Citation: 2014 TCC 75
Date: 20140307
Dockets: 2013-12(IT)I
2013-13(IT)I
2013-16(IT)I
2013-18(IT)I
2013-20(IT)I
2013-21(IT)I
BETWEEN:
LUCIE DESCARRIES,
RENÉ LEROUX,
SUZANNE GAUTHIER,
NICOLE BEAUREGARD,
JEAN LEROUX,
DENISE L. BISSONNETTE,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH
TRANSLATION]
REASONS FOR JUDGMENT
Hogan J.
I. Introduction
[1]
Between 2004 and 2008,
the appellants performed a series of transactions described at paragraph 6 below
relying on the advice of their tax specialist. The transactions at issue
included the redemption by 9149-7321 Québec inc. (9149) of shares held by the
appellants. The redemption was financed by Oka inc. (Oka), which was a wholly
owned subsidiary of 9149 at the time of the redemption. At first, Oka was held
directly by the appellants.
[2]
When the
appellants’ tax specialist presented his tax plan to them, he compared the tax
consequences for the appellants of the redemption of their shares in Oka with
the tax result of performing the transactions he proposed. If Oka redeemed the
shares held by the appellants, all of the appellants together would receive a
taxable dividend of $592,362. The transactions at issue generated an increase
in the paid-up capital of 9149 shares issued to the appellants in exchange for
their Oka shares. Consequently, according to the tax specialist, the redemption
of 9149 shares would result in lower taxable dividends.
[3]
The respondent invites
me to consider all of the transactions described below in order to determine
the tax consequences of the redemption of the 9149 shares. According to the
respondent, in this context, the redemption of the 9149 shares may be described
as a distribution or appropriation of Oka's funds or property for the benefit
of the appellants on the winding-up, discontinuance or reorganization of Oka's
business. This triggers the application of subsection 84(2) of the Income
Tax Act (the Act). Under that subsection, all of the appellants together are
liable to pay tax in respect of a deemed dividend of $592,366 rather than of
$265,505.
[4]
In making the
assessments in respect of the appellants, the Minister of National Revenue (the
Minister) also relied on the general anti-avoidance rule (the GAAR) contained
in section 245 of the Act.
[5]
The appeals were heard
on common evidence.
II. Factual background
[6]
The parties filed a
partial agreement on the facts, which reads as follows:
[Translation]
1. The company L’immobilière d’Oka Inc. (Oka) was incorporated
under Part I of the Quebec Companies Act by letters patent issued on
July 31, 1946, and continued to exist under Part IA of said Act on December 8,
2004.
2. Oka was a corporation resident in Canada for the purposes of
the Income Tax Act.
3. At December 31, 1971, Lionel Leroux held 3,178 common shares
in Oka.
4. Upon Lionel Leroux's death in 1982, his children (René
Leroux, Jean Leroux, Suzanne Gauthier, Denise Bissonnette and Lucie Descarries)
as well as his step-daughter, Nicole Beauregard (the appellants) became equal
owners of the 3,178 common shares of Oka.
5. The appellants also acquired 820 common shares of Oka from a
third party for $25,000 and subscribed to two common treasury shares for $100.
6. In December 2004, the appellants held all of the 4,000
common shares of Oka in circulation. The fair market value of the 4,000 shares
was at that time $617,466; the adjusted cost base was $361,658, and the paid-up
capital was $25,100.
7. Oka owned land for the purpose of selling it.
9149-7321
Québec Inc. is incorporated
8. On December 1, 2004, 9149-7321 Québec Inc. was incorporated
under Part IA of the Quebec Companies Act. Its authorized capital stock
included Class A voting and participating shares and Class B non-voting and
non-participating shares that were redeemable at the option of the holder for
an amount equivalent to that received when they were issued.
9. Oka loaned $544,354 to 9149-7321 Québec Inc.
Oka's
common shares are converted into Class A shares
10. On December 8, 2004, Oka modified its capital stock in order
to authorize an unlimited number of common Class A voting and participating
shares and an unlimited number of preferred Class B, C and D non-voting shares
redeemable at the option of the holder or of Oka.
11. On the same day, Oka converted its 4,000 common shares into
Class A shares. For each common share converted, the appellants received a
Class A share.
The
appellants exchange their Class A shares for preferred Class B and C shares of
Oka.
12. On March 1, 2005, the appellants exchanged, through a
roll-over under subsection 85(1) of the Income Tax Act, their 4,000
Class A shares in consideration for 269,618 preferred Class B shares and
347,848 preferred Class C shares.
13. The amount agreed on for the purposes of the rollover was the
fair market value of 4,000 Class A shares, namely, $617,466. A capital gain
equal to the difference between the ACB of the shares ($361,658) and the
agreed-on amount ($617,466) was realized. Each appellant reported a capital
gain of $42,635 when filing his or her tax return for the 2005 taxation year. No
capital gain deduction was claimed.
14. Applying the provisions in section 85 of the Act resulted in
Class B shares having an ACB of $269,618 and a paid-up capital of $10,960, and
the Class C shares having an ACB of $347,848 and a paid-up capital of $14,140.
The
appellant dispose of their Oka shares in favour of 9149-7321 Québec Inc.
15. On March 15, 2005, the appellants disposed of all of their
shares in Oka in favour of 9149‑7321 Québec Inc., in consideration for
347,848 Class A shares and 269,618 Class B shares:
|
Disposition
|
Consideration received
|
|
269,618 Class B shares of Oka
|
151,889 Class A shares of 9149-7321 Québec Inc.
117,729 Class B shares of 9149-7321 Québec Inc.
|
|
347,848 Class C shares of Oka
|
Class A shares of 9149-7321 Québec Inc.
