Citation: 2010TCC443
Date: 20100826
Docket: 2008-1622(IT)G
BETWEEN:
ESTATE OF THE LATE DONALD MILLS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Sheridan, J.
[1]
The Appellant, the
Estate of the Late Donald Mills, is appealing the assessment of the Minister of
National Revenue of the 1999 to 2003 taxation years; in particular, the Minister’s
disallowance of deductions for a bad debt
and, in 2003 only, accounting fees.
[2]
At the hearing, counsel advised
the Court that they had reached an agreement in respect of a deduction for
accounting fees the 2003 taxation year. That matter is dealt with at the end of
these Reasons for Judgment.
[3]
As for the bad debt issue, the
facts may be summarized as follows: in 2000, the Appellant sold some hi-tech
shares to his holding company, receiving in return a promissory note of $11,653,000.
To achieve certain tax planning objectives, the Appellant treated that amount
as a “deemed dividend” under paragraph 84.1(1)(b) and in accordance
with the formula provided for the calculation of its value, included in income $11,222,515
under paragraph 12(1)(j) of the Income Tax Act. By 2002, the
hi-tech bubble had burst and the debtor corporation defaulted on the promissory
note. The Appellant then claimed the unpaid portion of the promissory note, $10,588,133,
as a “bad debt” under subparagraph 20(1)(p)(i) of the Act.
[4]
Additional details are set out in
paragraphs 1 to 11 of the Partial Agreed Statement of Facts filed at the
hearing:
1.
On May 1st, 2000, the late Donald
Mills sold 21,500,000 of the common shares he held in 3748278 Canada Inc. to
100935 Canada Inc. for the purchase price of $11,653,000. At that time, Mr.
Mills was the sole shareholder (either directly or indirectly) and director of
both 37742878 Canada Inc. and 100935 Canada Inc.
2.
100935 Canada Inc. paid and satisfied the
purchase price for the shares by delivering to Mr. Mills a non-interest bearing
demand Promissory Note in the amount of $11,653,000.
3.
100935 Canada Inc. acquired the shares free and
clear of any lien, claim, demand, charge, mortgage, security interest or other
encumbrance.
4.
At the time of the disposition, Mr. Mills was
not dealing at arm’s length with 100935 Canada Inc. and, immediately after the
disposition, 3748278 Canada Inc. was connected to 100935 Canada Inc. pursuant
to subsections 84.1(1) and 186(4) of the Income Tax Act.
5.
Paragraph 84.1(1)(b) applied to the disposition,
deeming 100935 Canada Inc. to have paid and Mr. Mills to have received a
dividend in the amount of $11,222,515 ($11,653,000 minus the cost of the
shares). Mr. Mills reported the dividend in computing his income for the 2000
taxation year pursuant to paragraph 12(1)(j).
6.
Between the years 2000 and 2002, the value of
the assets of 100935 Canada Inc. depreciated significantly.
7.
After Mr. Mills demanded repayment of the
$11,653,000 Promissory Note in October 2002, 100935 Canada Inc. transferred
certain assets to Mr. Mills in partial repayment of the note. At the end of the
2002 taxation year, Mr. Mills considered that the balance of the Promissory
Note still owing was in the amount of $10,588,133.
8.
In filing his Income Tax Return for the 2002
taxation year, Mr. Mills claimed a deduction pursuant to paragraph 20(1)(p) in
the amount of $10,588,133, with respect to the balance owed on the Promissory
Note. Of the total amount, $306,590 was applied to the 2002 taxation year. The
unused balance of the non-capital loss was carried back to the 1999 and 2000
taxation years, in the amounts of $199,950 and $10,081,593 respectively,
pursuant to paragraph 111(1)(a).
9.
Mr. Mills did not carry on any business during the 2000
to 2002 taxation years and more specifically, was not a trader of shares, nor a
lender of money.
10.
Mr. Mills was reassessed on July 4th, 2006
to disallow the paragraph 20(1)(p) deduction.
11.
Mr. Mills did not make an election in his return of
income for the 2002 taxation year to have subsection 50(1) apply in respect of
the Promissory Note.
