Date: 20071026
Docket: A-474-06
Citation: 2007 FCA 337
CORAM: LINDEN J.A.
NOËL
J.A.
RYER
J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
and
JES INVESTMENTS LTD.
Respondent
REASONS FOR JUDGMENT
RYER J.A.
[1]
This is an
appeal from a decision of Sheridan J. (2006 TCC 508) of the Tax Court of
Canada, dated September 27, 2006, allowing an appeal of JES Investments Ltd.
(the “taxpayer”) against a reassessment that was issued in respect of its 1998
taxation year by the Minister of National Revenue (the “Minister”), pursuant to
the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the “ITA”), and that
denied a capital loss that was claimed by the taxpayer from a disposition of
certain shares in that taxation year. Unless otherwise indicated, all statutory
references are to the corresponding provisions of the ITA for the taxation
years under consideration.
[2]
The issue that
was before the Tax Court of Canada and that is present in this appeal is
whether the shares (the “Shares”) that the taxpayer acquired in 1997 from Deena
Energy Inc. (“Deena”) pursuant to a Share Subscription and Renunciation
Agreement (the “Agreement”), which bears the date of November 18, 1997,
constituted flow-through shares, as that term is defined in subsection 66(15)
(“flow-through shares”). The significance of the determination of this issue is
apparent from a brief review of the events that occurred.
Background
[3]
Pursuant
to the Agreement, Deena agreed to incur certain Canadian exploration expenses
and Canadian development expenses, as those terms are defined in the ITA, and
to renounce in favour of the taxpayer an amount of those expenses equal to the
subscription price that the taxpayer paid for the Shares. Deena failed to incur
any amount of those expenses and its purported renunciation of the agreed
amount of those expenses in favour of the taxpayer was invalid. To make matters
worse for the taxpayer, Deena went into receivership and as a consequence the
Shares became worthless.
[4]
Having
failed to receive a valid renunciation of the expenses that it had bargained
for, the taxpayer attempted to obtain some solace in the form of a capital loss
on the Shares as a result of the receivership of Deena. However, the Minister
resisted that outcome, contending that because the Shares constituted
flow-through shares, the taxpayer was deemed, by virtue of subsection 66.3(3),
to have acquired them at a cost of nil. As a result, a capital loss from an
actual or deemed disposition of the Shares was denied to the taxpayer.
[5]
In
allowing the appeal of the taxpayer, Sheridan J. held that the fact that Deena
had breached the Agreement in a number of respects, “deprived the shares issued
under that agreement from ever acquiring their intended status as flow-through
shares” (paragraph 12). In so deciding, Sheridan J. concluded that it was
unnecessary to consider the argument of the taxpayer that the Shares were
prescribed shares (“prescribed shares”), within the meaning of section 6202.1
of the Income Tax Regulations, C.R.C., c. 945 (the “ITR”), and therefore
were not flow-through shares.
[6]
While I am
in agreement with the conclusion that was reached by Sheridan J., with respect,
I cannot agree with the basis upon which that conclusion was reached. The
relevant time to determine whether a share is a flow-through share is the time
at which it is issued and the record shows that, at the time that the Shares
were issued, no breach of the Agreement had been committed by Deena. It was not
open to Sheridan J. to determine that the Shares were not flow-through shares
with the benefit of hindsight, that is to say with regard to breaches of the
Agreement that occurred after the issuance of the Shares. However, for the
reasons that follow, I am of the view that the Shares were not flow-through
shares because they were prescribed shares.
Relevant Statutory Provisions
[7]
The
relevant provisions of the ITA and the ITR are as follows:
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66(15)
"flow-through
share" means a share (other than a prescribed share) of the capital stock of a
principal-business corporation that is issued to a person under an agreement
in writing entered into between the person and the corporation after February
1986, under which the corporation agrees for consideration that does not
include property to be exchanged or transferred by the person under the
agreement in circumstances in which section 51, 85, 85.1, 86 or 87 applies
(a) to incur, in the period that begins on
the day the agreement was made and ends 24 months after the end of the month
that includes that day, Canadian exploration expenses or Canadian development
expenses in an amount not less than the consideration for which the share is
to be issued, and
(b) to renounce, before March of the first
calendar year that begins after that period, in prescribed form to the person
in respect of the share, an amount in respect of the Canadian exploration
expenses or Canadian development expenses so incurred by it not exceeding the
consideration received by the corporation for the share,
and includes a right of a person to have such a
share issued to that person and any interest acquired in such a share by a
person pursuant to such an agreement.
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66(15)
« action accréditive » ¯¯¯ « action
accréditive » Action du capital-actions d’une société exploitant une
enterprise principale, à l’exclusion d’une action visée par règlement,
émise en faveur d’une personne conformément à une convention écrite conclue
après février 1986 entre cette personne et la société et par laquelle la
société s’oblige, pour une contrepartie qui ne comprend pas un bien que la
personne doit échanger ou transférer aux termes de la convention dans des
circonstances où les articles 51, 85, 85.1, 86 ou 87 s’appliquent :
a) d’une part, à
engager, au cours de la période commençant à la date de conclusion de la
convention et se terminant 24 mois après la fin du mois qui comprend cette
date, des frais d’exploration au Canada ou des frais d’aménagement au Canada
pour un montant total au moins égal au paiement prévu pour l’action;
b) d’autre
part, à renoncer en ce qui concerne l’action en faveur de cette personne,
avant mars de la première année civile commençant après cette période, sur le
formulaire prescrit, à un montant au titre des frais ainsi engagés qui ne
dépasse pas le paiement reçu par la société pour l’action;
le droit d’une personne à l’émission
d’une telle action et tout droit sur une telle action acquis par une personne
conformément à une telle convention sont assimilés à une action accréditive.
