Daggett v. MNR, 93 DTC 14, [1992] 2 CTC 2764 (TCC)

Teskey, T.C.C.J.:— The appellant appeals from a reassessment for the 1981 and 1982 taxation years.

Facts

The evidence consisted of an agreed statement of facts which consists of five pages and six tabs, all of which were marked as Exhibit A-1 and is attached hereto and identified as such [not reproduced], and a copy of a letter dated December 3, 1983 from Alberta Consumer and Corporate Affairs, Corporate Registry addressed to Bonavista Travel Ltd. ("Bonavista") and marked as Exhibit A-2 which is also attached hereto and identified as such [not reproduced].

Issues

There are two issues;

Firstly, were the various steps or transactions taken between the appellant and his company Bonavista complete and effective?

Secondly, was an artificial capital loss created contrary to subsection 55(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act") (as then in force) as a result of the transactions described herein?

Analysis

The corporate manoeuvring that went on between the appellant and Bonavista was a comedy of errors.

Tab B of Exhibit A-1 contains a copy of a special resolution passed December 19, 1983. I can only assume that the word "dividend" in the second line was a typographical error and the author of this resolution meant "divided". Paragraph 2 of Tab C of Exhibit A-1 makes it abundantly clear that what was intended was a special resolution of the shareholders of Bonavista increasing the authorized capital from $20,000 to $250,000. The original authorized 20,000 no par value shares was neither to be increased or decreased. The first 20 words of this resolution are unnecessary. The resolution could have started with the word "the" at the end of line 3. Even at that, it would still be badly worded. Subsection 36(1) of the Alberta Companies Act, R.S.A. 1980, C-20 provides that where a company wishes to increase its capitalization, it may do so by special resolution. Subsection 36(4) provides that the special resolution "does not take effect until a copy has been filed” with the registrar of companies and the proper fees are paid. Thus, the subscription by the appellant for 19,900 common shares at an amount of $151,000 and its acceptance were contrary to Bonavista's articles of incorporation.

Section 104 of the Alberta Companies Act provides that no dividend shall be declared if the dividend will impair the capital of the company, or render it insolvent. Subsection 104(1) reads:

No dividend shall be declared

(a) when the company is insolvent,

(b) if the dividend renders the company insolvent, or

(c) if the dividend will impair the capital of the company.

Prior to the passing of the dividend resolution, Bonavista had $151,000 in its bank which was intended to be capital by both the appellant and Bonavista. Immediately upon completing the issuance of the purported dividend of $7.55 per common share, the capital of Bonavista was reduced to zero. This resolution was passed contrary to section 104 of the Alberta Companies Act in that it impaired the capital of Bonavista.

The appellant finds himself in this position. On December 18, 1983, the value of his 50 shares in Bonavista was nil or $1. On December 19, 1983, he, as a shareholder, passed a resolution to increase the capital of Bonavista, which resolution was not effective until February of 1984. On December 20, 1983, he, in his personal capacity, attempted to purchase 19,900 shares of Bonavista for $151,000. As an officer of Bonavista, he accepted the $151,000 and purported to issue the shares to himself contrary to the articles of incorporation. Then, as a director, he voted to declare a dividend contrary to section 104 of the Alberta Companies Act, and, as an officer, he caused Bonavista to pay the sum of $151,000 to himself in satisfaction of the dividend. The value of his shares of Bonavista on December 21, 1983, was nil or $1.

The appellant comes to this Court and submits that the defects as described in the above transactions should be ignored and submits that he did not artificially increase the adjusted cost base of his shares in Bonavista from $50 to $151,050 and thus on the disposition of the shares at $1, his loss was $151,049 instead of $49.

It is my opinion, where a taxpayer in a non-arm's length situation purports to enter into a transaction or a series of transactions in order to take advantage of benefit provisions under statutes, such as are found in the Act or to avoid such provisions as contained in subsection 55(1) of the Act, he has to do it right. That is, the" I's" must be dotted and the"T's" crossed. The form must be operative and complete, without defects, in all respects. This concept is still a valid legal principle as Estey, J. said in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6304, at page 579 (C.T.C. 316-17, D.T.C. 6324):

2. In those circumstances where section 137 does not apply, the older rule of strict construction of a taxation statute, as modified by the courts in recent years, supra, prevails but will not assist the taxpayer where:

(a) the transaction is legally ineffective or incomplete; or,

Heald, J. of the Federal Court of Appeal in The Queen v. J.J. Daly, [1981] C.T.C. 270, 81 D.T.C. 5197 said at page 279 (D.T.C. 5204):

In a case of this kind, where it is acknowledged that what is sought by a certain course of action is a tax advantage, it is the duty of the Court to examine all [emphasis in original] of the evidence relating to the transaction in order to satisfy itself that what was done resulted in a valid, completed transaction. In my view, the proper approach for the Court to take is concisely stated by Urie, J. in the case of Atinco Paper Products v. The Queen, [1978] C.T.C. 566, 78 D.T.C. 6387 at pages 577-78 (D.T.C. 6395), as follows:

