Winter v. The Queen, 90 DTC 6681, [1991] 1 CTC 113 (FCA)

Marceau, J.A.:—This appeal from a judgment of the trial division is concerned with the interpretation and conditions of application of subsection 56(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), which states as follows:

56. (2) A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer's income to the extent that it would be if the payment or transfer had been made to him.

This well-known tax-avoidance provision, which gives effect to the indirect benefits principle, has a long legislative history dating back to1948 [1] . It gave rise to important decisions, among which: A. Miller v. M.N.R., [1962] C.T.C. 199; 62 D.T.C. 1139, and M.N.R. v. A. Bronfman, [1965] C.T.C. 378; 65 D.T.C. 5235, in the Exchequer Court; G.A. Murphy v. The Queen, [1980] C.T.C. 386; 80 D.T.C. 6314, in the trial division of the Federal Court; and, more recently, in this Court, of J.A. McClurg v. The Queen, [1988] 1 C.T.C. 75; 88 D.T.C. 6047, affirming [1986] 1 C.T.C. 355; 86 D.T.C. 6128, a decision now under appeal before the Supreme Court. And yet the vagueness of its wording has never been totally surmounted and its aim and purpose are still subject of controversy. The case at bar is yet another example of the difficulty one has to fully understand how Parliament meant it to be applied in practice.

In 1979, Sir Leonard C. Outerbridge, a resident of St. John's, Newfoundland, then 91 years of age, was the controlling shareholder of Littlefield Investments Ltd. ('Littlefield"), a company incorporated under the laws of Canada, on December 8, 1961, as an investment holding company. He held 99.16 per cent of the issued shares of the company (9,916 shares) while his daughter, Nancy D. Winter, held .83 per cent (83 shares) and his son-in-law, Herbert H. Winter (Dick) held .01 per cent (1 share). Both Sir Leonard personally and his investment company were beneficial owners of shares of A. Harvey & Company Ltd. ('Harvey"), an operating company engaged in various distribution, transportation and warehousing activities: Sir Leonard owned 254 Harvey shares and Littlefield, 661.

On September 19, 1979, the Board of Directors of Littlefield (then consisting of the three shareholders), in a regularly held meeting, resolved that the 661 Harvey shares owned by the company be sold to Dick Winter for a price of $100 per share. The resolution was acted upon shortly thereafter and the sale price was fully paid. Approximately one month later, Sir Leonard gifted to his daughter, Mrs. Winter, the 254 Harvey shares that he owned personally, a gift that he reported, in his 1979 tax return, as a disposition for deemed proceeds of $100 per share.

On October 21, 1985, by notice of reassessment, Sir Leonard was advised that the Minister of National Revenue had added to his income for his 1979 taxation year: (a) an amount of $648,368, pursuant to subsection 56(2) of the Act, as a benefit conferred on him by virtue of the sale by Littlefield to Dick Winter of the 661 Harvey shares; and (b) an amount of $54,673, pursuant to section 69 of the Act, as a taxable capital gain realized by him on the gift of the 254 Harvey shares to his daughter. To calculate the benefit and the capital gain, the Minister had ascribed a value of $1,089 to each of the Harvey shares at the time of their disposition in 1979, a figure arrived at following a valuation survey conducted the year before, 1984. Sir Leonard duly objected. On July 3, 1986, the Minister issued a second notice of reassessment which reduced the amount which had been added pursuant to subsection 56(2) by some $150, on the basis that Sir Leonard, in 1979, held only 99.16 per cent of the shares of Littlefield, not 99.18 per cent as previously calculated, but otherwise confirmed the first one. Sir Leonard, of course, reiterated his objection.

On September 7, 1986, Sir Leonard passed away. Nancy Winter and Dick Winter were appointed as the sole executors under the last will and testament of the deceased, but Nancy Winter died on December 25, 1986 and was replaced by David Herbert Outerbridge Winter. On June 16, 1987, after rejection by the Minister of the objection filed by Sir Leonard before his death, the executors, in the exercise of the rights and remedies of the deceased, took action, in the trial division, claiming that the reassessment of July 3, 1986 was unfounded in fact and in law. The attack in the action was directed against both branches of the assessment but before trial the plaintiffs withdrew their opposition to the second one dealing with the capital gain deemed to have been realized by the taxpayer on his gift to his daughter of the personally owned shares. On May 29, 1989, judgment was rendered dismissing the action. This is the judgment here under appeal.