151,889 Class B shares of 9149-7321 Québec Inc.
|
16. Section 84.1 of the Act applied to that transaction to limit
the paid-up capital of the new shares issued. Normally, under this section, the
paid-up capital of the shares received by the appellants at the time of the
transfer would be equal to the greater of the paid-up capital of the exchanged
shares or their adjusted cost base. However, some adjustments had to be made to
the adjusted cost base of the shares under paragraph 84.1(2)(a.1) in
order, among other things, to account for the added value accumulated before
1971. The 347,848 Class A shares of 9149-7321 Québec Inc. therefore had a
paid-up capital and an ACB of $347,848, and the 269,618 Class B shares had an
ACB of $269,618 and a paid-up capital of $0.
9149-7321
Québec Inc. redeems its common Class A shares and part of its preferred Class B
shares.
17. On March 29, 2005, 9149-7321 Québec Inc. redeemed all of its
Class A shares, namely, 347,848 shares, for $347,848. The redemption had no tax
consequences:
|
Proceeds of disposition
|
$347,848
|
|
Paid-up capital
|
- $347,848
|
|
84(3) dividend
|
$0
|
|
|
|
|
Proceeds of disposition
|
$347,848
|
|
Adjusted cost base
|
- $347,848
|
|
Capital gain
|
$0
|
18. On March 29, 2005, 9149-7321 Québec Inc. also redeemed
196,506 Class B shares for the amount of $196,506, which resulted in a deemed
dividend in the amount of $196,506 under subsection 84(3) of the Act and in a
capital loss of $196,506.
|
Proceeds of disposition
|
$196,506
|
|
Paid-up capital
|
- $0
|
|
84(3) dividend
|
$196,506
|
|
|
|
|
Proceeds of disposition
|
$196,506
|
|
84(3) dividend
|
- $196,506
|
|
Adjusted cost base
|
- $196,506
|
|
Capital gain (loss)
|
- $196,506
|
19. Each appellant reported a deemed dividend (before gross-up)
of $32,751 ($196,506 / 6) and a capital loss of $32,751 ($196,506 / 6) in
filing his or her income tax return for the 2005 taxation year.
20. The capital loss of $32,751 reduced the capital gain of
$42,635 described at paragraph 13 of this agreement.
Oka Inc. is wound up
21. On December 15, 2006, the directors of Oka and of its sole
shareholder, 9149‑7321 Québec Inc., passed resolutions to wind up and
dissolve Oka.
22. In the context of Oka's winding-up, the obligation to pay the
amount of $544,354 was extinguished by merger given the union of the qualities
of creditor and debtor.
9149-7321
Québec Inc. redeems the other preferred Class B shares
23. At the end of 2008, 9149-7321 Québec Inc. redeemed the
balance of the Class B shares held by the appellants, that is 73,112
shares for $69,000, which resulted in a deemed dividend in the amount of
$69,000 under subsection 84(3) of the Act and in a capital loss of
$73,112.
|
Proceeds of disposition
|
$69,000
|
|
Paid-up capital
|
- $0
|
|
84(3) dividend
|
$69,000
|
|
|
|
|
Proceeds of disposition
|
$69,000
|
|
84(3) dividend
|
- $69,000
|
|
Adjusted cost base
|
- $73,112
|
|
Capital gain (loss)
|
- $73,112
|
24. Each appellant reported a deemed dividend (before gross-up)
of $11,500 ($69,000 / 6) and a capital loss of $12,185 ($73,112 / 6) in filing
his or her income tax return for the 2008 taxation year.
Dissolving the companies
25. Oka was dissolved on September 10, 2008.
26. 9149-7321 Québec Inc. was dissolved on February 24, 2009.
[7]
The tax consequences of
the transactions at issue are summarized in Appendix A attached hereto.
[8]
In addition to the
facts described in the partial agreement on the facts filed by the parties, the
testimony at the hearing revealed the following.
[9]
Oka's business
consisted in selling land located in the Oka area.
[10]
At the time of the
first redemption of shares by 9149, namely, in March 2005, Oka still had four
lots in stock. On December 22, 2005, the lots were sold to Armand Dagenais
et Fils inc. and to Denis Dagenais.
[11]
The sale of the lots
required, among other things, an agreement to be negotiated with Maurice
Vaillancourt, who was using a garage located on one of the lots sold to Armand
Dagenais et Fils inc. In addition, Oka had to institute legal proceedings
before the Superior Court in order to legalize certain title deeds. The
judgment was not rendered until December 12, 2006.
III. Analysis
A. Subsection 84(2) of the Act
(i) Requirements for the application of
subsection 84(2) of the Act
[12]
Subsection 84(2) of the
Act, which is at the heart of the analysis, reads as follows:
84(2)
Distribution on winding-up, etc. Where funds or
property of a corporation resident in Canada have at any time after March 31,
1977 been distributed or otherwise appropriated in any manner whatever to or
for the benefit of the shareholders of any class of shares in its capital
stock, on the winding-up, discontinuance or reorganization of its business, the
corporation shall be deemed to have paid at that time a dividend on the shares
of that class equal to the amount, if any, by which
(a) the
amount or value of the funds or property distributed or appropriated, as the
case may be,
exceeds
(b) the amount,
if any, by which the paid-up capital in respect of the shares of that class is
reduced on the distribution or appropriation, as the case may be,
and a dividend shall be
deemed to have been received at that time by each person who held any of the
issued shares at that time equal to that proportion of the amount of the excess
that the number of the shares of that class held by the person immediately
before that time is of the number of the issued shares of that class
outstanding immediately before that time.
[13]
This subsection
therefore requires a number of elements to be present in order for it to apply
to a given situation. As explained by the Federal Court of Appeal in Canada
v. MacDonald,
the conditions for its application may be summarized as follows:
17
A plain reading of the text reveals several elements that are necessary for its
application: (1) a Canadian resident corporation that is (2) winding-up,
discontinuing or reorganizing; (3) a distribution or appropriation of the
corporation’s funds or property in any manner whatever; (4) to or for the
benefit of its shareholders.