…
[5]
The Respondent also called
André Dulude, the chartered accountant who advised the late Mr. Mills on the transactions
under appeal. Mr. Dulude gave his evidence in a knowledgeable and candid manner.
No witnesses were called for the Appellant.
[6]
The relevant legislative
provisions are paragraph 84.1(1)(b), paragraph 12(1)(j)
and subparagraph 20(1)(p)(i) of the Act.
[7]
Section 84.1 is an anti-avoidance
provision aimed at preventing corporations from transferring taxable surplus to
connected corporations as a tax-free return of capital.
It is triggered when a taxpayer disposes of shares that it holds in one
corporation to another corporation with which it does not deal at arm's length.
It creates a legal fiction under which the sale of shares that would otherwise give
rise to a capital gain are deemed to be a dividend in an amount calculated by
statutory formula:
84.1: Non-arm's length sale of shares.
(1) Where after May 22, 1985 a taxpayer
resident in Canada (other than a corporation) disposes of shares that are
capital property of the taxpayer (in this section referred to as the
"subject shares") of any class of the capital stock of a corporation
resident in Canada (in this section referred to as the "subject corporation")
to another corporation (in this section referred to as the "purchaser
corporation") with which the taxpayer does not deal at arm's length and,
immediately after the disposition, the subject corporation would be connected
(within the meaning assigned by subsection 186(4) if the references therein to
"payer corporation" and to "particular corporation" were
read as "subject corporation" and "purchaser corporation"
respectively) with the purchaser corporation,
…
(b) for the purposes of this Act, a dividend shall be
deemed to be paid to the taxpayer by the purchaser corporation and received by
the taxpayer from the purchaser corporation at the time of the disposition in
an amount determined by the formula
(A + D) - (E + F)
where
A is the increase, if any, determined
without reference to this section as it applies to the acquisition of the
subject shares, in the paid-up capital in respect of all shares of the capital
stock of the purchaser corporation as a result of the issue of the new shares,
D is the fair market value, immediately
after the disposition, of any consideration (other than the new shares)
received by the taxpayer from the purchaser corporation for the subject shares,
E is the greater of
(i) the paid-up capital, immediately
before the disposition, in respect of the subject shares, and
(ii) subject to paragraphs 84.1(2)(a)
and 84.1(2)(a.1), the adjusted cost base to the taxpayer, immediately
before the disposition, of the subject shares, and
F is the total of all amounts each of
which is an amount required to be deducted by the purchaser corporation under
paragraph 84.1(1)(a) in computing the paid-up capital in respect of any class
of shares of its capital stock by virtue of the acquisition of the subject
shares.
[8]
Paragraph 12(1)(j) requires
the inclusion in income of dividends paid by a corporation resident in Canada
under subdivision h, the statutory home of paragraph 84.1(1)(b):
SECTION 12: Income
inclusions.
(1) There
shall be included in computing the income of a taxpayer for a taxation year as
income from a business or property such of the following amounts as are
applicable:
(j) Dividends
from resident corporations – any amount required by subdivision h to be
included in computing the taxpayers income for the year in respect of a
dividend paid by a corporation resident in Canada on a share of its capital
stock;
[9]
Subparagraph 20(1)(p)(i)
permits the deduction of a “bad debt” from business or property income:
SECTION 20:
Deductions permitted in computing income from business or property.
(1) Notwithstanding
paragraphs 18(1)(a), (b) and (h), in computing a
taxpayer’s income for a taxation year from a business or property, there may be
deducted such of the following amounts as are wholly applicable to that source
or such part of the following amounts as may reasonably be regarded as
applicable thereto:
…
(p) Bad
debts – the total of
(i) all debts owing to the taxpayer that are
established by the taxpayer to have become bad debts in the year and that have
been included in computing the taxpayer’s income for the year or a preceding
taxation year; and
Minister’s Position
[10]
In reassessing the Appellant, the
Minister disallowed a bad debt deduction under subparagraph 20(1)(p)(i)
on the basis that the loss in connection with the promissory note was capital
in nature. The appeal proceeded, however, on the footing that
paragraph 84.1(1)(b) applied to the Appellant’s sale of the shares so as
to convert the proceeds of the disposition from what would otherwise have been
a capital gain into income from property.
