Date: 19980731
Docket: 96-588-IT-G
BETWEEN:
JEAN-LUC BIGRAS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
P. R. DUSSAULT, J.T.C.C.
[1] The appellant is appealing an assessment made on July 4,
1994 in respect of his 1990 taxation year. By this assessment,
the Minister of National Revenue (the "Minister")
disallowed, with respect to a gain which resulted from a sale of
shares occurring in 1988 but a part of which was not declared
until 1990 as a reserve claimed the preceding year, the capital
gains deduction provided for under section 110.6 of the Income
Tax Act (the "Act").
[2] The deduction was disallowed on the ground that the
anti-avoidance provision of subsection 245(1.1) applies in
this instance. This provision, which was applicable to a series
of transactions or events commencing after
November 21, 1985, has since been repealed and replaced
by the new general anti-avoidance provision of section 245
of the Act. Subsection 245(1.1) was applicable to
transactions that were part of a series of transactions
commencing before September 13, 1988 and ending before
1989.[1] During the
period in question, subsection 245(1.1) of the Act read as
follows:
(1.1) Idem. Where it may reasonably be considered that
one of the purposes of a series of transactions or events is that
an individual convert into a capital gain from the disposition of
property an amount that would
(a) but for one or more of such transactions or events
in the series, or
(b) on a disposition by him of property in respect of
which the property is a substituted property
otherwise have been received by the individual and included in
computing his income under paragraph 3(a), no amount shall
be deducted by the individual under section 110.6 in respect of
that capital gain.
[3] In the amended Reply to the Notice of Appeal, the
respondent further submits that the appellant is not entitled to
the deduction under section 110.6 of the Act because the
sale of the shares produced business income and not a capital
gain, as, according to the respondent, the appellant acquired the
shares for the purpose of immediately reselling them at a
profit.
[4] Counsel for the parties submitted a partial agreement on
the facts and documentary evidence but reserved the right to
present additional evidence not inconsistent with the terms of
the agreement. The facts agreed upon are as follows:
[TRANSLATION]
1. Until June 15, 1988, the appellant was the sole shareholder
of Les Entreprises Jean-Luc Bigras Ltée (hereinafter
"JLB Ltée").
2. JLB Ltée was incorporated in 1980 and its business
thereafter consisted in the purchase and sale of land.
3. The only issued and outstanding shares of JLB Ltée
were 100 common shares held by the appellant since the
incorporation of JLB Ltée. Each of these shares was a
qualified small business corporation share as defined in
subsection 110.6(1) of the Income Tax Act
(hereinafter the "Act") R.S.C. 1985 (5th
Supp.).
4. The appellant's paid-up capital and adjusted cost
base (hereinafter the "ACB") for each of the said JLB
Ltée common shares was $1.
5. On November 16, 1987, the appellant received from third
parties an offer to purchase with respect to all of the shares of
JLB Ltée or of any other company that might own certain
land belonging to JLB Ltée and described in the said offer
(hereinafter the "Land").
- See document at tab 49, Volume II, which for reference
purposes is designated as "C-49".
6. The Land represented at least 80% of the value of the JLB
Ltée land inventory at the time of the said offer.
7. The initial purchase offer was $400,000 with a price of
$422,500 finally being agreed upon on November 17, 1987.
8. The appellant, through his accountant, Michel
Désilets, C.A., consulted Jacques Pontbriand, C.A.,
M.Fisc., to review the tax aspects of the offer to purchase
described in paragraph 5 above.
9. On April 15, 1988, Jacques Pontbriand, C.A., M.Fisc.,
completed his review by submitting a written report.
- See document at tab 52, Volume III, which for reference
purposes is designated as "C-52".
10. On May 18, 1988, 161978 Canada Inc. (hereinafter
"161978 Inc.") was incorporated and issued the
following capital stock:
a. 10 Class A voting and participating shares to the
appellant; and
b. 90 Class D voting and non-participating shares to JLB
Ltée.
