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Citation: 2006TCC194
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Date: 20060324
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Docket: 2002-1323(IT)G
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BETWEEN:
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JACQUES GAGNON,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
[OFFICIAL
ENGLISH TRANSLATION]
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REASONS FOR JUDGMENT
Lamarre J.
[1] This
is an appeal from an assessment made by the Minister of National Revenue
("the Minister") under the Income Tax Act ("the
Act") in which the Minister included a grossed-up taxable dividend of
$124,998 in the Appellant's income for the 1997 taxation year and, at the same
time, allowed a dividend tax credit of $16,666.39 in computing the tax payable
by the Appellant during that year.
[2] During
his testimony, the Appellant explained that he and his brother André Gagnon
purchased a business called "Le Bar Billard Allium" in early
1995. Officially, the bar was purchased by 139028 Canada Inc. ("the
corporation"), whose sole shareholder at the time was André Gagnon,
the Appellant's brother. The bar was operated under the business name
"La Galanterie" (see the financial statements at December 31,
1995, Exhibit I‑1, tab 14).
[3] At
the time of this purchase, the Appellant's father allegedly gave him and his
brother $5,000 each to invest in the bar. The Appellant says that he endorsed
this cheque and gave it directly to his brother. He said that he invested no
other sum of money in the business – his brother is the one who advanced the
funds to pay the roughly $23,000 balance on the purchase and to pay for the
renovation work on the bar. For his part, the Appellant looked after the
operations, including the purchase of video machine terminals and various
supplies on behalf of the corporation. He said that he was never remunerated
for his services. There was supposedly an informal agreement with his brother
under which the Appellant owned 50% of the bar. However, the Appellant was not
issued any shares in the corporation during this period.
[4] On
March 8, 1997, the Appellant sought to sell his share of the bar.
An agreement between him and his brother (Exhibit I‑1, tab 6)
was made, stating:
[TRANSLATION]
AGREEMENT BETWEEN:
JACQUES
GAGNON,
"Seller"
- and -
ANDRÉ
GAGNON,
"Purchaser"
THE FOLLOWING HAS BEEN AGREED TO:
1. Jacques Gagnon
hereby sells all his interest in the business called "Le Bar Billard
Allium", property of 139028 Canada Inc., effective today, to André Gagnon,
for the sum of $50,000 and other consideration, payable as follows:
1. (a) $ 25,000
on March 13, 1997; and
(b) $ 25,000
on May 10, 1997.
2. André
Gagnon shall be solely responsible for all the debts of Le Bar Billard
Allium.
3. André
Gagnon grants Jacques Gagnon an interest‑free loan of $50,000, in the
form of demand notes, to be advanced to Jacques Gagnon as follows:
(a) $25,000 on July
10, 1997; and
(b) $25,000 on
September 10, 1997.
2. This sale also
includes all of Jacques Gagnon's interests in the "Deli Bar
O'Max" restaurant. Such interests are immediately transferred to André
Gagnon for the sum of $1.00, on the condition that André Gagnon shall pay all
the debts that it owed prior to the sale to Christian Gaudreau.
3. In
consideration of the foregoing, the two (2) parties release each other fully
and finally from any claim that either might have had against the other while
they were in business together.
4. If a single one
of the payments is not made on the dates specified above, this agreement shall
become null and of no effect and the parties shall be placed in the same
situation that they were in prior to this agreement, without restitution of the
amounts already paid.
5. This agreement
is a transaction within the meaning of the Civil Code of the province of
Quebec.
6. The parties
agree to sign all appropriate documents upon request in order to give effect to
this agreement.
7. Ronald Bélec,
attorney, has been chosen by the parties as trustee of this agreement and of
all documents necessary for its execution.
Signed at Hull, March 6,
1997.
(Signature)
JACQUES GAGNON,
"Seller"
(Signature)
ANDRÉ GAGNON,
"Purchaser"
[5] While
this agreement refers to $50,000 in consideration and a $50,000 loan to the
Appellant, the Appellant clearly told the Court that he owed nothing to his
brother and had received the $100,000 in consideration of his equity in the
bar. He received this amount in five instalments: two instalments on
March 13, 1997, and the other three on May 10, July 10 and
September 10, 1997, respectively. These amounts were paid to him by the
corporation, not by André Gagnon directly (see Exhibit I‑1,
tab 11).
[6] According
to the Appellant, on September 10, 1997, when the Appellant received the last
payment, his brother asked him to sign a new agreement that would annul the
preceding one and would be retroactive to March 8, 1997. By this new
agreement, the Appellant would be considered not to have received $100,000 from
his brother in consideration of his equity in the bar. Rather, under this new
agreement, two shares in the corporation would be issued to the Appellant
retroactively and, in the transaction of March 8, 1997, the corporation would
be considered to have redeemed the two shares from the Appellant in
consideration of $100,000.