[11]
Citing the analysis of the Federal
Court of Appeal in Terrador Investments Ltd. et al v. R.,
counsel for the Respondent submitted that by virtue of paragraph 84.1(1)(b)
and paragraph 12(1)(j), the Appellant was unable to meet the statutory
criteria for a deduction of the unpaid balance of the promissory note as a bad
debt under subparagraph 20(1)(p)(i) of the Act.
[12]
Although the Terrador
Investments case also concerned a bad debt deduction, the transaction
underpinning the taxpayer’s claim arose under subsections 93(1) and 113(1) of
the Act. At paragraphs 5 to 8 of his reasons, Décary, J.A. summarized
the facts and the operation of these provisions:
[5] Both Serin Holdings Ltd (“Serin”)
and Terrador Investments Ltd. ("Terrador") are corporations resident
in Canada. Up to April, 1985, Serin held 100%
of the shares of Serin (U.S.) Holdings Ltd. (“Serin (U.S.)”). Serin wished to
liquidate its Serin (U.S.) assets and in order to do so with the full benefit
of American legislation, it had first to divest itself of at least 20% of the
shares of Serin (U.S.). Therefore, on April 19, 1985, Serin transferred 21% of
the shares of Serin (U.S.) to Terrador and kept the remaining 79%.
[6] On April 24, 1985, Serin
(U.S.) was liquidated. As partial consideration for the sale of all its
properties, Serin (U.S.) received interest bearing promissory notes. At the
time of liquidation Serin (U.S.) distributed the promissory notes with a value
of (U.S.) $1,661,782.00 and cash in the amount of approximately (U.S.) $117,000.00 to Serin and Terrador as liquidation
proceeds in proportion to their shareholdings of Serin (U.S.).
[7] Serin
and Terrador each elected pursuant to subsection 93(1) of the Income Tax Act2
[Footnote 2: L.C.
1970-71-72, c. 63, as. amended.] ("the Act") to deem a
portion of their share of the proceeds of disposition on liquidation to be a
dividend received from Serin (U.S.). The deemed dividend was equal in amount to
the balance of Serin (U.S.)'s “exempt surplus account” as that term is defined
in regulation 5907. Upon liquidation the deemed dividends were included in
computing the income of Serin and Terrador for the 1985 taxation year as
required by subsection 90(1) and paragraph 12(1)(k) of the Act.
[8] In computing their taxable incomes
for the 1985 taxation year, Serin and Terrador each claimed a deduction
pursuant to subsection 113(1) of the Act, as the dividend included in their
income pursuant to subsection 90(1) and paragraph 12(1)(k) was paid out of the “exempt
surplus” of Serin (U.S.).
[13]
When Serin and Terrador were later
unable to collect in full on the promissory notes, they attempted to deduct the
outstanding balance as a bad debt under subparagraph 20(1)(p)(i). The Federal
Court of Appeal dismissed their appeal on the following basis:
[18] Once
a taxpayer has voluntarily elected, pursuant to subsection 93(1), to treat part
of the proceeds of disposition comprised of some cash and of some promissory
notes, as a "deemed dividend received", the cash and parts of the
promissory notes at issue loose their identity "for the purposes of this
Act". When the deemed dividend is included in the taxpayer's income
pursuant to paragraph 12(1)(k), it is included as a "paid" dividend,
not as cash and parts of promissory notes. And it is only as a
"received" dividend that if may afterwards be deducted from the
taxpayer's taxable income pursuant to subsection 113(1).
[19] The
"deemed dividend" being said by the Act to have been "paid"
and "received", it cannot at the same time be a "doubtful
debt" or a "bad debt". What is deemed to have been paid cannot
also be said to be due. The taxpayer cannot have its cake and eat it, too. Once
it elects to treat proceeds of disposition as paid dividends rather than as
cash and promissory notes, the proceeds find their way into its income through
paragraph 12(1)(k). The proceeds of disposition cannot then make their way into
the taxpayer's income as a reserve for doubtful debts nor as bad debts.
