May Estate v. MNR, 88 DTC 1189, [1988] 1 CTC 2303 (TCC)

Goetz, T.C.J.:—The present appeal, heard on November 19, 1987, at Toronto, Ontario, is from an assessment for the appellant's 1983 taxation year by which the respondent disallowed the appellant's claim for a business investment loss in the amount of $163,260.

Facts

Karna May died on February 28, 1982. The terms of her Will provided that the beneficial ownership of her assets would be left as follows:

40 per cent to her husband, Dr. Douglas May;

40 per cent to her mother, Mrs. Martha Ivey;

20 per cent to the C.H. Ivey Foundation, a registered charitable organization.

The assets would be administered by a trust having two trustees, Dr. Douglas May, the deceased's husband and Mr. Peter Hockin, a lawyer.

Among the assets of the trust created by the Will were 3,136 common shares of Maziv Industries Ltd. ("the corporation”), a Canadian-controlled private corporation. The remainder of the corporation's shares were owned by various members of the deceased's family.

In February 1983 the trustees decided to sell the shares back to the corporation for $184,421. A dividend of $163,260 was deemed received by the appellant on the sale, pursuant to subsection 84(3) of the Income Tax Act. Through the application of subparagraph 54(h)(x) a loss for the same amount resulted from the transaction. The appellant sought to deduct the loss on its 1983 income tax return as an allowable business investment loss. The respondent refused to allow the deduction and treated the amount as a capital loss.

The shares in question had been received by Karna May from a trust her father had set up for her benefit. Upon her death she was deemed, pursuant to subsection 70(5) of the Act to have disposed of the shares immediately before her death for their fair market value. The trust created by her Will was deemed, pursuant to the same subsection, to have acquired it immediately thereafter for the same price. The capital gain resulting from the disposition of the shares by Karna May to the trust was recognized on her terminal return.

Karna May's husband, one of the trustees, received an offer to purchase the shares from the corporation, signed by its president, C.R. Ivey, Karna May's father. The offer was for $182,000, the price the shares were deemed disposed of at the time of Karna May's death. The respondent conceded the price represented the shares' fair market value. The trustees did not seek any other buyer for the shares but accepted the offer. The shares were redeemed by the corporation and the trustees received the sale price.

Analysis

The redemption of the shares by the corporation gave rise to a deemed dividend pursuant to subsection 84(3) of the Act equal to the difference between the paid up capital and the proceeds of disposition. Pursuant to subparagraph 54(h)(x) of the Act the deemed dividend is not included in the proceeds of disposition for the purposes of calculating the capital gain or loss resulting from the sale of the shares.

The relevant provisions of the Act read as follows:

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 (2)) any of the shares of any class of its capital stock,

(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 (a) that the number of those shares held by him 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.

54. In this subdivision,

(h) "proceeds of disposition” of property includes,

(i) the sale price of property that has been sold,

but notwithstanding any other provision of this Part, does not include

(x) any amount that would otherwise be proceeds of disposition of a share to the extent that such amount is deemed by subsection 84(2) or (3) to be a dividend received and is not deemed by paragraph 55(2)(a) or subparagraph 88(2)(b)(ii) not to be a dividend,. . .

The parties agree that a loss of $163,260 resulted from the sale of the shares. The issue before the Court is whether this loss constituted a capital loss or an admissible capital loss.

Paragraph 39(1)(c) of the Act defines admissible capital loss as follows:

39. (1) For the purposes of this Act,

(c) a taxpayer's business investment loss for a taxation year from the disposition of any property is the amount, if any, by which his capital loss for the year from a disposition after 1977

(i) to which subsection 50(1) applies, or

(ii) to a person with whom he was dealing at arm's length

of any property that is

(iii) a share of the capital stock of a Canadian-controlled private corporation, or

(iv) a debt owing to the taxpayer by a Canadian-controlled private corporation other than, where the taxpayer is a corporation, a debt owed to it by another corporation with which it does not deal at arm's length,

exceeds the aggregate of

(v) in the case of a share referred to in subparagraph (iii), the amount, if any, of the increase after 1977 by virtue of the application of subsection 85(4) in the adjusted cost base to a taxpayer of the share or of any share (in this subparagraph referred to as a ‘replaced share') for which the share or a replaced share was substituted or exchanged,

(vi) in the case of a share referred to in subparagraph (iii), that was issued before 1972 (other than a share that was acquired after 1971 from a person with whom the taxpayer was dealing at arm's length) or a share (in this subparagraph and subparagraph (vii), referred to as a ‘substituted share') that was substituted or exchanged for such a share or for a substituted share, the aggregate of all amounts each of which is an amount received after 1971 and before or upon the disposition of the share or an amount receivable at the time of such a disposition by

(A) the taxpayer,

(B) where the taxpayer is an individual, his spouse, or

(C) a trust of which the taxpayer or his spouse was a beneficiary as a taxable dividend on the share or on any other share in respect of which it is a substituted share,. . .

In light of the definition of business investment loss, the appellant must, to succeed in his appeal, establish both that the shares were acquired from the late Karna May in an arm's length transaction and that the sale of these shares to the corporation also occurred at arm's length.

Subsection 251(1) of the Act states:

251. (1) For the purposes of this Act,

(a) related persons shall be deemed not to deal with each other at arm's length; and

(b) it is a question of fact whether persons not related to each other were at a particular time dealing with each other at arm's length.

Subsection 251(2) of the Act lists the cases where individuals and corporations are related persons.

Subsection 104(1) of the Act deems a reference to a trust or estate to be a reference to the trustee, executor, administrator, heir or other legal representative having ownership or control of the trust property. In order to determine if the parties to the transactions in question dealt with each other at arm's length, one must first establish whether the trust was related to the parties to the disposition pursuant to subsection 251(1) of the Act. We shall first examine the sale of the shares by the trust to the corporation.