11. The said shares of 161878 [sic] Inc. had an ACB and
paid-up capital of $1 per share.
12. On May 18, 1988, 161979 Canada Inc. (hereinafter
"161979 Inc.") was incorporated and issued the
following capital stock:
(a) 12 Class A voting and participating shares to the
appellant; and
(b) 110 Class D voting and non-participating shares to
161978 Inc.
13. The said shares of 161979 Inc. had an ACB and
paid-up capital of $1 per share.
14. On June 16, 1988, the following transactions were
successively carried out:
(a) JLB Ltée sold some of the Land it owned to
161978 Inc. for $422,500. This sale price was paid by means
of a $22,500 cash payment and the issuing of a
non-interest-bearing note in the amount of $400,000
to the order of JLB Ltée., payable on demand on
May 1, 1991;
- See document at tab 6, Volume I, which for reference
purposes is designated as "C-6".
(b) 161978 Inc. sold the Land to 161979 Inc. for $422,500.
This sale price was paid by the issuing of a
non-interest-bearing note in the amount of $422,500 to the
order of 161978 Inc., payable on demand;
- See document at tab 7, Volume I, which for reference
purposes is designated as "C-7".
(c) The appellant sold to 161979 Inc. 44 of his common shares
in JLB Ltée and received in exchange 44 Class A voting and
participating shares in 161979 Inc. The fair market value of the
44 JLB Ltée shares sold by the appellant was declared to
be $211,250. An election under section 85 of the Act
was made so that the appellant's proceeds of disposition of
the 44 JLB Ltée common shares were deemed to be equal to
$44, that is, their ACB;
- See documents at tabs 8 to 10, Volume I of this binder,
which for reference purposes are designated as “C-8
to C-10”.
(d) JLB Ltée purchased for cancellation the 44 common
shares of its capital stock now held by 161979 Inc. for the sum
of $211,250. Under subsection 84(3) of the Act, JLB
Ltée was deemed to have paid a dividend of $211,206, and
161979 Inc. was deemed to have received a dividend of
$211,206, at the time of this purchase for cancellation. The
price was paid by issuing a demand note in the amount of $211,250
to the order of 161979 Inc.;
- See documents at tabs 11 to 13, Volume I, which for
reference purposes are designated as “C-11 to
C-13”.
(e) 161979 Inc. assigned to 161978 Inc. JLB Ltée's
$211,250 debt arising from the redemption of the 44 common shares
of JLB Ltée, and 161978 Inc. accepted the said debt in
partial payment of the amount owed to it by 161979 Inc. under the
contract of sale of the Land entered into between 161978 Inc. and
161979 Inc., described in greater detail in subparagraph (b)
above.
- See documents at tabs 14 to 17, Volume I, which for
reference purposes are designated as “C-14 to
C-17”.
(f) The appellant sold to 161979 Inc. another 44 of his common
shares in JLB Ltée and received in exchange another 44
Class A voting and participating shares in 161979 Inc. The fair
market value of these 44 JLB Ltée shares sold by the
appellant was declared to be $211,250. An election under
section 85 of the Act was made so that the
appellant's proceeds of disposition of the appellant of the
44 JLB Ltée common shares were deemed to be equal to $44,
that is, their ACB;
- See documents at tabs 18 to 20, Volume I, which for
reference purposes are designated as “C-18 to
C-20”.
(g) JLB Ltée purchased for cancellation the 44 common
shares of its capital stock now held by 161979 Inc. for the sum
of $211,250. Under subsection 84(3) of the Act, JLB
Ltée was deemed to have paid a dividend of $211,206 and
161979 Inc. was deemed to have received a dividend of $211,206 at
the time of this purchase for cancellation. The price was paid by
issuing a demand note in the amount of $211,250 to the order of
161979 Inc.
- See documents at tabs 21 to 23, Volume I, which for
reference purposes are designated as “C-21 to
C-23”.
