McLeod v. The Queen, 97 DTC 777, [1997] 1 CTC 2515 (TCC)

Bowie J.T.C.C.: — These two appeals were heard together on common evidence by agreement of the parties. The sole issue for decision is whether the ostensible sale by each of these Appellants of the shares they held in Silvertip Holdings Ltd. (Silvertip) to 401349 Alberta Ltd. (the numbered company) is effective to convey the shares. If it is, then a deemed dividend arises for each Appellant pursuant to the provisions of paragraph 84.1 (1 )(b) of the Income Tax Act (the Act). If the transaction is ineffective then there is no disposition, and therefore no deemed dividend, and the appeals succeed. The position of the Appellants is that at the time the contracts were entered into the vendors and the purchasers were all labouring under a common mistake so fundamental that its effect is to render the transactions void ab initio.

The Respondent takes the position that if there is a mistake it is a mistake of law, in that the parties did not understand the tax consequences of the transactions that they were entering into, but that does not vitiate the contract. Alternatively, she takes the position that the legal effect of the mistake would be. at most, to render the contract voidable but not void, and as the Appellants have taken no steps to rescind it, the contract remains extant, and the Appellants must live with the consequences in the form of the deemed dividend.

Counsel helpfully filed at the opening of the trial a Statement of Agreed Facts, together with a book of the documents referred to in it. As a result there are very few facts in dispute. The parties to the transaction are the two Appellants, and their son James McLeod and his wife Lesley McLeod, through the medium of the numbered company. I shall refer to them as the McLeods Senior and the McLeods Junior, as has been done in the Statement of Agreed Facts.

For many years the McLeods Senior owned and operated a resort property called Castle Mountain Village, near Banff, Alberta. Title to the property and the business was held by Silvertip, and the McLeods Senior owned all of the 100 outstanding shares of that company. As they approached retirement age they thought it desirable that their son become involved in the operation of the business. The McLeods Junior therefore joined in the running of the business in 1978, and between then and 1980 they took over most of the responsibility for it. In 1980 the McLeods Senior sold to the McLeods Junior 49 of their 100 shares in Silvertip. The ownership and the operating arrangements remained unchanged until the fall of 1988, at which time the McLeods Senior wished to retire, and discussions were held among them concerning the purchase of the remaining 51 shares of Silvertip by the McLeods Junior.

During the discussions and negotiations that ensued, and which culminated in the transaction here in question, the McLeods Senior had one main objective in mind, which was to ensure that the purchase price was adequate to meet their needs for a retirement fund. The first proposal made by the McLeods Junior was that they would purchase the remaining 51 Silvertip shares, and the McLeods Senior’s shareholder loans, for either $187,282 payable over a ten-year term, or alternatively, for a cash payment of $157,000. The McLeods Senior sought the advice of their accountant and their lawyer. The accountant’s advice was that the sale for $157,000 cash would have no adverse tax consequences, because any capital gain would be subject to the capital gains exemption available to them. Over the winter of 1988/1989 the McLeods Senior decided that the price was not adequate, and that they would make a counter offer, which they did in the spring of 1989. That offer provided that the McLeods Senior would sell all of their shares, and their shareholder loans, to the McLeods Junior for a total amount of $250,000. Fifty thousand dollars was to be payable on December 1, 1989, with the balance payable over 10 years, with interest at 8% per annum. Agreement in principle was reached between the McLeods Senior and the McLeods Junior for the sale on these terms at a meeting of the shareholders of Silvertip which was held on May 9, 1989. It was agreed that the McLeods Junior would draw up an offer to purchase on these terms and present it to the McLeods Senior before the end of June. On June 26, Lesley McLeod wrote to the McLeods Senior, enclosing a detailed six-page offer to purchase which had been prepared by the solicitors for the McLeods Junior. This document was on the terms that had been agreed upon in May, but with one significant difference. The purchaser was to be the numbered company, rather than the McLeods Junior in their personal capacities. The numbered company had by then been incorporated, and the offer was executed on its behalf by James McLeod and Lesley McLeod. They also each signed it as guarantor of the obligations which the numbered company would assume under the proposed transaction. The McLeods Senior passed this offer to their solicitor for his advice. He replied with a number of suggestions concerning the terms of the agreement, none of which touched upon the prospect of the deemed dividend under section 84.1 of the Act. Allan McLeod also made inquiries of his accountant, Barry Carter, and of the McLeods Junior, concerning the implication of the purchaser being a numbered company. He testified that he spoke with Mr. Carter by telephone, who advised him that this would not create any problem. The McLeods Junior responded by saying it was a “tax dodge” for them. A second draft of the agreement was prepared, which included some changes requested by the McLeods Senior in accordance with their solicitor’s advice. It was dated August 1, 1989, and like the first offer it was executed by James McLeod and Lesley McLeod for 401349 Alberta Ltd., and also by each of them as guarantor of its obligations under the agreement. This document was forwarded to the McLeods Senior under cover of a short hand-written letter dated August 3, signed by Lesley McLeod. The second paragraph of that letter reads as follows:

If the number company is what is causing you concern - that is our tax dodge. Otherwise we would have to pay personal income tax on the $210,000.00 that covers your 51% shares - just as we have had to pay on [sic] tax on the $127,400.00 already.

