The Queen v. W. Ralston & Co., 96 DTC 6488, [1996] 3 CTC 346 (FCTD)

Pinard J.: — This is an appeal by way of action against a judgment of the Tax Review Board (the “Board”) dated February 8, 1982, 82 D.T.C. 1128 (T.R.B.), which allowed the defendant’s appeal against reassessments for income tax dated April 30, 1976 with respect to the defendant’s 1970, 1971, 1972, 1973 and 1974 taxation years.

The reassessments under attack were issued by the Minister of National Revenue (the “Minister”) on the assumption that the defendant was associated with the following companies namely Canadian Technical Tape Limited (“C.T.T.”), Lenalco Holdings Inc. (“Lenalco”) and Technical Products (Cornwall) Ltd. (“Technical”) pursuant to paragraph 39(4)(b) of the Income Tax Act 1952, S.C. c. 148 (the “old Z.T.A.”) as applicable for the defendant’s 1970 and 1971 taxation years and pursuant to paragraph 256(l)(b) of the Income Tax Act, S.C. 1970-71-72, c. 63, as amended (the “new /.T.A.”) as applicable for the defendant’s 1972, 1973 and 1974 taxation years; accordingly, the companies were associated with each other within the meaning of subsection 39(5) of the old I.T.A. and subsection 256(2) of the new I.T.A.

The Facts

The following facts are either undisputed or well-established by the evidence which, by consent, is the same evidence which was adduced before the Board:

— During the 1970 to 1974 taxation years, the registered holders of the issued capital of Lenalco, C.T.T., Technical and the defendant were as follows:

	Lenalco	Canadian	W. Ralston &. Co.		Technical
	Holdings	Technical	Canada		Products
		Tape Lid.	Ltd. - Defendant		(Cornwall) Lid
	Inc.
	Common	Common	Common	Voting	Common
	shares	shares	shares	Preferred	shares
				Shares
Leonard Cohen	1048	1	49		1
Alice Cohen	1050	1	49
Louis Cohen		1	1
David Lack	2	1	1		1
Peter Lack				50
Claire Schecter				50	1
In trust for:
Nosh H. Cohen	350
Aren Jeffrey	350
Paul Joseph Cohen	350
Louis E. Cohen	350

Lenalco Holdings Inc.	1016
Canadian Technical
Tape Ltd.				997
3500	1020	100	100	1000

— During these years, Lenalco was controlled by the group (hereinafter called the “Cohen group”), composed of Alice Cohen, Leonard Cohen, Louis Cohen and David Lack.

- C.T.T. was then controlled by Lenalco, and Technical, by C.T.T.

— During these years, the Cohen group held all the defendant’s issued common shares (100) and each member of this group was officer and director of the defendant.

— David Lack acted as attorney for the defendant from at least 1962 to the end of 1974.

- The defendant was incorporated on January 5, 1955, pursuant to the Québec Companies Act, R.S. 1925, c. 223, as amended (“Q.C.A.”). Its objects included the manufacture of extruded polyethylene film products.

— The defendant’s original Letters Patent provided for a capital of ten thousand dollars ($10,000) divided into one thousand (1,000) common shares of the par value of ten dollars ($10.00) each.

— Prior to 1962, one hundred (100) common shares had been issued and allotted and were fully paid up. Leonard Cohen held forty-nine (49) common shares of the defendant, Alice Cohen held forty-nine (49) common shares, Louis Cohen held one (1) common share and David Lack held one (1) common share.

— On September 18, 1962, the defendant converted five hundred (500) unissued common shares at a par value of ten dollars ($10.00) each into five hundred

(500) unissued preferred shares at a par value of ten dollars ($10) each.

— In September 1962, Claire Schecter became a registered holder of fifty (50) preferred shares of the defendant; she personally paid five hundred dollars ($500) for her fifty (50) preferred shares; from 1962 up to at least the end of 1974, Claire Schecter was David Lack’s secretary.

- In September 1962, Gilda Mostovitch, another secretary to David Lack, became a registered holder of fifty (50) preferred shares of the defendant; she personally paid five hundred dollars ($500) for her fifty (50) preferred shares.