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66.3(3) Any flow-through share (within the
meaning assigned by subsection 66(15)) of a corporation acquired by a person
who was a party to the agreement pursuant to which it was issued shall be
deemed to have been acquired by the person at a cost to the person of nil.
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66.3(3)
La personne qui acquiert une action accréditive – au sens du paragraphe
66(15) – auprès d’une société et qui est partie à la convention relative à
l’émission de l’action est réputée acquérir celle-ci à un coût nul.
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6202.1(1)(c)(i)
For the purposes of the definition "flow-through share" in
subsection 66(15) of the Act, a new share of the capital stock of a
corporation is a prescribed share if, at the time it is issued,
(c)
any person or partnership has, either absolutely or contingently,
an obligation (other than an excluded obligation in relation to the share) to
effect any undertaking, either immediately or in the future, with
respect to the share or the agreement under which the share is issued (including
any guarantee, security, indemnity, covenant or agreement and
including the lending of funds to or the placing of amounts on deposit with,
or on behalf of, the holder of the share or, where the holder is a
partnership, the members thereof or specified persons in relation to the
holder or the members of the partnership, as the case may be) that may
reasonably be considered to have been given to ensure, directly or
indirectly, that
(i) any
loss that the holder of the share and, where the holder is a partnership,
the members thereof or specified persons in relation to the holder or the
members of the partnership, as the case may be, may sustain by reason of
the holding, ownership or disposition of the share or any other property is
limited in any respect, or
[Emphasis added.]
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6202.1(1)c)(i)
Pour l’application de l’alinéa 66(15)d.1) de la Loi, est une action
exclue l’action nouvelle du capital-actions d’une sociétée si au moment de
son emission, selon le cas:
c) une
personne ou une société de personnes a l’obligation, conditionnelle
ou non (à l’exception d’une obligation exclue relative à l’action), de
fournir un engagement, immédiat ou futur, relatif à l’action ou à la
convention en vertu de laquelle l’action est émise – notamment une
garantie, une sûreté, une promesse ou un accord et y compris le dépôt d’un
montant ou le prêt de fonds au détenteur de l’action ou, si celui-ci est une
société de personnes, aux associés de celle-ci ou aux personnes apparentées
au détenteur de l’action ou aux associés, ou pour le compte des uns ou des
autres – qu’il est raisonnable de considérer comme donné pour faire en
sorte, directement ou indirectement:
(i) qui soit
limitée d’une façon quelconque toute perte que le détenteur de l’action
et, si celui-ci est une société de personnes, les associés de celle-ci ou les
personnes apparentées au détenteur de l’action ou aux associés peuvent
subir parce qu’ils détiennent l’action ou un autre bien, en sont propriétaires
ou en disposent, ou
[Je me souligne.]
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Relevant Provisions of the Agreement
[8]
The
application of subparagraph 6202.1(1)(c)(i) of the ITR to several
provisions of the Agreement, which are reproduced below, must be considered:
9. The
Corporation covenants and agrees with the Subscriber:
. . .
(b) to
incur, during the Expenditure Period, Qualifying Expenditures in such amount as
enables the Corporation to renounce the Subscriber in accordance with the Act
and this Subscription Agreement, Qualifying Expenditures equal to the Subscription
Amount with effect on or before December 31, 1997;
(c) to
renounce (in accordance with the Act and this Subscription Agreement) to the
Subscriber, effective on or before December 31, 1997, Qualifying Expenditures
incurred during the Expenditure Period equal to the Subscription Amount;
.
. .
10. The
Corporation hereby agrees to indemnify and save harmless the Subscriber from
and against any liability, loss, damage, cost or expense which the Subscriber
may sustain or incur arising out of or in any way connected with the
expenditure of the Subscription Amount.
Analysis
[9]
A share
cannot be a flow-through share if it is determined to be a prescribed share.
That determination is also required to be made at the time of issuance of the
share in question.
[10]
The narrow
issue in this appeal is whether the Shares are prescribed shares, within the
meaning of subparagraph 6202.1(1)(c)(i) of the ITR, which will be the
case if it may reasonably be considered, at the time the Shares were issued,
that the indemnity that is contained in clause 10 of the Agreement (the
“Indemnity”) was given by Deena to the taxpayer to ensure, directly or
indirectly, that any loss that the taxpayer may sustain by reason of the
holding, ownership or disposition of the Shares was limited in any respect.