[14]
Having explained the
difference between the position of the Tax Court of Canada and that of the
Crown concerning the element to which a particular importance should be
attributed, the Federal Court of Appeal added the following:
21
In my view, a textual, contextual and purposive analysis of subsection 84(2)
leads the Court to look to: (i) who initiated the winding-up, discontinuance or
reorganization of the business; (ii) who received the funds or property of the
corporation at the end of that winding-up, discontinuance or reorganization;
and (iii) the circumstances in which the purported distributions took place.
This approach is consistent with the jurisprudence interpreting this provision
and provides the consistency of approach with respect to subsection 84(2)
spoken to by both parties to this appeal.
(ii) Existence of a distribution
[15]
The Act does not define
distribution; therefore, we must turn to case law. First, let us consider Minister
of National Revenue v. Merritt,
the facts of which were summarized as follows by the trial court:
4
The issue here had its origin in a Provisional Agreement entered into, in
March, 1937, between the Directors of the Security Loan and Trust Company
(hereafter called "the Security Company"), a Loan Company
incorporated under the laws of the Province of Ontario, and the Directors of
the Premier Trust Company (hereafter called "the Premier Company"), a
Trust Company incorporated by an Act of the Parliament of Canada, and the
principal terms of the Agreement were the following. The Security Company
agreed to sell and transfer to the Premier Company, and the Premier Company
agreed to purchase from the Security Company, the whole of the assets and
undertaking of the Security Company as a going concern, including the goodwill
of its business, and the same was so described in the Agreement as to include
any reserves or undistributed profits to which the Security Company was
entitled in connection with its business. . . . The consideration for the
assets and property so agreed to be sold was that the Premier Company should
allot and issue to each shareholder of the Security Company one and one-half
fully paid shares (of the par value of $100 each) of its capital stock for each
fully paid share held by such shareholder, or, at the option of such
shareholder, to pay $102 in cash and to allot and issue one-half share of its
capital stock, for each fully paid share held by such shareholder; and
provision was made for the adjustment of fractions of shares of the Premier
Company by payment in cash, and the shareholders of the Security Company were
also to be paid a sum in cash equivalent to accrued dividend, at the rate of
five per cent per annum, on each fully paid share held by them, for the period
from December 31, 1936, to the date of the issuance of the shares of the
Premier Company to which they would be entitled under the terms of the
Agreement.
5
In due course the appellant, by her Trustees, exercised the option of accepting
as the consideration for her shares $102 in cash and one-half share of the
Premier Company for each fully paid share held by her in the capital stock of
the Security Company. On October 5, 1937, the Premier Company remitted to the
Trustees, on behalf of the appellant, a cheque for $26,690.75, being, it was so
stated in a covering letter, the cash consideration for the appellant's 259
shares in the capital stock of the Security Company, at $102 per share, and an
amount for an accrued dividend as provided for by the Agreement, less a deduction
resulting from the cash adjustment of a fraction of one fully paid share
receivable by the appellant, under the terms of the option exercised.
Concurrently the Trustees received a certificate for 130 fully paid shares of
the Premier Company registered in the name of the Trustees for the appellant.
6
As already stated, in May, 1939, the appellant was assessed for additional
income in the period in question, in the sum of $10,192.60, and that additional
income is claimed to have been the appellant's proportion of the undistributed
income which the Security Company had on hand, when its property was
distributed on the discontinuance of its business.
[16]
Regarding the
distribution, the President came to the following conclusion:
7 . . . Neither do I entertain any doubt that there
was a distribution of the property of the Security Company among its
shareholders, in the sense contemplated by s. 19 (1) of the Act, under the
terms of the Agreement after its ratification by the shareholders of the
Security Company. It is immaterial, in my opinion, that the consideration
received by the appellant for her shares happened to reach her directly from
the Premier Company and not through the medium of the Security Company.
[17]
That finding was
confirmed by the Supreme Court of Canada in Merritt at page 274.
[18]
In Merritt, instead
of the normal process to wind up the corporation, that is, naming a liquidator
who would distribute the corporation's revenue among shareholders, a process
was used whereby the shareholders received their share of the funds through a
third-party purchaser. In the end, the corporation was stripped of its assets,
which were from then on held by the purchaser, and the shareholders each
received a part of them.
[19]
In the case at bar,
according to the respondent, the distribution happened when 9149 redeemed
shares because it was at that time that the shareholders received their share
of the funds. However, Oka had not been stripped of its assets at that time.
[20]
In fact, at the time of
the redemption, Oka was 9149's creditor because of the loan that it had given
to it.
Because of that amount receivable, Oka still held assets.
[21]
The definition of
"distribution", which requires both a gain for the shareholders and a
loss for the company is based solely on Merritt. Several decisions that
found that subsection 84(2) of the Act or one of its earlier versions applied indeed
referred to similar factual situations.
[22]
In the Tax Court of
Canada decision MacDonald v. The Queen, a shareholder had appropriated a company's
funds, and the company's assets were reduced by the same amount. Indeed,
Dr. MacDonald thus received close to $525,000 from the company, which was
not compensated in any way.
[23]
In McNichol v.
Canada,
subsection 84(2) was found not to apply to the facts at issue. To summarize,
the shareholders of the company Bec wanted to sell their shares to the company
Beformac. That company did not have the funds to purchase the Bec shares;
therefore, it had to take out a loan from a bank. The shareholders were then
paid for the shares with the money from the loan. The two companies amalgamated
some time after the sale of the shares. Bec's funds remained in that company
until several days after the amalgamation when they were used to repay
Beformac's loan.