[7] Based
on the understanding that this new agreement would not alter his situation, the
Appellant signed this second agreement at the request of lawyer
Ronald Bélec, who acted as a sort of intermediary between the two
brothers. It should also be said that, as of March 8, 1997, the date of
the first agreement, the Appellant thought, based on information obtained
from Mr. Bélec, that the $100,000 transaction was tax-neutral for him,
because, in the negotiations, his brother had agreed to assume all tax
liabilities related to the transaction. This is apparently why the Appellant
did not include this amount in his income tax return for the 1997 taxation
year.
[8] Mr.
Bélec testified to explain the circumstances under which the two agreements
were signed. He explained that the Appellant wanted to sell his interest in the
bar and was asking his brother for $200,000 to cover the tax payable.
Supposedly, the Appellant's brother ultimately agreed to pay the Appellant
$100,000, and told him that he would assume the tax liability himself. All of
these negotiations were held over a very brief period in March 1997, and
Mr. Bélec drafted the first agreement at that time. Since the Appellant
did not appear to own any shares in the corporation, Mr. Bélec wrote in the
first agreement that the Appellant was selling his "interest" in the
business, which was the property of the corporation. In addition, even though
the first agreement stipulates otherwise, Mr. Bélec clearly stated that
André Gagnon did not grant a $50,000 loan to the Appellant.
[9] When
the last $25,000 instalment was made, André Gagnon, the Appellant's brother,
supposedly realized that he had to justify a $100,000 payment from the
corporation to the Appellant. At this time, on André Gagnon's request,
Mr. Bélec issued two shares of the corporation to the Appellant,
retroactive to May 6, 1996 (Exhibit I‑1, tab 10) in
order to justify the sale of the Appellant's interest in the corporation, which
owned the bar. André Gagnon, the corporation's president, then signed a
resolution of the directors dated March 8, 1997, approving the
redemption of the Appellant's two shares by the corporation (Exhibit I‑1,
tab 9). A second agreement was then prepared by Mr. Bélec in
September 1997, but dated March 8, 1997. It was signed by the
Appellant as seller; and by his brother, both on behalf of the purchaser
corporation, and personally as surety. This agreement, Exhibit I‑1,
tab 8, reads as follows:
[TRANSLATION]
JACQUES GAGNON,
"Seller"
- and -
139028 CANADA LTD.,
"Purchaser"
- and -
ANDRÉ GAGNON,
"Surety"
________________________
THE FOLLOWING HAS BEEN AGREED TO:
1. On this day,
Jacques Gagnon hereby sells his shares in 139028 Canada Ltd. to that
corporation for the sum of $100,000 and other consideration, payable as
follows:
1. (a) $25,000.00
on March 13, 1997;
(b) $25,000.00
on May 10, 1997;
(c) $25,000.00
on July 10, 1997; and
(d) $25,000.00
on September 10, 1997.
2. Jacques Gagnon
renounces the $4,900 demand note made out to him by 139028 Canada Ltd. on May
6, 1995.
3. André Gagnon
shall be solely responsible for all the debts of "Le Bar Billard
Allium", property of 139028 Canada Ltd.
2. This sale also
includes all interests that Jacques Gagnon had in "Deli Bar O'Max"
restaurant. Such interests are immediately transferred to 139028
Canada Ltd. for the sum of one dollar ($1.00), on the condition that
corporation shall pay off all the debts that this business owed prior to the
sale to Christian Gaudreau.
3. In
consideration of the foregoing, the parties hereto give each other a full and
final release from all claims that each might have against the other during the
entire period in which they were in business together.
4. Should any one
of the instalments not be paid on the dates specified above, this sale shall
become null and of no effect, and the parties shall be placed back in the same
situation that they were in prior to this agreement, without restitution of the
amounts already paid.
5. This agreement
is a transaction within the meaning of the Civil Code of the province of
Quebec.
6. André Gagnon
intervenes herein as surety for the obligations contracted by 139028 Canada
Ltd. in favour of Jacques Gagnon.
7. The parties
agree to sign all appropriate documents upon request in order to give effect to
this agreement.
Signed at Hull, March 8,
1997.
[10] At the same time, the Appellant agreed to annul the first agreement
signed on March 8, 1997 (Exhibit I‑1, tab 7).
[11] Mr. Bélec acknowledged that the Appellant had been reticent to sign
the second agreement and annul the first one. He signed it on the understanding
that his brother would be responsible for paying the applicable tax. As for
André Gagnon, he did not come before the Court to provide his version of the
facts.