Paragraphs 20(1)(l) and (p) of the Act cannot come into play because it cannot be
said that the debts reflected in the promissory notes have not been included as
such in the taxpayer's income.
[20] It
would not only be wrong in law to equate the "deemed dividend" with
the promissory notes, it would also be wrong in fact. The proceeds of
liquidation, in the case at bar, consisted of some cash and of promissory
notes. In its election the taxpayer designated an amount which was less than
the total value of the proceeds. As a result only an unspecified portion of the
cash and promissory notes received were designated as a deemed dividend. The
taxpayer eventually recovered part of the promissory notes. However, as the
taxpayer had designated an amount less than the total value of the proceeds, it
is unclear the extent to which the amounts recovered were from the promissory
notes which were deemed dividends. It is therefore not possible to suggest that
the deemed dividend and the promissory notes are one and the same.
[14]
Following the logic of Terrador
Investments, counsel for the Respondent argued, an amount deemed under the Act to be a “dividend” that
had been “paid to” and “received by” a taxpayer under paragraph 84.1(1)(b)
cannot also be said to have been a “debt” within the meaning of subparagraph
20(1)(p)(i). To be eligible to claim a bad debt under subparagraph
20(1)(p)(i), the Appellant must be able to establish that the amount
included in income in 2000 was a “debt”. This the Appellant could not do since by
virtue of paragraph 84.1(1)(b), what was included in income in 2000 was
deemed to be a “dividend”; hence, its inclusion under paragraph 12(1)(j).
[15]
Finally, in support of the
Minister’s position that the promissory note and the deemed dividend are not,
in law, the same thing, counsel for the Respondent referred to the formula in
paragraph 84.1(1)(b) for the determination of the amount of the
“deemed dividend”, arguing that the value of the promissory note was but one
factor in that calculation. She made the further point that even had the Appellant
not triggered paragraph 84.1(1)(b) and the proceeds of disposition of
the sale of the shares been included in income under subdivision c, what
would have been included in income was the gain realized, not the value of the
promissory note itself.
Appellant’s
Position
[16]
Counsel for the Appellant rejected
this line of reasoning, arguing that Terrador Investments was
distinguishable from the present matter on both the facts and the law.
[17]
First, counsel submitted, the
relevant provisions in each case operate quite differently: in Terrador
Investments, the deeming of the dividend was a matter of election; here, it
was mandatory as soon as the conditions of paragraph 84.1(1)(b) were
satisfied.
[18]
Further, because of the tandem
operation of subsections 93(1) and 113(1), Terrador Investments had
already received a deduction for the amount it was also seeking to claim as a
bad debt. There is no risk of a double deduction in the present matter that
would make the Appellant’s claim offensive on that score. Indeed, counsel submitted,
to accept the Minister’s position would result in an “injustice” as the
Appellant had reported and been taxed on an amount which, in the end, was never
actually received.
[19]
A final and significant distinction,
according to counsel for the Appellant, lay in the fact that the promissory
note was received by the Appellant in full payment of the share purchase price.
In Terrador Investments, the Federal Court of Appeal noted that the
taxpayer had designated an amount less than the total value of the proceeds
from the liquidation of the shares, leading Décary J.A. to conclude that “…
only an unspecified portion of the cash and promissory notes received were
designated as a deemed dividend” and therefore, it was “… not possible to suggest that
the deemed dividend and the promissory notes are one and the same”.
[20]
In the present case, counsel
contended, paragraph 84.1(1)(b) “… says that a dividend is paid … deemed
to have been paid equal to the consideration received. And the consideration
received, of course, was the note”. There being no dispute that the promissory note was
the sole consideration for the shares, the deemed dividend and the promissory
notes were “one and the same”, thus sidestepping the factual difficulties in Terrador
Investments. The full amount of the promissory note having been duly
included in income under paragraph 12(1)(j) and there being no question
that the debtor corporation defaulted on the payment of some $10 million of the
total amount of the promissory note, the outstanding balance ought to be
deductible under subparagraph 20(1)(p)(i).
Analysis
[21]
In my view, the analysis in Terrador
Investments is equally applicable to the Appellant’s circumstances.
