Finch, J.: —
In December 1980 the plaintiff company, by its principal John Newton, agreed to sell all of the shares which it held (90 per cent of the total) in Fletcher's Ltd., a meat packing and processing company, to the Alberta Pork Producers Marketing Board (“the Pork Board"), for $14,160,000. The defendant Thorne Riddell, a firm of chartered accountants, with whom the defendants Fox and Ramsay were then associated, advised the plaintiffs and their solicitor, John W. Norton, as to how the sale could be structured so as to minimize any capital gains tax payable on the sale proceeds. The defendant Thorne Ernst & Wninney is the successor firm to Thorne Riddell as a result of an amalgamation.
In 1982 Thorne Riddell prepared the plaintiff company's income tax return for its 1982 fiscal year, to reflect the consequences or the sale, and calculated the tax payable by the plaintiffs as a result. Revenue Canada, Taxation, proposed reassessments of the income tax calculated by the defendants. On January 4, 1988, after lengthy negotiations, Revenue Canada reassessed the plaintiff company on the proceeds of the sale. As a result of the reassessment, the plaintiff company was required to pay a further amount of tax as well as interest on unpaid taxes. The plaintiff company incurred expenses in negotiating a settlement of the reassessment with Revenue Canada.
Now, the plaintiff company claims to recover the additional taxes paid, the interest and the costs of representations made, all totalling $940,412.69 from the defendants. The plaintiffs say the defendants were negligent in the advice they gave as to how to structure the sale, and how to allocate the proceeds of the sale. The plaintiffs say the defendants failed to warn them of the risks involved in following its tax plan. They say they are entitled to recover damages suffered as a result of the defendants' negligence.
The defendants deny that they were negligent in any way. They say the sale was structured as it was, at the request of the plaintiffs, on account of business considerations other than tax. And they say that in any event, the plaintiffs have suffered no loss as a result of the defendants' advice.
Events Leading to the Sale
The plaintiff John F. Newton is an accountant by profession. In 1967 he purchased a controlling interest in Fletcher's Ltd. His solicitor at the time, Mr. Brent Kenny, became a minority shareholder in Fletcher's to the extent of eight per cent. In 1976 Mr. Newton acquired Kenny's shares, so that he then owned 100 per cent of the shares in Fletcher's. He transferred ownership of those shares to the plaintiff company.
In 1978 Mr. Ervin Dusik acquired ten per cent of the shares in Fletcher's, and he continued to hold those shares until 1980. Shortly before the plaintiffs agreed to sell their 90 per cent shareholding in Fletcher's to the Pork Board, Dusik sold his ten per cent shareholding to the Pork Board for approximately $450,000.
During the years that the plaintiff company owned the controlling interest in Fletcher's, from 1967 to 1981, that company experienced very substantial growth in size and value. In 1967 when Mr. Newton purchased his shares in Fletcher’s he paid approximately $250,000. The company then had 20 to 25 employees, and one small place of business in Vancouver. When Mr. Newton sold his 90 per cent interest in Fletcher's in 1981 to the Pork Board the sale price was $14,160,000. The company had between 800 and 900 employees, and substantial business operations in Vancouver and in Red Deer, Alberta.
Fletcher's substantial growth, and the consequent increased value of the plaintiff company's shareholdings in Fletcher's, was an important consideration at the time the business was sold to the Pork Board. In Canada, before January 1,1972, capital gains could be realized free of income tax. The Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the 'Act") was amended in 1971 so that after January 1, 1972 one-half of all capital gains realized in Canada by both corporations and individuals became subject to tax. Tax advisors then developed plans, designed to comply with the provisions of the Income Tax Act, by which post-1971 corporate capital gains could be paid out to shareholders without attracting income tax. These plans are sometimes referred to as "capital gains strips". It is the defendant's advice with respect to the disposition of Fletcher's post-1971 capital gains which has given rise to the present dispute.
In June of 1980 the Pork Board acquired an option to purchase Mr. Dusik's ten per cent shareholding in Fletcher's. Dusik remained the registered owner of these shares until December 1980. In that month the Pork Board paid Mr. Dusik about $450,000 to acquire his ten per cent shareholding of Fletcher's. Mr. Dusik was apparently unaware of the laintiffs’ plan to sell their shares at more than three times the price per share that he agreed to accept.
On December 10, 1980 the plaintiff company and the Pork Board executed a letter of intent by which the Pork Board evidenced its intention to purchase all of the plaintiffs' shares in Fletcher's for $14,160,000. The letter of intent provided in part, in paragraph 6, as follows:
On or prior to the closing, the Company (i.e. Fletcher’s) may repurchase its shares or declare and pay dividends equal to its post-1971 retained earnings (which we understand are currently approximately $3,500,000). The purchase price will be reduced by the amount of this dividend or repurchase price payable to you and by any tax cost to the Company resulting therefrom. The Company shall repay all outstanding shareholder loans on or prior to closing.
This letter was drafted by Mr. Norton, as solicitor for the plaintiffs, in conjunction with the solicitors for the Pork Board.