Allan McLeod testified that he did not understand why this paragraph was included in Lesley’s letter of August 3; he continued to rely on the advice of his accountant that no problem arose from the introduction of a corporation into the transaction as purchaser. The McLeods Senior executed the agreement of purchase and sale on August 4, and the transaction closed later that year.

The evidence of each of the Appellants was quite clear that they would not have sold their interest in Silvertip for the price that they did if they had known of the tax consequences for them that would flow from the sale. They had received advice from their accountant at the time of the original proposal that the proceeds would be received by them tax free. They also had him review the formal offer of June 21, 1989, which made it very clear that the purchaser would be a numbered company brought into existence by the McLeods Junior for that purpose. He did not amend his original advice as a result of this, and the Mcleods Senior, quite reasonably, continued to believe that the proceeds of the sale would be free of tax in their hands. Certainly, when they entered into the transaction at the beginning of August, they held a mistaken belief as to the amount of the after-tax proceeds they would receive from the sale.

The same cannot be said with respect to the McLeods Junior. They also had the advice of an accountant as to the tax consequences for them of the transaction. It was as a result of this advice that the purchase was structured in the way that it was. They did not know what the tax consequences would be for the vendors. Early in the negotiations, as a result of their initial consultation with their own accountant, the McLeods Junior asked the McLeods Senior about their financial situation. The response from the McLeods Senior was that they had their own accountant and lawyer to take care of their interest, and that they, the McLeods Junior, should not concern themselves about it. After the first formal offer was presented, the McLeods Senior inquired of the McLeods Junior concerning the reason that the purchaser was to be a company, rather than the two individuals. Their concern, it seems, was that the company might be a front for Japanese interests. Lesley McLeod’s August 3 letter, quoted above, was intended to allay that concern. At the time the contract was entered into, then, the situation was this. The McLeods Senior had fixed the price at which they were willing to sell their total combined interest in Silvertip at $250,000. This was arrived at on the basis that they needed no less than that to ensure their comfortable retirement, and as a result of professional advice that the full amount of the selling price would be tax free in their hands. The McLeods Junior were willing to pay $250,000, but no more, and they structured their acquisition of the shares through the medium of a corporation brought into being for that purpose because their professional advisors told them that this would secure a tax advantage for them. Because of the negative response to their earlier inquiry they did not concern themselves one way or the other about the tax consequences of the transaction for the McLeods Senior.

In my opinion this case does not fall within the relatively narrow confines of the doctrine of common mistake. The Appellants’ case rests on what they say is a common mistake at law, as opposed to one established in equity. The significant distinction between the two for present purposes is that the former may lead to the conclusion that the contract is void ab initio, while the latter results in a contract which may be voidable in equity. The modern history of the common law doctrine has its origins in the judgment of House of Lords in Bell v. Lever Brothers Ltd., [1932] A.C. 161, [1931] All E.R. Rep. 1. That decision was examined in some detail by Steyn J. in Associated Japanese Bank v. Crédit du Nord, [1988] 3 All E.R. 902. Steyn J. concludes his examination of Bell v. Lever Brothers Ltd. with what I believe is an accurate statement of the applicable principles: [1]

It might be useful if I now summarised what appears to me to be a satisfactory way of approaching this subject. Logically, before one can turn to the rules as to mistake, whether at common law or in equity, one must first determine whether the contract itself, by express or implied condition precedent or otherwise, provides who bears the risk of the relevant mistake. It is at this hurdle that many pleas of mistake will either fail or prove to have been unnecessary. Only if the contract is silent on the point is there scope for invoking mistake. That brings me to the relationship between common law mistake and mistake in equity. Where common law mistake has been pleaded, the court must first consider this plea. If the contract is held to be void, no question of mistake in equity arises. But, if the contract is held to be valid, a plea of mistake in equity may still have to be considered: see Grist v. Bailey [1966] 2 All E.R. 875, [1967] Ch 532 and the analysis in Anson’s Law of Contract (26th edn, 1984) pp 290- 291. Turning now to the approach to common law mistake, it seems to me that the following propositions are valid although not necessarily all entitled to be dignified as propositions of law.

