International Aviation Terminals (Calgary) Ltd. v. MNR, 89 DTC 671, [1990] 1 CTC 2017 (TCC)

Mogan, T.C.J.: —In 1981, the appellant purchased from the treasury of Lormur Investments Ltd. ("Lormur") 286,000 redeemable preference shares for an aggregate price of $286,000. In December 1985, the appellant sold the 286,000 preference shares of Lormur for aggregate proceeds of $2.86 and suffered a net loss of $285,997.14. When computing its income for the taxation year ending December 31, 1985, the appellant deducted an "allowable business investment loss" in the amount of $142,999 with respect to the sale of the Lormur preference shares.

The respondent reduced the amount of the appellant's “allowable business investment loss" from $142,999 to $44,329 on the assumptions that, when the appellant acquired the 286,000 preference shares of Lormur in 1981, (a) the appellant and Lormur were not at arm's length; and (b) the fair market value of the 286,000 preference shares of Lormur did not exceed $88,660. The primary issue in this appeal is whether the appellant and Lormur were at arm's length in March 1981. To resolve this issue, it is necessary to consider the interlocking shareholdings of three individuals and five private corporations and the manner in which money was moved within this group. The individuals and the corporations and their abbreviated names are set out below:

Dennis Heffering (“Heffering”)

Murray White ("White")

William Thudium ("Thudium")

D. Heffering Investments Ltd. ("HIL")

Lormur Investments Ltd. ("Lormur")

W. Thudium Investments Ltd. ("TIL")

International Aviation Terminals Ltd. ("IAT")

International Aviation Terminals (Calgary) Ltd. (“IAT Calgary”)

The appellant will sometimes be referred to herein as “IAT Calgary". Heffering owned 100 per cent of the issued common shares of HIL. White owned 100 per cent of the issued common shares of Lormur. Thudium owned 100 per cent of the issued common shares of TIL. The issued common shares of IAT were owned 50 per cent by Heffering and 50 per cent by White. The issued common shares of IAT Calgary were owned 80 per cent by IAT and 20 per cent by TIL. The above shareholdings are shown in the following diagram [see page 2019]. Heffering, White and Thudium are not related to each other in any way.

IAT was engaged in the design, construction and management of cargo terminals at airports for Vancouver, Edmonton, Saskatoon and Winnipeg. IAT Calgary operated the cargo terminal at the Calgary Airport where Mr. Thudium was the operations manager. The other three corporations HIL, Lormur and TIL were the personal investment corporations of their respective shareholders.

In August 1979, IAT purchased at a price of $1 per share 475,000 preference shares of Lormur and 475,000 preference shares of HIL. And in December 1979, IAT purchased at a price of $1 per share an additional 225,000 preference shares of Lormur and an additional 225,000 preference shares of HIL. Therefore, at the end of 1979, IAT had paid $700,000 to each of Lormur and HIL to acquire 700,000 preference shares in each corporation.

HOLDING Qf CORPORATE SHARES

On March 15, 1981, the appellant paid an aggregate amount of $715,000 to purchase at a price of $1 per share 286,000 preference shares of Lormur, 286,000 preference shares of HIL and 143,000 preference shares of TIL.

The only witness who testified at this appeal was Heffering who first became associated with White in 1959 when IAT was incorporated under a different name. Heffering explained the reason for the incorporation of Lormur and HIL in the following words:

A. The reason was, is the pursuing of outside investment of some of the resources of International Aviation Terminals Limited, because there was a difference in thinking of investment philosophy. I myself being a little more conservative than Mr. White was.

And so it was decided that we would take equal amounts of equity from the parent company and see which—who did the best with it.

Q. Now, in that thinking, was there any element there regarding the risk to I.A.T. if I.A.T. had itself done these investments?

A. No, there wasn't—it was not considered to be part of the I.A.T. Limited, because our thinking was different. The individual major shareholders investment philosophy was basically different.

When IAT Calgary paid $715,000 in March 1981 to acquire preference shares in Lormur, HIL and TIL, Heffering had never seen the financial statements of Lormur but he assumed that White was financially successful because he was involved in several real estate transactions; he had a chauffeur-driven limousine; and he was written up in Maclean's magazine as a big investor and jet-setter. In fact, White's financial success was short-lived. In 1982 or 1983, Heffering learned that White's shares in IAT had been assigned to a bank to secure a loan and it required $1,000,000 to redeem those shares. Heffering personally raised the $1,000,000 and paid off the bank so that he could acquire the shares which White had owned in IAT. The appropriate documents were signed and when the transaction was completed by the end of 1983, Heffering owned 100 per cent of the issued shares in IAT.