“I do not think that I should leave this appeal without expressing my views on the general question of transactions undertaken purportedly for the purpose of estate planning and tax avoidance. It is trite law to say that every taxpayer is entitled to so arrange his affairs as to minimize his tax liability. No one has ever suggested that this is contrary to public policy. It is equally true that this Court is not the watchdog of the Minister of National Revenue. Nonetheless, it is the duty of the Court to carefully scrutinize everything that a taxpayer has done to ensure that everything which appears to have been done, in fact, has been done in accordance with applicable law. It is not sufficient to employ devices to achieve a desired result without ensuring that those devices are not simply cosmetically correct, that is, correct in form, but, in fact, are in all respects legally correct, real transactions. If this Court, or any other court, were to fail to carry out its elementary duty to examine with care all aspects of the transactions in issue, it would not only be derelict in carrying out its judicial duties, but in its duty to the public at large."

Herein the steps taken by the shareholders and directors of Bonavista are not only legally ineffective or incomplete, they are illegal and ipso facto ultra vires since they were taken in contravention of the articles of incorporation and the Alberta Companies Act (Angus v. R. Angus Alta Ltd., [1988] 3 W.W.R. 737, 58 Alta L.R. (2d) 76 (C.A.) and Edmonton Country Club Ltd. v. Case, [1975] 1 S.C.R. 534, 44 D.L.R. (3d) 554).

On this basis alone, I am prepared to dismiss the appeal.

I believe that I should also deal with the second issue, namely subsection 55(1) of the Act. For this purpose, I will assume that what the appellant did and what he caused Bonavista to do was totally effective. That is, he validly subscribed for and received 19,900 shares for $151,000 and that the dividend declared and paid was totally effective and not contrary to the Alberta Companies Act. Subsection 55(1) of the Act is under the heading “Avoidance” and reads as follows:

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.

For the purposes of this action, this section can be paraphrased to read:

Where the result of one or more transactions of any kind is that the appellant has disposed of his shares in Bonavista under circumstances that the appellant may be considered to have artificially increased the amount of his loss from the sale of the shares, the appellant's loss shall be computed as if such increase had not occurred.

The series of events or transactions are to be regarded as a whole. All the steps were agreed in advance by the appellant and his wife (in consultation with his financial adviser, see Tab C of Exhibit A-1) who were in a position to make sure that all of them were carried through to completion.

Chief Justice Dickson, as he then was, in McClurg v. M.N.R., [1991] 1 S.C.R. 169, [1991] 1 C.T.C. 169, 91 D.T.C. 5001 found that a discretionary dividend clause was valid and refused to find that the use of the discretionary dividend clause on the facts therein was an invalid exercise of the discretion of the directors.

He said at pages 182-83 C.T.C. (D.T.C. 5010-11) under the heading "Interpretation of Taxing Statutes”:

In recent years this Court, in an income tax appeal, has found it beneficial to engage explicitly in the development of an interpretive approach to the Income Tax Act; an approach which is wedded neither to a rule of” strict construction” nor to an all-encompassing test of“ independent business purpose.” This trend began with the judgment of Estey, J. in his majority reasons in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6304, 84 D.T.C. 6305. In that case, Estey, J. undertook an extensive discussion of interpretative techniques, and he drew a conclusion as to the preferred approach to be taken by the Courts at page 576 (C.T.C. 315, D.T.C. 6322):

It seems more appropriate to turn to an interpretation test which would provide a means of applying the Act so as to affect only the conduct of a taxpayer which has the designed effect of defeating the expressed intention of Parliament. In short, the tax statute, by this interpretative technique, is extended to reach conduct of the taxpayer which clearly falls within "the object and spirit” of the taxing provisions.

Estey, J. expanded upon this test of” "object and spirit" in his majority judgment in The Queen v. Golden, [1986] 1 S.C.R. 209, [1986] 1 C.T.C. 274, 86 D.T.C. 6138 at pages 214-15 (C.T.C. 277, D.T.C. 6140):

. . .the law is not confined to a literal and virtually meaningless interpretation of the Act where the words will support on a broader construction a conclusion which is workable and in harmony with the evident purposes of the Act in question. Strict construction in the historic sense no longer finds a place in the canons of interpretation applicable to taxation statutes in an era such as the present

More recently, in Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 5059, I described the approach in terms of the need to discern the commercial reality of a taxpayer's transaction at pages 52-53 (C.T.C. 128, D.T.C. 5066-67):

I acknowledge, however, that just as there has been a recent trend away from strict construction of taxation statutes. . . so too has the recent trend in tax cases been towards attempting to ascertain the true commercial and practical nature of the taxpayer's transactions. There has been, in this country and elsewhere, a movement away from tests based on the form of transactions and towards tests based on . . . a common sense appreciation of all the guiding features of the events in question.

This is, I believe, a laudable trend provided it is consistent with the text and purposes of the taxation statute. Assessment of taxpayers" transactions with an eye to commercial and economic realities, rather than juristic classification of form, may help to avoid the inequity of tax liability being dependent upon the taxpayer's sophistication at manipulating a sequence of events to achieve a patina of compliance with the apparent prerequisites for a tax deduction.