(h) 161979 Inc. assigned to 161978 Inc. JLB Ltée's
$211,250 debt arising from the redemption of the 44 common shares
of JLB Ltée, this assignment being in payment of the
balance due to 161978 Inc. by 161979 Inc. under the contract
of sale of the Land entered into between these two parties and
described in greater detail in subparagraph (b) above;
- See documents at tabs 24 to 27, Volume I, which for
reference purposes are designated as “C-24 to
C-27”.
(i) 161978 Inc. redeemed for the amount of $90 the 90 of its
Class D shares held by JLB Ltée; and 161979 Inc. redeemed
for the amount of $110 the 110 of its Class D shares held by
161978 Inc.
15. Following the transactions described in the preceding
paragraph, the only 161979 Inc. shares issued and outstanding
were the 100 Class A shares held by the appellant and each of
those shares constituted a qualified small business
corporation share as defined in subsection 110.6(1) of the
Act.
16. On June 23, 1988, the appellant sold his 100 Class A
shares in 161979 Inc. to Gestion G. Brunet Inc. and Gestion
T.V.J.F. Inc. (hereinafter the “purchaser”) for
$422,500 payable as follows:
(a) a $22,500 cash payment upon acceptance of the offer to
purchase dated November 16, 1987;
(b) a $100,000 cash payment at the time of sale; and
(c) $300,000 payable on or before May 1, 1993, in accordance
with the agreed upon terms and conditions and rates of interest,
specifically:
- $80,000 on or before May 1, 1989;
- $60,000 on or before May 1, 1990;
- $160,000 on or before May 1, 1993.
- See the document at tab 28, Volume I, which for reference
purposes is designated as “C-28”.
17. The sale concluded on June 23, 1988 gave effect to the
offer to purchase of November 16, 1987 described in paragraph 5
above.
18. At all relevant times, the purchaser was dealing at
arm’s length with the appellant, JLB Ltée,
161978 Inc. and 161979 Inc.
19. In his 1988 income tax return the appellant declared a
capital gain of $422,488 earned on the disposition of the 100
Class A shares of 161979 Inc., less a reserve of $300,000, for a
capital gain of $122,488 and a taxable capital gain of
$81,658.66.
20. In his 1989 income tax return the appellant declared a
capital gain on the inclusion of the $300,000 reserve, less a new
reserve of $220,000, for a capital gain of $80,000 and a taxable
capital gain of $60,000.
21. In his 1990 income tax return the appellant declared a
capital gain on the inclusion of the $220,000 reserve, for a
capital gain of $220,000 and a taxable capital gain of
$165,000.
22. In each of his income tax returns for 1988 to 1990 the
appellant claimed, under subsection 110.6(2.1) of the Act,
a deduction equal to the amount of the taxable capital gains
included in his income.
23. As a result of the transaction described in subparagraph
14(b) above, 161978 Inc. did not realize a profit on the
resale of the Land to 161979 Inc.
24. Beginning on August 10, 1992 and until March 11, 1994,
Jacques Pontbriand, C.A., M.Fisc., and Pierre Jolin of the Audit
Division of the Department of National Revenue had discussions
concerning the transactions described above.
- See documents at tabs 53 to 60, Volume III, which for
reference purposes are designated as “C-53 to
C-60”.
25. In a reassessment dated July 4, 1994, the Minister of
National Revenue (hereinafter the “MNR”) disallowed
the deduction of $165,000 claimed by the appellant for the 1990
taxation year on the ground that subsection 245(1.1) of the
Act applied.
- See documents at tab 61, Volume III, which for reference
purposes are designated as “C-61”.
26. On September 27, 1994, the appellant duly objected to the
July 4, 1994 reassessment.
- See document at tab 62, Volume III, which for reference
purposes is designated as “C-62”.