[22]
Turning first to matter of
election, while it is true that paragraph 84.1(1)(b) lacks the elective
quality of subsection 93(1), the Appellant’s decision to unleash it was nonetheless
entirely a matter of choice. As mentioned above, paragraph 84.1(1)(b)
is an anti‑avoidance tool normally invoked by the Minister to assess for
amounts stripped out of a non-arm’s length corporation. Here, it was the
Appellant’s decision to trigger its application to produce dividend income for certain
tax planning purposes rather than taking advantage of the rollover provisions.
As Mr. Dulude explained it:
[97] Q.
So, why was it advantageous for him to sell these shares and trigger an 84.1
deemed dividend, as opposed to just rolling them over?
A. I think it was because there was a … the company had
refundable tax on end, so a significant part of corporate tax have been paid,
and there was a significant amount of corporate tax which is called “refundable
tax on end”, and that tax is repaid to the corporation when the corporation
pays a dividend to a shareholder. So, it was … it was advisable to structure
the transaction that way, so that the corporation could get a refund that … it
… of taxes that it had already paid on transactions, on par transactions. And
so, he would pay tax on the dividend, but the company would get a refund of
taxes paid on par transactions, so …
[23]
On cross-examination, Mr. Dulude
provided the following additional clarification:
[99] …
Q. Just a few questions. You … just picking up on the last
point, you say that Mr. Mills did report the amount of the deemed dividend in
computing his income for the 2000 taxation year?
A. Yes,
he did.
[100] Q. Did
he pay full tax on such amount?
A. Yes,
paid the taxes.
[101] Q. The
“party to a wage” concept to which you refer, am I correct that we’re talking
about the provisions of sections 129(1) and 129(3) of the Act, that’s the mechanism
provided under those provisions?
A. Yes,
I think so.
[102] Q. And
the refundable portion that is … that can be obtained by a company as a result
of paying a taxable dividend, does that … all taxes paid by the company or just
a portion, such …
A. Just
a portion.
[103] Q. Just
a portion, as provided under that legislation?
A. Yes.
[104] Q. Now,
in all the transactions that my friend has described, apart from the one that
is at issue before the Court, the rollover that was made in the other transactions
with the numbered company on a full taxable basis, was that challenged in any
way by the Canada Revenue Agency?
A. No.
[24]
While it is correct that once the
Appellant triggered paragraph 84.1(1)(b) by fulfilling the relevant statutory
criteria its operation became mandatory, he was under no obligation to do so.
In that regard, he was in the same position as the taxpayers in Terrador
Investments but once having made their election under subsection 93(1), they
were similarly bound by their choice.
[25]
Had the Appellant not chosen to
convert the capital gain into a deemed dividend, when the debtor corporation
later defaulted on the promissory note, that loss could have been recognized
under the provisions of subdivision c dealing with taxable capital gains
and allowable capital losses. For his own reasons, however, the late Mr. Mills removed
himself from that regime by triggering paragraph 84.1(1)(b). While
doing so may not have been offensive to the Act, the practical result
was to bar the Appellant from recourse to the provisions designed to alleviate
the very difficulties later faced. In these circumstances, to label the result
an injustice is, with respect, a little overstated.
[26]
Turning, then, to counsel’s final
submission, it is not entirely accurate to say that the amount of the deemed
dividend is “equal” to the amount of the promissory note. Paragraph
84.1(1)(b) provides a formula for the calculation of the amount of the
deemed dividend, only one variable of which is “any consideration” received by
the taxpayer from the purchaser corporation for the subject shares. The use of
the word “any” suggests that the legislation is indifferent to the forms that
consideration may take. Depending on the variables in any particular case, the
amount of the deemed dividend might work out to be equal to the consideration
received but that calculation, in itself, would not prevent paragraph 84.1(1)(b)
from converting the gain realized, regardless of its form of payment, into a “deemed
dividend”.