Paragraph 6 was included on the advice of the defendants so that the final agreement could be drawn in the form most advantageous to the plaintiff company from a tax standpoint.
Various drafts of the final agreement were prepared and revised by the plaintiffs’ solicitors, and by solicitors for the Pork Board. The early drafts of the agreement of purchase and sale contained a paragraph in these words:
5. The Vendor may cause the Company prior to the Closing Date to declare and pay dividends which can reasonably be considered to be attributable to income earned by the Company and its subsidiaries after 1971 provided that (a) there are no adverse tax consequences, directly or indirectly, to the Company or the Purchaser; (b) the amount paid is immediately loaned back to the Company payable without interest on the Closing Date; and (c) the Purchaser [sic] Price set forth in paragraph 3 shall be reduced by an amount equal to 90% of the total amount paid by the Company.
In the final draft of the agreement, paragraph 5 was changed so that it read:
5. The Vendor may cause the Company, prior to the Closing Date, to redeem 337 shares held by the Vendor for a total purchase price of Five Million Three Hundred Thousand ($5,300,000.00) Dollars provided that:
(a) such redemption is lawful;
(b) there are no adverse tax consequences, directly or indirectly, to the Company or to the Purchaser;
(c) the amount paid is immediately loaned back to the Company by the Vendor, payable without interest, on the Closing Date; and
(d) the Purchase Price set forth in paragraph 3 shall be reduced by an amount equal to the Purchase Price for the redeemed shares.
The sum of $5.3 million replaced the sum of $3,500,000 on the advice of Thorne Riddell. The larger figure included the sum of $1,300,000, a "lease cancellation payment", as well as additional retained earnings for a part of the year 1980. Inclusion of the lease cancellation payment became a subject of dispute with Revenue Canada, and will be referred to at greater length later in these reasons.
The agreement's final wording was settled upon by the lawyers representing both parties at some time between January 20 and January 23, 1981. The latter is the date upon which the formal agreement was executed by the parties. The effect of this change was to alter the “capital gains strip” mechanism by which post-1971 retained earnings ("safe income") were to be paid out of Fletcher's. The earlier drafts provided for dividends as the means of paying out these earnings. The final draft provided for share redemption by Fletcher's as the means of paying out these retained earnings.
The plaintiffs contend that the change in the agreement was made solely on the defendants' recommendation as the means of best minimizing the impact of income tax to the plaintiffs on the sale proceeds. The plaintiffs contend that this advice was faulty. The plaintiffs say that the defendants never advised them as to the effects of this change for tax purposes, nor as to any risks associated with structuring the sale in this way. The plaintiffs say that the defendants are therefore liable for the additional tax and costs to the plaintiff which result from having chosen to pay out the earnings by way of share redemption.
The defendants maintain that the change in the form of the agreement of purchase and sale was made on the plaintiffs’ instructions, in concert with the Pork Board, because of concern over potential litigation by Mr. Dusik when he became aware of the plaintiffs' sale of their interest in Fletcher's. If the final agreement had provided for payment out of the earnings by way of dividend, the Pork Board, who had already acquired Dusik's ten per cent shareholding, would have become entitled to a dividend of $530,000. This was more than the Pork Board had paid Mr. Dusik for his shares.
The plaintiffs vigorously deny that the change in the method of paying out these retained earnings was in any way related to their concern, or to the Pork Board's concern, over the possibility of litigation by Mr. Dusik. The plaintiffs say they had no concern, and no reason for concern, for the risk of litigation by Dusik.
The defendants say there was clearly a risk of Mr. Dusik suing. The Pork Board had acquired his shares at a very low price. The plaintiffs had not told Mr. Dusik about their negotiations with the Pork Board. As a Director of Fletcher's, Mr. Newton had authorized the transfer of Mr. Dusik's shares to the Pork Board. Mr. Dusik was known to be in difficult financial circumstances.
The defendants say there was every reason to anticipate a claim by the minority shareholder for oppression, and that the risk of such a claim would be increased if the Pork Board received a dividend on his ten per cent shareholding of more than it had paid to acquire it. In hindsight, of course, the risk of a suit by Dusik became a reality: see Dusik v. Newton, 50 B.C.L.R. 321 (B.C.S.C.); var'd (1985), 62 B.C.L.R. 1 (B.C.C.A.).
I am satisfied that the defendant Fox did discuss with Mr. Newton, and with his solicitor Mr. Norton, at the time the wording of the formal agreement was being settled, the concern which both the plaintiffs and the Pork Board had over the very real likelihood of a lawsuit being commenced by Mr. Dusik. The parties to the sale decided that it would not be prudent to pay dividends out of Fletcher's because it would increase the risk of a lawsuit by Mr. Dusik and it would increase the risk of an adverse outcome in the event of such a lawsuit.