[11]
In
interpreting subparagraph 6202.1(1)(c)(i) of the ITR and considering its
potential application to the circumstances under consideration in this appeal,
in my view, the phrase “may reasonably be considered to have been given”
mandates an objective determination of the proper construction of clause 10 of
the Agreement and the reason that the Indemnity was given by Deena to the
taxpayer. Two different interpretations of clause 10 of the Agreement were put
forward by the parties.
[12]
The
Minister stated that clause 10 of the Agreement was a typical indemnity that
was necessary in the flow-through share regime that existed prior to 1986,
under which an investor was required to incur resource expenditures (directly
or, more often, through an agency agreement with the issuing corporation)
solely as consideration for flow-through shares. According to the Minister, the
typical indemnity protected investors against unanticipated third party
liabilities (see paragraph 50 of the Minister’s factum).
[13]
The
Minister further stated that the administrative practice of the Canada Revenue
Agency, as stated at the 1984 Canadian Tax Foundation Annual Conference, was
that the prescribed share regulations would not apply to an indemnity given by
a resource company to a subscriber against liability that might be incurred as
a result of the resource company incurring the requisite expenses as agent for
the subscriber (see paragraph 51 of the Minister’s factum).
[14]
The
Minister further argued that the Indemnity protected the taxpayer against third
party liability arising from Deena’s exploration programs and concluded that
the Indemnity did not operate to limit any loss that the taxpayer may sustain
by reason of its holding, ownership or disposition of the Shares (see paragraph
52 of the Minister’s factum).
[15]
The
Minister’s argument that the purpose of the Indemnity was to protect the
taxpayer from third party liabilities that might arise out of the expenditure
by Deena of the subscription price of the Shares is, in my respectful view,
untenable. By the Minister’s own admission, clauses like the Indemnity were
typically used in the pre 1986 era in relation to resource expenditures that
were incurred by the resource company as agent for the subscriber. In those
circumstances, the subscriber was exposed to third party liabilities. However,
under the current flow-through share regime, a subscriber for flow-through
shares does not have an obligation to incur resource expenses (directly or
through an agent) and therefore does not face risks of third party liability as
a result of the subscription for flow-through shares and the expenditure of the
subscription price of those shares. I therefore do not accept the Minister’s
characterization of the purpose of the Indemnity, nor do I accept that the
Indemnity can be read out of the Agreement altogether. Some meaning must be
given to that provision.
[16]
In that
regard, the taxpayer contends that clause 10 of the Agreement must be
interpreted as providing a right to recover any loss that the taxpayer may
incur as a result of the expenditure of the subscription price of the Shares by
Deena. By way of example, if, in the expenditure of the subscription funds
provided by the taxpayer, Deena could be shown to have acted negligently and if
that negligence could be shown to have led to a drop in the trading value of
the Shares, the taxpayer contends that it could claim indemnification, pursuant
to clause 10 of the Agreement, from Deena for that loss in the value of the
Shares.
[17]
In my
view, the taxpayer’s interpretation of clause 10 of the Agreement is reasonable
and must be preferred. Under the Agreement and the current flow-through share
rules contained in the ITA, the taxpayer had no right or obligation to
participate, in any way, in the expenditure of the subscription price of the
Shares. Indeed, under clause 9(b) of the Agreement, Deena covenanted to incur
expenses of the amount and type that would have enabled it to meet its
renunciation obligation to the taxpayer under clause 9(c) of the Agreement. Moreover,
after the payment of the subscription price of the Shares, the only meaningful
connection of the taxpayer to Deena was by virtue of the taxpayer’s holding and
ownership of the Shares. It is readily apparent that the broad language
contained in subparagraph 6202.1(1)(c)(i) of the ITR embraces rights
that are “contingent”, rights that are effective “either immediately or in the
future”, rights that “directly or indirectly” provide assurances and rights to
loss limitation protection “in any respect” and, in my view, the rights that
accrued to the taxpayer under the Indemnity are within the broad language of
that provision.
[18]
I realize
that the taxpayer would not have supported this interpretation of clause 10 of
the Agreement if Deena had fulfilled all of its obligations under the Agreement
since the taxpayer’s intention, at the time that the Agreement was entered
into, was to acquire shares that qualified as flow-through shares. However, the
intention that a share should qualify as a flow-through share cannot prevent
that share from constituting a prescribed share if the requirements of section
6202.1 of the ITR are met and as I have concluded, the rights of the taxpayer
under clause 10 of the Agreement are of the type specified by subparagraph
6202.1(1)(c)(i) of the ITR.
Conclusion
[19]
In my
view, it may reasonably be considered that, at the time that the Shares were
issued, clause 10 of the Agreement constituted an undertaking or obligation
that was given by Deena to the taxpayer to ensure, directly or indirectly, that
any loss that the taxpayer may sustain from the holding or ownership of the
Shares, to the extent that such a loss was related to the expenditure by Deena
of the subscription price of the Shares, was limited. It follows that the
Shares were prescribed shares, by virtue of subparagraph 6202.1(1)(c)(i)
of the ITR, and as such were not flow-through shares.
[20]
Accordingly,
I would dismiss the appeal with costs.
“C. Michael Ryer”
“I
agree.
A.M.
Linden J.A.”
“I
agree
Marc
Noël J.A.”
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