H.T. Hoy Holdings Ltd. v. R., 97 DTC 1180, [1997] 2 CTC 2874 (TCC)

McArthur T.CJ.:

In calculating its income for the 1986, 1987 and 1988 taxation years, the Appellant included amounts of $599,115, $1,039,521 and $669,805, respectively, as deemed dividends in respect of the proceeds it received upon the redemption of certain shares: Deductions were claimed in those amounts, pursuant to subsection 112(1) of the Income Tax Act (the “Act”). Applying subsection 55(2) of the Act the Minister reassessed the Appellant in respect of those taxation years, denying the deductions claimed under subsection 112(1) and adding to the Appellant’s income the amounts of $299,557, $519,760, and $446,537, respectively, pursuant to subsection 55(2).

The issue is whether subsection 55(2) applies to the present circumstances.

Relevant Facts

Prior to July 1983, the Appellant carried on a successful General Motors Automobile Dealership under the name Parkway Chevrolet Oldsmobile Cadillac Inc. (“Parkway”).

For personal reasons H.T. Hoy, the operating mind of the Appellant and Parkway, commenced a series of steps resulting in Pierre Cloutier and the companies he controlled becoming the owner of what had been Parkway. The entire transaction was structured to take advantage of the redemption of shares to trigger subsection 84(3) deemed dividends and the deductions permitted under subsection 112(1).

On July 1, 1983, Parkway sold most of its operating assets to a numbered company later renamed Plaza Chevrolet Oldsmobile Cadillac Inc. (“Plaza”). This transfer of assets was made through the election provisions of subsection 85(1) of the Act. Also on July 1, 1983, Plaza issued Class B, D and E shares to the Appellant.

On July 2, 1983, the Appellant and Les Placements Pierre Cloutier Inc. (“Cloutier Inc.”) entered into a unanimous shareholder agreement (the “agreement”) for the purpose of enabling Cloutier Inc. to become the owner and shareholder of the dealership. Mr. Hoy retained the ownership of the land and buildings from which Plaza operated, charging Plaza an annual rental of $467,000 on a long term lease providing for an escalation of rent. On the same day Plaza issued Class A and C shares to Cloutier Inc. At that time, the Appellant retained 99.88% of the voting rights of Plaza.

The Parkway dealership continued on business under the name Plaza and under the direction of Mr. Cloutier although Mr. Hoy had ultimate control. Plaza was bound by two clauses of its dealership agreement with General Motors of Canada. The first required that Plaza maintain a minimum level of net working capital, set at $800,000. The second was a clause referred to as “paragraph 3”, whereby in the event that Cloutier Inc. failed to remedy a default of any terms of the dealership agreement, thus resulting in its termination, Mr. Hoy was named as the successor for the control and operation of Plaza. The “agreement” also provided for the redemption of the Class B, Class D, Class E, and Class H shares held by the Appellant in Plaza in a certain order and according to various valuation mechanisms.

On January 1, 1984, the Appellant and Parkway were amalgamated, with the Appellant being the continuing corporation. From June 1985 to March 1988, Plaza redeemed all its shares held by the Appellant and paid $3,317,121 in the form of dividends to the Appellant. In particular, the Class B shares were redeemed for a total of $2,315,941. The redemption of the Class B shares forms the basis of the Minister’s reassessment of the Appellant.

Position of the Appellant

The thrust of counsel’s submissions was that the two corporations, the Appellant and Cloutier Inc., were dealing with each other at non-arm’s length, either factually or legally and as such, subsection 55(2) does not apply pursuant to the exceptions in subsections 55(3) and 55(5). Counsel presented three arguments:

(1) Subsection 55(2) does not apply because based on the facts, there was a nonarm’s length relationship between Mr. Hoy and Mr. Cloutier and between the companies which they controlled.

(2) Under the provisions of the Act at law, these companies are all deemed to be related parties and are therefore deemed not to deal at arm’s length.

(3) This is not the kind of income tax paid dollars from annual earnings that should be subject to the provisions of subsection 55(2).

Expanding on these arguments, the Appellant submitted the following:

Factual Non-Arm’s Length Transaction

Subsection 55(3) provides that subsection 55(2) does not apply to a dividend received by a corporation unless the parties were dealing at arm’s length. Messrs. Hoy and Cloutier acted so interdependently that they did not deal at arm’s length and the corporations they controlled were not dealing at arm’s length with each other. Before the series of transactions started and even after they were meant to have ended factually, they did not deal in relation to Plaza at arm’s length.