[12] Based on the second agreement, the Minister assessed the Appellant
for a deemed dividend upon a redemption of shares pursuant to subsections 82(1)
and 84(3) of the Act on the assumption that the Appellant had received $100,000
from the corporation upon the redemption of two shares for which the paid-up
capital was $2.00. Indeed, for accounting purposes, the corporation treated the
transfer of the shares like a redemption, as shown by the financial statements
of the corporation at December 31, 1998 (Exhibit I‑1, tab
15, pages 4 and 9).
[13] At the hearing, counsel for the Respondent appeared to acknowledge
that the second agreement was null, and relied, instead, on the alternative
position stated in the Reply to the Notice of Appeal, namely that the Appellant
should have been taxed on a capital gain following the sale of his equity in
the bar, not on a deemed dividend upon a redemption of shares.
[14] The Respondent agrees that the Appellant invested $5,000 into the
business (the money from his father). In addition, the Minister has
already agreed that the $1,880 in legal fees incurred by the Appellant (Exhibit
I-1, tab 12) at the time of the sale of his equity in the bar could be deducted
as a capital loss offsetting a capital gain (see Exhibit I‑1, tab 3, the
Notice of Reassessment dated October 17, 2000, acknowledging a net capital loss
of $1,410, which is 75% of $1,880).
[15] In a document tendered in the Court, the Respondent showed that,
assuming an adjusted cost base of $5,000 and disposition expenses of $1,880,
the tax payable by the Appellant on the capital gain would be $15,771. But the
Appellant was assessed $15,048 on a deemed dividend. The Respondent
acknowledges that, regardless of the decision of this Court, the amount
assessed cannot be increased. In this regard, the Respondent refers to Harris
v. M.N.R., 64 DTC 5332 (Exch. Ct.).
[16] As for the Appellant, he says that he signed the second agreement
based on false considerations, believing that it was mere courtesy done for
internal accounting convenience in accordance with instructions given by André
Gagnon's accountant. Moreover, having received all the payments, he signed the
original of the first agreement stating that it was annulled on the
understanding that it was terminated (see Notice of Appeal, page 2, paragraphs
4 to 6). In any event, the Appellant does not believe that this transaction is
taxable at all. He does not acknowledge the existence of a capital gain or of a
deemed dividend. In his view, his brother should be responsible for any tax
assessment.
[17] In my opinion, and even if counsel for the Respondent recognizes the
preponderance of the first agreement, this first agreement was not legally
valid and could be declared null. Indeed, in this first agreement, the
Appellant sold something that did not belong to him. The bar was owned by the
corporation, and I do not see how the Appellant could have alienated his
interest in a business that did not belong to him. The purchaser (the
Appellant's brother) was therefore justified in seeking to set it aside.
[18] Articles 1713 to 1715 of the Civil Code of Québec stipulate as
follows:
3. – Sale of property of another
ART. 1713 The sale of property by
a person other than the owner or than a person charged with its sale or
authorized to sell it may be declared null.
The sale may not be
declared null, however, if the seller becomes the owner of the property. ‑ CCLC
1487, 1488
ART. 1714 The true owner may apply
for the annulment of the sale and revendicate the sold property from the buyer
unless the sale was made under judicial authority or unless the buyer can set
up positive prescription.
If the property is a
movable sold in the ordinary course of business of an enterprise, the owner is
bound to reimburse the buyer in good faith for the price he has paid. – CCLC
1489, 1490
ART. 1715 The
buyer as well may apply for the annulment of the sale.
He may not do so,
however, where the owner himself is not entitled to revendicate the property. –
CCLC 1487
[19] In addition, Mr. Bélec acknowledged that André Gagnon did not lend
the Appellant $50,000 as stipulated in the first agreement. The Appellant also
acknowledged this state of affairs when he insisted that he owed his brother
nothing. Mr. Bélec said that he drafted the first agreement very quickly,
after the two brothers appeared to have reached an agreement on the amount to
pay the Appellant. Clearly, however, and leaving aside the tax consequences of
the transaction, this first agreement, as drafted, was invalid, and did not
reflect the legal reality of the agreement negotiated by the two brothers.
[20] In fact, it is the corporation that paid the Appellant, and the
Appellant agreed to cash the cheques drawn on the corporation's account. Only
in September 1997 did André Gagnon realize (having been so informed by his
accountant) that the first agreement, as drafted, was not consistent with the
actual transaction between the two brothers. The situation was therefore
corrected retroactively in order to recognize the Appellant's legal rights.
Shares were issued retroactively to the Appellant, thereby acknowledging that
he had invested in the corporation and had then disposed of his equity in March
1997.
[21] As for the Appellant, while he says that, in a sense, he was
compelled by false representations to sign the second agreement retroactively,
he does acknowledge that the first agreement was erroneous because no loan was
advanced to him. In addition, from the very outset of this adventure, he
believed he was entitled to 50% of the appreciation of the value of the
business. He agreed from the outset to the business being purchased by the
corporation, and he agreed to the corporation repurchasing his equity directly.