— Gilda Mostovitch offered for sale all of her fifty (50) preferred shares to Peter Lack upon her leaving her employment in 1964; pursuant to an agreement dated November 30, 1964, Peter Lack purchased the fifty (50) preferred shares of Gilda Mostovitch for an amount of ten dollars ($10) per share and personally paid five hundred dollars ($500) for them.

- The registered preferred shareholders were never directors or officers of the defendant; however, they were entitled to and did receive notice of all meetings of the shareholders.

- The common shares and the preferred shares of the defendant carried one (1) vote each.

— The holders of the common shares held fifty percent (50 per cent) of the voting shares of the defendant and the holders of the preferred shares held the other fifty percent (50 per cent) of the voting shares.

— The holders of the preferred shares were entitled to receive a fixed, cumulative annual dividend at the rate of eight percent (8 per cent) per annum out of the profits of the defendant, to be declared and paid before any dividend was declared or paid in respect of the common shares.

— The holders of the preferred shares of the defendant received and kept dividends in the amount of forty dollars ($40.00) per year, for each taxation year under appeal.

- The holders of the common shares were entitled to all the surplus profits on a distribution by way of dividend after the payment of the fixed cumulative annual dividend in respect of the preferred shares.

— In case of the liquidation, dissolution, winding-up or bankruptcy of the defendant or other distribution of the assets of the defendant, the holders of the preferred shares were entitled to be paid in full in priority over the common shareholders. However, any such payout was not to exceed the par value of the preferred shares and the accrued dividend charges in respect thereof. The assets and funds of the defendant remaining after distribution to the holders of the preferred shares would be divided among the holders of the common shares according to their rights.

— The Letters Patent of the defendant did not provide that the Board of Directors could cause the liquidation, dissolution or winding-up of the defendant; the liquidation, dissolution or winding-up of the defendant could not be effected by the holders of 50 per cent of the voting shares.

- Pursuant to sections 52 to 62 of the Qubec Companies Act, R.S. 1925, c. 223, as amended, applicable at the time the relevant preferred shares were issued in 1962, the defendant could not, by by-law, reduce its share capital in any way unless such by-law was approved by the vote of at least two thirds (2/3) in value of all the voting shares, common as well as preferred, of the defendant.

- Neither Leonard Cohen nor members of his family owned in the aggregate more than fifty percent (50 per cent) of all of the voting shares of the defendant.

— Neither the remaining common shareholder nor the preferred shareholders of the defendant were related to either Leonard Cohen or to members of his family.

— Alice Cohen was the wife of Leonard Cohen and Louis Cohen was his brother; Gilda Mostovitch and Claire Schecter were not related to David Lack who was the father of Peter Lack.

— There was never any agreement, verbal or written, with respect to the preferred shares, the preferred shareholders’ holding thereof or their voting rights thereon, between any of the holders of the common shares and any of the holders of the preferred shares of the defendant.

- There was never any agreement, verbal or written, to the effect that any of the holders of the preferred shares would act as agent or nominee for any of the holders of the common shares of the defendant.

- The holders of the preferred shares of the defendant were never reimbursed by any of the holders of the common shares of the defendant for the amount they paid as purchase price for their preferred shares. They also never received a guarantee from any of the holders of the common shares of the defendant that their preferred shares would be bought back by any of them.

Point in Issue

In order to determine whether the defendant company was “associated” with C.T.T., Technical and Lenalco within the meaning of subsection 39(5) and paragraph 39(4)(b) of the old I.T.A. and subsection 256(2) and paragraph 256(1 )(b) of the new I.T.A., the Court must resolve the same issue raised before the Board below, to wit, whether the Cohen group controlled the defendant company throughout the relevant period.

Analysis

The relevant provisions of the old I.T.A., as applicable, before 1972, and the new I.T.A., after 1972 are, for the purpose of this appeal, essentially the same. Those provisions read:

Old “I.T.A.”

39(4) For the purpose of this section, one corporation is associated with another in a taxation year if, at any time in the year,

[...]

(b) both of the corporations were controlled by the same person or group of persons,

39(5) When two corporations are associated, or are deemed by this subsection to be associated, with the same corporation at the same time, they shall, for the purpose of this section, be deemed to be associated with each other.

New “I.T.A.”

256(1) For the purposes of this Act one corporation is associated with another in a taxation year if at any time in the year,

[.J

(b) both of the corporations were controlled by the same person or group of persons.