Mr. Hoy chose Mr. Cloutier to take over his ownership of the dealership over other candidates because Mr. Cloutier was reputed to be a very able young man who, at the age of 27 or 28, had earned a very positive reputation in the industry. Mr. Cloutier was offered the same favourable terms and conditions for Plaza that Mr. Hoy offered his daughter for another adjoining dealership at Parkway that Mr. Hoy owned or controlled.

Mr. Cloutier was to pay for the dealership from profits, a common practice in the takeover of General Motors franchises which is referred to as an “earn-out”. Mr. Hoy continued to give counsel and concessions to Mr. Cloutier even after the shares had been redeemed. There was something more to this than a relationship in which each party is looking out for his own best interests.

During the time that Mr. Hoy and Mr. Cloutier were shareholders of Plaza, Mr. Hoy monitored the management of Plaza, although Mr. Cloutier ran the day-to-day operations. “Paragraph 3” of the dealership agreement between Plaza and General Motors provided that, if Mr. Cloutier did not meet expectations, Mr. Hoy would have had to re-take control of the dealership.

Following the final redemption of the Appellant’s shares, Mr. Hoy’s support of Mr. Cloutier was still necessary. Since Mr. Hoy remained responsible pursuant to “paragraph 3”, he supported Mr. Cloutier with favourable terms, such as lowering Plaza’s monthly rental payments during difficult times in the early 1990s and permitting the subordination of his company’s collateral security on inventory in favor of a bank.

Counsel added that Mr. Hoy was in a position to effectively dictate the terms of the bargain when he approached Mr. Cloutier and it was a great opportunity for Mr. Cloutier, something that he probably would not have dreamed would come his way. He would have been imprudent not to do it and it was achieved through a technique known to General Motors dealers. Mr. Hoy retained the ultimate control of both parties to the agreement of July 1, 1983 until the final shares had been redeemed. The essential purpose of the “agreement” was to enable Cloutier to become owner of the dealership. Mr. Hoy and Mr. Cloutier were not related in the familial sense.

Position of the Appellant applying provisions of the Act

A plain reading of the Act reveals that the Appellant, Cloutier Inc. and Plaza were legally related during the period in question and, therefore, they were not dealing with each other at arm’s length. The Appellant was related to Plaza, pursuant to subparagraph 251(2)(b)(i) of the Act, because it controlled Plaza through a majority ownership of the voting shares. Cloutier Inc. was also related to Plaza, pursuant to paragraph 251(5)(b), because Cloutier Inc. had a right to cause the redemption of the Appellant’s shares and, thus, to control the voting rights of Plaza. Since all three corporations are related to each other, paragraph 251(1)(a) deems that they are not dealing at arm’s length.

Nothing to be Taxed

The Appellant claims that the redemptions were made from after-tax profits, not from gains on shares issued for the sale of assets. Subsection 55(2) is concerned with catching unrealized capital gains, not gains from after-tax profits. The assets included in the July 1, 1983 transfer were essentially just equipment and furniture, and not of the type that has latent capital gains, such as real estate. There was no monetary allocation for goodwill because the Appellant did not control the assignment of the General Motors dealership. Only General Motors had control over the assignment.

The interaction between the redemption provisions and the working capital requirements results in the fact that any increase in the redemption value of the Class B shares was the product of Plaza’s after-tax profitability. Where the working capital requirement was met, accumulated dividends still had to be paid prior to any redemption. The redemptions were dependent upon there being a surplus of working capital, not whether the value of Plaza’s fixed assets appreciated and therefore subsection 55(2) does not apply.

Position of the Respondent

Subsection 55(2) prevents the avoidance of tax on capital gains by taxpayers taking advantage of subsections 84(3) and 112(1) in order to bring about tax-free dividends as opposed to taxable capital gains upon the disposition of shares.

The Appellant structured a series of transactions to convert what otherwise would be taxable capital gains into tax-free dividends. Subsection 55(2) was enacted to prevent this. One must consider the transactions col- lectively as a series and not individually. The series of transactions started in 1983 and were concluded in 1988 with the last share redemption.

From the evidence before the Court one must conclude that the parties to the “agreement” were dealing at arms’ length. Mr. Hoy, directing the Appellant, wanted to sell the business and Mr. Cloutier, directing Cloutier Inc., wanted to purchase it. There were two directing minds. While they had a common objective, being the sale and purchase of the automobile dealership, it was a transaction of approximately $4,000,000 and it is obvious that the vendor sought a high purchase price and the purchaser sought a low purchase price. Both parties had separate, conflicting interests to protect in arriving at a common goal.