The first imperative must be that the law ought to uphold rather than destroy apparent contracts. Second, the common law rules as to a mistake regarding the quality of the subject matter, like the common law rules regarding commercial frustration, are designed to cope with the impact of unexpected and wholly exceptional circumstances on apparent contracts. Third, such a mistake in order to attract legal consequences must substantially be shared by both parties, and must relate to facts as they existed at the time the contract was made. Fourth, and this is the point established by Bell v. Lever Bros Ltd, the mistake must render the subject matter of the contract essentially and radically different from the subject matter which the parties believed to exist. While the civilian distinction between the substance and attributes of the subject matter of a contract has played a role in the development of our law (and was cited in the speeches in Bell v. Lever Bros. Ltd’, the principle enunciated in Bell v. Lever Bros Ltd. is markedly narrower in scope than the civilian doctrine. It is therefore no longer useful to invoke the civilian distinction. The principles enunciated by Lord Atkin and Lord Thankerton represent the ratio decidendi of Bell v. Lever Bros Ltd.. Fifth, there is a requirement which was not specifically discussed in Bell v. Lever Bros. Ltd. What happens if the party who is seeking to rely on the mistake had no reasonable grounds for his belief? An extreme example is that of the man who makes a contract with minimal knowledge of the facts to which the mistake relates but is content that it is a good speculative risk. In my judgment a party cannot be allowed to rely on a common mistake where the mistake consists of a belief which is entertained by him without any reasonable grounds for such belief.

This passage was adopted by Mandel J. of the Ontario Court of Justice (General Division) in Canadian Medical Laboratories Ltd. v. Stabile (1992), 25 R.P.R. (2d) 106. How then do these principles apply in the present case?

Mr. Nitikman argued strenuously that this unusual factual situation brings into play the common law doctrine of common mistake. Both parties, he said, shared the same mistaken belief, not as to the operation of the Income Tax Act upon the proceeds of sale, but as to the fact that the introduction into the transaction of a numbered company incorporated by James and Lesley to be the purchaser was not a matter about which the vendors need be concerned. This argument cannot be reconciled with the principles as Steyn J. has summarized them. Looking first at the question of who bears the risk, it is obvious, I think, that the McLeods Senior (or their professional advisor) must bear the risk so far as it relates to the tax consequences of the transaction. The McLeods Junior raised this question early in the negotiations, and were, in effect, told to mind their own business. Absent some special reason arising out of the negotiations, and there is none here, it would be remarkable if each party were not himself liable to bear the risk of adverse tax consequences.

As counsel for the Appellants would characterize the issue, it is whether or not the existence of a corporate purchaser should be a matter of concern to the vendors that is the subject of the mistake. That alone, as opposed to mistake as to a specific reason for them to be concerned about the cor- porate purchaser, cannot amount to a mistake going to the root of the contract. The Appellants’ case founders on the second and the fourth of Steyn J.’s principles. The circumstances encountered here cannot be said to be “unexpected or wholly exceptional”. Transactions of this kind take place every day. They often involve corporate purchasers. The tax consequences are predictable. What was perhaps exceptional about this case is that the vendors’ advisors failed to warn them about the deemed dividend that would arise on completion of the sale, but that is wholly collateral to the contract. Nor is there a mistake of fact shared by both parties which renders the subject matter of the contract “essentially and radically different from the subject matter which the parties believed to exist”. The subject matter was exactly what the parties thought is was - a sale of shares in the business for cash and future payments. Only the incidence of taxation on the proceeds of sale was different, and that mistake was neither common to both parties, nor fundamental to the contract.

There is another reason why these appeals must fail. It is clear from the judgment of Mandel J. in the Canadian Medical Laboratories case that in a case where the requirements of the doctrine of common mistake do exist, the parties may nevertheless adopt the terms of the contract after the true facts are known. This may be done either by express agreement, or by their conduct. [2] In the present case the contract called for payment of the balance of the purchase price in monthly instalments of $2,500 per month for a ten -year term, beginning on January 1, 1990. Each of these payments up to and including the first of May 1996, one week before the trial, 77 in all, was made by the McLeods Junior, and accepted by the Appellants. The Minister of National Revenue had made known his intention to reassess the McLeods Senior for the 1989 taxation year in July 1993. This was known also to the McLeods Junior by August 2 that year, when James McLeod wrote to his father to say that he and his wife at no time knew of the tax consequences that would result from the sale. I have no hesitation in finding that the conduct of the parties on both sides of the transaction, the McLeods Junior in continuing to make the monthly payments, and the McLeods Senior in continuing to accept them, would, even if the doctrine of common mistake were otherwise applicable, establish an agreement by the parties to treat the contract as enforceable and existing [3]

I find that the contract between the McLeods Senior and the McLeods Junior is a valid and subsisting one which has legal effect. It follows that there was a disposition by the Appellants of the shares of Sil vertip in 1989, which resulted in the deemed dividend pursuant to paragraph 84.1(1)(b) of the Act. The appeals are dismissed. The Respondent is entitled to costs, but with one counsel fee only, as the two appeals were tried together on common evidence.

Appeal dismissed.