[27]
In the present matter, even
counsel for the Appellant acknowledged that under the formula, the amount of
the promissory note included as consideration under “D” was somewhat reduced by
the subtraction of the adjusted cost base under “E”. Thus, even if I accepted
counsel’s legal characterization of the promissory note, the Appellant would be
no more able than the taxpayers in Terrador Investments to make a
precise factual correspondence between it and the deemed dividend. But in any
case, as I read Terrador Investments, that factual incongruity was merely
supplementary to the legal impossibility of an amount being simultaneously
“paid” and “due”, exactly the difficulty faced by the Appellant in the present
matter.
[28]
To borrow from the analysis of
Décary, J.A., then, once the Appellant voluntarily decided, under paragraph
84.1(1)(b), to treat the promissory note received in absolute payment
for the shares as a “deemed dividend” paid to and received by him, the
promissory note lost its identity “for the purposes of this Act”. Thus excluded
from the capital gains regime of the Act, the promissory note became
relevant only as a factor in the calculation of the value to be ascribed to the
deemed dividend. From this it follows that what was included in income in 2000
under paragraph 12(1)(j) was a dividend, deemed by paragraph 84.1(1)(b)
to have been fully paid, not a “debt” as required by subparagraph 20(1)(p)(i).
In the words of Décary, J.A. above, “What is deemed to have been paid cannot
also be said to be due”.
[29]
The Appellant is thus unable to establish
that the unpaid amount of the promissory note was “a debt owing” to him that
was included in income, an element fundamental to a his claim for a deduction
under subparagraph 20(1)(p)(i). Accordingly, the Appellant is not
entitled to a bad debt deduction under that provision and the appeals of the
1999 to 2002 taxation years are dismissed, with costs to the Respondent.
[30]
In respect of the 2003 taxation
year, at the commencement of the hearing, counsel advised that the parties had
agreed that the Appellant was entitled to accounting fees in his 2003 taxation
year of $95,765 in accordance with paragraphs 12 and 13 of the
Partial Agreed Statement of Facts:
Accounting fees
12. In filing his Income Tax Return for the 2002 taxation
year, Mr. Mills claimed a deduction for accounting fees in the amount of
$133,215 by submitting 4 invoices detailed as follows:
|
Invoice Date
|
Description
|
Amount
|
Total
|
|
14 May 20026
|
- Monthly accounting fees
(January to April 2002)
- Preparation of 2001 tax return
- GST
|
$20,000
$8,000
$1,960
|
$29,960
|
|
28 June 20027
|
- Monthly accounting fees
(November 2001 to May 2002)
- GST
|
$15,000
$1,050
|
$16,050
|
|
4 April 20038
|
- Planning, Research
re: 20(1)(p)
- GST
|
$52,500
$3,675
|
$56,175
|
|
20 April 20039
|
- Preparation of 2002 return for Mr. Mills & spouse
- Monthly accounting fees
(June to December 2002)
- GST
|
$14,000
$15,000
$2,030
|
$31,030
|
GRAND TOTAL: $133,215
6 Invoice of May 14, 2002, Exhibit A-5.
7 Invoice of June 28, 2002, Exhibit A-6.
8 Invoice of April
4, 2003, Exhibit A-7.
9 Invoice of April 20, 2003, Exhibit A-8.
13. In reassessing Mr. Mills for his 2002 taxation year, the
Minister only allowed $37,450 of the $133,215 claimed, as follows:
|
Date Invoice
|
Description
|
Amount
|
Total
|
|
14 May 2002
|
- Monthly accounting fees
(January to
April 2002)
- Preparation of 2001 tax return
- GST
|
$20,000
0
$1,400
|
$21,400
|
|
28 June 2002
|
- Monthly accounting fees
(November 2001 to May 2002)
- GST
|
$15,000
$1,050
|
$16,050
|
|
4 April 2003
|
- Planning, Research
re: 20(1)(p)
- GST
|
0
0
|
0
|
|
20 April 2003
|
- Preparation of 2002 return for Mr. Mills & spouse
- Monthly accounting fees
(June to December 2002)
- GST
|
0
0
0
|
0
|
GRAND TOTAL: $37,450
[31]
The appeal of the 2003 taxation
year is allowed accordingly. Each party shall bear its own costs in respect of
the 2003 appeal.
Signed at Ottawa,
Canada, this 26th day of August, 2010.
“G. A. Sheridan”
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