27. Discussions then took place between the MNR's
representatives and Jacques Pontbriand, C.A., M.Fisc.
- See documents at tabs 63 to 65, Volume III, which for
reference purposes are designated as “C-63 to
C-65”.
28. On November 9, 1995, the MNR confirmed the
July 4, 1994 reassessment on the ground:
THAT ONE OF THE PURPOSES OF THE SERIES OF TRANSACTIONS CARRIED
OUT BETWEEN MAY 18, 1988 AND JUNE 23, 1988
WAS TO ENABLE MR. BIGRAS TO CONVERT INTO A CAPITAL GAIN A
DIVIDEND AMOUNT THAT WOULD OTHERWISE HAVE BEEN RECEIVED BY HIM
AND INCLUDED IN HIS INCOME.
- See document at tab 51, Volume II, which for reference
purposes is designated as “C-51”.
[5] It was at the request of Michel Désilets, the
appellant’s accountant, that Jacques Pontbriand, a
chartered accountant specializing in tax matters, planned the
transactions described above in the partial agreement on the
facts following an offer of $422,500 received by the appellant
for all of the shares of the capital stock of JLB Ltée or
of any other company that might own certain lands held by JLB
Ltée. According to Mr. Pontbriand, the aim was to
structure the transaction in such a way that it would be
acceptable to both parties. On the one hand, the sale by the
appellant of his shares of JLB Ltée's capital
stock would have resulted in his realizing a capital gain that
would have been eliminated through the deduction under section
110.6 of the Act. However, this solution did not suit the
purchasers because the low cost of the land held by
JLB Ltée would have meant too high an amount of
deferred tax for them. On the other hand, the sale of the land by
JLB Ltée at its fair market value did suit the
purchasers because it eliminated the deferred tax problem, but
was not acceptable to the appellant who would not then have been
able to take advantage of the deduction under section 110.6 of
the Act. According to Mr. Pontbriand, since the
appellant wanted to sell his shares without any tax consequences
by taking this deduction, the plan worked out essentially avoided
the deferred tax problem by transferring the land at its fair
market value to a new company in order to increase its cost while
also rolling over the shares in JLB Ltée's
capital stock held by the appellant into the new company in
exchange for shares in that company's capital stock. The plan
was for the appellant to then sell the newly acquired shares in
the new company's capital stock to the third party
purchasers, thereby realizing a capital gain eligible for the
deduction under section 110.6 of the Act. As can be seen
on reading the transactions described in the partial agreement on
the facts, in order to avoid certain technical difficulties
Mr. Pontbriand planned on using two new companies to achieve
his objectives.
- [6] In fact, the plan devised by Mr. Pontbriand was
carried out in May and June 1988. The two new companies, 161978
Canada Inc. (“161978 Inc.”) and 161979 Canada Inc.
(“161979 Inc.”) were incorporated on May 18,
1988. On June 16, 1988, following several successive
transactions between JLB Ltée, 161978 Inc.,
161979 Inc. and the appellant, 161979 Inc. acquired
ownership of the desired land for $422,500 and the appellant
became the holder of 100 Class A shares of 161979 Inc.'s
capital stock. The upshot of the various transactions was that
these shares were the only shares of 161979 Inc.'s capital
stock issued and outstanding. They had an adjusted cost base of
$1 each. When 161979 Inc. was incorporated, the appellant
had initially purchased 12 of those shares. The other 88 shares
were acquired as a result of two successive rollovers of 44
shares of JLB Ltée's capital stock held by the
appellant.
[7] On June 23, 1988, the appellant sold his 100 Class A
shares of 161979 Inc.'s capital stock to third party
purchasers for $422,500, thereby realizing a capital gain of
$422,488.