Subsection 84(9) of the Act states for greater certainty that the transaction whereby a corporation redeems its shares is deemed to be a disposition of the shares by the shareholder. The rules governing arm's length transactions therefore apply to such operations.

It is clear that, in the case of Peter Hockin, no relation exists between him and the corporation. Dr. Douglas May, executor and one of the beneficiaries of the trust was, however, married to Karna May. The shareholders of the corporation are related to Karna May. Was Dr. May related to the corporation at the time the shares were sold?

In the case of Pembroke Ferry Limited v. M.N.R., 6 Tax ABC 389 at 393; 52 D.T.C. 255 at 257, Chairman Monet, of the Income Tax Appeal Board, determined that:

. . . a woman is not “connected by marriage” with her deceased husband's father subsequent to her husband's death,. . .

As I understand the provisions of the above section, I am to interpret the words "connected by marriage” as used in section 127(5)(c) of the Income Tax Act when applied to the facts of the present case as connected by marriage in the year 1949, and this, irrespective of whether Irene E. McCool may have been connected by marriage with Thomas E. McCool in some years prior to the year 1949. Because Irene E. McCool may have been “connected by marriage” in some year prior to the year 1949 with Thomas E. McCool, it does not mean that forever thereafter she must still be “connected by marriage” with him; and since the marriage of Irene E. McCool to Edward Patrick McCool did not exist in the year 1949, I am of the opinion that she cannot be said to have been "connected by marriage” in that year with Thomas E. McCool.

Applying the principle stated in Pembroke Ferry to the present case I find that Dr. May was not related to the corporation at the time the shares were sold.

It is therefore a question of fact whether the trust dealt with the corporation at arm's length. Although the parties agreed the shares were sold at fair market value, it is well settled law that this is not sufficient to establish arm's length dealings between the parties. In the words of Bonner, T.C.J. in the recent case of Noranda Mines v. M.N.R., [1987] 2 C.T.C. 2089 at 2095; 87 D.T.C. 379 at 384:

. . . An unusual result may well be indicative of the absence of an arm's length relationship, but the fact that a result is typical of what might be expected between parties who do not deal at arm's length does not negative the existence of a nonarm's length relationship.

In the case of Swiss Bank Corp. et al. v. M.N.R., [1972] C.T.C. 614; 72 D.T.C. 6470, the Supreme Court of Canada came to the conclusion that a Swiss bank acting as a trustee for an investment fund and an Ontario real estate company were not dealing at arm's length because the absence of separate interests of the parties did not insure that the transactions between the parties would reflect ordinary commercial dealings. In the Noranda Mines case (supra) Bonner, T.C.J. stated at page 2095 (D.T.C. 384):

The arm's length test looks to the presence or absence of the power to influence or control.

A most helpful formulation of the test to be applied in determining whether parties are dealing at arm's length is found in the case of M.N.R. v. Estate of Thomas Rodman Merritt, [1969] C.T.C. 207; 69 D.T.C. 5159. At page 217 (D.T.C. 5165-66) Cattanach, J. stated:

. . . In my view, the basic premise on which this analysis is based is that, where the "mind" by which the bargaining is directed on behalf of one party to a contract is the same "mind" that directs the bargaining on behalf of the other party, it cannot be said that the parties were dealing at arm's length. In other words where the evidence reveals that the same person was “dictating” the "terms of the bargain” on behalf of both parties, it cannot be said that the parties were dealing at arm's length.

Can the trust and the corporation be said to be directed by the same "mind" in the transaction concerning the sale of the shares? The evidence indicates that both the trustees and the beneficiaries of the trust had interests that were opposed to those of the corporation and that the corporation had no power to influence or control the trustees. The Court therefore finds that the disposition of the shares from the trust of the corporation occurred at arm's length.

The same issue must now be determined with respect to the acquisition of the shares by the trust from Karna May. Paragraph 70(5)(c) of the Act deems the person who acquires capital property as a consequence of the death of a taxpayer to have acquired the property immediately after that time. Such a section should, according to the decision of Heald, J. in The Queen v. Mastronardi Estate, [1977] C.T.C. 355; 77 D.T.C. 5217, be construed according to the plain meaning of the language used by the legislator. In light of the decision in Pembroke Ferry (supra) the Court finds that Dr. Douglas May and Mrs. Karna May were no longer related for the purposes of subsection 251(1) of the Act when the trust acquired the shares and that the trust was not related to the deceased at that time.

Whether the trust and the late Karna May dealt at arm's length therefore remains a question of fact to be determined by the Court pursuant to paragraph 251(1)(b) of the Act. The determination of the issue of arm's length dealings between a settlor and a trust is governed by the same principles as those respecting other dealings between non-related persons.

Once again, the fact that the trust acquired the shares at fair market value is not conclusive. The operation must be analysed in light of the test formulated by Cattanach, J. in the case of Merritt Estate (supra). Was the mind which directed the disposition of the shares the same mind which directed the acquisition of the shares? Can the same person be said to be “dictating the terms of the bargain" on behalf of both the settlor and the trust as far as the transfer of the shares is concerned? In the case before the Court these questions must be answered in the affirmative. The trust created by the settlor could not alter the conditions under which the shares were transferred. The essential "separate interest" between parties to the disposition of property at arm's length, referred to in the Swiss Bank case (supra), was not present in the transfer of shares between the settlor and the trust it created.

The Court therefore finds that the estate did not acquire the shares at arm's length and that pursuant to paragraph 39(1)(c) of the Act the estate suffered no business investment loss from the disposition of the shares.

For the above reasons, the appeal is dismissed.

Appeal dismissed.