[24]
Judge Bonner found as
follows regarding the distribution in McNichol:
11 .
. . It is impossible to conclude that the money which found its way into the
pockets of the appellants was Bec's money in the face of evidence which
demonstrates clearly that
(a) Beformac used money borrowed from CIBC to fund the payment of
the sale price to the appellants and
(b) Bec's money remained in its bank account until the amalgamation
of Bec and Beformac on April 5, 1989 and continued to sit in that same bank
account as an asset of the amalgamated company until April 21, 1989 when a
portion of the money was used to retire the $300,000 debt to CIBC which had
been incurred by Beformac.
. .
.
[25]
Subsection 84(2)
therefore did not apply because it was money from the bank loan rather than the
company's money that was given to the shareholders in payment for their shares.
The company's assets therefore remained unchanged at the time of the alleged
distribution.
[26]
The Federal Court of
Appeal distinguished the facts of McNichol in MacDonald. The
Court of Appeal stated the following in this regard:
25
Contrary to the judge's assertions, McNichol is readily distinguishable
from the case at hand. In McNichol, the shareholders of Bec sold their
shares to Beformac, a holding company, for less than their book value. To fund
the purchase, Beformac obtained a loan from a bank, secured against the amount
of money Bec held in its account (which was, incidentally, its only asset). Bec
and Beformac amalgamated five days after the share sale, and the loan from the
bank was repaid two weeks later. The Tax Court held that subsection 84(2) of
the Income Tax Act did not apply because it could not be said that any
of Bec's funds found their way into the shareholder's hands. Specifically, the
financing of the share purchase came from the bank, and Bec's assets remained
deposited in its bank account for some time after the amalgamation. It is
clear that the same cannot be said of Dr. MacDonald's case. Indeed, PC's
property ended up in his hands and the entire series of events was designed and
executed to achieve this result.
[27]
In the appeals at bar,
Oka's funds were loaned to 9149 in 2004. The cash was therefore replaced by an
amount receivable, although the overall assets remained unchanged. The same
happened at the time of the redemption, which was also the time of the alleged
distribution. This situation is therefore more similar to that in McNichol.
[28]
Oka's assets were
reduced only after 9149's debt was extinguished through a merge on December 15,
2006. Therefore, it cannot be said that there was stripping in March 2005 at
the time of the distribution. In addition, when the shares were redeemed in
March 2005, Oka still owned four lots, which were not distributed to the
appellants.
(iii) Concurrency with winding-up
[29]
There must not only be
a distribution of funds of the company, but that distribution must also
coincide with a winding-up, discontinuance or reorganization, as indicated by
the wording of subsection 84(2) of the Act.
Where
funds or property of a corporation resident
in Canada have . . . been distributed or otherwise appropriated in
any manner whatever to or for the benefit of the shareholders of any
class of shares in its capital stock, on the winding-up, discontinuance or
reorganization of its business . . .
[Emphasis added.]
[30]
Since one of the
alleged distributions took place in March 2005, it must be determined whether
the winding-up, discontinuance or reorganization also took place at that time.
[31]
In Kennedy v. M.N.R.
subsection 81(1), the predecessor of subsection 84(2), was discussed. The
meaning of the wording at issue was explained as follows:
In
section 81(1) the word “reorganization” is used in association with the words “winding-up”
and “discontinuance”. Both of those words contain an element of finality. The
company is ended, It is therefore logical to assume that the word “reorganization”
presupposes the conclusion of the conduct of the business in one form and its
continuance in a different form.
In
the Shorter Oxford Dictionary, 3rd ed. at page 1704, the word “reorganization”
is defined as “a fresh organization” and the verb “reorganize” is defined as “to
organize anew”.
In
the circumstances of the present case there has been no “fresh” organization. The
same company continued the same business in the same manner and in the same
form. The only difference was that by reason of the sale of its premises the
Company operated the same business from the same premises which were rented by
it rather than being owned by it.
[32]
In MacDonald and
Merritt, the concurrence of the winding-up, discontinuance or
reorganization with the distribution was not in doubt. In MacDonald, the
first distributions took place on June 25, 2002. The company had already
discontinued its business, since Dr. MacDonald had, among other things, let his
medical licence expire. This was made official on June 26, 2002, by changing
the company's name. In Merritt, the winding-up and the distribution
happened at the same time because it was the sale of assets that made it
impossible to continue the company's activities.
[33]
On March 29, 2005, when
9149 first redeemed the shares, Oka still had four lots. The sale to Armand
Dagenais et Fils inc. and to Denis Dagenais took place only in December 2005,
and Oka was involved in the acquisitive prescription proceedings until
December 2006. Thus, Oka continued to operate its business until
December 2006.
[34]
To summarize, in the
case of Oka, the business continued to operate after the alleged distribution.
No persuasive factual evidence to the contrary has been filed. The activities
continued as usual, and the format of the business remained the same until
2005. Oka's business ceased to operate only in December 2006.
(iv) Conflict with subsection 84(3) of
the Act
[35]
As mentioned earlier,
the respondent claims that there was a distribution or an appropriation of
Oka's property when 9149 redeemed shares from its capital stock in 2005 and
2008. However, in my view, there is no impediment to the application of
subsection 84(3) of the Act, which reads as follows:
84(3)
Where at any time after December 31, 1977 a corporation resident in Canada has
redeemed, acquired or cancelled in any manner whatever (otherwise than by way
of a transaction described in subsection 84(2)) any of the shares of any class
of its capital stock,
(a)
the corporation shall be deemed to have paid at that time a dividend on a
separate class of shares comprising the shares so redeemed, acquired or
cancelled equal to the amount, if any, by which the amount paid by the
corporation on the redemption, acquisition or cancellation, as the case may be,
of those shares exceeds the paid-up capital in respect of those shares
immediately before that time; and
(b)
a dividend shall be deemed to have been received at that time by each person who
held any of the shares of that separate class at that time equal to that
portion of the amount of the excess determined under paragraph 84(3)(a) that
the number of those shares held by the person immediately before that time is
of the total number of shares of that separate class that the corporation has
redeemed, acquired or cancelled, at that time.