[8] Given the terms of payment of the price of the shares, the
appellant claimed in 1988 a reserve of $300,000 and declared a
capital gain of $122,488 and a taxable capital gain of
$81,658.66. In 1989, he claimed a new reserve of $220,000 and
declared a capital gain of $80,000 and a taxable capital gain of
$60,000. Lastly, in 1990, the appellant declared a capital gain
of $220,000 (that is, the amount of the reserve claimed in 1989)
and a taxable capital gain of $165,000.
[9] Although the appellant claimed the capital gains deduction
under section 110.6 of the Act for 1988, 1989 and 1990, it
was not until after a two-year audit and numerous discussions
that a reassessment was finally made on July 4, 1994
with respect to the 1990 taxation year alone, as time had by then
expired for the 1988 and 1989 taxation years. According to
Mr. Pontbriand, Pierre Jolin, the Revenue Canada auditor,
initially questioned the reserve claimed by JLB Ltée
with respect to the sale of the land, and then questioned the
validity of the election with respect to one of the rollovers of
44 shares of JLB Ltée's capital stock by the
appellant into 161979 Inc. These issues were ultimately resolved
and Mr. Jolin then invoked subsection 245(1.1) of the
Act in disallowing the deduction claimed by the appellant
under section 110.6 of the Act for his 1990 taxation
year.
[10] It should be pointed out immediately that it was not
until November 1996 that the respondent, following a court
order allowing the filing of an amended Reply to the Notice of
Appeal, added a new justification for the refusal to allow the
appellant's deduction under section 110.6 of the Act,
namely, that the appellant had acquired the 161979 Inc. shares
for the purpose of immediately reselling them at a profit so that
the disposition of the shares would have produced business income
rather than a capital gain.
[11] During his testimony, Mr. Pontbriand admitted that
the shares of 161979 Inc.'s capital stock acquired by
the appellant had to be resold quickly because, according to the
plan put forward, the value of the shares of
JLB Ltée's capital stock held by the appellant
was in fact to be transferred to the new company so that this
value would be reflected in the shares of the capital stock of
that company which were acquired by the appellant following the
rollover of his shares of JLB Ltée's capital
stock.
[12] The appellant's testimony added little to that of
Mr. Pontbriand except for the confirmation that the third
party purchasers were basically interested in certain land in
Ste-Marthe, which JLB Ltée could moreover have
sold directly.
[13] According to Mr. Bigras, JLB Ltée owned
only one other, small, parcel of land that it resold to him at a
loss a short time later. JLB Ltée then apparently
ceased all operations.
[14] Mr. Bigras confirmed that the various transactions
were carried out to implement the recommendations of
Mr. Pontbriand and of Mr. Bigras's accountant,
Mr. Désilets, whom Mr. Bigras trusted, in order to
pay less tax. Mr. Bigras added that the third party purchasers
had made it clear during negotiations that they were not
interested in acquiring "an old company because of potential
debts".
[15] Before reviewing the argument of counsel for the parties,
it would be useful to point out that, during examination for
discovery,[2]
Pierre Jolin admitted that the fact that
JLB Ltée had been the owner of the land since 1980
could not be denied. Moreover, although he acknowledged that
JLB Ltée was entitled to receive the proceeds of the
sale of the land, he nevertheless considered that it was the
profit realized by JLB Ltée on the sale of that land,
namely an amount of approximately $306,000 less related taxes
(but not taking into account other losses unrelated to the sale),
that might have been received by the appellant as a dividend (the
least expensive hypothesis), or even as wages or as a gift, but
for the series of transactions. Mr. Jolin did, however,
admit that JLB Ltée had declared no dividend nor any bonus
or salary. Mr. Jolin further confirmed that there was no
relation between the $306,000 which, according to him, was
received by the appellant and the last portion of the taxable
capital gain included in 1990, that is, the amount of $165,000,
except for the fact that subsection 245(1.1) of the Act
was in fact applied in disallowing the section 110.6 deduction
with respect to this portion. He stated however that the sale by
the appellant of his shares of JLB Ltée's capital
stock (to third parties) would have given rise to a capital gain
and to the capital gains deduction.
