subsection 84(3) can be applied so as to have MFT declared
the recipient of a deemed dividend on the redemption of the 2003 and 2004 stock
dividend shares.
[66]
The Supreme Court of
Canada has made it clear in many decisions that, absent a specific provision to
the contrary, it is not the Court’s role to prevent taxpayers from relying on
the sophisticated structure of their transactions, arranged in such a way that
the requirements of the particular provisions of the ITA are met, on the
basis that to allow it would be inequitable for those taxpayers who have chosen
not to structure their transactions that way (Shell Canada Ltd. v. R.,
[1999] 4 C.T.C. 313; Stubart Investments Ltd. v. The Queen, [1984] 1
S.C.R. 536; Singleton v. R., [2002] 1 C.T.C. 121.
[67]
Except in the GAAR context,
the guidelines provided by the above decisions are still valid.
[68]
The appeals are allowed
with one set of costs.
Signed at Ottawa, Canada, this 21st day of March 2012.
"François Angers"
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