The Chief Justice agreed with Strayer, J. of the Federal Court-Trial Division wherein he concluded that in the background and context of the transaction therein that it could be described as a "legitimate business transaction”. He said at page 185 (D.T.C. 5012-13):

In my opinion, if a distinction is to be drawn in the application of subsection 56(2) between arm's length and non-arm’s length transactions, it should be made between the exercise of a discretionary power to distribute dividends when the non-arm's length shareholder has made no contribution to the company (in which case s. 56(1) may be applicable), and those cases in which a legitimate contribution has been made. In the case of the latter, of which this appeal is an example, I do not think it can be said that there was no legitimate purpose to the dividend distribution.

I cannot find a legitimate purpose for the transactions before me. The appellant manipulated a series of events over a two day period in an obvious attempt to increase his loss on the shares of Bonavista to $151,000.

The McClurg, supra, decision is therefore clearly distinguishable from the facts herein.

Estey, J. in Stubart, supra, rejected the proposition that a transaction may be disregarded for tax purposes "solely" on the basis that it was entered into by a taxpayer without an independent or bona fide business purpose.

Estey, J. in Stubart, supra, refers at length to three English House of Lords decisions namely:

W.T. Ramsay Ltd. v. 1.R.C., [1981] 2 W.L.R. 449,

C.I.R. v. Burmah Oil Co. (1981), 42 T.R. 535,

Furniss (Inspector of Taxes) v. Dawson, [1984] 1 All E.R. 530.

At page 306 (D.T.C. 6315), he said when dealing with Ramsay:

There are features about that case and its disposition that must be noted when considering its application in our law.The transaction created an accounting result which was then applied to reduce taxes otherwise exigible. The taxpayer did more than rearrange its affairs to avail itself of a statutory tax allowance. It was not, in my view, the non-arm’s length ideas radiating out from a central control of the corporate group that was fatal. It was the synthetic nature of the gain and the loss which rendered it unrecognizable in the eyes of the taxation program adopted by the legislature.

Then again, when dealing with all three of these decisions, he said at page 308 (C.T.C. 6316):

It may well be that each of the three House of Lords decisions, supra, can be simply distinguished on the basis that in each case, a plan was adopted whereby the taxpayer took affirmative action to create the "loss" or "gain" by a procedure not otherwise required in the ordinary course of business; or that the taxpayer designed an accounting holding tank to delay artificially the receipt by the vendor of the proceeds of sale under an agreement for sale reached directly between the true parties to the transaction before the accounting scheme was established.

Estey, J. does not comment either negatively or positively on these three House of Lords decisions. He says that the Stubart, supra, case is simply distinguished. I therefore conclude that the principle coming out of the Ramsay, Burmah and Furniss, supra, decisions is still valid in Canada.

Herein, the appellant attempted a series of transactions to artificially increase his adjusted cost base in his share investment in Bonavista to create an illusionary or a synthetic loss of $151,000.

The remaining question to be determined is whether the Federal Court of Appeal in Canada v. Irving Oil Ltd., [1991] 1 C.T.C. 350, 91 D.T.C. 5106 cast doubt on these three House of Lords decisions. I think not.

In Irving Oil, supra, the Court dealt with the artificial reduction of income. Irving Oil was purchasing crude oil from a partially owned subsidiary which charged Irving Oil at a rate of 66 per cent above wholesale. In upholding the scheme, at page 360 (D.T.C. 5114) the Court held that: [1]

In order to come within the terms of subsection 245(1), a transaction or operation must have the effect of unduly or artificially reducing income; the artificiality of the transaction or operation itself does not determine the issue. Heald, J.A., speaking for the Court in Spur Oil v. The Queen, [1981] C.T.C. 336, 82 D.T.C. 5168, at page 343 (D.T.C 5173), said:

. . . the finding of artificiality in the transaction does not, per se, attract the prohibition set out in subsection [245(1)] of the Income Tax Act. To be caught by that subsection, the expense or disbursement being impeached must result in an artificial or undue reduction of income.“ Undue” when used in this context should be given its dictionary meaning of "excessive". . . . Turning now to artificial, the dictionary meaning when used in this context is, in my view, “simulated” or“ "fictitious".

The Irving Oil, supra, decision does not affect this case. Bonavista was not in business or conducting any business. Herein, there is a one shot series of transactions which I regard as a whole over a very brief period of time (two days), which steps were taken for the sole purpose of tax avoidance. The transactions herein were synthetic in nature in an attempt to create an accounting result to artificially increase what would have been a very small loss of $49 to a make believe amount of $151,049.

This finding brings the facts herein squarely within the anti-avoidance doctrine established by Ramsay, Burmah and Furniss, supra, as modified or limited by Craven v. White, [1989] A.C. 398, [1988] 3 All E.R. 495.

I am satisfied that the transactions herein fall squarely within the purview of subsection 55(1) of the Act, any holding to the contrary would render this subsection meaningless.

For these reasons, I dismiss the appeals.

Appeals dismissed.