[16] Counsel for the appellant began by emphasizing the
admission that the desired land represented at least 80% of the
value of the land inventory of JLB Ltée at the time
of the offer of November 17, 1987. He argued that, in
reality, the proportion was equal to 88% since the appellant
assigned to 161979 Inc. 88 of the 100 shares of
JLB Ltée's capital stock belonging to him.
Referring to the decision of the Federal Court, Trial Division in
Imapro Corporation v. The Queen, 92 DTC 6487 at page 6494,
he argued that the transaction involved in a manner of speaking
the sale of virtually all of JLB Ltée's business,
thereby producing a capital gain and not business income
according to the decision of the Supreme Court of Canada in
Frankel Corporation Ltd. v. M.N.R., [1959] S.C.R. 713, 59
DTC 1161. Thus, according to counsel for the appellant, the
decision of the Supreme Court of Canada in Fraser v.
M.N.R., [1964] S.C.R. 657, 64 DTC 5224 could not apply
because the sale by the appellant of his shares of
JLB Ltée's capital stock could not be considered
to be another way of disposing of property (the land) the sale of
which would have generated business income.
[17] I admit having some difficulty understanding the
relevance and soundness of this argument as a basis for
concluding that the decision in Fraser, supra, in
which the sale of shares of a company was held to be simply
another way of disposing of land held for resale which, upon
disposition, would have produced business income, does not
apply.
[18] Section 23 of the Act clearly establishes that
upon disposing of a business or part of that business or upon or
after fully or partially ceasing to carry on the business,
property sold that was included in the inventory of the business
is deemed to have been sold in the course of carrying on the
business. Section 23 replaced the former section 85E applicable
to sales of property included in the inventory of a business from
April 5, 1955. This provision was introduced specifically for the
purpose of neutralizing the effect of the decision of the Supreme
Court of Canada in Frankel, supra.
[19] Does this mean that the principle laid down by the
Supreme Court of Canada in Fraser, supra, is
applicable to the facts of the instant case? It is my view that
the answer must be a categorical no. There is no evidence that
the appellant ever held the land of which JLB Ltée
had been the owner since 1980. The appellant was a shareholder of
JLB Ltée and nothing more. To settle this point it
will suffice here to refer to the words of my colleague judge
Bowman in Rudacel Investment Co. Ltd. v. M.N.R., 92
DTC 1118, on which counsel for the appellant also relied. In my
view, those comments, found on page 1121, are directly applicable
to this case. They read as follows:
Kinwest, a separate juridical entity, acquired land and
engaged for five years in the business of developing and selling
it. The shareholders' ownership of shares in Kinwest was a
capital investment in a business enterprise carried on by a
separate legal entity. Kinwest's business and its profits
from that business were its own and not those of its
shareholders. That principle has been entrenched in our law for
at least a century. The Fraser case neither erodes the
principle nor blurs the distinction.
[20] There is no doubt that the shares of
JLB Ltée's capital stock held by the appellant
were capital property in his hands. Their disposition to a third
party therefore could only have produced a capital gain and not
business income.
[21] Before examining the question of the application of
subsection 245(1.1) of the Act, logic demands that one
deal first with the respondent's new claim that the sale by
the appellant to third party purchasers of the shares of
161979 Inc.'s capital stock would have yielded business
income. The allegation behind this claim is that these shares
were acquired by the appellant for the purpose of reselling them
immediately at a profit. Counsel for the respondent therefore
argued that the appellant would not have been entitled to the
capital gains deduction under section 110.6 of the Act but
for the application of subsection 245(1.1) of the Act.