One of the results of the series of transactions that occurred with the redemption of the Class B shares was a significant reduction in the capital gain that, but for the subsection 84(3) dividend, would have been realized on the disposition at fair market value of the shares immediately before the dividend. Furthermore, the capital gain that would have been realized for the applicable period could reasonably be considered to be attributable to anything other than the income earned or realized by Plaza for that period. The capital gain that would have otherwise resulted, but for the dividend, is as follows:

The income earned or realized from Plaza’s date of incorporation (June 30, 1983) until the commencement of the series of transactions (July 2, 1983) is equal to nil. Also, the Appellant, being connected to Plaza at the relevant time, was not subject to a Part IV tax on the dividend it received from Plaza, pursuant to subsection 186(4).

Legislation

Subsection 55(2) is an anti-avoidance provision. Subsection 55(3) provides that subsection 55(2) does not apply to parties that are not dealing at arm’s length. It also ensures that of subsection 55(2) does not apply to an internal reorganization of companies where the ownership of the corpora- tion does not change. It is the arm’s length part of subsection 55(3) with which we are concerned in this appeal.

During the relevant period, the applicable sections of the Act read as follows:

55. (2) Deemed proceeds or capital gain - Where a corporation resident in Canada has after April 21, 1980 received a taxable dividend in respect of which it is entitled to a deduction under subsection 112(1) or 138(6) as part of a transaction or event or a series of transactions or events (other than as part of a series of transactions or events that commenced before April 22, 1980), one of the purposes of which (or, in the case of a dividend under subsection 84(3), one of the results of which) was to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at fair market value of any share of capital stock immediately before the dividend and that could reasonably be considered to be attributable to anything other than income earned or realized by any corporation after 1971 and before the transaction or event or the commencement of the series of transactions or events referred to in paragraph (3)(a), notwithstanding any other section of this Act, the amount of the dividend (other than the portion thereof, if any, subject to tax under Part IV that is not refunded as a consequence of the payment of a dividend to a corporation where the payment is part of the series of transactions or events)

(a) shall be deemed not to be a dividend received by the corporation;

(b) where a corporation has disposed of the share, shall be deemed to be proceeds of disposition of the share except to the extent that it is otherwise included in computing such proceeds; and

(c) where a corporation has not disposed of the share, shall be deemed to be a gain of the corporation for the year in which the dividend was received from the disposition of a capital property.

(3) Exception - Subsection (2) does not apply to any dividend received by a corporation,

(a) unless such dividend was received as part of a transaction or event or a series of transactions or events that resulted in

(i) a disposition of any property to a person with whom that corporation was dealing at arm’s length, or

(ii) a significant increase in the interest in any corporation of any person with whom the corporation that received the dividend was dealing at arm’s length; or

(4) Arm’s length dealings — Where it may reasonably be considered that the principal purpose of one or more transactions or events was to cause two or more persons to be related or to not deal with each other at arm’s length, or to cause one corporation to control another corporation, so as to make subsection (2) inapplicable, for the purposes of this section, those persons shall be deemed not to be related or shall be deemed to deal with each other at arm’s length, or the corporation shall be deemed not to control the other corporation, as the case may be. 25]. Arm’s length - (1) For the purposes of this Act,

(a) related persons shall be deemed not to deal with each other at arm’s length; and

(b) it is a question of fact whether persons not related to each other were at a particular time dealing with each other at arm’s length.

(2) Definition of “related persons" - For the purpose of this Act, “related persons”, or persons related to each other, are

(b) a corporation and

(i) a person who controls the corporation, if it is controlled by one person,

For the 1988 taxation year, there are two versions of the Act, the 58th and 59th editions. These versions differ in respect to pararagraph 251(5)(b), the relevance of which is outlined below.

In the 58th edition of the Act, the relevant paragraph is as follows: 251(5) Control by related groups, options, etc. For the purposes of paragraph 125(7)(b), subsection (2) and section 256,

(b) a person who had a right under contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently, to, or to acquire, shares in a corporation, or to control the voting rights of shares in a corporation, shall, except where the contract provided that the right is not exercisable until the death of an individual designated therein, be deemed to have has the same position in relation to the control of the corporation as if he owned the shares; and

In the 59th edition of the Act, the relevant paragraph is as follows:

257(5) Control by related groups, options, etc. For the purposes of paragraph 125(7)(b) and subsection (2),

(b) a person who has a right under a contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently,

(ii) to cause a corporation to redeem, acquire or cancel any shares of its capital stock owned by other shareholders of the corporation shall, except where the right is not exercisable until the death, bankruptcy or permanent disability of an individual designated therein, be deemed to have the same position in relation to the control of the corporation as if the shares were redeemed, acquired or canceled by the corporation; and

Analysis

The majority of the Appellant’s submissions were directed toward establishing that the Appellant and Cloutier Inc. were not dealing at arms’ length. In the reasons that follow, I come to the conclusion that they were dealing with one another at arm’s length.

