Sears Canada Inc. v. The Queen, 89 DTC 5039, [1989] 1 CTC 128 (FCA)

Marceau, J. (Hugessen, J. concurring): —On March 7, 1988, Special Risks Holdings Inc., a Canadian corporation, filed a statement of claim, in the Trial Division of this Court, against Her Majesty the Queen. An application was made on behalf of the defendant to strike out the statement of claim on the ground that the Court had no jurisdiction to entertain the claim made therein or alternatively, that it disclosed no cause of action. The application was dismissed by the motions judge and this is an appeal against that decision.

The statute involved in the litigation is the Income Tax Act (the I.T.A. or the Act) and the provisions thereof more directly put in question are quite special, having been enacted to meet a temporary situation, and also quite complex. Going over that legislation right now could, it seems to me, make the analysis of the statement of claim more telling and useful and the consideration of the motion to strike all the easier.

The legislation involved

What I understand of the general content and purpose of these special provisions of the I.T.A., which are here put in question, namely subsections 83(1), 184(1), 184(3.1) and section 185, is this. When the I.T.A. was substantially reformed in 1972 and tax on capital gains was introduced, every corporation was given the right to distribute to its shareholders, by special dividend, all its surplus on hand computed on the basis of the rules which were in force until then, together with the pre-1972 content of capital gains it would realize in the years ahead (basically, capital gains less capital losses accrued prior to 1972). The two surplus accounts were called "1971 tax-paid undistributed income on hand” (T.P.U.S.) and "1971 capital surplus on hand" (C.S.O.H.). Through a formal election, the directors of the corporation could proceed to the distribution (subject in the case of the T.P.U.S. account to a 15 per cent tax), and the dividend so paid was not included in the income of the Canadian shareholders, its only effect being to reduce the adjusted cost base of the shares in respect of which it was paid.

As the calculation of the two surplus accounts was governed by somewhat complex rules, it was to be expected that a corporation could elect, even in good faith, on an amount larger than it was entitled to. The law then provided for a penalty tax on excessive election, which was designed to offset the benefit that a tax-free dividend instead of a taxable one could mean to the shareholders. The penalty was initially set at 100 per cent and later reduced to 50 per cent (apparently to take into account the effect of the payment on the adjusted cost base of the shares as a result of which part of the tax was only deferred).

Even at 50 per cent, however, the penalty for an excessive election could, in certain circumstances, be quite hefty for a corporation and it seems that many corporations, in their haste to meet the deadline of December 31, 1978, made excessive elections, albeit in good faith. Parliament decided to bring relief to those corporations and, in February 1981, added a new provi- sion whereby they were given the possibility, in effect, to "sort of recall” the excess dividend and have it returned by the shareholders. The first election could thus be retroactively altered by yet another election.

Subsection 83(1) of the Act established the right of the corporation to elect to pay a dividend out of its two surplus accounts. Subsection 184(1) in Part III of the Act imposed the 100 per cent (subsequently 50 per cent) tax where the surplus accounts of the corporation proved inadequate to cover the subsection 83(1) dividend distributed. Section 185 required the Minister of National Revenue to examine each subsection 83(1) election with all due dispatch and determine whether a Part III tax for excess had to be levied. And finally subsection 184(3.1), enacted as indicated in February 1981, provided for the new possibility, in the case of a subsection 83(1) dividend payable between March 1977 and December 1978, of what I loosely described as a sort of recalling of the excess, setting forth the conditions on which a corporation would be entitled to resort to it. This subsection 184(3.1) lies more directly at the centre of the litigation; it ought to be reproduced in its integrity:

Sec. 184(3.1) Election to treat dividend as loan. Where a corporation has elected in accordance with subsection 83(1) in respect of the full amount of any dividend that became payable by it at a particular time after March 31, 1977 and before 1979 and the corporation made a reasonable attempt to correctly determine its tax-paid undistributed surplus on hand immediately before the particular time and its 1971 capital surplus on hand immediately before the particular time and all or any portion of the dividend

