Canwest Capital Inc. v. The Queen, 97 DTC 1, [1996] 1 CTC 2974 (TCC)

Bell J.T.C.C.: — The Minister of National Revenue reassessed the Appellant by Notices of Reassessment dated June 14, 1993 for its 1989, 1990 and 1991 taxation years disallowing dividend refunds to it as follows:

1989 - $109,254

1990- $126,386

1991 - $113,570

TOTAL - $349,210

The Appellant claimed the dividend refund in respect of the following dividends paid on its Class “B” shares to Tingley Leasing Venture Capital Inc. (“Inc.”) as follows:

1989 - $440,000

1990 - $510,000

1991 - $455,000

TOTAL-$1,405,000

Issues

The issues are:

1. whether the Appellant is entitled in each of those taxation years to a dividend refund under subsection 129(1) of the Income Tax Act (“Act”) as a result of paying dividends to Inc. in each of those years, or whether, by virtue of subsection 129(1.2), an anti-avoidance provision, it was not so entitled, and

2. if the Appellant is entitled to such dividend refund, whether the interest income earned by the Appellant in those years was “Canadian Investment Income” under subsection 129(4). If so, it would be included in the calculation of “Refundable Dividend Tax On Hand” (“RDTOH”) under subsection 129(3), thereby entitling the Appellant to the dividend refund.

Introductory information

In order to assist comprehension of this case, a diagram illustrating the operation of relevant income tax provisions is presented. In drafting these provisions, the legislature sought to achieve “integration” in that a shareholder and a private corporation would be in the same tax situation if dividends were paid directly from the corporation to the shareholder as they would be if dividends were paid first to another corporation and then to the shareholder. Diagram I illustrates the steps and pertinent tax results of a taxable dividend paid by a private corporation to an individual. Diagram II illustrates the steps and pertinent tax results of a taxable dividend paid by a private corporation to another private corporation and thence to an individual.

DIAGRAM I

A and B are private corporations and C is an individual.

(1) taxable dividend of $800 to individual shareholder C

Steps and pertinent tax results

(1) B pays taxable dividend of $800 to C (individual).

(2) Such dividend payment entitles B to a dividend refund of $200! [1] assuming it has RDTOH* [2] of $200. B would have such RDTOH if it had received Canadian Investment Income [3] of $800.

DIAGRAM II

(6) taxable dividend of $800 to individual C

(1) taxable dividend of $800 from B to A

Steps and pertinent tax results

(1) B pays taxable dividend of $800 to A. (2) B entitled to dividend refund of $200 [4] assuming it has RDTOH [5] of $200. B would have such RDTOH if it had received Canadian Investment Income [6] of $800. (3) A includes $800 taxable dividend in income and deducts same under section 112. (not on diagram) (4) A pays Part IV tax, generally, of 1/4 of that dividend (section 186) . (5) Because the dividend is tax free to A it is not Canadian Investment Income and adds nil to RDTOH but an amount equal to Part IV tax is added to RDTOH [7] . (6) A pays taxable dividend of $800 to C (individual). (7) Such dividend payment entitles A to a dividend refund of $200 [8] assuming it has RDTOH [9] of $200 which it will have under [10] 10

DIAGRAM III

The foregoing principles are applied to this case by the following diagram. The steps below set forth some facts in advance of the section entitled FACTS and constitute a graphic presentation of the apparent reason for reassessment.

52,041 “A” shares 50,000 B preferential dividend shares

(1) Appellant paid dividends, in 1989, 1990 and 1991 of $1,405,000 to Inc. Appellant regarded these as “taxable dividends” entitling it to dividend refunds [section 129(1)].

(2) Appellant sought dividend refund of $349,210.

(3) Inc., being a “prescribed venture capital corporation” under section 186.2 paid no Part IV tax on dividends from a “prescribed qualifying corporation”. The parties agreed that the Appellant was, at all relevant times, a “prescribed qualifying corporation”.

