Luise Zinkhofer and Bernard Zinkhofer v. Minister of National Revenue, 91 DTC 643, [1991] 1 CTC 2493 (TCC)

Sobier, T.C.J.:—By agreement, these appeals were heard on common evidence. The appellants appeal the reassessments of the Minister of National Revenue (the ” Minister”) for the taxation years 1982, 1983, 1984 and 1985.

The events leading to the reassessments occurred in 1984 and the terminal losses and capital losses claimed by the appellants were disallowed for the 1984 taxation year as were the losses carried back to the 1982 and 1983 taxation years and the losses carried forward to the 1985 taxation year.

The respondent disallowed the claims for the losses pursuant to subsection 85(4) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") with respect to the capital losses and subsection 85(5.1) with respect to the terminal losses.

The provisions of those subsections would be applicable and the Minister's assessment correct if the taxpayer disposed of property to a corporation that, immediately after the disposition, was controlled directly or indirectly in any manner whatever, by the taxpayer, by the spouse of the taxpayer or by a person or group of persons by whom the taxpayer was controlled, directly or indirectly in any manner whatever.

Prior to the events leading to the reassessment, the appellants jointly owned two parcels of rental real estate which can be identified as a 54-unit apartment building (the"apartment building”) and an adjacent bungalow (the "bungalow").

On March 30, 1984, the appellants took over a corporation 292245 Alberta Ltd. (the "corporation"), and it was organized on that date with the result that one Class "A" voting share without nominal or par value ("Class A Share") was issued to each of the appellants and their three sons. The issue price was $1 per Class A Share. In addition, on March 31, 1984, the appellants were elected directors of the corporation at a meeting of shareholders. It was Mr. Zinkhofer’s evidence that it was always intended that the three sons were also to be elected as directors and he pointed out this mistake to his son Frederick Zinkhofer who was the solicitor for his parents and the corporation. This mistake was apparently rectified at the next annual meeting of the shareholders held on November 4, 1985. No reason was given for the delay except that it was believed that immediate rectification was not important.

Effective April 1, 1985, the appellants entered into an agreement with the corporation to sell the apartment building and the bungalow. In short, the purchase price for the bungalow was such that each of the appellants appeared to have suffered an allowable capital loss of $6,506.25 and a terminal loss of $45,016.25.

As part of the consideration for the sale, the corporation issued to each of the appellants 461,608 Class D shares without nominal or par value C Class D shares"). The Class D shares were redeemable, retractable, purchasable by the corporation, could be entitled to a fixed preferential non-cumulative cash dividend, entitled to a prior return of capital on liquidation or winding up, were non-participating in profits and were non-voting. In addition, the purchase price for the bungalow and apartment building was partially satisfied by issuing promissory notes to the appellants payable 30 days after demand and by the assumption by the corporation of a portion of the appellants’ indebtedness.

The issue is clear. After the disposition of the bungalow, was the corporation controlled directly or indirectly in any manner whatever, by Mr. Zinkhofer or his spouse or by a person or group of persons by whom he was controlled, directly or indirectly in any manner whatever? The same question may be posed with respect to Mrs. Zinkhofer.

It is the appellants’ contention that since the five Class A shares of the corporation were owned by five individuals, the corporation had no controlling shareholder and since the Class D shares were non-voting, the fact that the appellants each owned 461,608 Class D shares did not alter that fact.

The respondent argues that more than just the number of voting shares must be considered in determining who controls the corporation.

It is the appellants’ contention that prior to enactment in 1988 of subsection 256(5.1) which extended the meaning of the expression “ controlled directly or indirectly in any manner whatever" to include direct or indirect influence, de jure control was the only criterion to be used in establishing control of a corporation. In short, the appellants’ position is that in order to control a corporation, the controller must be the owner of a majority of the voting power in the company or as put by Jackett, P. in Buckerfield's Ltd. v. M.N.R., [1964] C.T.C. 504; 64 D.T.C. 5301 (Ex. Ct.) at page 507 (D.T.C. 5303):

Many approaches might conceivably be adopted in applying the word "control" in a statute such as the Income Tax Act to a corporation. It might, for example, refer to control by" management”, where management and the Board of Directors are separate, or it might refer to control by the Board of Directors. The kind of control exercised by management officials of the Board of Directors is, however, clearly not intended by section 39 when it contemplates control of one corporation by another as well as control of a corporation by individuals (see subsection (6) of section 39). The word “control” might conceivably refer to de facto control by one or more shareholders whether or not they hold a majority of shares. I am of the view, however, that, in section 39 of the Income Tax Act, the word "controlled" contemplates the right of control that rests in ownership of such a number of shares as carries with it the right to a majority of the votes in the election of the Board of Directors. See British American Tobacco Co. v C.I.R., [1943] 1 A.E.R. 13, where Viscount Simon L.C., at page 15, says:

The owners of the majority of the voting power in a company are the persons who are in effective control of its affairs and fortunes.