By 1985, Lormur was insolvent and the large number of preference shares of Lormur which were owned by IAT and the appellant had little or no value. In 1985, Heffering arranged for one Duane N. Hamm (a stranger) to purchase from the appellant its 286,000 preference shares of Lormur at a price of $2.86; and Mr. Hamm also purchased from IAT its 700,000 preference shares of Lormur at a price of $7. It was the loss of $285,998 suffered by the appellant on its sale of the Lormur preference shares to Mr. Hamm which the appellant claimed as a "business investment loss" within the meaning of paragraph 39(1 )(c) of the Income Tax Act (the Act).

The respondent relies on paragraph 69(1)(a) of the Act to reduce such loss from $285,998 to $88,660. The respondent claims that Lormur was in a deficit position in March 1981; that the 286,000 preference shares of Lormur purchased by the appellant in March 1981 were not worth the $286,000 paid the appellant; and that if Lormur were required to redeem simultaneously in March 1981 the 286,000 preference shares issued to the appellant and the 700,000 preference shares issued in 1979 to IAT, there would be only 31¢ paid in respect of each share. The respondent therefore claims that the fair market value of the 286,000 preference shares in March 1981 was only $88,660 and, if the appellant and Lormur were not at arm's length in March 1981, the appellant's deemed cost of those shares would be only $88,660 under paragraph 69(1)(a) of the Act.

At trial, counsel for both parties were in agreement that if all of the 986,000 Lormur preference shares had been redeemed simultaneously in March 1981, Lormur would have been able to pay only 31¢ in respect of the redemption price of each share; but if the 286,000 Lormur preference shares held by the appellant had been redeemed before the 700,000 Lormur preference shares held by IAT, then Lormur would have been able to pay the full redemption price of $1 in respect of each of the 286,000 shares. As stated above, the primary issue is whether the appellant and Lormur were at arm's length in March 1981. If those parties were not at arm's length, then subsidiary issues arise as to whether there was a priority agreement among Heffering, White and Thudium that preference shares of the holding companies held by the appellant would be redeemed before preference shares held by IAT; and as to whether such a priority agreement would affect the fair market value of the Lormur preference shares.

The appellant and Lormur are not "related persons" under section 251 of the Act and it is therefore a question of fact whether the appellant and Lormur were in March 1981 dealing with each other at arm's length. For the reasons set out below, I have concluded that the appellant and Lormur were not dealing with each other at arm's length when the appellant acquired the 286,000 preference shares of Lormur on March 15, 1981.

There were three significant transactions involving preference shares. On August 20, 1979, IAT paid out $950,000 to purchase 475,000 preference shares of Lormur and 475,000 preference shares of HIL. On December 12, 1979, IAT paid out an additional $450,000 to purchase 225,000 preference shares of Lormur and 225,000 preference shares of HIL. And finally, on March 15, 1981, the appellant paid out $715,000 to purchase 286,000 preference shares of Lormur, 286,000 preference shares of HIL and 143,000 preference shares of TIL. In each transaction, preference shares were purchased from the holding companies of White, Heffering and Thudium in the precise proportion which matched their respective equity ownership of the purchasing corporation. Also, the only preference shares purchased by IAT and the appellant at any time were those shares issued by the same three holding companies of White, Heffering and Thudium.

In substance, the payments of money on August 20, 1979, December 12, 1979 and March 15, 1981 appear to be more a pro rata distribution of shareholders' equity by IAT and the appellant than a prudent investment in preference shares. The following answers by Mr. Heffering under cross- examination indicate that the “investing” was to be done by the individuals through their respective holding companies and not by IAT or the appellant:

Q. What I'm trying to get is how did you say conclude with Mr. White that Lormur Investments Limited needed 286,000 and D. Heffering Investments Limited also needed 286,000 on or about March 1981? How did you come to cause International Aviations Terminal (Calgary) Limited to buy these preferred shares? What was the reason?

A. Well, because there was substantial equity in International Aviations Terminal (Calgary) Limited that had built up and that we were in the second stage of expansion of the Calgary Terminals operation.

Q. So it was something like a refinancing. The equity was available there.

A. Some of the equity.

Q. Yes.

A. Was available.

Q. And you would then probably take some of the equity out, is that it?

A. And we took it out for investment purposes.

Q. So everyone, Mr. White, yourself and Mr. Thudium felt that this was a good time then to take some money out and put it into each of your corporations and do investments?