The position taken by counsel for the plaintiffs before the trial judge, as I understand it, was essentially the following. The value of $1,089 per share attributed to the Harvey shares by the Minister was one that was arrived at after a complex valuation conducted “with ex post facto wisdom", to use the expression of the trial judge. It was not one respectful of the parties' perception at the time of the transaction. Considering the price that had been attributed to the shares in some contemporary transactions, the restrictions to which the transfer of the shares was subjected by the articles of the corporation, the opinion of the accountant present at the directors' meeting when the sale was authorized, it was reasonable for Sir Leonard, argued counsel, to believe that $100 was the fair market value of a Harvey share on September 19, 1979. There was no indication that Sir Leonard had a wishor a desire to confer a benefit on Dick Winter. Besides, Sir Leonard had himself no right to those shares, he was certainly not attempting to divert part of his income into the hands of a third party to avoid tax. The conditions of application of subsection 56(2), which is a tax-avoidance provision, therefore do not exist.

The learned trial judge disagreed. Being satisfied on the evidence that the Minister was right in his valuation of the shares, he said he had to find, on the basis of the relationship between the taxpayer and his son-in-law, as well as on the more objective circumstances surrounding the specific transactions ancillary to it, that in causing the Littlefield shares to be transferred, the taxpayer desired to confer a benefit to his son-in-law”. Then, rejecting the interpretation of paragraph 56(2) suggested by the plaintiffs as one which would " put the kind of strain on the language of the section that it cannot reasonably bear", he concluded that the conditions of application of the provision were met.

In this Court, counsel had to narrow further his position after acknowledging, at the opening of the hearing, that the findings of fact of the trial judge were difficult to assail. His claim was now simply that, even if the parties to the transaction in 1979 were aware that the fair market value of the Harvey shares was $1,089 per share, the conditions of application of subsection 56(2) properly construed according to its aim and purpose were not present. In support thereof, he submitted a two-fold argument.

1. It must not be forgotten, said counsel, that the shares belonged to Littlefield, not to Sir Leonard who was acting only as director of the company. To say that Sir Leonard conferred a benefit on Dick Winter would be to ignore the distinction between Sir Leonard and the company, which would amount to piercing the corporate veil for which there was no justification. On the other and, argued counsel, the language of the provision did not justify the notion that a director acting as such could be seen as causing a corporation to divert a transfer or payment for his own benefit or the benefit of another person, absent bad faith or breach of fiduciary duty, which was not the case, and was not even alleged to be the case here. And counsel referred to the case of McClurg, supra, which indeed decided that the language of subsection 56(2) does not encompass acts of a director when he participates in the declaration of a dividend.

I do not agree with this first part of the argument. There is no question of piercing the corporate veil here. The distinction between Littlefield and Sir Leonard is fully respected. The question is whether Sir Leonard could cause the corporation to sell shares that belonged to it for a price below the market value, with a view to conferring a benefit on the buyer; and the answer is certainly yes. The fact that Sir Leonard had no direct right to the shares would have a bearing if the provision was to be construed as covering only cases of diversion of income receivable by the taxpayer and there is no indication whatever that the provision was meant to be so confined. Finally, the McClurg decision was concerned with a declaration of dividend in accordance (in the views of the majority) with the powers conferred by the share structure of the corporation, and I do not see it as having authority beyond the particular type of situation with which it was dealing.

2. Besides, counsel continued, Dick Winter, as a shareholder, was already subject to tax for the benefit conferred on him by the transaction pursuant to subsection 15(1). Even if it could be said that, broadly interpreted, the conditions of application of the provision as it reads were present, an assessment pursuant to it could not, in those conditions, be valid. Here is how he put the submission in his factum:

8. In the alternative, it is submitted that under the scheme of the Income Tax Act shareholder A should not be taxed pursuant to subsection 56(2) in respect of a benefit conferred on shareholder B when shareholder B can be taxed pursuant to subsection 15(1) in respect of that same benefit. There is a natural order to the provisions of the Income Tax Act, with technical rules such as subsection 15(1) at the base, specific anti-avoidance rules like subsection 56(2) one level higher, and the general anti-avoidance rule in section 245 at the apex. As a matter of assessment practice, a specific anti-avoidance rule should be resorted to only when a particular transaction is not caught by any technical rule, just as the general antiavoidance rule should not be invoked except in the absence of a specific antiavoidance rule.