(4) Minister of National Revenue assessed Appellant under ss. 129(1.2) denying the dividend refund on the basis that the dividends paid were not taxable dividends resulting in no RDTOH. (not on diagram)

Anti-avoidance rule

Subsection 129(1.2) reads as follows,

Where a dividend is paid on a share of the capital stock of a corporation and the Share ... was acquired by the holder thereof in a transaction or as part of a series of transactions one of the main purposes of which was to enable the corporation to obtain a dividend refund, the dividend shall, for the purpose of subsection (1), be deemed not to be a taxable dividend.

If the dividends paid by the Appellant are not taxable dividends the Appellant would not be entitled to any dividend refund under subsection 129(1).

A provision in a self-assessing taxation system should be clear and capable of ready comprehension. Subsection 129(1.2) falls short of this standard. Subsection 129(1) entitles a taxpayer to a dividend refund on the payment of taxable dividends. Subsection 129(1.2) disentitles a taxpayer to such refund without any description of circumstances justifying that result. The Court should be able to interpret legislation and to apply it to the facts without the task of having to divine meaning from an assemblage of words whose intended objective could hardly be better disguised. In such circumstance the Court must reluctantly resort to other materials in an effort to glimpse the creature concealed.

In Hawboldt Hydraulics (Canada) Inc. (Trustee of) v. Canada (sub nom. Hawboldt Hydraulics Inc. Estate (Trustee of) v. Canada), [1994] 2 C.T.C. 336, (sub nom. R. v. Hawboldt Hydraulics (Canada) Inc., leave to appeal to S.C.C. refused (sub nom. Hawboldt Hydraulics (Canada) Inc. (Bankrupt) v. Minister of National Revenue) (1995) 187 N.R. 237 (S.C.C.) 94 D.T.C. 6541, Isaac, C.J. at 341 (D.T.C. 6545) said,

It is now well settled that in construing legislation Courts may consider, as part of the external context, materials such as Reports of House of Commons Debates or of Committees of the House of Commons as aids to discovering the aims of the legislating body, the evils or mischief with which it was contending at the time of enactment, and the background and purpose of the legislation.

He then quotes from the comments of the Minister of Finance on second reading of a bill amending the Income Tax Act describing the basic objectives of the measures before the House. In Maritime Telegraph and Telephone Company, Ltd. v. R. (sub nom. Maritime Telephraph & Telephone Co. v. Canada) [1992] 1 C.T.C. 264, 92 D.T.C. 6191 (F.C.A.), MacGuigan, J.A. at page 267 (D.T.C. 6194), without reasons for the reference, said,

This interpretation is, I believe, supported by the only extrinsic evidence available. The Technical Note accompanying the 1983 amendment reads as follows:

In Anderson v. R. (sub nom. Anderson v. Canada) [1992] 2 C.T.C. 2406, (sub nom. Anderson v. Minister of National Revenue) 92 D.T.C. 2296, Beaubier, J. of this Court referred to Department of Finance Technical Notes in saying, before quoting therefrom, at 2409 (D.T.C. 2298), that the document

... gives some insight into the intention and operation of the legislative amendments.

The Technical Notes issued by the Department of Finance at the time subsection 129(1.2) was introduced read as follows:

New subsection 129(1.2) of the Act provides an anti-avoidance rule which is designed to prevent a private corporation from structuring arrangements in order to obtain a dividend refund without the related shareholder tax being paid. For example, a private corporation with refundable dividend tax on hand may seek to issue shares with a high redemption price but low paid-up capital to a tax- exempt entity or other corporation that receives ordinary dividends on a non-taxable basis and obtain a dividend refund on the subsequent share redemption....

The Rule provided in new subsection 129(1.2) is not intended to interfere with the normal operation of subsection 129(1) as part of the system for integrating the taxes paid on investment income by a private corporation and the taxes paid by the shareholders on the subsequent distribution of that income.

[Emphasis added.]

It appears from an examination of Hansard that there was no Parliamentary debate on this subsection. While there appears to be authority for reference to extrinsic material to explain the objective of an amendment to the Income Tax Act, the amendment, not the Technical Note constitutes the expression of Parliament’s will, however well considered. It is the legislation created by the amendment that must be interpreted by the Court.