I accept the evidence of the defendants Fox and Ramsay that the decision not to dispose of Fletcher's safe income by paying a dividend was a business decision made by the plaintiffs. The plaintiffs’ contention that the defendants made the change on their own initiative without consulting, advising or taking instructions from the plaintiffs is simply not tenable. Using the dividend method for the capital gain strip would have been the usual course for the defendants to recommend in these circumstances. They would not have suggested change from the dividend method as originally contemplated to the share redemption method unless there was some compelling reason to do so. The only reason either party has put forward is the concern of Mr. Newton and of the Pork Board representatives over a potential claim by Mr. Dusik. The plaintiffs offer no other explanation for the last minute change in the document.
I do not accept that a change in the form of this document would have occurred without the plaintiffs’ knowledge and authority.
The agreement of purchase and sale as finally amended was executed by the parties on January 23, 1981, and it was carried out according to its terms. On February 25, 1981 Fletcher's repurchased 337 of its shares from the plaintiff company for $5,300,000 payable without interest, 366 days after demand. The promise of payment was evidenced by a promissory note from Fletcher's to the plaintiff company. On February 27, 1981 the Pork Board purchased the remaining 563 shares from the plaintiff company for $8,860,000.
The repurchase by Fletcher's of the 337 shares resulted in a deemed dividend to the plaintiff in the amount of $5,254,455, by virtue of subsection 84(3) of the Income Tax Act. This deemed dividend arose on the repurchase of the shares on February 25, 1981. The plaintiff company's fiscal year end was anuary 30, so the repurchase on February 25, 1981 occurred in the plaintiff company's 1982 fiscal year (January 31, 1981 to January 30, 982).
Thorne Riddell prepared the plaintiff company's income tax return for the 1982 taxation year. In that return the plaintiff company reported a capital gain on the sale of 563 shares, and it paid the required tax on that capital gain. In that tax return, the plaintiff company took the position that the sum of $5,300,000 received on the repurchase of 337 shares in Fletcher's Ltd. resulted in a deemed dividend under subsection 84(3) of the Income Tax Act, in the amount of $5,254,455. The entire deemed dividend was reported as qualifying for deduction from income in computing the plaintiff company's taxable income under subsection 112(1) of the Income Tax Act. No part of the deemed dividend was reported as being subject to subsection 55(2) of the Income Tax Act.
Revenue Canada subsequently proposed reassessments against the plaintiff company on the following basis:
(a) The safe income (i.e., the post-1971 earnings) of the plaintiff company as computed by Thorne Riddell at $5,254,455 was to be reduced by $1,300,000. This was the amount of a lease cancellation payment previously made by the plaintiff company. Revenue Canada's position was that the lease cancellation payment was an expense allowed by the Income Tax Act and should not be added back in calculating “safe income".
(b) Each issued share of a corporation represents only its proportionate share of the value of the corporation and is therefore entitled only to its proportionate share of any "safe income” on hand.
(c) There is no provision in the law providing for a late filed designation under paragraph 55(5)(f) of the Income Tax Act after a corporation has filed its return for the year in which the transaction(s) took place. Revenue Canada pointed out that the risk of losing the benefits of having "safe income” by an improper designation can be reduced by various means. None of these means was taken by the plaintiff company. If no designation is made under subsection 55(5) the full amount of the dividend and not just the excess is subject to subsection 55(2).
The plaintiff company retained the law firm of Thorsteinsson, Mitchell, Little, O'Keefe & Davidson, tax specialists, to make submissions on its behalf to Revenue Canada. The basic submission made on behalf of the plaintiff company to Revenue Canada was that "the company's accountants have taken the position that the proceeds of the redemption can ‘... reasonably be considered to be attributed to . . . income earned or realized by any corporation after 1971 . . . ' and are therefore excluded from the provisions of section 55".
The tax lawyers made several submissions to, and held meetings with, the Minister of Revenue Canada. Then, on January 4, 1988, a notice of reassessment was issued by Revenue Canada, whereby credit was given for $1,321,295 of safe income. That was the prorated share of $3,920,759, determined to be the total safe income, for 337 shares out of a total of 1,000 issued shares of Fletcher's. This resulted in an additional capital gain of $3,035,011 and an additional taxable capital gain ('/2 thereof) of $1,517,505 to the plaintiff company. Interest was charged on the past due additional tax from March 31, 1982, to the date of reassessment. The plaintiff company paid the tax and interest as assessed.
When the tax system was reformed in 1972, section 55 of the Income Tax Act was enacted. It was worded in general language, and was designed to prevent taxpayers from avoiding tax where by sales, exchanges, or other transactions, a gain on the disposition of property was artificially or unduly reduced.
Revenue Canada developed guidelines for the application of section 55 in the years following its enactment. The guidelines became known as "Robertson's Rules”, so-called for Mr. John Robertson who was then the Director General of the Corporate Ruling Directorate of Revenue Canada, Taxation. There was doubt among tax professionals as to whether section 55 provided sufficient legislative authority to support the application of Robertson's Rules. As a result, the Department of Finance proposed to amend section 55 by adding specific provisions to deal with so-called "capital gain strips".