(A) Were the Appellant and Cloutier Inc. Dealing at Arm s Length?

The following tests are much used in determining whether parties to a transaction are factually dealing at arm’s length:

(a) the existence of a common mind which directs the bargaining for both parties to the transaction,

(b) parties to a transaction acting in concert without separate interests, and

(c) “de facto” control.

(a) The common mind test was discussed in the decision of Cattanach, J. in Minister of National Revenue v. Merritt, (1969), 69 D.T.C. 5159 (Can. Ex. Ct.). At pages 5165-66 he said:

In my view, the basic premise on which this analysis is based is that, where the “mind” by which the bargaining is directed on behalf of one party to a contract is the same “mind” that directs the bargaining on behalf of the other party, it cannot be said that the parties were dealing at arm’s length. In other words where the evidence reveals that the same person was “dictating” the “terms of the bargain” on behalf of both parties, it cannot be said that the parties were dealing at arm’s length.

(b) The acting in concert test illustrates the importance of bargaining between separate parties, each seeking to protect his own independent interest. The Appellant referred the Court to the decision of the Exchequer Court in Swiss Bank Corp. v. Minister of National Revenue, (1971), 71 D.T.C. 5235 (Can. Ex. Ct.). At page 5241 Thurlow J. said:

To this I would add that where several parties -- whether natural persons or corporations or a combination of the two - act in concert, and in the same interest, to direct or dictate the conduct of another, in my opinion the “mind” that directs may be that of the combination as a whole acting in concert or that of any of them in carrying out particular parts or functions of what the common object involves. Moreover as I see it no distinction is to be made for this purpose between persons who act for themselves in exercising control over another and those who, however numerous, act through a representative. On the other hand if one of several parties involved in a transaction acts in or represents a different interest from the others the fact that the common purpose may be to so direct the acts of another as to achieve a particular result will not by itself serve to disqual- ify the transaction as one between parties dealing at arm’s length. The Sheldon’s Engineering case, 1955 S.C.R. 637 [55 DTC 1110], as I see it, is an instance of this.

(c) With reference to the third test it may be noted that the existence of an arm’s length relationship is excluded when one of the parties to the transaction under review has de facto control of the other. In this regard reference may be made to the decision of the Federal Court of Appeal in Robson Leather Co. v. Minister of National Revenue, (1977), 77 D.T.C. 5106 (Fed. C.A.).

I will apply these tests to the present facts. The Appellant had the burden of establishing that arm’s length bargaining and conduct was not present during the transfer of control of Plaza from Mr. Hoy to Mr. Cloutier. No evidence was given by anyone who had advised the parties to this transaction, such as accountants or lawyers. The only evidence adduced was from Mr. Hoy who stated that he wanted to sell the dealership and found a willing and very capable purchaser in Mr. Cloutier. Common sense leads me to conclude that the parties were price-sensitive. Of importance in establishing that the vendor and purchaser dealt with each other at arm’s length is of course the fact that Mr. Cloutier did not have to purchase Plaza nor did Mr. Hoy have to sell to him. Each party had his or its own individual needs.

Mr. Hoy did not make all of the decisions for both parties. While both wanted to make money, Mr. Hoy wanted to sell the automobile business and Mr. Cloutier wanted to purchase it. No one was obligated to act. Each participant was looking after his or its own interests while having a common goal.

While Mr. Hoy may have offered favorable terms to Mr. Cloutier, one cannot conclude from this that Mr. Hoy directed the bargaining of the terms on behalf of both parties. There was no reason for Mr. Cloutier to have agreed to terms which were inopportune to him. Messrs. Hoy and Cloutier are very able businessmen who are not related to each other in a familial way. One was at the end of a successful career and the other beginning one. Mr. Cloutier was under no obligation to accept the terms of the “agreement” which obviously resulted from independent bargaining. They were not acting in concert. The transaction was not unilaterally imposed upon Mr. Cloutier.