9. In the specific context of shareholder benefits, the scheme of the Income Tax Act is made even clearer by the presence of subsection 52(1). This provision provides that a taxpayer who has had an amount in respect of the value of property ne acquires added to his income shall add this same amount to his cost base for the property. Where a taxpayer is taxed under subsection 15(1) on property acquired from a corporation in which he is a shareholder, subsection 52(1) thus operates automatically so as to make the consequential modification to adjusted cost base for purposes of computing the future capital gain or capital loss. Where subsection 56(2) is invoked, by contrast, subsection 52(1) cannot operate since the taxpayer suffering taxation has not himself acquired any property. If any party to the subject transaction was to attract taxation, it should have been Mr. Winter pursuant to subsection 15(1) and not the Deceased pursuant to subsection 56(2).

I would be prepared to go along with that line of thinking. As was so often pointed out, again by both the trial judge and the Court of Appeal in the McClurg decision, the language of subsection 56(2) cannot be taken in its broadest possible meaning without leading to results obviously untenable, particularly in the context of corporate management. Some qualification suggested by the aim and purpose for which the rule was adopted must be read into it so as to avoid those unreasonable results.

It is generally accepted that the provision of subsection 56(2) is rooted in the doctrine of "constructive receipt" and was meant to cover principally cases where a taxpayer seeks to avoid receipt of what in his hands would be income by arranging to have the amount paid to some other person either for his own benefit (for example the extinction of a liability) or for the benefit of that other person (see the reasons of Thurlow, J. in Miller, supra, and of Cattanach, J. in Murphy, supra). There is no doubt, however, that the wording of the provision does not allow to its being confined to such clear cases of tax-avoidance. The Bronfman judgment, which upheld the assessment, under the predecessor of subsection 56(2), of a shareholder of a closely held private company, for corporate gifts made over a number of years to family members, is usually cited as authority for the proposition that it is not a pre-condition to the application of the rule that the individual being taxed have some right or interest in the payment made or the property transferred. The precedent does not appear to me quite compelling, since gifts by a corporation come out of profits to which the shareholders have a prospective right. But the fact is that the language of the provision does not require, for its application, that the taxpayer be initially entitled to the payment or transfer of property made to the third party, only that he would have been subject to tax had the payment or transfer been made to him. It seems to me, however, that when the doctrine of “constructive receipt” is not clearly involved, because the taxpayer had no entitlement to the payment being made or the property being transferred, it is fair to infer that subsection 56(2) may receive application only if the benefit conferred is not directly taxable in the hands of the transferee. Indeed, as I see it, a tax-avoidance provision is subsidiary in nature; it exists to prevent the avoidance of a tax payable on a particular transaction, not simply to double the tax normally due? [2] nor to give the taxing authorities an administrative discretion to choose between two possible taxpayers [3] .

So, I agree that the validity of an assessment under subsection 56(2) of the Act when the taxpayer had himself no entitlement to the payment made or the property transferred is subject to an implied condition, namely that the payee or transferee not be subject to tax on the benefit he received. The problem for the appellants, however, is that, in my judgment, this qualification does not come into play in this case. It seems clear to me that, although holder of one share in Littlefield, it is not qua shareholder but qua son-in-law of the controller of the company that Dick Winter entered into the transaction with the corporation and acquired the benefit; he could not, therefore, be assessed with respect to it under subsection 15(1) of the Act (see M.N.R. v. Pillsbury Holdings Ltd., [1964] C.T.C. 294; 64 D.T.C. 5184 (F.C.T.D.)). It follows that, in my view, the appellants’ alternative argument also fails.

The appeal should, I think, be dismissed.

MacGuigan, J.A.:—I agree.

Décary, J.A.:—I agree.

Appeal dismissed.