(a) has given rise to a gain from the disposition of a share of the corporation by virtue of subsection 40(3), or

(b) in an excess referred to in subsection (1),

if the corporation so elects under this subsection,

(c) in any case referred to in paragraph (a), not later than December 31, 1982 or such earlier day as is 90 days after the latest of

(i) the day on which this subsection comes into force,

(ii) the day on which a notice of assessment or reassessment is mailed to a shareholder of the corporation in respect of a gain referred to in paragraph (a), and

(iii) such day as is agreed to by the Minister in writing, or

(d) in any other case, not later than 90 days after the later of

(i) the day on which this subsection comes into force, and

(ii) the day on which the Minister notifies the corporation by registered letter that it has an excess referred to in subsection (1) in respect of the dividend,

and the penalty referred to in subsection (5) in respect of such election is paid by the corporation at the time the election is made, the following rules apply:

(e) all or such portion of the dividend as the corporation may claim shall, for the purposes of this Act, be deemed not to be a dividend but to be a loan made at the particular time by the corporation to the persons who received all or any portion of the dividend if the full amount of such loan is repaid to the corporation before such date as is stipulated by the Minister and the corporation satisfies such terms and conditions as are specified by the Minister, and

(f) sections 15 and 80.4 do not apply to such a loan.

The analysis of the statement of claim

First the allegations. The relevant facts, as they are set out in the statement of claim,—and, of course, for the purpose of a motion to strike under Rule 419 of the Rules of the Court, they are to be taken as accurate—, are the following.

In 1978, after a corporate restructuring, the respondent elected under subsection 83.1 of the I.T.A. to pay a dividend out of its T.P.U.S. and C.S.O.H. accounts. The tax-free dividend was payable on March 31, 1978.

On March 19, 1981, the Minister of National Revenue issued a notice of assessment levying a 50 per cent Part III penalty tax on the basis that the dividend paid was in excess of the T.P.U.S. and C.S.O.H. accounts of the respondent. On June 3, 1981, the respondent filed a notice of objection to the assessment.

On June 17, 1981, less than 90 days after the coming into force of the new subsection 184(3.1), the respondent made with respect to the aforesaid dividend the election contemplated by the new provision and filed it with the Minister on the understanding that such election would have no operative effect pending final determination of the issue of the liability of the respondent for the Part III tax.

On September 11, 1981, the Minister confirmed the assessment established by the March 19 notice. The respondent then commenced an action in the Trial Division in order to determine the underlying controversy, namely whether the proceeds of a disposition, in 1976, of certain shares held by the corporation could be included in the computation of its surplus accounts. On September 6, 1984, the Trial Division ruled in favour of the Minister, a ruling which the Appeal Division of this Court confirmed on January 8, 1986.

On February 25, 1988, the Minister rejected the June 17, 1981 subsection 184(3.1) election, the “operative effect" of which, according to the respondent's understanding, had merely been suspended.

Now the prayer for relief. It reads thus:

The plaintiff, therefore, claims

(a) a declaration

(i) that subsection 184(3.1) of the I.T.A. had no operative effect in the aforesaid circumstances until the repayment of the dividend (loan) to the Plaintiff, which was subsequent to the final determination of the appeals from the Part III assessment,

(ii) that, on such repayment, subsection 184(3.1) became operative as a statutory declaration that, for the purposes of the I.T.A., the portion of the aforesaid dividend that is deemed to be a loan is deemed not to be a dividend, which gives rise to the necessary implication that the Part III tax that has been found to have been payable in respect of the "loan” is deemed not to have been payable, and

(iii) that, as such statutory declaration became operative after the disposition of the final appeals from the Part III assessment, it is effective, notwithstanding subsection 152(8) of the I.T.A. to render null and void the Plaintiff's liability for Part III tax as determined by the aforesaid assessment,

(b) judgment for repayment of the sum of $2,980.97 with interest thereon;

(c) for such further and other relief as this Court deems just and equitable in the circumstances; and

(d) its costs of this action.