[36]
The respondent did not
offer any explanation to resolve the obvious conflict between the application
of subsection 84(2) and that of subsection 84(3) of the Act to the redemption
of the shares by 9149. I note that the precedence rule in subsection 84(3),
which promotes the application of subsection 84(2), does not apply to the
transactions at issue. For the precedence rule to apply, there must be only one
complete transaction performed by one taxpayer. In this case, the redemption of
shares and the distribution of assets took place in respect of different
companies. The winding-up to which the Minister is referring is that of Oka,
while the shares were redeemed by 9149. Accepting the respondent's point of
view that subsection 84(2) of the Act is applicable would mean that the
appellants received two deemed dividends, namely, one under subsection 84(2) of
the Act regarding the appropriation or the distribution of Oka's property, and
the other under subsection 84(3) of the Act regarding the redemption of the
9149 shares. Nonetheless, the fact remains that the appellants received only
one distribution.
[37]
I do not think that
subsections 84(2) and 84(3) of the Act may be applied at the same time to the
same distributions. Only applying the GAAR can change the tax consequences of
the series of transactions that the redemption of the 9149 shares fits into.
B. The general anti-avoidance rule
[38]
The respondent relies
on the GAAR on an auxiliary basis in defence of the assessments at issue.
[39]
The appellants concede
the existence of an avoidance transaction. The resolution of the appeals thus
depends on the third condition established in Canada Trustco Mortgage Co. v.
Canada,
namely, that the avoidance transaction giving rise to a tax benefit must be
abusive under subsection 245(4).
Based on the process outlined by the Supreme Court of Canada, the abuse inquiry
involves, first, interpreting the relevant provisions of the Act to determine
their object, spirit or purpose and, second, determining whether the impugned
transactions fall within, or frustrate the purpose of those provisions. Copthorne
Holdings Ltd. v. Canada describes this as follows:
69
In order to determine whether a transaction is an abuse or misuse of the Act, a
court must first determine the “object, spirit or purpose of the provisions . .
. that are relied on for the tax benefit, having regard to the scheme of the
Act, the relevant provisions and permissible extrinsic aids” (Trustco,
at para. 55). The object, spirit or purpose of the provisions has been
referred to as the “legislative rationale that underlies specific or
interrelated provisions of the Act” (V. Krishna, The Fundamentals of Income
Tax Law (2009), at p. 818).
70
The object, spirit or purpose can be identified by applying the same
interpretive approach employed by this Court in all questions of statutory
interpretation — a “unified textual, contextual and purposive approach” (Trustco,
at para. 47; Lipson v. Canada, 2009 SCC 1, [2009] 1 S.C.R. 3, at para.
26). While the approach is the same as in all statutory interpretation, the
analysis seeks to determine a different aspect of the statute than in other
cases. In a traditional statutory interpretation approach the court applies the
textual, contextual and purposive analysis to determine what the words of the
statute mean. In a GAAR analysis the textual, contextual and purposive
analysis is employed to determine the object, spirit or purpose of a provision.
Here the meaning of the words of the statute may be clear enough. The search
is for the rationale that underlies the words that may not be captured by the
bare meaning of the words themselves. However, determining the rationale of
the relevant provisions of the Act should not be conflated with a value
judgment of what is right or wrong nor with theories about what tax law ought
to be or ought to do.
[40]
The existence of
abusive tax avoidance must be clear. If it is not, the benefit of the doubt must
be given to the taxpayer.
[41]
The respondent claims
that the transactions at issue frustrate the object, spirit or purpose of
subsection 84(2) of the Act. She essentially reiterates the arguments put
forward by the respondent in MacDonald. My colleague, Justice Hershfield, ruled
as follows regarding these arguments:
63
That takes me to what I see as the Respondent's third argument. Inherently, by
pleading for a purposive rather than literal construction of subsection 84(2),
the Respondent asserts an abuse of the Act in this case broader than one that
relates to the interaction of capital gains and capital losses in the
calculation of income and taxable income. As stated earlier in these Reasons,
referring to paragraph 18 of the Reply, the broader concern is the avoidance of
the ordinary consequences of distributions of corporate assets, as dividends,
that are meant to arise on a wind-up or discontinuance of business. More
specifically it is a concern, not so much as to a particular tax benefit that might
arise from the tax difference between shareholders accessing retained earnings
as a dividend versus receiving capital gains treatment, it is a concern
stemming from a view that the purpose of subsection 84(2), as it was brought in
by legislation affecting post-1971 dispositions of capital property, was to
prevent capital gains treatment. The suggestion is that it was, and remains, an
anti-avoidance provision the language of which must be construed more broadly
to ensure dividend treatment when a taxpayer indirectly receives the retained
earnings of a company that he was entitled to receive as a shareholder.
64
In my view, that suggestion is tenuous. It is even more of a leap to suggest
that the post-1971 provision, following the former model, was intended to
ensure the post-1971 restrictions on the use of capital losses when neither
such losses nor such restrictions existed in the pre-1972 Act. In fact, the
historical references relied on by the Respondent underline that this third
argument is all about an attack on surplus stripping transactions per se.
65
This strikes me as a GAAR issue, however before taking the analysis there, the
Respondent's suggestion that this rationale to 84(2) dictates against a literal
construction of that provision, requires more to be said about surplus
stripping in the context of that provision.