A. And put it into different investments to follow our own individual investment philosophies.

It is clear from the evidence that the appellant was not "investing" $715,000 on March 15, 1981 when it acquired the preference shares of Lormur, HIL and TIL because the appellant took none of the steps which a genuine investor would ordinarily take like reviewing the balance sheet of the issuer corporation and attempting to compare the capital risk with the rate of return. In the mind of Heffering (and apparently in the minds of White and Thudium), the real investing was done by the three individual shareholders through their respective holding companies (HIL, Lormur and TIL) using the funds which had been obtained from the appellant.

On March 15, 1981, the individual shareholders acted in concert to cause the appellant to distribute $715,000 pro rata in accordance with their personal equity in the appellant by causing the appellant to purchase preference shares in their respective holding companies. In Swiss Bank Corporation et al. v. M.N.R., [1971] C.T.C. 427; 71 D.T.C. 5235, Thurlow, J. (as he then was) quoted from the 1955 decision of the Supreme Court of Canada in M.N.R. v. Sheldon's Engineering Ltd., [1955] S.C.R. 637; [1955] C.T.C. 174; 55 D.T.C. 1110, and he then stated at page 5241:

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 one of them in carrying out particular parts or functions of what the common object involves.

In this appeal, the "mind" that directed the appellant in its purchase of the 715,000 preference shares on March 15, 1981 was the combination of Heffer- ing, White and Thudium and, in that sense, they and their respective holding companies (HIL, Lormur and TIL) cannot be said to be at arm's length with the appellant.

In M.N.R. v. Estate of Thomas Merritt, [1969] 2 Ex. C.R. 51; [1969] C.T.C. 207; 69 D.T.C. 5159, Cattanach, J. quoted a portion of the same passage from the Sheldon's Engineering, supra, decision and went on to state at page 217 (D.T.C. 5165):

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 are 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.

In this appeal, the "terms of the bargain” were a distribution of $715,000 by the appellant in the ratio of 40/40/20 through the purchase of preference shares on the basis that the appellant would not look behind the shares to determine the financial stability of the issuing corporations. Indeed, when counsel can agree that a simultaneous redemption of Lormur's 986,000 preference shares immediately after March 15, 1981 would yield a return of only 31¢ per share, it is difficult to understand how an arm's length purchaser could or would purchase the 286,000 Lormur preference shares which are at the heart of this appeal.

As indicated above, the substance of the transaction on March 15, 1981 appears to be a dividend in the aggregate amount of $715,000 paid by the appellant although the form of the transaction was the purchase of preference shares in Lormur, HIL and TIL. The preference shares of HIL which were held by IAT and the appellant and the preference shares of TIL which were held by the appellant were not redeemed by the issuer corporations or sold by the respective shareholder corporations in 1985 when the preference shares of Lormur were sold for a nominal amount. In November 1988, the common shares of IAT and the appellant were sold in an arm’s length transaction to Western Corporate Enterprises, a public corporation; and the preference shares of HIL and TIL held by IAT and the appellant were redeemed prior to the sale as a condition of the sale. Although the money paid by the appellant and IAT for preference shares in HIL and TIL was "put back" in one sense through the redemption of those preference shares in the fall of 1988, that money returned to Heffering and Thudium immediately through an increase in the value of the common shares of IAT and the appellant resulting from such redemption and through the immediate sale of those common shares.

I am not required to determine the substance of the transaction between the appellant and Lormur on March 15, 1981. 1 do find, however, that the appellant and Lormur did not deal with each other at arm's length on that date.

Having found that the appellant and Lormur did not deal at arm's length at the critical time, I must now consider the subsidiary issues. Mr. Heffering stated that there was a priority agreement among White, Thudium and himself to the effect that, if any preference shares of Lormur or HIL were to be redeemed, those preference shares held by the appellant would be redeemed before any preference shares held by IAT so that the minority investment of Thudium in the appellant (through TIL) would be protected. That kind of priority agreement would be fair and reasonable in the circumstances. I found Mr. Heffering to be a credible witness and I have no difficulty in concluding that such a priority agreement existed among the parties.

In my view, the existence of such a priority agreement would not affect the fair market value of the Lormur preference shares. Failure to comply with the priority agreement could give rise to a cause of action by any party to the agreement who suffered as a result of the non-compliance, but the courts have construed fair market value as the best price which can be obtained in an open market where buyers and sellers are negotiating without pressure. In such a market on March 15, 1985, the Lormur preference shares would not fetch $1 per share and they might not even fetch 31¢ per share. The respondent has assumed, however, that the fair market value of the Lormur preference shares on March 15, 1981 was 31¢ per share; and the assessment under appeal is based on that assumption. I conclude that the assessment is well- founded and the appeal should be dismissed.

Appeal dismissed.