Lamarre Proulx J.T.C.C.:—This is an appeal for the taxation year ending on January 31, 1989.
The issue is whether there was a disposition of shares within the mean- ing of subsection 54(c) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") when the appellant transferred the ownership of its shares to a lender on August 18, 1988, with an option to repurchase at a price different from the transfer price, at the time of a loan made to a subsidiary, or whether this transfer of property is included in the exception described in subparagraph 54(c)(iv) of the Act because the shares were transferred solely for the purpose of securing a loan, in which case the transfer of property is not a disposition of property.
The appellant became owner of all the common shares of Les Entreprises Jean Mercier Ltée ("Les Entreprises") in two stages, in 1981 and 1987, for a total amount of $150,000. In 1988 Les Entreprises, which needed a contribution of capital, obtained a loan of $300,000 from 2622-6233 Québec Inc. ("2622"). This loan was made directly to the appellant’s subsidiary but the appellant had to agree to transfer 50 per cent of the common shares held by it in Les Entreprises. It is this transfer which is at issue here.
The transfer was made pursuant to an agreement concluded on August 18, 1988. The agreement is short and as it is central to solution of the dispute I reproduce it in full.
AGREEMENT CONCLUDED AUGUST 18, 1988
BETWEEN: 106443 CANADA LTEE, having its head office at 12272, rue April, Pointe-aux-Trembles, province of Quebec,
AND: 2622-6233 QUÉBEC INC., a corporation legally incorporated, with its head office at 625, ouest, boul. René Lévesque, suite 800, Montréal, Quebec, represented herein by Mr. George Weber;
WHEREAS 2622 has made a loan of $300,000 to Les Entreprises Jean Mercier Ltée (hereinafter the company).
WHEREAS in consideration of this loan to the company 106 agrees, on the conditions hereinafter stated, to transfer 50 per cent of the Class A shares held by it in the capital stock of Les Entreprises Jean Mercier Ltée.
THE PARTIES HAVE AGREED AS FOLLOWS:
1. The preamble shall be part of this agreement.
2. 106 hereby assigns and transfers to 2622, for $1, 50 per cent of the Class A shares held by it in the capital stock of the company.
3. The said shares are deposited in trust with the trustee Daniel Kochenburger, attorney, 625 ouest, boul. René Lévesque, suite 800, Montréal, Quebec.
4. These shares may be repurchased at the book value once the following conditions are met:
(a) the capital and interest of the loan made to the company by 106 are repaid or a release obtained therefor;
(b) the capital and interest of the loan made to the company by 2622 are repaid or a release obtained therefor.
5. The parties agree that authorizations for the transfers will be obtained and the secretary instructed to issue the certificates accordingly and to make entries in the register.
6. The trustee shall not transfer the shares or endorse one or more of the certificates representing the shares held by him in trust without the consent of 2622 and 106.
7. As long as 2622 is owner of the shares so transferred it shall receive the dividends declared, if any.
SIGNED BY THE PARTIES AT MONTREAL ON AUGUST 18, 1988. By: 2622-6233 QUÉBEC INC. By: 106443 CANADA LTÉE
Mr. Jean-Pierre Mercier and Mr. George Weber testified for the appellant. They had never met before 1988. They were introduced by their mutual accountant. Mr. Weber stated that the loan looked to him like a good investment. He and two other partners each loaned $100,000 to 2622, making a total of $300,000, and this amount was loaned to Les Entreprises by 2622.
There was no explanation by the witnesses as to why the agreement provided for a transfer at $1 and repurchase at the book value. From certain comments made at the hearing it would appear that this was a last-minute inducement. 2622 did not intervene in the management of Les Entreprises but its shareholders took part in a few meetings with the Les Entreprises bankers. The latter company went into bankruptcy in 1992.
In view of this bankruptcy the Minister of National Revenue (the "Minister") is not disputing that the appellant is entitled to a business investment loss in accordance with paragraph 39(1 )(c) of the Act in 1992. The appellant is asking that this loss be included in calculating its income for the year at issue, if it is entitled to it.
Counsel for the appellant maintained that the transfer of the shares was genuine: they were not transferred solely as security for the loan. He argued that in a transfer of property as security for a loan the transferor recovers the thing transferred when the loan is repaid, without having to repurchase it. He further pointed out that in the instant agreement the repurchase price is different from the price at which the lender acquired the thing, which makes it even more different from the usual legal form of a transfer as security.
The agreement provided that the shares would be transferred to the lender (the transferee) for $1 and could be repurchased by the appellant at the book value when two loans had been repaid, that of 2622 and an earlier loan obtained by the appellant in 1987. Counsel for the appellant maintained that the effect of this requirement that the two loans be repaid was to increase the book value and that repurchase at a price greater than the disposition price could not be regarded as the return of property used as security.