66
In my view, there is nothing in the language of subsection 84(2) that warrants
a finding of a rationale other than liquidating distributions out of a
corporation's earnings to its shareholders - holding a particular class of
shares - are to be treated as dividends to the extent the distribution exceeds
the paid-up capital of the particular class of shares held by persons receiving
the distribution. That rationale formulation is set out in paragraphs 84(2)(a)
and (b). More generally, that rationale is part of a consistent theme
that retained earning of a corporation are a source of dividends and their use
or withdrawal for the benefit of shareholders should not be subject to different
tax treatment than applicable to dividends.
67
That said, it is dubious whether subsection 84(2) was ever an anti-avoidance
provision in the sense of ensuring this result in the case of a so-called
surplus strip which is what the Appellant's tax plan accomplished. The surplus
strip here was having the Appellant's shares acquired with corporate funds
funnelled through a related corporation as a tax-free dividend. This classic
strip in the old system was subject to a specific anti-avoidance provision;
namely section 138A of the old, pre-1972 Act. That provision was replaced in
1972 with section 247 which was repealed in 1988. The section that survived is,
of course, section 245. That is the provision to look at in these
circumstances. Essentially that is what Justice Bonner concluded in McNichol
and I agree.
68
In coming to this conclusion, I cannot ignore the Supreme Court of Canada
decision in Smythe et al. v. Minister of National Revenue even though
the parties made no direct reference to it. In that case, the Crown was
successful in applying the subsection 81(1) of the pre-1972 Act (the
predecessor to subsection 84(2)) to a dividend strip. While the Supreme Court
of Canada found it unnecessary to express any opinion on the scope of
subsection 137(2) of the pre-1972 Act as a condition of applying the former
section 81(1), it is interesting to note that the Exchequer Court did rely on
that former provision as an anti-dividend stripping provision. Subsection
137(2) was an artificial transactions provision. If a transaction artificially
conferred a benefit, the benefit was deemed to have been conferred
"notwithstanding the form or legal effect of the transactions". The
Supreme Court of Canada just relied on the artificiality of the transaction
that gave rise to the dividend strip without reliance on the former subsection
137(2). In the case at bar, no assertion was made that the subject transactions
were artificial. Furthermore, and importantly, as noted earlier in these
Reasons, former subsection 137(2) was replaced in the post-1971 Act by the
former section 247 which became the current section 245 in 1988.31 All this is
to say that the appropriate provision to apply in the case at bar given the
withdrawal of the sham basis for the subject assessment, in my view, is section
245 of the Act.
69
Accordingly, I see no basis to find that a purposive contextual analysis of
subsection 84(2) would invite a less literal interpretation of its language
than that I have found must govern, although there remains one last aspect of
this argument that needs to be addressed.
. .
.
128
Insisting that the maintenance of a dividend regime per se is required to
maintain the integrity of the scheme of the Act in the context of the
distribution of retained earnings on a winding up or discontinuance of a
business, requires that subsection 84(2) be found to operate beyond its express
language. I have found to the contrary. That sits well, in my view. A proper
reading of the subject provisions dictates only one approach: find the abusive
benefit and look to GAAR to maintain the integrity of the scheme of the Act in
the context of the distribution of retained earnings on a winding up or
discontinuance of a business.
[42]
I agree with Justice
Hershfield's findings.
[43]
As stated by the
appellants in their written submissions, I noted in Gwartz v. The Queen that
the Act does not contain any general prohibition stating that any distribution
by a company must be done in the form of a dividend. However, I also specified
in that case that, although the taxpayers may arrange to distribute surpluses
in the form of dividends or of capital gains, that option is not limitless. Any
tax planning done for that purpose must comply with the specific anti-avoidance
provisions found in sections 84.1 and 212.1 of the Act.
[44]
In the GAAR context,
the transactions at issue must also fall within the object, spirit or purpose
of those provisions. In this case, section 212.1 of the Act is irrelevant
because it applies to non-residents. However, section 84.1 of the Act is
relevant because, among other things, it prevents individuals from stripping a
company of its surpluses including through the use of a tax-exempt margin.
[45]
For these reasons,
after receiving their written submission, I contacted the parties' counsel to
inform them that I was going to consider whether the transactions at issue
frustrated, in an abusive fashion, the specific anti-avoidance rule established
in section 84.1 of the Act. Although the respondent did not refer to this
provision at the trial in order to defend the assessments relying on the GAAR,
I do not believe that I am bound when deciding on a question of law to agree to
an interpretation on which the parties agree. Therefore, I invited the parties' counsel
to file additional written submissions on section 84.1 of the Act and on the
issue of the potential abuse, which I was going to consider.
[46]
The appellants argue
that I must allow their appeals even if I find that there was abusive avoidance
under section 84.1 of the Act. According to the appellants, the respondent did
not discharge her burden of proof regarding the issue of abuse. I believe that it
is a burden of persuasion, rather than a burden of proof, that must be
discussed. This term relates to a question of fact. I agree that when the
respondent attempts to rely on the GAAR, she would do well to describe the
object, spirit and purpose of the provisions of the Act, which she believes
were frustrated by the transactions at issue. Clearly, if the Court is not
satisfied that there has been abuse, the appeals will be allowed because the
taxpayers have the benefit of the doubt with respect to this issue.
[47]
I believe that the
appellants were not prejudiced by the fact that the respondent did not take
into account the GAAR in the context of section 84.1 of the Act. The appellants
had the chance to provide additional submissions on the issue. In addition, I
note that the appellants dealt with section 84.1 of the Act in their initial
written submissions regarding the GAAR in the context of subsection 84(2) of
the Act.