See also M.N.R. v. Wrights' Canadian Ropes, Ltd., [1947] A.C. 109; [1947] C.T.C. 1, per Lord Greene M.R., at page 118 (C.T.C. 6), where it was held that the mere fact that one corporation had less than 50 per cent of the shares of another was “conclusive” that the one corporation was not "controlled" by the other within section 6 of the Income War Tax Act.

The appellants also referred to Dworkin Furs (Pembroke) Ltd. v. M.N.R., [1965] C.T.C. 465; 65 D.T.C. 5277 (Ex. Ct.). In Dworkin one of the shareholders of the appellant owned 50 per cent of the voting shares and others the remaining 50 per cent. Therefore, on the basis only of the number of shares owned, there was no control. But the Minister argued that control was established by coupling the fact that one of the shareholders owned 50 per cent of the shares with other circumstances. At page 468 (D.T.C. 5279) Jackett,

P. stated:

After giving careful attention to the argument of counsel for the Minister, I have come to the conclusion that I adhere to a view that I expressed in Buckerfield's Ltd. v. M.N.R., [1965] Ex. C.R. 299; [1964] C.T.C. 504, in the course of setting out the point that I had to decide in that case. I cannot do better than repeat that view here and adopt it for the decision of this case.

Jackett, P. then repeated the above quotation from his reasons in Buckerfield's, supra. Dworkin was appealed to the Supreme Court of Canada in M.N.R. v. Dworkin Furs (Pembroke) Ltd., [1967] C.T.C. 50; 67 D.T.C. 5035 (S.C.C.).

Hall, J., stated at page 52 (D.T.C. 5036): "The word "controlled" as used in this subsection was held by Jackett, P. to mean de jure control and not de facto control and with this I agree."

His Lordship then went on to repeat the reasons of Jackett, P. as set out above.

This line of cases all stand for the proposition that the holder of a majority of the voting shares of a corporation controls that corporation. However, in The Quedn v. Imperial General Properties Ltd., [1985] 2 C.T.C. 299; 85 D.T.C. 5500 (S.C.C.), the Court appears to have gone beyond Buckerfield's, supra.

In Imperial General Properties, supra, prior to a reorganization, the Wing- old family owned 90 shares and Meyer Gasner owned ten shares. After the issuance of supplementary letters patent increasing the authorized capital of the company by creating 10,000 voting non-participating cumulative preferred shares with a par value of $1 each (the"preferred shares") and the issue to the Gasner family of 80 of those preferred shares, the Wingold family held 90 common shares and the Gasner family owned ten common shares and 80 preferred shares so that each family controlled 90 votes.

In analyzing the facts in Imperial General Properties, supra, Estey, J. had these remarks to make at pages 302-303 (D.T.C. 5503):

In determining the proper application of subsection 39(4) to circumstances before a court, the court is not limited to a highly technical and narrow interpretation of the legal rights attached to the shares of a corporation. Neither is the court constrained to examine those rights in the context only of their immediate application in a corporate meeting. It has long been said that these rights must be assessed in their impact” over the long run”. See Thurlow, J. in Donald Applicators Ltd. v. M.N.R., [1969] 2 Ex. C.R. 43 at 51; [1969] C.T.C. 98 at 105, affirmed by this Court at [1971] S.C.R. v; [1971] C.T.C. 402.

Some comfort was sought by the respondent here in the judgment in Oakfield, supra, at 1037 (C.T.C. 286), where Judson, J. stated, in distinguishing the Dworkin case, supra:

. . . the voting was split equally between two groups also, but there was only one class of shares. Each group had the same de jure rights, and each shareholder was entitled to share rateably in the profits and assets of the company by dividends or on winding up. In addition, neither group could itself wind up the company.

I do not think that the fulcrum upon which that case turned was the presence of two classes of shares in Oakfield as against only one class in Dworkin. The repeated reference by Judson, J. to the significance of the final omnipotent right to wind up the company retained by the prior controlling stockholder was the bedrock upon which the Oakfield judgment was founded. When the Wingolds purported to terminate their control of the respondent causing the respondent to issue 80 preference shares for $80 to the ten per cent minority shareholder Gasners, the Wingolds retained one central critical right, which they then passed on to Validor, namely the right, should their interest ever require, to wind up the respondent. The only penalty to be suffered by the Wingolds, and later Validor, upon such a wind-up (in addition to the nominal payments on return of capital on the preference shares and any accrued but unpaid dividends) remained a ten per cent distribution to Meyer Gasner which was precisely the same penalty as existed prior to the alleged termination of the Wingolds' control.

As in Oakfield, the continued existence, alter the 1960 reorganization, of the right to terminate the corporate existence should the presence of the minority common and preference shareholders become undesirable to the 90 per cent common stockholder, Validor, is, in my view, the linchpin of the tax plan introduced following the 1960 amendments to the tax statute. Control, in the real sense of the term, was not surrendered by the Wingolds (and their successor, Validor) in 1960 upon the issuance to the Gasner group of $80 in preference shares. Accordingly, the respondent remains controlled by Validor within the meaning of the term as it is employed by Parliament in subsection 39(4).