[22] The appellant held his shares of
JLB Ltée's capital stock as capital property. The
value of these shares reflected the value of the land held by
JLB Ltée. Given the offer received on November 16,
1987, the appellant was in a position to sell his shares and
realize a capital gain measurable according to the value of the
land desired by the third party purchasers. Under
Mr. Pontbriand's tax planning scheme, the appellant
instead transferred 88 of the 100 shares he held in
JLB Ltée's capital stock to 161979 Inc. by
using the rollover provided for in section 85 of the Act
and by agreeing to an amount equal to the adjusted cost base of
the shares, namely $1 per share, for the purposes of the
transactions. In exchange, he received 88 shares of
161979 Inc.'s capital stock with the same adjusted cost
base. Having already subscribed for 12 shares whose adjusted cost
base was the same, the appellant held, after the various
transactions, 100 shares of 161979 Inc.'s capital stock,
its only shares issued and outstanding at the time. Further,
161979 Inc. had acquired the desired land for an amount
equal to their fair market value, that is, $422,500. It is easy
to understand that the market value of the 88 shares in
JLB Ltée, declared as being $422,500 for the purposes
of the election made under section 85 of the Act, was
thereupon transferred or carried over to the 100 shares of
161979 Inc's capital stock held by the appellant. This
value also reflected the value of the land acquired by
161979 Inc. It seems clear to me that the shares of
161979 Inc.'s capital stock held by the appellant were
thus, for the most part, simply substituted for the 88 shares of
JLB Ltée's capital stock that he held. In my
view, the new shares must therefore be of the same nature as the
old ones, that is, capital property. As for the other 12 shares
subscribed for when the company was incorporated, they were so
subscribed for simply to counterbalance the 12 shares of
JLB Ltée's capital stock excluded from the
transactions. In my view, it was not even necessary for them to
be issued and acquired by the appellant.
[23] In short, it is my view that the shares of 161979
Inc.'s capital stock acquired by the appellant were simply
acquired to replace the shares of JLB Ltée's
capital stock that he held as capital property and which were
transferred to 161979 Inc. under the tax planning scheme
devised by Mr. Pontbriand. The appellant was not in the
business of trading shares and transactions carried out solely
for the purposes of such planning cannot be characterized as
"an adventure or concern in the nature of trade" such
that the disposition of the property involved in those
transactions could generate business income. The following
extract from the majority decision of the Federal Court of Appeal
in Canada v. Loewen, [1994] 3 F.C. 83, at page 98, is
more than sufficient to resolve the question:
The test for an adventure in the nature of trade is an
objective one based upon the standard of the "ordinary
trader or dealer." If the Income Tax Act is to
deem a transaction to produce a notional profit, that profit must
not be treated as real for the purposes of applying the test. In
the context of the present case that means that the question to
be asked must be whether such a purely notional profit would
serve to induce a trader to enter into the transaction. In my
view, it is clear that it would not. The real and only
inducement here was the tax credit but that, as we have seen,
cannot serve to turn the transaction into an adventure in the
nature of trade.
I conclude, therefore, as did the Tax Court Judge, that the
appellant's purchase and subsequent redemption of the
SRTC debenture was not an adventure in the nature of trade
and that his deemed gain therefrom should be treated as a capital
gain and not as income.
(Emphasis added.)
[24] I would simply add that, in the instant case, the
acquisition by the appellant of shares of 161979 Inc.'s
capital stock to replace shares he held in the capital stock of
JLB Ltée did not in itself produce any benefit of a
business nature since the shares of 161979 Inc.'s
capital stock held by the appellant before their sale to the
third party purchasers had exactly the same value as the 88
shares of JLB Ltée's capital stock that were
transferred to 161979 Inc. using the rollover provided for
in section 85 of the Act.
[25] The fact that the value of 88 shares of JLB
Ltée's capital stock held by the appellant was
transferred to 100 shares of 161979 Inc.'s capital stock
rather than 88 is of little importance since the appellant was,
after all the transactions, the sole owner of all of the shares
then issued and outstanding.
[26] This brings us to the question of subsection 245(1.1) of
the Act.