In providing concessions and business advice to Mr. Cloutier and Plaza, Mr. Hoy’s course of conduct was not inconsistent with that of a normal arm’s length business relationship. The existence of a common goal should not be equated with having a common interest. Although Mr. Hoy and Mr. Cloutier shared a common goal in seeking to further the success of Plaza in order to finance the redemption of shares, distinct interests were to be served in so doing. Mr. Hoy sought to divest himself of the dealership and Mr. Cloutier sought to attain full ownership.

It is not uncommon for concessions to be made in business dealings, particularly in circumstances such as these, where one party has an interest in the continued financial well-being of another. While Mr. Hoy still controlled the Appellant, he remained bound by “paragraph 3”of the agreement. Following the divestiture of his ownership share, he continued to have a financial stake through the leasing of the premises while still remaining bound by “paragraph 3”. Therefore, Mr. Cloutier’s success was in the best interest of Mr. Hoy. Based on the facts one must conclude that the Appellant and Cloutier Inc. dealt at arm’s length.

There is insufficient evidence before the Court to conclude that the actions of the Appellant and Cloutier Inc. in negotiating the share sale transaction were governed by anything but their respective perceptions of their own self-interest. The fact that the tax savings potentially accruing to the Appellant as a consequence of the sale, formed the boundaries within which the sale price might be negotiated, does not suggest that the Appellant and Cloutier Inc. acted in concert. Buyer and seller do not act in concert simply because the agreement which they seek to achieve can be expected to benefit both.

In the present case the Appellant’s shares were redeemed by Plaza in a gradual and chronological manner, as dictated by the terms of the “agreement”. Until all shares were redeemed, Mr. Hoy had the right to receive $40,000 in expenses and was given the use of two cars. Both these advantages were withdrawn when he ceased being a director of Plaza.

While it is not determinative of my decision, I note that no evidence was given to corroborate the self-serving evidence of Mr. Hoy. The question of whether the impugned transaction was conducted at arm’s length is the substantive issue before this Court. Neither Mr. Cloutier nor any of his advisers regarding this transaction were made available to corroborate Mr. Hoy’s evidence. It strains one’s common sense not to conclude that such evidence may have adversely affected Mr. Hoy’s cause.

Were the Appellant and Cloutier Inc. Legally Related Persons?

In the event this Court found that the parties were factually dealing at arm’s length, the Appellant submitted, in the alternative, that pursuant to paragraph 251(5)(b) of the Act they are deemed at law to be related persons and, thus, they were dealing at non-arm’s length. The relevant section was amended in 1988 to include in subparagraph 251(5)(&)(ii). Both are reproduced earlier in these reasons.

The Appellant submitted that the amended 59th version of the Act applies to the present appeals. I accept the argument of the Respondent that the 58th version of the Act is the relevant one. In any event, I do not believe that either version assists the Appellant’s position. Immediately after the 59th version, being paragraphs 251(5)(a), (b) and (c), is the history of this legislation which reads in part as follows:

That portion of subsec. 251(5) preceding para. (c) substituted by 1988, c. 55, subsec. 190(1) applicable

(a) for taxation years commencing after 1988, and

I interpret this to mean that the application of the 59th edition commences in 1989. The present appeals are for the 1986, 1987 and 1988 taxation years. Applying the earlier edition to the present appeal, I find the Appellant’s argument fails. Paragraph 251(5)(b) includes the words “a person who has a right under a contract ... (i) to acquire shares in a corporation...”. Cloutier Inc. did not have an unrestricted right under contract to acquire the Appellant’s shares in Plaza. It had a right of redemption under a formula contained in the “agreement”. The majority of voting shares of Plaza were not turned over to Cloutier Inc. until all of the shares had been redeemed. The “agreement” contained a mandatory redemption clause. The redemption was contractual and in no way permitted Cloutier Inc. to exercise a redemption arbitrarily. Thus, Cloutier Inc. did not have the right to acquire the shares of the Appellant in a manner that would meet the requirements of subsection 251(5).

In addition, subsection 55(4) would apply to negate a finding that Plaza and Cloutier Inc. are deemed related pursuant to the interconnecting paragraphs 251(l)(a), 251(5)(b) and subparagraph 251(2)(t)(i). Subsection 55(4) reads as follows:

Where it may reasonably be considered that the principal purpose of one or more transactions or events was to cause two or more persons to be related or to not deal with each other at arm’s length, or to cause one corporation to control another corporation, so as to make subsection (2) inapplicable, for the purposes of this section, those persons shall be deemed not to be related or shall be deemed to deal with each other at arm’s length or the corporation shall be deemed not to control the other corporation, as the case may be.