The proposed amendments were first introduced with the Federal Budget of December 11, 1979. These provisions were not enacted into law. In April 1980 the proposed amendments were re-introduced as a Budget Resolution. The first draft of what is now subsection 55(2) was published on August 28, 1980. Further drafts of the amending legislation were prepared. The last draft was introduced in the House of Commons as Bill C-54, an Act to Amend the Statute Law Relating to Income Tax, in January 13, 1981. These amendments were published on January 15, 1981 in the Canadian Tax Reports, and the amendments were passed into law in February 1981, applicable to transactions after April 21, 1980.
It will be recalled that the plaintiffs’ sale of Fletcher's shares to the Pork Board was agreed to in December 1980, that the formal agreement of purchase of sale was negotiated in December 1980 and January 1981, and that the agreement was finally executed on January 23, 1981, ten days after the amendments to section 55 were first introduced into the House of Commons. The legislation became law late in February 1981, at about the time the parties' agreement was acted upon by them.
It is common ground that the amended law as introduced on January 13, 1981 and enacted in February 1981 applies to the disposition of the plaintiffs’ shares in Fletcher's.
The relevant parts of section 55 as amended provide as follows:
55.(1) Avoidance. —For the purposes of this subdivision, where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatever is that a taxpayer has disposed of property under circumstances such that he may reasonably be considered to have artificially or unduly
(a) reduced the amount of his gain from the disposition,
(b) created a loss from the disposition, or
(c) increased the amount of his loss from the disposition,
the taxpayer's gain or loss, as the case may be, from the disposition of the property shall be computed as if such reduction, creation or increase, as the case may be, had not occurred.
(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 dividend was received, 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)
(a) shall, except for the purpose of computing the corporation's cumulative deduction account (within the meaning assigned by paragraph 125(6) (b)), 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.
(5) Applicable rules.—For the purposes of this section,
(a) the portion of any capital gain attributable to any income that is expected to be earned or realized by a corporation after the time of receipt of dividend referred to in subsection (2) shall, for greater certainty, be deemed to be a portion of the capital gain attributable to anything other than income;
(b) the income earned or realized by a corporation for a period throughout which it was resident in Canada and not a private corporation shall be deemed to be the aggregate of
(i) its income for the period otherwise determined on the assumption that no amounts were deductible by the corporation by virtue of paragraph 20(1)(gg) or section 37.1,
(ii) /2 of the amount, if any, by which the aggregate of the capital gain of the corporation for the period exceeds the aggregate of its capital losses for the period, and
(iii) the aggregate of all amounts each of which is an amount in respect of a business carried on by the corporation at any time in the period, equal to the amount, if any, by which
(A) the aggregate of the eligible capital amounts (within the meaning assigned by subsection 14(1)) in respect of the business that became payable to the corporation in the period exceeds the aggregate of
(B) the cumulative eligible capital of the corporation in respect of the business at the commencement of the period, and
(C) /2 of the aggregate of the eligible capital expenditures in respect of the business that were made or incurred by the corporation in the period;
(c) the income earned or realized by a corporation for a period throughout which it was a private corporation shall be deemed to be its income for that period otherwise determined on the assumption that no amounts were deductible by the corporation by virtue of paragraph 20(1)(gg) or section 37.1;
(d) the income earned or realized by a corporation for a period ending at a time when it was a foreign affiliate of another corporation shall be deemed to be the aggregate of the amount, if any, that would have been deductible by that other corporation at that time by virtue of paragraph 113(1)(a) and the amount, if any, that would have been deductible by that other corporation at that time by virtue of paragraph 113(1)(b) if that other corporation
(i) owned all of the shares of the capital stock of the foreign affiliate immediately before that time,
(ii) had disposed at that time of all of the shares referred to in subparagraph (i) for proceeds of disposition equal to their fair market value at that time, and
(iii) had made an election under subsection 93(1) in respect of the full amount of the proceeds of disposition referred to in subparagraph (ii);
(e) in determining whether two or more persons are dealing with each other at arm's length, persons shall be deemed to be dealing with each other at arm's length and not to be related to each other if one is the brother or sister of the other; and
(f) where a corporation has received a dividend any portion of which is a taxable dividend,
(i) the corporation may designate in its return of income under this Part for the taxation year during which the dividend was received any portion of the taxable dividend to be a separate taxable dividend, and
(ii) the amount, if any, by which the portion of the dividend that is a taxable dividend exceeds the portion designated under subparagraph (i) shall be deemed to be a separate taxable dividend.
It surpasses my imagination that anyone considers language such as this to be capable of an intelligent understanding, or that such language is thought to be capable of application to the events of real life, such as the sale of a business.
Nevertheless, the defendants alon with other tax accountants and tax lawyers, hold themselves out as specialists in advising upon such laws. The defendants owed to the plaintiffs the duty to provide the professional advice which a reasonably well informed and competent tax specialist would have given in 1980, 1981 and 1982 when the defendants rendered their advice on the provisions of section 55.
Allegations of Negligence Against the Defendants
The plaintiffs allege that the defendants were negligent in the following respects.