256. (2) When two corporations are associated, or are deemed by this subsection to be associated, with the same corporation at the same time, they shall, for the purpose of this Act, be deemed to be associated with each other.

It is a well-settled principle that the test for determining control within the meaning of the above provisions is de jure and not de facto control by the shareholders. In Duha Printers (Western) Ltd. v. R., (sub nom. Minister of National Revenue v. Duha Printers (Western) Ltd.) 198 N.R. 359, (sub nom. R. v. Duha Printers (Western) Ltd.) 96 D.T.C. 6323, a recent decision of the Federal Court of Appeal, Linden J.A. undertook a thorough analysis of the applicable concept of “control” in the light of the relevant jurisprudence. At page 15 of his Reasons for Judgment, he stated:

Though the word “control” is not defined in the Income Tax Act, it has been considered many times in the jurisprudence. This jurisprudence has settled that control is based on de jure control and not de facto control, and that the most important single factor to be considered is the voting rights attaching to shares. In the past, the share register, by itself, has usually been the main basis for determining corporate control, even though the Income Tax Act did not adopt that idea expressly. The scope of scrutiny under the de jure test has wisely been extended more recently beyond a mere technical reference to the share register.

Although the scope of scrutiny under the de jure test has been extended beyond a mere examination of the share register in order to determine who really has voting control, I am of the view that there has been no deviation from the well settled and fundamental principle of the de jure control, as opposed to the de facto control, by the shareholders. This principle has withstood the test of time and numerous judicial decisions since first enunciated in British American Tobacco Co. Ltd. v. Inland Revenue Commissioners, [1943] 1 All E.R. 13, [1943] A.C. 335 (H.L.), and adopted by Jackett P. in Buckerfield’s Ltd. v. Minister of National Revenue, [1965] C.T.C. 504, 64 D.T.C. 5301 (Ex. Ct.). I agree with the defendant’s proposition that the basic and uncontroverted principle is that the test for determining control has remained de jure control by the shareholders based on the “corporate structure”, and that there has been no evolution towards a de facto test. The rule established by Jackett P. in Buckerfield’s was confirmed by the Supreme Court of Canada in Minister of National Revenue v. Dworkin Furs (Pembroke) Ltd., [1967] S.C.R. 223, [1967] C.T.C. 50, 67 D.T.C. 5035 where the Court held that where the governing authority in the corporation was divided between two groups, each of which held fifty percent (50 per cent) of the voting shares, and where the by- laws of the company provided that the Chairman did not have a casting vote in the event of an equality of votes, there was no control. The same fundamental rule was reaffirmed by the Supreme Court of Canada in Oakfield Developments (Toronto) Ltd. v. Minister of National Revenue, [1971] S.C.R. 1032, [1971] C.T.C. 283, 71 D.T.C. 5175 although the Court found in that case that control existed because, fundamentally, fifty percent (50 per cent) of shareholders’ votes could authorize a surrender of the company’s Letters Patent (see also Imperial General Properties Ltd. v. R. (sub nom. The Queen v. Imperial General Properties Ltd. (formerly Speedway Realty Corp. Ltd.)), [1985] 2 S.C.R. 288, [1985] 2 C.T.C. 299, 85 D.T.C. 5500). Oakfield was not any departure from the Dworkin Furs principle that “control” is not a question of who, in fact, directs the affairs of the company (e.g. management officials or the directors) but of who, under the company’s constitution, has the right to control. It is, however, an extension of the rule in that it determines the question of control by reference to the right to control the ultimate destiny of the company rather than the right to direct the current destinies (i.e. the operation) of the company. In Imperial, the majority merely applied Oakfield and, in doing so, made it clear that the test must depend on the constitution of the company. In Duha Printers, supra, at page 25, it appears that the overriding consideration for the Federal Court of Appeal was the corporate structure of the impugned companies and the legal rights which flowed therefrom and the existence of binding agreements which gave the shareholders clear and unequivocal rights in law:

Any binding instrument, therefore, must be reckoned in the analysis if it affects voting rights.