[48]
I also note that the
appellants' tax specialist acknowledged that section 84.1 of the Act should be
taken into account in analyzing the issue of abuse for the purposes of
subsection 245(4) of the Act. In a memorandum (Exhibit I-1), he deals with the
GAAR issue as follows:
[Translation]
Application
of the general anti-avoidance rule (GAAR)
The
proposed steps raise the issue of the potential application of the GAAR. This
rule specifies that, where a transaction is an avoidance transaction, the tax
consequences to a person shall be determined as is reasonable in the
circumstances in order to deny a tax benefit that would result from that
transaction or from a series of transactions that includes that transaction.
An
avoidance transaction is a single transaction or a transaction that is part of
a series of transactions that would result, directly or indirectly, in a tax
benefit, unless the transaction is undertaken or arranged primarily for bona
fide purposes other than to obtain the tax benefit;.
The
“tax benefit” is defined as a reduction, avoidance or deferral of tax or other
amount payable or an increase in a refund of tax or other amount under the Act.
However,
if it may reasonably be considered that the transaction would not result
directly or indirectly in an abuse of any provision having regard to the Act
read as a whole, the GAAR does not apply.
In
this case, without the proposed transactions, following the sale of all the
lots, the company would plausibly have proceeded by redeeming its shares thus generating
a dividend of $592,366 to its shareholders. The proposed transactions increase
the ACB of the shares following the realization of a capital gain and then
increase the paid-up capital of the shares to an amount corresponding to the
new ACB despite the effect of section 84.1 ITA.
Tax
authorities have not ruled on whether the GAAR applies in such a situation. However,
the economic benefits stemming from the proposed transactions result from the
consequences of applying sections of the ITA. Indeed, the increase in the ACB
of the shares does not flow from section 84.1 ITA, but from the regular rules
of determining the cost of property. Therefore, subsection 84.1(1) is not used
to obtain a given result; rather, transactions are performed in a context where
this subsection is applicable and produces the effects it must produce.
In
addition, section 84.1 ITA sets limits regarding the amount that may be removed
from a corporation without tax consequences. One of these limits is the ACB of
the transferred shares. In the series of transactions being considered, the
capital gain realized by the taxpayer at the time of the internal rollover is
indeed bona fide. The fact that the ACB obtained through this transfer makes it
possible to extract surpluses during the second transfer is within the limits
set by section 84.1 ITA.
[49]
It is well established
that the GAAR may apply if the transactions at issue frustrate the object,
spirit or purpose of a specific anti-avoidance rule. In this context, I believe
that, in addition to the transaction details, the object, spirit or purpose of
section 84.1 of the Act must be considered to determine whether the GAAR
applies to the transactions at issue.
[50]
The rule applies when
the following key components are present:
(a) A taxpayer resident in
Canada (the transferor), other than a corporation, disposes of shares (the
subject shares);
(b) The shares are shares
of a corporation resident in Canada (the subject corporation);
(c) The subject shares
are capital assets;
(d) The taxpayer transfers
the subject shares to a corporation (purchaser corporation) with which the
taxpayer does not deal at arm's length;
(e) The subject
corporation is connected to the purchaser corporation.
[51]
In this case, the
parties agree that the application conditions were met when the appellants
disposed of their Oka shares for the benefit of 9149.
[52]
When section 84.1 of
the Act applies, it may cause either a reduction in the paid-up capital of the
shares issued by the purchaser corporation or an immediate taxable dividend to
the transferor. In general, such negative tax consequences are produced only
when either the non-share consideration or the paid-up capital of the shares
issued by the purchaser corporation or both exceed the greater of the paid-up
capital and the adjusted cost base.
[53]
Paragraphs 84.1(2)(a)
and (a.1) and subsection 84.1(2.01) change how the adjusted cost base of
the subject shares is calculated for the purposes mentioned above. Under the rules
established in these provisions, the part of the adjusted cost base of the
subject shares that is attributable to the value accumulated as of 1971 is not
recognized in order to prevent shareholders from using the tax-exempt margin to
strip a corporation of its surpluses. This adjustment also applies when the
shareholders purchased the subject shares after 1971 from a person with whom
they were not dealing at arm's length. A similar rule applies to prevent the
capital gain exemption from being used to strip a corporation of its surpluses
in similar cases. In summary, the specific rules show that the object, spirit or
purpose of section 84.1 of the Act is to prevent taxpayers from performing
transactions whose goal is to strip a corporation of its surpluses tax-free
through the use of a tax-exempt margin or a capital gain exemption.
[54]
My description of the
object, spirit or purpose of this provision is consistent with the presentation
made by the Minister of Finance when he proposed amendments to section 84.1 in
1985 during his introduction of the new provisions concerning the capital gain
exemption.
Section 84.1 of the Act
is an anti-avoidance rule to prevent the removal of the taxable surpluses of a
corporation as a tax-free repayment of capital where there is a non-arm's
length transfer of shares by an individual resident in Canada to a corporation.
While the purpose of this provision is maintained, both the means by which
it is achieved and its scope are being changed as a result of the introduction
of the new lifetime capital gains exemption.
Subsection 84.1(1) of the Act presently applies to deem an
immediate capital gain or an adjusted cost base reduction on certain non-arm's
length transfers of shares of a corporation resident in Canada to another corporation
by a taxpayer resident in Canada other than a corporation. Since the net tax on
dividends approximated the tax on capital gains, section 84.1 was designed
to discourage the use by corporations of certain techniques for stripping
surpluses known as "Valuation Day" strips.
With the introduction
of the capital gains exemption, the existing rules in subsection 84.1(1) are no
longer appropriate since the gain on the share transfer may be exempt.