1. Miscalculation of "safe income"
In calculating the safe income of $5,300,000 for the purposes of the share redemption, Thorne Riddell included the sum of $1,300,000 which represented the amount paid by Fletcher's in 1979 to obtain the cancellation of a lease. In its reassessment, Revenue Canada disallowed this amount as safe income, and reduced the safe income calculation accordingly. The plaintiffs say that the defendants were negligent in including the lease cancellation payment of $1,300,000 in the safe income calculation, and that its inclusion resulted in a reassessment of all safe income claimed.
2. Failure to prorate safe income on a pro rata basis over all of Fletcher's shares
In the sale of the plaintiffs’ shares in Fletcher's to the Pork Board, Thorne Riddell advised the application of 100 per cent of the plaintiff company's safe income to the deemed dividend arising on the repurchase of 337 Fletcher shares. In its reassessment Revenue Canada took the position that it was necessary to allocate the safe income on a pro rata share basis over all 1,000 Fletcher's shares. The plaintiffs say that the defendants were negligent in failing to prorate the safe income as required by Revenue Canada, ana that this failure resulted in the reassessment, late payment of tax, interest charges and legal expense.
3. Failure to make an election under paragraph 55(5)(f) of the Income Tax Act
The plaintiffs say that the defendants were negligent in failing to make an election under paragraph 55(5)(f). They say that if a series of dividends had been paid and if the election procedure under 55(5)(f) had been invoked, the plaintiffs could have avoided the penalty provisions of section 55 even if the safe income had been overstated. The plaintiffs claim they lost the benefit of this provision which can only be invoked at the time the tax return is filed.
The Defendants' Advice
There is no opinion letter from the defendants with advice on how the Income Tax Act would apply to the sale proceeds, or considering alternative methods available for disposition of safe income, or advising on any risks which might accompany any particular form of sale structure. Nor are there any internal memoranda of the defendants dealing with these matters. The only memorandum produced is one prepared by the defendant Ramsay dated December 4, 1980. It does not deal in any way with the share redemption plan which was used as the means of stripping out the capital gains.
The absence of documentary evidence makes it more difficult to ascertain just what advice, if any, was given by the defendants to the plaintiffs on the subject matters for which the plaintiffs now complain. The absence of written advice, from the defendants to the plaintiffs, and the absence of internal memoranda prepared by the defendants is explained in the oral evidence. In January 1981, the defendant Fox had had a professional relationship with Mr. Newton for about ten years. Fox began doing the work of a junior auditor for Fletcher's in the early 1970s. In the mid-1970s he became the Thorne Riddell partner responsible for client contact with Fletcher's. By 1980 he had a close and comfortable working relationship with Mr. Newton.
Mr. Newton was, of course, an accountant by profession. He had at one time worked for Revenue Canada. Although he relied upon Thorne Riddell for tax advice, he was a knowledgeable and tax conscious client. He was able to understand the tax advice he was given, and was able to ask pertinent questions with respect to that advice.
It appears that over the years of their professional relationship, the defendants were accustomed to giving, and the plaintiffs were accustomed to receiving and acting upon, oral advice.
In this case there are particular reasons why the defendants expected to give, and the plaintiffs expected to receive, oral advice. Concern over litigation by Mr. Dusik was a live issue. That is the reason that the plaintiffs and the Pork Board decided at the last minute to change the mechanics of the "safe income" payout from a dividend to a share repurchase. There was considerable pressure from the Pork Board to finalize the sale document by January 23, 1981. The proposed amendments to the Income Tax Act were introduced into the House of Commons on January 13, 1981. There were no decided cases and very little other material to assist in advising on the probable interpretation of those amendments.
Moreover, the plaintiffs regarded any possible tax saving to be achieved to ‘be "found" money. That is to say, when Mr. Newton struck his original oral bargain with the Pork Board on November 20, 1980, he was prepared to accept the purchase price then discussed of $13.5 million even if capital gains tax treatment applied to the whole of the purchase price. He expected a tax bill on the order of $3.5 million because he knew that about one-half of the sale price would be the taxable portion of the capital gain, and he knew that the taxable portion would be subject to tax of approximately 50 per cent. When Mr. Newton agreed to the sale, he made a mental calculation that about 25 per cent of the gross sale price would have to be paid as capital gains tax. In his mind, any reduction of that tax liability would be an unexpected benefit. And, any such tax advantage was but one of many considerations in the completion of this sale.
In these circumstances, and given the time pressures under which the defendants worked, it was well understood by both Mr. Newton and the defendants that written advice was neither expected nor necessary.
Mr. Newton agrees that the tax plan upon which he acted was in fact orally discussed by him with partners of the defendant Thorne Riddell, although he is unsure as to just who that was. These discussions occurred in the days leading up to the completion of the sale documents on January 23, 1981. They were detailed discussions, and Mr. Newton asked questions concerning the plan.
I am satisfied that the discussions concerning the tax plan included a discussion of the risks perceived by the defendants of a reassessment if the plan were followed. Mr. Newton was well aware in a general way of the risks of reassessment. And while he wished to minimize his tax liability if possible, that was not the sole or governing consideration in structuring the sale.