At the hearing before me, counsel for the plaintiff agreed that this Court could not, given the evidence, conclude that the registered holders of the preferred shares were, in effect, acting as nominees for the Cohen group; counsel for the plaintiff simply argued that the Cohen group controlled the defendant by reason of:

1. the possibility of a deadlock at the shareholders’ level in electing the directors of the defendant for the ensuing year, and the doctrine of “holding over”;

2. the right of the Board of Directors to issue the unallotted common shares to the Cohen group, in order to break any deadlock which may exist among the shareholders;

3. the right of the Board of Directors to redeem the preferred shares; and

4. the right to apply for a judicial wind-up of the defendant.

The plaintiffs first argument based on deadlock and the doctrine of “holding over” was specifically rejected by Jackett P. in Dworkin Furs, supra, at page 468:

Even assuming the correctness of all such propositions, I doubt that the holding of a veto over the replacement of a particular board of directors constitutes control in any of the possible senses in which that word may have been used. One corporation cannot, in my view, be said to be “controlled” by another in any possible sense of that word unless that other can, over the long run, determine the conduct of its affairs. The mere fact that one corporation can prevent a change in some or all of the directors of another is not a power of positive control. It is a mere veto over change in management.

The argument based on the issuance of shares must also be dismissed on the ground that the Board of Directors of the defendant had no authority to issue shares to the Cohen group at their request in order to brake the alleged deadlock. The law is clear. Directors may not act for one group of shareholders only. On this issue, M. Martel & P. Martel, La compagnie au Québec, vol. 1 (Montréal: Éditions Wilson & Lafleur Ltée, 1992)

(“Martel”) state:

Le premier droit conféré l’actionnaire est celui de l’égalité de traitement. Ce droit découle de l’économie générale des lois corporatives plutôt que de textes précis, et il a maintes fois été confirmé par la jurisprudence et la doctrine. Les actionnaires doivent être traités sur le même pied, sans favoritisme ou discrimination et ils peuvent contester et faire annuler tout acte de la compagnie qui contrevient à cette exigence, (page 334, footnotes omitted)

[...]

Les administrateurs ne doivent pas non plus se servir de l’instrument de l’émission d’actions pour conserver ou s’emparer du contrôle des votes à l’assemblée générale, ou pour accorder ce contrôle à des personnes choisies…

(page 532)

The same principle must equally apply to the redemption of shares. There is no more authority in the directors to cause the redemption of shares to favour a particular group of shareholders than there is to issue shares for that same purpose. The plaintiff’s third argument, therefore, must also fail.

Finally, the plaintiff’s last argument is not valid because the right to apply for a judicial wind-up of the defendant company in case of a deadlock is a question of fact, and not of right. Therefore, the argument can hardly stand with the well-settled jurisprudence as to the requirements for a determination of control, as was made plain by Martel, supra:

On a amendé la loi en 1963, pour adopter l’expression plus générale “juste et équitable”. Il ne fait pas de doute cependant que l’impasse fasse partie des motifs “justes et équitables”.

Généralement, l’impasse suffit à entraîner la liquidation de la compagnie, mais encore une fois c’est une question de faits. Si l’impasse n’est que temporaire ou si on prévoit qu’elle prendra fin si les parties font preuve de tolérance et de bon sens, ou si elle est directement attribuable au requérant, la Cour ne rendra pas d’ordonnance de liquidation. Même chose si l’impasse n’empêche pas la compagnie d’opérer rentablement et d’atteindre ses objectifs économiques, ou encore si elle a été résolue avant l’audition du procès.

L’impasse n’est donc pas toujours un motif de liquidation judiciaire. D’autre part, il peut arriver qu’une situation de conflit perpétuel qui ne constitue pas tout à fait une impasse soit considérée comme motif suffisant. (pages 932-933, footnotes omitted)

Furthermore, Oakfield, supra, was decided on the fact that fifty percent (50 per cent) of votes of shareholders could authorize a surrender of the company’s Letters Patent, and not on the mere right, like in this case, to apply for a judicial wind-up on such terms which the Court may deem just.

The case at bar does not involve any sophisticated class of shares or instruments binding on shareholders and/or directors alike which must be considered in assessing control. I see nothing in the defendant company’s simple structure which grants a de jure control to the Cohen group. In light of the specific facts of this case and of the applicable law, I find, therefore, that the Cohen group did not control the defendant company and accordingly, the defendant was not associated with C.T.T., Technical and Lenalco.

Consequently, the plaintiffs action must be dismissed, with costs.

Action dismissed.