As indicated at the outset, the grounds formally alleged in support of the motion to strike are that this Court has no jurisdiction to entertain the claim made in the statement of claim or alternatively that the statement of claim discloses no reasonable cause of action. In fact, both grounds stem from the same basic submission, namely: that the action as instituted is, in effect, a challenge to the Minister's assessment of March 1981. To support the lack of jurisdiction, it is argued that since there is express provision in the I.T.A. providing for an objection to or an appeal from an assessment, provisions to which any challenge to an assessment is subject, section 29 of the Federal Court Act deprives the Trial Division of this Court of any power to intervene. [1] And to support the absence of a reasonable cause of action, it is said that the respondent has no right to advance that its tax liability is other than that fixed by an assessment which has been confirmed by this Court and whose validity and finality are therefore unassailable.

I will say right away that if my understanding of what the statement of claim amounts to was no different than that of the appellant, I would readily agree that the action could not be allowed to go on. I will concede also that some of the remedies sought appear to substantiate such understanding. Indeed, in regard to paragraph (a)(iii) of the prayer for relief, I fail to see how the Court could now, after having confirmed the assessment, by way of a declaration "render null and void" respondent's liability as determined by it. An assessment from which no liability flows is no assessment. Nor do I see how the Court could now, as prayed in paragraph (b), order reimbursement of money paid on the basis of an assessment it has already confirmed, thereby contradicting the effect of its first judgment. But these are not the only remedies sought, and moreover the possibility of future amendments is to be reckoned with on a Rule 419 motion to strike.

What the respondent seeks, in general terms, is easy to define; it is that its election under subsection 184(3.1) of the I.T.A. be recognized as valid and be given effect to. The problem is whether the respondent may have a right to that effect enforceable in a court of law and, if so, to what type of relief it could be entitled.

The problem can only be solved properly, it seems to me, by breaking it down to its components and dealing with them one by one. The most basic of the questions arising is whether subsection 184(3.1) was meant to give the taxpayer corporation complying with its requirements a right of some kind, which would, as all rights when denied, be somehow enforceable in a court of law. An affirmative answer quickly appears necessary since otherwise the Minister would be endowed with a purely arbitrary power subject to no control, an untenable interpretation. Going a step further, one is entitled to inquire whether subsection 184(3.1) was meant to benefit even a corporation which had already been assessed a Part II] tax. Again, however, it is easy to see that the first of the two conditions established by paragraph 184(3.1)(d) respecting the time limit for making an election, i.e. within 90 days of the coming into effect of the new provision, had meaning only to a corporation already assessed.

This leads to a third incidential question which is whether subsection 184(3.1) was meant to exclude a corporation bound by a Part III tax assessment, once the assessment had become unassailable either because the time for objection had elapsed or because the objection would have been finally rejected by the courts. The answer to me again is easy. It has to be in the negative, considering that the new provision was enacted in February 1981 with respect to dividends payable between March 1977 and December 1978. It does not appear reasonable to suppose that Parliament meant to bring relief only to those few corporations which, for some reason, had not yet been assessed for the Part III tax they owed, or whose opposition to being so assessed would have not yet been put to rest. But a related question immediately arises which is, in fact, directly linked to one of the main contentions advanced by counsel for the appellant, to the effect that the only way the respondent could maintain the viability of its subsection 184(3.1) election was by incorporating it, before final judgment, into the proceedings already under way against the Part III tax assessment. The question is whether, after having agreed that subsection 184(3.1) was meant to benefit even corporations bound by final assessments, distinctions should nevertheless be introduced on the sole basis of how that finality would have come about. To support an affirmative answer here one would have to suppose that an assessment confirmed by judgment of a Court is somehow more final than an assessment whose validity cannot be disputed, because of the passage of time. I do not think that such a supposition is valid. In both cases, of course, the assessment can no longer be varied or vacated, but, in both cases also, the possibility that it be displaced or replaced by a reassessment based on new facts, seems to me to be the same. And at the same time we can see how the right conferred by a subsection 184(3.1) election can be given effect to in the case of a corporation already bound by a final assessment.