Mr. Ramsay knew about the Bill introduced into the House of Commons on January 13, 1981 to amend section 55 of the Income Tax Act. He studied the amending legislation with respect to its application and impact on the plaintiffs' impending sale. It is, in my view, probable that the plaintiffs were specifically advised of the risk of a reassessment on the inclusion of the $1.3 million lease cancellation fee in the calculation of safe income. It is also probable that the plaintiffs were advised as to the “all or nothing" effect of the safe income calculation under section 55. I accept Ramsay's evidence that he was aware of the all or nothing issue, and that he told Mr. Fox about it. I infer that Mr. Fox told Mr. Newton of this risk, and that while the “all or nothing" treatment of safe income was considered to be a possibility under the Act, the plaintiffs were advised they would be able to negotiate out of a complete disallowance by Revenue Canada of the declared safe income.
As to the question of whether the defendants advised the plaintiffs concerning the allocation of safe income, pro rata by share, as opposed to allocation by shareholders, I conclude that the defendants did not give advice on this subject. Neither Mr. Ramsay nor Mr. Fox perceived the risk that Revenue Canada might take the position that safe income had to be allocated pro rata per share. The question is whether a reasonably competent tax advisor would have perceived and advised upon this risk in December 1980 or January 1981.
The plaintiffs say that the defendants were negligent in failing to advise them to obtain an advance ruling on the proposed sale structure from Revenue Canada, before the agreement was concluded on January 23, 1981. The evidence is that Revenue Canada will give advance rulings in response to specific questions. Depending upon a number of factors, an advance ruling may be obtained as quickly as two weeks from the time the request is made.
In this case, it seems clear that an advance ruling could not have been obtained. At the time the sale agreement was executed on January 23, 1981, the proposed amendments to section 55 were not yet law. Revenue Canada will not give an advance ruling upon the interpretation of legislation which has not yet been enacted. Even if the amendments had become law when first introduced to the House of Commons on January 13, 1981 it would not have been possible to obtain an advance ruling prior to the closing date of January 23, 1981. The defendants were well aware of the possibility of obtaining advance rulings, and of the circumstances in which they could be obtained. In my view, the defendants were not negligent in failing to seek an advance ruling in the circumstances of this case.
The Expert Evidence
I have read, and reread, the opinion evidence adduced on behalf of both parties, and the submissions advanced on the basis of the opinion evidence and the other evidence. There is a conflict between the evidence of the plaintiffs’ and the defendants' experts. I conclude that the opinions put forward by the defendants are more reliable than those of the plaintiffs' experts. The plaintiffs’ experts made a number of errors in their written reports, which they were forced to concede when cross-examined. Those errors are detailed in the defendants' written submission, which sets them out fairly, and I will not repeat them here. I was left with the impression that the plaintiffs’ experts were less than objective in their treatment of the issues.
On the other hand, the experts' evidence adduced on the defendants' behalf impressed me as fair and objective. The two witnesses called by the defendants, Mr. Douglas Proctor, an accountant, and Mr. Randy Zien, a lawyer, did not change their opinions when cross-examined. Their reports and their oral evidence, had a cogency and consistency that persuaded me that it was reliable, and should be preferred to the evidence called on the plaintiffs’ behalf.
1. Calculation of Safe Income
On the issue of how "safe income" should have been calculated by the defendants, Mr. Proctor said this:
1. The computation of the amount of safe income was undertaken with due care and it is my opinion that the addition of the $1.3 million lease cancellation payment to safe income was arguably correct. To this date there have been no legislative changes or court determined clarification of “income earned or realized by any corporation after 1971” and therefore the position taken by the taxpayer in the computation of safe income cannot be said to be incorrect, even at this time.
Mr. Proctor supports this opinion with the following comments, at pages 4 and 5 of his report:
In determining the quantum of safe income, the firm of Thorne Riddell aggregated the income for tax purposes of the company during the relevant period and added to it the amount of $1.3 million which had been deducted for tax purposes in 1979, but which had been capitalized for accounting purposes. This addition of $1.3 million to otherwise determined net income for tax purposes in the computation of safe income may have been contrary to Revenue Canada, Taxation’s interpretation of safe income, but at the time it was done Revenue Canada's position was uncertain. The correct meaning of safe income is still an area of uncertainty although Revenue Canada's position has been clarified over time. The inclusion of the lease cancellation payment in safe income has not to this date been determined to be incorrect. The uncertainty of the language justified taking the position that the $1.3 million lease cancellation payment increased safe income.
. . . and further, at pages 5 and 6:
If the lease cancellation payment had not been added to safe income, the quantum of tax payable would have been due March 31, 1982 and there would have been no opportunity to argue that the $1.3 million was safe income. The position adopted by the taxpayer on the advice of Thorne Riddell had no cost associated with it other than a share of the interest cost for late payment of the taxes due as eventually settled with Revenue Canada.