In all of these cases, voting rights were equal. And yet, in Imperial General Properties, supra, the Court looked at other factors. The main one being the right of the holder of the majority of the common shares to take unto itself the residue of the assets of the company after paying a small price to eliminate the voting preference shares and paying its due to the holders of the remaining ten per cent of the common shares which, of course, was effected by the right of the holder of the common shares to wind up the company.

The respondent's position is that the economic clout wielded by the appellants gave them control of the corporation notwithstanding that together they only held 40 per cent of the voting shares.

After analyzing these cases, the inescapable conclusion is not that economic control alone will give or shift control but that where there is an apparent voting equality which may or may not be artificially contrived, one must look at other factors to determine control, such as the right to terminate a company's existence and seize the residue of its assets.

The respondent further contends that the retractable feature of the Class D shares gives the appellants that clout and vests control in them.

With this the Court cannot agree. What the appellants receive is their investment and no more. They cannot vote to elect or oust the directors, alter the corporation’s articles, demand increased dividends, wind up the corporation or cause its existence to cease or do any things which controlling shareholders may do. The amount of money they may remove from the corporation by way of return of capital is limited to their original investment. It cannot grow with the corporation. The increase in the value of the corporation is for the benefit of the holders of the Class A shares, they will eventually benefit from the reduction in the number of Class D shares and any growth in the corporation. In the long run, Class A shareholders will reap the benefits, if any, from the increased value of the corporation and in no event will any increase accrue to the benefit of the holders of Class D shares. In Imperial General Properties, supra, both classes of shares voted. Yet, the Court chose to look behind mere voting rights to see if by some other means the company could be controlled by one class of shareholders. It found by virtue of the Wingolds’ ability to unilaterally cause the company to be wound up, they had the power to appropriate all of the assets of the company unto themselves after returning capital to the preferred shareholders and distributing to the minority common shareholders their ten per cent of the residue. The holders of the Class D shares have no such rights.

In this instance, the parties have not bestowed voting rights on a class of shares in order to give the appearance of equality of votes and therefore there is nothing to look behind in order to determine actual control. Here, actual control rests in the hands of the holders of the Class A shares no matter how small their investment.

The mere fact that the Class D shares can be retracted is not the same as control. It may not even be a threat to the corporation if the corporation cannot comply with the provisions of the Alberta corporations legislation such as any solvency tests.

The respondent urged the Court to look to the fact that the appellants held promissory notes of the corporation which would again give them leverage over the corporation by the ability to call the notes. if this were the case then any creditor, particularly a secured creditor, could be said to control a corporation since it controls its assets. This could never be the meaning of control for the purposes of the Act. In order for the respondent to establish that the appellants control the corporation, he must establish that the appellants had a preponderance of the votes at a meeting of the shareholders of the corporation or that they had sufficient votes when coupled with other powers to control the corporation as that term was defined in Imperial General Properties, supra. All of the above arguments of counsel for the Minister on the issue of de facto control are predicated on the assumption that the appellants together controlled the corporation by preponderance of shares and by holding notes.

However, that is not the interpretation to be placed on subsections 85(4) and 85(5.1). For clarity, the relevant portions of those subsections are set out here.

In dealing with ineligibility of capital losses, subsection 85(4) of the Act reads in part as follows:

85. (4) Where a taxpayer or a partnership (hereinafter referred to as the taxpayer) has, after May 6, 1974, disposed of any capital property or eligible capital property of the taxpayer to a corporation that, immediately after the disposition, was controlled, directly or indirectly in any manner whatever, by the taxpayer, by the spouse of the taxpayer or by a person or group of persons by whom the taxpayer was controlled, directly or indirectly in any manner whatever. . .

Subsection 85(5.1) of the Act reads in part in dealing with terminal losses:

85. (5.1) Where a person or a partnership (in this subsection referred to as the "taxpayer") has disposed of any depreciable property of a prescribed class of the taxpayer to a transferee that was

(a) a corporation that, immediately after the disposition, was controlled, directly or indirectly in any manner whatever, by the taxpayer, by the spouse of the taxpayer or by a person, group of persons or partnership by whom the taxpayer was controlled, directly or indirectly in any manner whatever. . .

It is clear that after the transaction, Mr. Zinkhofer did not control the corporation through his Class A shares; Mrs. Zinkhofer did not control the corporation through her Class A shares and no person or group of persons controlled either of them directly or indirectly in any manner.

Even if the Class D shares were voting shares, neither of the appellants individually controlled the corporation. They each had exactly the same number of Class A shares and Class D shares and even using the economic clout argument they held notes on a 50:50 basis. Since neither controlled the corporation after the transaction in question, the appeal is allowed with costs and the matters are referred back to the Minister for reconsideration and reassessment on the basis that the provisions of subsections 85(4) and 85(5.1) of the Act are not applicable.

Appeal allowed.