It is normal for an informed taxpayer to establish a parent corporation and subsidiary corporation structure. It would be present to the founder’s mind that the subsidiary would obtain a dividend refund upon the payment of a taxable dividend to its parent. Does the establishment of such a normal structure have as one of its purposes the ability of the subsidiary to obtain a dividend refund on payment of a taxable dividend? If the answer is negative no further analysis is required. If the answer is affirmative, what elevates that purpose to being a main purpose under subsection 129(1.2)? The Technical Notes inform us that the government’s concern is no “related shareholder tax being paid”. That concern is not expressed in the provision under examination. How can subsection 129(1.2), without more, characterize the ability of a subsidiary corporation to receive a dividend refund, the normal result of paying a taxable dividend, as one of the main purposes for the acquisition of its shares by that related shareholder? Surely it is the combination of the normal ability to receive a dividend refund together with something else that is the target of subsection 129(1.2). Why does it not describe what that something else is? This is an anti-avoidance section that does not indicate what structures and/or transactions it seeks to redress.

Apparent reason for application of subsection 129(1.2)

Section 186 of the Act provides, generally, for the payment by a corporation of a special tax (Part IV tax) on taxable dividends received by it. Section 186.2 provides that dividends received by a “prescribed venture capital corporation” from a “prescribed qualifying corporation” are deemed not to be taxable dividends and are, therefore, not subject to that tax. An amendment to section 6700 of the Income Tax Regulations, effective January 18, 1985, qualified a corporation registered under The Venture Capital Tax Credit Act of Saskatchewan (“VCTCA”) as a “prescribed venture capital corporation” for the purposes of section 186.2 of the Act. The parties agreed that the Appellant was, at all relevant times a “prescribed qualifying corporation” under that section. Inc., which became a prescribed venture capital corporation in December, 1985, had acquired all 50,000 issued and outstanding Class B shares of the Appellant by the end of 1986. Apparently it is under these circumstances where the Appellant would receive a dividend refund and Inc. would pay no Part IV tax that the Minister decided to apply subsection 129(1.2) which, if effective, would deny a dividend refund to the Appellant. This information was not furnished by the Minister in any document in the appeal process. The Notices of Reassessment gave no information about the reason for reassessment. Form T7W-C attached to the 1989 Notice, being representative of the other two years merely advises that,

The provisions of subsection 129(1.2) have been applied to the dividend paid in the amount of $440,000, deeming the dividend not to be a taxable dividend for the purposes of the dividend refund thereby resulting in the denial of the dividend refund to the corporation.

The Notification is equally uninformative. It states in relation to this matter,

Tingley Leasing Venture Capital Inc. acquired your shares in a transaction or as part of a series of transactions one of the main purposes of which was to enable you to obtain a dividend refund; the dividends paid in each year are deemed not to be taxable dividends in accordance with subsection 129(1.2) of the Act and you are not entitled to a dividend refund pursuant to subsection 129(1) of the Act;

The Respondent’s 20 page Reply to the Notice of Appeal contains no statement or assumption of fact and no ground for the reassessment other than the simple statement that one of the main reasons or purposes for the acquisition of the Appellant’s shares was to enable it to obtain a refund.

Facts acts

The Appellant and Inc. were incorporated, as numbered companies, on June 10, 1985 and commenced activity on December 6, 1985. Mr. Dale Tingley (“Tingley”), the motivating force behind both companies, was the owner of an extremely successful General Motors agency. He and his accountant, Mr. Lee Hergott (“Hergott”), following the introduction of the VCTCA, created a structure in which Regehr Holdings Ltd. (“Regehr”) owned all of the 52,041 issued and outstanding Class A voting common shares of the Appellant and Inc. owned all of the 50,000 issued and outstanding Class B voting common shares of the Appellant. Regehr was, for purposes of the VCTCA, not related to Tingley or to any of his companies. As it was a requirement of the VCTCA that a venture capital corporation and affiliated corporations could not own more than 49% of the issued and outstanding equity shares of an “eligible investment corporation”, the 50,000 Class B shares of the Appellant held by Inc. were entitled, in priority to the holders of other classes of shares, to receive a preferential cumulative dividend at the rate of 12% of a formula computed amount. It seems obvious that Inc. was entitled to receive all or substantially all the dividends paid by the Appellant. At all relevant times the shares of the Appellant held by Inc. constituted an eligible investment under the VCTCA.