It is my opinion that including the $1.3 million lease cancellation payment in safe income was a reasonable position to take at the time the calculation was done and still is. The inclusion of the $1.3 million in safe income increased the amount of deemed dividend and decreased the capital gain subject to taxation. The eventual settlement reached with Revenue Canada excluded this amount from safe income and therefore subjected it to taxation, but not in excess of the amount that would have been payable had this position not been adopted. In examining the computation of safe income and the position adopted by the company on the advice of its advisors, it appears the only alternative to adding the $1.3 million lease cancellation payment to safe income would have been to pay the tax at the time of filing the tax returns (March, 1982) and therefore it is difficult to see what additional tax cost has been incurred by the taxpayer.
On the issue of how safe income should be calculated, Mr. Zien said this:
1.1 In January of 1981, subsection 55(2) was not yet law. Its interpretation was only starting to evolve from a concept which was originally based on book or accounting income. In my opinion many tax practitioners in early 1981 would have included the $1,300,000 lease cancellation payment in the calculation of Fletcher's safe income. Based on the information available to the tax community at the time, the inclusion of the lease cancellation payment is understandable and would not have been regarded as an unreasonable thing to do.
And further, at page 16:
4.14 In my opinion including the $1,300,000 lease cancellation payment in the calculation of Fletcher's safe income in early 1981 is something that many tax practitioners would have done. At the very least, it is an understandable inclusion and one which would not have been regarded by the tax community as an unreasonable thing to do in early 1981.
2. Pro-Rating Safe Income
On the issue of whether safe income should have been pro-rated over all of the Fletcher's shares, Mr. Proctor said this:
The allocation of all of the safe income to the portion of the shares redeemed in 1981 was reasonable. It is still uncertain that Revenue Canada, Taxation would maintain or succeed in the position that safe income is per share rather than per shareholder. It is my opinion that the purpose of section 55 is to prevent a shareholder from avoiding tax on a capital gain. Therefore a reasonable allocation of safe income per shareholder should be able to be removed from a corporation as a dividend, without allocating the safe income to each individual share.
He supports this opinion by examples showing that Revenue Canada has been inconsistent on the issue of pro-rating in the application of subsection 55(2). At pages 6 and 7 of his report he says:
Both the letter of September 9, 1981 and the Revenue Canada memorandum on subsection 55(2) are directly opposite to Revenue Canada's public position that safe income must be allocated per share. Both of these Revenue Canada opinions are similar to the facts in the Newton/Fletcher transaction and are inconsistent with the assessment by Revenue Canada and the eventual settlement thereof.
It is my opinion that the position taken by Thorne Riddell in allocating all the safe income to the shares redeemed was at the time a reasonable position to adopt. It is also my opinion that this position has not yet been determined to be incorrect.
Mr. Zien's opinion on the pro rata issue is expressed in this way:
1.2 To this day, it is not clear whether safe income is to be allocated on a "per shareholder” basis as opposed to a "per share" basis. Indeed, for reasons more fully outlined below it does not even appear that Revenue Canada has a consistent position in this regard.
In my opinion, until, at least to November, 1981, this was not even an issue which was being considered by the tax community. Rather, tax practitioners were concerned with the issue as to whether and, if so, how safe income was to be allocated amongst shareholders.
In my opinion the allocation of safe income on a per shareholder rather than a per share basis is something most practitioners would, under the circumstances of the Newton/Fletcher transaction, have done until at least November of 1981 when Revenue Canada began to take a public position in respect of the matter.
This opinion is, in my view, fully supported by his discussion of the issues at pages 17 to 20 of his report.
3. Election under paragraph 55(5)(f):
On the issue whether the defendants should have advised the use of the election procedure provided for in paragraph 55(5)(f) of the Income Tax Act, Mr. Proctor said this at page 3:
The election pursuant to paragraph 55(5)(f) might have been recommended by Thorne Riddell in April of 1982 but the disadvantage to filing the election was to increase the chance of an examination by Revenue Canada. The lack of the election has caused no monetary harm as the settlement accepted by Newton encompassed the division of the dividend as contemplated by this election pursuant to paragraph 55(5)(f).
He discusses the issue further at pages 7 and 8 of his report as follows:
The ability to first designate a dividend as being a separate dividend pursuant to paragraph 55(5)(f) and secondly to make a series of designations on the balance of the dividend was discussed in Mr. Robertson's paper at the 1981 Tax Conference and was known at the time of the preparation of the tax returns for the company in April of 1982.
In April of 1982 it was still doubtful if this designation would be useful as there was a concern that the election would alert Revenue Canada, Taxation to the "questionable dividend”. I have enclosed as Appendix C a copy of a letter I received from Mr. John A. Stacey on May 14, 1981 on Revenue Canada, Taxation's views on Section 55. Mr. Stacey at this time was the senior tax partner for Deloitte Haskins & Sells, having previously spent eight years with Revenue Canada, Taxation. His last position with Revenue Canada was as Director of the Corporate Rulings Division. This correspondence was sent to me as information relevant to teaching the CICA In-Depth Tax Course on Section 55 in June of 1981. I draw your attention to page 4 of the memorandum wherein Mr. Stacey expresses concern as to the usefulness of paragraph 55(5)(f) and his view of Revenue Canada's use of this designation section.