Counsel for the respondent argued, in reliance on the wording of the second whereas clause in the agreement and on the purpose of the agreement, that the transfer of shares was made only as security for the loan, that the situation is one to which paragraph 54(c)(iv) of the Act applies and that accordingly there was no disposition of the shares.
Paragraph 54(c)(iv) of the Act provides that a disposition of property does not include:
(iv) any transfer of property for the purpose only of securing a debt or a loan, or any transfer by a creditor for the purpose only of returning property that had been used as security for a debt or a loan....
For the purposes of this case and in order to determine the correct application of paragraph 54(c)(iv), the Court must consider the legal position of the transferor, that of the transferee and the nature of the legal act which transferred the ownership.
The transferor must not have the intention of absolutely giving up ownership to the property transferred. He must retain the power of recovery. It must be possible to infer from the circumstances of the transfer of ownership that the transferor’s intention was not to give up the ownership of property and that he only gave it up temporarily and in order to provide security for a loan.
In the instant case it should be noted regarding the transferor that the shares were given to a trustee who could not sell them without the consent of 2622 and the transferor. However, it was 2622 which was entitled to the dividends declared. However, the appellant retained the right to repurchase the shares. The provisions of the share transfer agreement thus do not indicate an intention to make an absolute disposition of them. They indicate an intention to retain some measure of ownership and be able to recover ownership completely once certain conditions have been met.
The intention of the transferee also must not be to absolutely acquire the property, and in my opinion the provisions of the agreement do not indicate such an intent either.
However, the paragraph speaks of the return ("restitution") by the creditor of the property transferred as security. It should be noted that the word used in the English version is "return". Can such a return encompass a sale at a price different from that of the acquisition price? It may seem surprising at first glance that the resale by the lender at their book value of shares purchased for $1 could be regarded as a return.
However, if we analyse the legal nature of this transfer with an option to repurchase at a price different from the disposition price, it would seem clear that this is a sale with a right of redemption as described in arts. 1546 et seq. of the Civil Code of Lower Canada.
In his Traité de droit civil du Québec, vol. II, L. Faribault says the following at heading 395, page 366:
It frequently happens that the parties will make use of a sale with a right of redemption to secure the repayment of a loan.
In heading 401, page 369 of the same Traité it is indicated that the redemption price is often the same as the selling price, but there is nothing to prevent its being different.
A sale with a right of redemption is a sale on a resolutory condition in which the seller retains a real right in the thing.
We feel that the seller with a right of redemption remains owner of the thing sold on a suspensive condition and that the buyer with a right of redemption becomes owner subject to a resolutory condition. Contrary to the opinion stated by Pothier, the seller with a right of redemption thus retains a real right in the thing, a jus in re [Traité de droit civil du Québec, vol. II, L.Faribault, page 365]
In his article entitled "Précis sur la vente" contained in the digest entitled La réforme du Code civil, Obligations, Contrats nommés, Les Presses de F Université Laval, page 365, Pierre Gabriel Jobin says the following at 513:
A sale with a right of redemption, now known as a sale with an option to repurchase, is less used now than it was formerly, especially at times when the lending of money at interest was prohibited or severely restricted: at those times the sale with a right of redemption was used to disguise a loan of money....
The Office de révision recommended that no provision be adopted on _ sales with a right of redemption, as it had recommended the establishment of a general presumption of a hypothec which would have met the objectives of protection generally sought through a sale with a right of redemption used as security for a loan....
In the same series on La réforme du Code civil du Québec, dealing in particular with priorities and hypothecs, volume 3, page 9, Louis Payette in his article entitled Des Priorités et des Hypothèques at page 58 also notes that sales with an option to repurchase may be used to provide security for a loan.
As we have just seen a sale with a right of redemption is a legal act occurring frequently in connection with the security for a loan. The fact that the repurchase price is different from the transfer price does not alter the purpose for which this transfer or sale with a right of redemption was made. The transferor retains over the thing transferred rights which are consistent with the legal nature of a security for a loan.
When the borrower returns the property at a price higher than the acquisition price, there will also be no disposition and the difference between the amounts in my opinion will constitute additional income from the money loaned.
The purpose of paragraph 54(c)(iv) is to state that what would otherwise be a disposition or transfer is not one when the transfer is made solely for the purpose of securing the repayment of a debt and not so as to absolutely give up the ownership of property.
In the circumstances of the instant case it seems quite clear to me that the appellant’s shares were transferred as security for a loan and not to make a final transfer, and the legal method used, namely a sale with an option to repurchase, is one that can be used for this purpose.
The appeal is accordingly dismissed with costs.