On December 17, 1985 a final form Confidential Offering Memorandum was filed by Inc. with the Saskatchewan Securities Commission. On December 19, 1985 the Commission issued an order allowing the distribution of shares by Inc. On December 24, 1985 Inc. issued shares to two partnerships consisting of 60 to 70 investors for the aggregate amount of $2,310,000. By virtue of the VCTCA those investors were entitled to a Saskatchewan income tax credit equal to 30% of the amount invested, the result being that their net cost of shares of Inc. was 70% of their investment. On February 27, 1986 Tingley purchased from those investors all of their shares of Inc. for 78 cents on the dollar, yielding them a gain of 8 cents on the dollar for a holding period of less than two months. In 1986 Tingley, his wife and related companies acquired additional shares of Inc. By the end of that year, Inc. had invested $5,000,000 in the Appellant by the purchase of its Class B shares.

Tingley testified that the Appellant planned to invest its money in assets for a vehicle leasing business. The advantages were extraordinary. The Appellant would buy vehicles from Tingley’s automobile agency thereby increasing its sales and profits. The Appellant would lease its vehicles and “shelter” tax on its rental profits by claiming capital cost allowance on the vehicles. The operation was made even more attractive by the ability to obtain fleet discounts from the manufacturer. Further, because of vehicle price increases, the Appellant could obtain proceeds on vehicle sales almost equal to cost. The profits were substantial. Tingley was also motivated to pursue this structure because he had permission from the VCTCA to organize four more funds of $5,000,000 each.

The Appellant’s leasing activities were adversely affected by a downturn in the economy and by the General Motors decision to support leasing programs. Tingley testified that the Appellant bought leases from other dealers and started leasing office equipment, garden equipment and other assets. He also testified that the venture capital administrators, out of concern over the fact that the full $5,000,000 had not been used in the leasing business, discussed this matter with him and Hergott. They accepted his explanation of the reasons for same. The Appellant then invested substantial sums of money in mortgages, treasury bills and long-term securities, some as long as five years. Tingley also stated that the sums so invested were not necessary for the leasing business and that the business could not have used these monies. The tax returns for the years in question showed the following proportion of monies used in leasing and investment

Leasing: Invest

1989: 30%: 60%

1990: 20%: 80%

1991: 30%: 70%

Tingley testified that he received tax advice only from Hergott and that he would defer to Hergott in tax matters.

Hergott described the unusual economic advantage to the Appellant conducting the leasing business and said that the use of the capital subscribed by the investors together with additional capital and all the advantages above set forth literally guaranteed a profitable deal. Hergott also said that his firm prepared the Appellant’s January 31, 1987 year end income tax returns for that year in or about June 1987. He stated that there would have been no discussion about tax until the returns for that year were being prepared. He stated further that he was positive that no discussion had taken place about the tax aspects of dividends on the preferred shares issued by the Appellant before the acquisition of those shares by Inc. He said that he was not aware in 1985 of the January 17, 1985 amendment to section 6700 of the Income Tax Regulations qualifying a corporation registered under the VCTCA as a “prescribed venture capital corporation” for the purposes of section 186.2 of the Act. He stated that if that regulation was amended in January, 1985 his firm would not have been interested because it was not then doing venture capital corporation work. He further stated that he did not consider the provisions of section 186, imposing the Part IV tax, when Inc. acquired shares of the Appellant. He said that the only matter in the minds of those involved was to get the $5,000,000 invested and to obtain a larger leasing fleet. He said that the concept of the Appellant obtaining dividend refunds while Inc., the recipient of dividends from the Appellant, would be exempt from Part IV tax was not considered.

Hergott confirmed Tingley’s evidence with respect to none of the Appellant’s money in investments being needed in the leasing business for the years in question. He stated that it would never have been so needed.