Under paragraph 55(5)(f) a corporation can designate a taxable dividend which it has received to be in fact two separate taxable dividends. Presumably this is to allow a taxpayer which is receiving a dividend which it considers to be 'questionable' under section 55 to have only the questionable portion (i.e., less than 100%) subject to an assessment. As a practical matter it is unlikely that taxpayers who are engaging in a reorganization which may result in 'questionable dividends' to alert Revenue Canada to this fact by an election. Therefore one wonders about the usefulness of this paragraph. The indication from Revenue was that they were going to use this paragraph to allow taxpayers to make what amounts to a retroactive election if, upon audit, Revenue wants to proceed under section 55 with respect to a portion of the dividend. Although the words do not say this, this appears to be their intention.
Mr. Stacey's comments above indicate it was reasonable not to make an election pursuant to paragraph 55(5)(f) in order to minimize the risk of examination of the transaction by Revenue Canada. These comments also substantiate the view that a late filed election to designate pursuant to paragraph 55(5)(f) was contemplated by Revenue Canada at that time.
It is my understanding that in the settlement agreed to by the taxpayer and his advisor the dividend was divided as though an election had been executed and therefore I question why this is an issue as the taxpayer was afforded the effect of an election by settlement with Revenue Canada.
Further, the filing of an election to split the dividend does not reduce the taxpayer's liability. It is only the decision to treat a portion as proceeds of disposition and the payment of the tax that reduces the liability.
On the election issue, Mr. Zien says this at page 3 of his letter:
1.3 The election procedure provided for in paragraph 55(5)(f) of the Act was first introduced to the tax community with the tabling of draft legislation on January 15, 1981. By April of 1982, all members of the tax community would have been aware of this provision.
Nevertheless, it does not appear to me that the filing of such an election would have altered the income tax liability of Newton since it appears that Revenue permitted either the late filing of an election or the same tax treatment as if an election had been made all along.
He concludes on this issue at pages 22 and 23:
If the mechanism had been used in Newton's case, the deemed dividend would presumably have been broken into that many parts as there were contentious items. Assuming the lease cancellation payment to be contentious, one of the parts would have been for $1,300,000. Breaking this part down any further would have had no purpose other than as a subterfuge. In my view it would be clearly inappropriate to do so.
In any event having broken the dividend into parts, Newton presumably would have filed on the basis that the $1,300,000 part constituted a dividend out of safe income, which of course is effectively the same filing position he achieved by not using the paragraph 55(5)(f) election.
At the audit stage and in the first instance, Revenue's challenge to the safe income calculation exposed the entire amount of the dividend to tax. However, in the final analysis and in Newton's case since the Department seems to have ultimately permitted the filing of an election it is difficult to see how Newton was adversely affected.
As I have said, I found the evidence of Mr. Proctor and Mr. Zien to be reliable, and I accept their opinions as expressing the correct inferences to be drawn in the circumstances of this case.
In consultation with their legal advisors, the plaintiffs and the Pork Board decided that the sale of the plaintiffs' shares in Fletcher's should not provide for a capital gains strip by way of dividend. The plaintiffs discussed with the defendants Fox and Ramsay an alternative method for the capital gains strip, namely the share redemption plan which was used. The defendants advised that the safe income should be claimed at $5,300,000, to include the earlier lease cancellation payment of $1,300,000. The defendants did not advise that the distribution of safe income on the share redemption should be pro-rated over all of the outstanding shares in Fletcher's. The defendants did not advise the use of an election procedure under paragraph 55(5)(f). The plaintiffs were aware of the risks that the tax plan might not be accepted by Revenue Canada, and that there was a risk of reassessment. The plaintiffs accepted those risks.
The defendants' advice on the tax plan met the standard to be expected of reasonably competent tax specialists at the time the advice was given. Such advisors would have recommended the inclusion of the lease cancellation payment in the calculation of safe income. Such advisors would not have advised that distribution of safe income would have to be pro-rated per share, as opposed to per shareholder. Such advisors would not nave recommended the use of an election under paragraph 55(5)(f).
The laintiffs’ acceptance of the defendants' advice on the tax plan has not resulted in any loss or extra expense to the plaintiffs. The plaintiffs were successful in negotiating with Revenue Canada the optimum result that could have been achieved. The plaintiffs have not been required to pay any additional tax as a result of the defendants' advice. The plaintiffs have paid interest charges on tax paid late, but there is no loss to the plaintiffs, because they have had the use of the money during the time the tax remained unpaid. The plaintiffs incurred extra expense in negotiating a settlement with Revenue Canada, but the plaintiffs were aware of, and accepted, the risks of a reassessment, and of the costs which might be incurred in negotiating a settlement of any such reassessment.
I conclude that the plaintiffs have failed to prove any negligence on the defendants' part, and have failed to prove any loss resulting from reliance on the defendants' advice.
The action is dismissed with costs.