Consequently, subsection 84.1(1) is being repealed and replaced by a rule that
requires a paid-up capital reduction and, in certain circumstances, the
immediate recognition of a dividend on certain non-arm's length transfers of
shares to a corporation after May 22, 1985. For these purposes, the non-arm’s
length test currently contained in subsection 84.1(2) is being maintained. The
basic rule under new subsection 84.1(1) is that the maximum amount that can be
received by the transferor from the transferee corporation as proceeds in the
form of any non-share consideration and the paid-up capital of the share
consideration is restricted to the greater of the paid-up capital of the
transferred shares and what could be called the actual non-arm's length
adjusted cost base to the transferor of the shares.
New paragraph 84.1(1)(a)
provides for a paid-up capital reduction for each class of shares of the
purchaser corporation for which shares were issued as consideration for its
acquisition of shares of another corporation. A paid-up capital reduction must
be made in the event of an increase in the legal paid-up capital of the shares
of the purchaser corporation arising as a result of the share transfer is more
than the excess, if any, of the greater of the paid-up capital of the
transferred shares and the adjusted cost base, as modified under new paragraph
84.1(2)(a) or (a.1), to the transferor of the transferred shares
over the fair market value of any non-share consideration paid by the purchaser
corporation as part of the purchase price for the transferred shares. The paid-up
capital reduction is divided among the different share classes of the purchaser
corporation on the basis of the legal paid-up capital increases occurring as a
result of the share transfer.
New paragraph 84.1(1)(b) treats the purchaser corporation as
having paid a dividend to the transferor where the aggregate of the amount of
the increase in the legal paid‑up capital of its shares arising as a
result of the share transfer and the fair market value of the non-share
consideration given by it for the transferred shares exceeds the total of
(a) the greater of the adjusted cost base, modified under new
paragraph 84.1(2)(a) or (a.1) to the transferor of the
transferred shares and the paid-up capital of the transferred shares, and
(b) the total paid-up capital reductions required by paragraph
84.1(1)(a) to be made by the purchaser corporation.
The excess is the amount that will be treated as a dividend.
[Emphasis added.]
[55]
In this case, the
person who had conducted the tax planning was aware that having Oka simply
redeem the shares held by the appellants would not produce an optimal tax
result. The redemption generates a taxable dividend of $592,366 and a capital
loss of $336,558 for all of the appellants. Without tax planning, the capital
loss is not available to reduce the tax payable by the appellants on the deemed
dividend. The internal rollover of Oka's common shares was introduced in order
to bridge this gap in matching. The goal of this transaction was to create a
capital gain of $255,808, which would generate an increase in the adjusted cost
base of Oka's shares by the same amount. The increase in the adjusted cost base
allowed 9149 to issue Class A shares with a maximum adjusted cost base and
paid-up capital.
[56]
Clearly, it was not by
chance that the tax planner proposed to the appellants to realize a capital
gain of $255,808 during Oka's capital reorganization. The tax specialist was aware
of the fact that section 84.1 of the Act would cause the Class B shares issued
by 9149 to have an adjusted cost base that is higher than their paid-up
capital, which would prevent the additional value accumulated before 1971 from
being used to strip Oka of its surpluses. However, applying this rule ensures
that the redemption of these shares will generate a capital loss that is
sufficient to erase the capital gain realized in the preceding step, namely,
the internal rollover of Oka's common shares.
[57]
In this light, the
analysis shown above allows me to find that the additional value accumulated
before 1971 was used to avoid the tax payable on the capital gain. Since the
capital gain was created to allow the appellants to receive the Class A shares
with a maximum adjusted cost base and paid-up capital, I find that the
transactions at issue allowed the appellants to use the value accumulated
before 1971 to indirectly distribute part of Oka's surpluses tax‑free.
[58]
In summary, the three
transactions described above have allowed the appellants to indirectly receive
part of Oka's surpluses tax-free. The following transactions took place:
(a) internal rollover of
Oka's shares, which allowed the appellants to increase the adjusted cost base
of their shares by an amount equal to $255,808.
(b) transfer of Class A
and B shares of Oka to 9149;
(c) redemption of Class A
and B shares by 9149.
[59]
Had it not been for the
internal rollover, the paid-up capital of all of the shares of 9149 would have
been limited to $92,040. This number represents the capital gain amount assessed
at the time of the appellants’ father's death, namely, $66,940 and the adjusted
cost base of Oka's shares purchased from a third party for $25,100. The result
of all three transactions described above is that the tax-exempt margin made it
possible for part of Oka's surplus to be distributed to the appellants tax-free
in a manner contrary to the object, spirit or purpose of section 84.1 of the
Act. For these reasons, I find that this provision was applied in an abusive
fashion.
[60]
The Minister made
assessments regarding a deemed dividend of $592,362 for all of the appellants
for all of the redemptions of 9149's shares. I believe that this amount is too
high. Based on my calculations, section 84.1 of the Act would make it possible
for the appellants to receive shares from the capital stock of 9149 having a
paid-up capital of $92,040 rather than $25,100. There is nothing in section
84.1 of the Act that prevents the appellants from having it recognized that the
paid-up capital of their 9149 shares is $92,040, which represents a capital
gain of $66,940 assessed on the death of their father following a deemed
disposition of Oka's common shares and the adjusted cost base of $25,100 of
Oka's shares purchased from a third party. None of these elements is
attributable to value accumulated before 1971 or to the use of the capital gain
exemption by a person with whom the appellants are not dealing at arm's length.
Consequently, the deemed dividend for all of the appellants for all redeemed
shares of 9149 is $525,422. Appendix B attached illustrates the impact of my decision
on each appellant.
IV. Conclusion
[61]
For all of these
reasons, the appeals are allowed in part and the assessments are referred back
to the Minister for reconsideration and reassessment, in accordance with the
above reasons for judgment.
Signed at Ottawa, Canada, on this 7th day of March
2014.
“Robert J. Hogan”
Translation certified true
on this 10th day of June 2014
Margarita Gorbounova, Translator
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