This, I think, gives us the solution to the problem as I defined it. The respondent, on the basis of the allegations contained in its statement of claim may “possibly” have a right and a right which could “possibly” be enforced by requiring the Minister to reassess. I repeated the word "possibly" on purpose, of course. There are many hurdles to confront before a positive conclusion may be reached, some of which result from strictly legal difficulties. The most obvious of those legal difficulties are with respect to the possibility of an election with a suspended "operativeness", and the pwer of the Minister to reassess after so many years. But the existence, the content and the purpose of the alleged understanding may be directly put in question in the consideration of those difficulties, and the Court cannot now dispose of them.

Thus, my opinion is that, at this juncture, it cannot be said that the allegations of the statement of claim definitely reveal no cause of action nor can it be said that none of the remedies sought or amendments thereto could ever be awarded.

I would therefore confirm the order of the Trial Division rejecting the motion to strike.

Pratte, J. (dissenting): —I have had the advantage of reading the reasons for judgment prepared by my brother, Marceau, J. I regret not to be able to agree with him.

The judgment of the Trial Division, as I understand it, is based on the assumption that the effect of subsection 184(3.1) of the Income Tax Act is that a company to which it is applicable and which has paid the subsection 184(1) tax for which it has been assessed, has a right, upon complying with the conditions prescribed, to the repayment of the subsection 184(1) tax. In my view, that assumption is wrong.

Subsection 184(1) imposed a tax on companies that had declared and paid dividends in certain circumstances. When a company, which had paid such a dividend and was as a consequence taxable under subsection 184(1), took advantage of subsection 184(3.1) and complied with all its conditions, the dividend in question was deemed, for the purposes of the Act, to have been a loan rather than a dividend. This is made clear by paragraph 184(3.1)(e). If, at that time, the taxpayer had not yet been assessed for the subsection 184(1) tax, no problem could arise: no tax was payable under that subsection since the company was deemed not to have paid a dividend. If, however, the company had already been assessed under subsection 184(1) when subsection 184(3.1) produced its effect, then the situation was exactly the same as if it had been discovered that the company had, by mistake, been assessed on the basis of wrong facts. The only way to correct such a mistake, if the assessment is not set aside on appeal, is for the Minister to use his power of reassessment under subsection 152(4). If at that time, however, the Minister may not reassess under subsection 152(4), the error cannot be corrected.

In this case, according to the statement of claim, the respondent, which was assessed for the subsection 184(1) tax by notice of assessment dated March 19, 1981, complied with the requirements of subsection 184(3.1) on March 2, 1988, nearly seven years later after its appeal against that assessment had been dismissed. It is clear that, at that time, the assessment could not be set aside by the court; it is also clear that the Minister could no longer reassess under subsection 152(4) since the respondent had not filed any waiver. True, it is alleged in the respondent's statement of claim that the respondent, after having objected to the subsection 184(1) assessment, made a subsection 184(3.1) election "on the Plaintiff's understanding, which was shared by the Minister, that subsection 184(3.1) of the I.T.A. would have no operative effect pending final determination of the issue between the Plaintiff and the Minister as to the Plaintiff's liability to pay Part III tax.” I do not see how such an understanding can help the respondent whose predicament originates from the fact that subsection 184(3.1) became operative too late, not too soon.

I would allow the appeal, set aside the order of the Trial Division, strike out the respondent's statement of claim and dismiss its action, the whole with costs both here and below.

Appeal dismissed.