First issue

Obviously Hergott knew about dividend refunds under subsection 129(1). However, it is clear from the evidence both of Tingley and Hergott, which evidence I accept without reservation, that the corporate structure in this case was created for the purpose of achieving extraordinary economic results for Tingley’s enterprises, namely those outlined above. Hergott did not even know that Inc. was, from January 17, 1995, free of Part IV tax on dividends received from the Appellant. His evidence was clear that he was not aware of the result of both a dividend refund to the Appellant and the freedom of Inc. from Part IV tax until mid 1987 when reviewing the income tax return of the Appellant for its year ended January 31, 1987. This was after the acquisition of shares of the Appellant by Inc., which acquisition was completed on December 30, 1986. He described Tingley’s joyous reaction at the discovery of the tax result at the time of that review. Hergott knew, of course, that the Appellant, under subsection 129(1) qualified for a dividend refund on dividends paid in the years in question. This provision had been in effect for some time. The normal application of that subsection cannot be altered by the application of subsection 129(1.2) in circumstances where the quest for such refund was made in the ordinary course without knowledge of the fact that Part IV tax would not be paid by the recipient corporation. This is buttressed by the fact of the substantial economic advantages accompanying the structure as conceived and implemented. Not only do I conclude that that quest for a dividend refund was not one of the main purposes of the transaction or series of transactions in which the Appellant’s shares were acquired by Inc. but it was not a purpose at all. Subsection 129(1.2), viewed in the context of these facts simply cannot apply to the Appellant.

Second issue

Respecting the second issue I have no difficulty in concluding that the interest income was “Canadian investment income” and not income from an “active business”. The evidence was clear that no portion of the money invested was needed in the Appellant’s leasing business and that the Appellant had exhaustively sought more leasing activities to add to those operations. It cannot be said that the substantial amounts invested in this case were part of, or a result of, or indeed allied with, the leasing business conducted by the Appellant.

Paragraph 125(7)(a) of the Act, in part, defines “active business carried on by a corporation” to mean any business carried on by the corporation other than a “specified investment business”. “Specified investment business” is defined under paragraph 125(7)(e) to mean a business (other than a business of leasing property other than real property) the principal purpose of which is to derive income from property unless the corporation employs in the business throughout the year more than five full-time employees. The Appellant did not have more than five full-time employees. Accordingly, Appellant’s counsel submitted that it carried on two businesses, namely the active business of leasing and the specified investment business of investing its money not required for the leasing business.

Paragraph 129(4)(a) defines “Canadian investment income” to include all amounts from a source in Canada that is property, except certain amounts not applicable in this case. Subsection 129(4.1) states that for purposes of this definition, the income of a corporation from a source in Canada that includes income from a specified investment business carried on in Canada is included in “Canadian investment income”.

Respondent’s counsel referred to Cornwall Gravel Co. v. R. (sub nom. Cornwall Gravel Co. v. Canada), 94 D.T.C. 1709. That case, involved an effort by the taxpayer to have investment income categorized as active business income in quest of a lower tax rate. It refers to Canadian Marconi Co. v. H.M.Q. [1986] 2 C.T.C. 465, 86 D.T.C. 6526 which states that there is a rebuttable presumption that income derived by a corporation from an activity in which it is specifically permitted by its corporate objects to engage, is to be regarded as income from a business. Apart from the fact that the corporate objects of the Appellant were not presented to the Court, this case is of no assistance. The Appellant carried on a specified investment business, it being the source of investment income which qualifies as Canadian investment income under the definition set out above. The sum of $5,000,000 had been injected into the company for a leasing business which could not, in spite of the Appellant’s efforts, employ capital of that dimension in same. Therefore, the Appellant pursued the only logical step open to it, namely, to invest those excess funds. The funds were independent of any portion of the leasing operation, never having been identified with it in any fashion, and were used, having regard to the limitations of the leasing business, in its investment operations.

Accordingly, the appeal is allowed with costs and an amount equal to the goods and services tax paid thereon pursuant to the Excise Tax Act (Canada).

Appeal allowed.