[22] In my opinion, the second agreement embodies the legal reality of the
parties' contractual intent. Since no share certificate was issued to the
Appellant at the time that he decided to invest in the business, and the
business was held by the corporation, Mr. Bélec rectified the situation in
order to give legal meaning to the transaction. Indeed, by agreeing to pay the
Appellant $100,000, the corporation was implicitly acknowledging that the
Appellant had subscribed for shares that gave him rights in respect of the
profits and assets of the business owned by the corporation. The fact that
these shares were issued in September 1997, retroactive to
May 6, 1995, does not alter this state of affairs because the shares
need not necessarily be issued at the time of the subscription. A person can be
declared a shareholder retroactively: see Paul Martel, La compagnie au
Québec - Les aspects juridiques, volume 1 (Ottawa: Wilson & Lafleur
Martel, 2005) at pages 14‑9 and 19‑31; and Dubeau v. Groupe T.S.
Inc., J.E. 95-1149 (Que. S.C.).
[23] In my opinion, the first agreement was relatively null, and both the
corporation (the true owner of the business) and André Gagnon (the purchaser)
were entitled to invoke this nullity: see articles 1713 to 1715 C.C.Q. and
Didier Lluelles, Droit québecois des obligations, vol. 1 (Montréal:
Thémis, 1998) at page 680, paragraph 2053, and page 689, paragraph 2068.
In the instant case, it appears that André Gagnon did not want to annul the
transaction, but merely to rectify the agreement signed on March 8, 1997, so
that it would legally reflect the transaction between himself, the corporation
and the Appellant. In fact, based on the statement of account that
Mr. Bélec sent to the Appellant, which states, among other things,
[TRANSLATION] "preparation of an amended agreement approved by the two (2)
partners" (Exhibit I‑1, tab 12, invoice of September 15,
1997), it appears that the Appellant approved of this state of affairs. I
therefore find that, having regard to the circumstances, the second agreement
is the one that prevails and reflects the contractual reality negotiated by the
two brothers. The Minister was therefore warranted in assessing the Appellant
for a redemption of shares by the corporation under subsections 82(1) and 84(3)
of the Act.
[24] The fact that the Appellant negotiated the sum of $100,000 on the
assumption that his brother would pay the tax liability cannot be binding on
the Respondent. The Appellant is the one who sold his equity in the business,
via the corporation, and he is the person who owes tax to Her Majesty under the
Act. If he feels that his brother did not comply with his contractual
obligation, he will have to commence proceedings against him.
[25] In addition, even if one attempts to argue that the Appellant sold
his "interest" in the bar under the first agreement, the computation
of the tax payable on the capital gain shows that the tax would be higher.
Since the Appellant did not declare the income, he is not eligible for the
capital gain exemption under section 110.6 of the Act.
[26] In addition, the Minister already recognized that the $1,880 in legal
fees was a capital loss that be could be set off against a capital gain in the
future. As for the $5,000 investment allegedly made by the Appellant in
1995, it appears that the corporation recorded it as a long-term liability
toward the Appellant (based on notes reading [TRANSLATION] "long-term
liability" in the financial statements at December 31, 1995, and
December 31, 1997: Exhibit I-1, tab 14, page 5, note 5; and
tab 15, page 8, note 6.) By signing the second agreement, the Appellant
renounced $4,900 of this debt, leaving a balance of $100 which was not treated
as a bad debt.
[27] Thus, I find that the Minister correctly assessed the Appellant on a
deemed dividend based on the second agreement. Since the Appellant received
$100,000 from the corporation for the redemption of shares for which the
paid-up capital is $2.00 based on the corporation's financial statements, the
Minister was justified in including a grossed-up taxable dividend of $124,998
in the Appellant's income and in granting him a $16,666.39 dividend tax credit,
pursuant to subsections 82(1) and 84(3) of the Act and section 121 of the Act.
[28] The appeal is dismissed, with costs.
Signed at Ottawa, Canada, this 24th day of
March 2006.
Lamarre
J.
Translation certified true
on this 26th day of October 2006.
Monica F. Chamberlain, Reviser
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COURT FILE NO.:
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2002-1323(IT)G
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STYLE OF CAUSE:
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Jacques Gagnon v.
The Queen
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PLACE OF
HEARING:
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Ottawa, Ontario
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DATES OF
HEARING:
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January 17 and
April 14, 2005
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REASONS FOR
JUDGMENT BY:
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The Honourable
Justice Lucie Lamarre
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DATE OF
JUDGMENT:
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March 24, 2006
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For the
Appellant:
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The Appellant
himself
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Counsel for the
Respondent:
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Carole Benoît
and Nicolas Simard
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For the
Respondent:
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John H. Sims,
Q.C.
Deputy Attorney
General of Canada
Ottawa, Canada
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