Mr. Hoy continued to exercise full voting control over Plaza until the final redemption took place. What would otherwise be an arm’s length sale of shares, either as a single transaction or as a series of transactions over time, had been carefully structured so as to cause the parties to be related over the course of the series. Although the redemption mechanism was structured so as to ensure compliance with the working capital requirement set by General Motors, there is no reason why this could not have been achieved through a direct sale of shares by the Appellant to Cloutier Inc. I conclude that the share redemption was structured to circumvent the application of subsection 55(2).

Does Subsection 55(2) apply to the Redemption of the Class B Shares Held by the Appellant?

The parties have made submissions on the issue of the timing of subsection 55(2), particularly as to whether the subsection applies at the end of an individual transaction or solely at the end of a series of transactions. The subsection clearly states that it applies to taxable dividends that are entitled to a deduction under subsections 112(1) or 138(6) and that are part of a transaction or a series of transactions that had a purpose or effect of reducing the capital gain that, but for the dividend, would have resulted. In the present case, the facts are clear that there was a series of transactions which was aimed at gradually reducing Mr. Hoy’s holdings in Plaza while gradually increasing Mr. Cloutier’s ownership stake through the redemptions of the shares in Plaza held by the Appellant. That series began on July 2, 1983, when Cloutier Inc. subscribed to shares of Plaza. The share redemptions are not to be considered individually but taken as one at the conclusion of the series of transactions. Sarchuk J., in 454538 Ontario Ltd. v. Minister of National Revenue, (1993), 93 D.T.C. 427 (T.C.C.), stated at page 431:

...it seems reasonable to conclude that in order for the events to form part of a series they must follow each other in time and must somehow be logically or reasonably connected to one another.

This reasoning can be applied to the present facts and leads one to the conclusion that subsection 55(2) applies at the end of the series of redemptions in 1988.

As previously stated, subsection 55(2) is aimed at preventing the avoidance of tax on what would otherwise be a capital gain where an inter-corporate dividend is issued. Subsection 84(3) deems that upon a corporation’s redemption of its capital stock, the corporation is deemed to have paid a dividend at that time. Subsection 112(1) permits a corporation to deduct an amount equal to any taxable dividends received from a taxable Canadian corporation. Subsection 55(2), in turn, catches transactions where subsections 84(3) and 112(1) would otherwise apply, treating what would normally be a tax-free inter-corporate dividend as a capital gain.

The Appellant argued that subsection 55(2) is not concerned with gains arising from after-tax profits but rather, it is meant to catch unrealized capital gains arising from the appreciation of fixed assets. I disagree. The source of the gain is irrelevant, unless it could reasonably be considered to be attributable to income earned by any corporation between 1971 and the time that the transaction or series of transactions commence. In this instance that time is July 1983. The Appellant conceded that Plaza earned no income from the time of its incorporation on June 30, 1983 to July 2, 1983.

On July 1, 1983, Parkway sold most of its operating assets to Plaza for a total value of $4,864,846.34. Subsequently, the Appellant and Cloutier Inc. subscribed to shares of Plaza for a total consideration of $800,000, which enabled Plaza to meet the working capital requirements set by General Motors. At that time, Class B, Class D and Class E shares were issued to the Appellant. The Class D and Class E shares held by the Appellant were later redeemed for an amount equal to their paid-up capital. The Class B shares held by the Appellant, meanwhile, were redeemed between March 21, 1986, and March 17, 1988, for a total consideration of $2,315,941, resulting in a net gain of $2,308,441.

The redemption mechanism was not essential if the Appellant’s goals were as stated, namely to conduct a gradual earn-out which would enable Cloutier Inc. to assume ownership of Plaza at a rate which it could afford while conforming to General Motors working capital requirements. Similar ends could have been met if Cloutier Inc. simply bought the Appellant’s shares in Plaza over a gradual period, whenever it could afford to do so. A sale of shares, however, would have resulted in capital gains which would have been taxable in the hands of the Appellant, in the amounts of $599,115 in 1986, $1,039,521 in 1987 and $669,805 in 1988. The Appellant chose a route which would allow it to divest itself of its shares in Plaza by receiving tax-free dividends. I find that the Minister correctly applied subsection 55(2) which is designed to capture transactions such as in this case and, as such, prevent avoidance of taxable capital gains. The appeals are dismissed with costs.

Appeal dismissed.