[27] The application of paragraph 245(1.1)(b) was not
raised by the respondent and rightly so since the 100 shares of
161979 Inc.'s capital stock are essentially property
substituted for the 88 shares of JLB Ltée's
capital stock held previously by the appellant. Since these
shares were capital property in his hands, their disposition
could only have produced a capital gain and not income that
should be included under paragraph 3(a) of the
Act.
[28] In fact, the respondent invoked paragraph
245(1.1)(a) of the Act on the ground that one of
the purposes of the series of transactions or events was to
enable the appellant to convert into a capital gain an amount
which would otherwise have been received from
JLB Ltée as a dividend, salary or bonus or in some
other form and thus included in his income under paragraph
3(a) of the Act. The respondent assumed that the
sale of the land by JLB Ltée to 161978 Inc.
produced a profit and that that profit net of tax, or if one
prefers, that surplus, would have been received by the appellant
as income in one form or another that he would have had to
include in computing his income in accordance with paragraph
3(a) of the Act but for one or more operations or
events in the series.
[29] Counsel for the appellant, while admitting that there was
indeed a series of transactions or events, argued that the
appellant simply converted a capital gain that he could have
realized by disposing of his shares of JLB Ltée's
capital stock into a capital gain realized by disposing instead
of the shares of 161979 Inc.'s capital stock. In his
view, the appellant was not entitled to anything other than a
capital gain: not a dividend, not salary and not a bonus.
[30] As for the entitlement to dividends, counsel for the
appellant relied on the analysis of this question found in La
Compagnie au Québec - les aspects juridiques by
Maurice and Paul Martel, Éditions Wilson &
Lafleur, Martel Ltée, 1994, Montréal. At pages 345
and 346, the authors comment as follows:
[TRANSLATION]
1 — Entitlement to profits: dividends. It is the
shareholder's right to receive part of the company's
profits, in proportion to his investment in the company. This
sharing in the profits occurs through the payment of dividends by
the company. The shareholder's entitlement to the
dividends is, however, subject to a precondition: the dividends
must be declared. The declaration of dividends is
at the discretion of the directors. Indeed, it is for the
directors alone to determine the amount of profits that the
company will distribute as dividends; they are entirely at
liberty to decide that these profits will not be distributed at
all, but will be reinvested in the companyor will serve as a
"reserve fund". The directors are free to declare
dividends or not when the company has profits, and the courts
will not intervene to change their decision except in the event
of fraud or bad faith. This approach is based on the
principle that the directors must consider the interest of the
company as a whole before that of the shareholders individually
or even collectively.
(Emphasis added; footnotes omitted.)
[31] According to counsel for the appellant, the intent of
subsection 245(1.1) was to cover only situations such as that in
Fraser, supra. In this regard, counsel referred to
the technical notes published at the time this provision was
introduced by the Honourable Michael Wilson, Minister of Finance.
Those notes are the "Technical Notes relating to the Bill
amending the Income Tax Act and other related
acts" (Bill C-84), November 1985, at pages 138 to
140.
[32] In my view, subsection 245(1.1) was not intended solely
to cover situations similar to that found in
Fraser,supra. Although the criterion set out in
paragraph 245(1.1)(b) may, at first glance, appear to
have been enacted for that purpose, it may legitimately be asked
what the limits are to the principle laid down in
Fraser,supra. While the principle is probably
applicable to property other than property that is part of a
taxpayer's inventory, it is not certain that it would apply
where a company was not created for the sole purpose of disposing
of a specific property. Given its very broad wording, paragraph
245(1.1)(b) presumably could have applied to situations
not covered by the principle laid down in Fraser,
supra, just as it could also have applied following
the disposition of an interest in a company or a trust.[3] Furthermore, as we
know, the application of the principle laid down by the Supreme
Court of Canada results in business income and not a capital gain
on the sale of shares of the capital stock of a company to which
property included in a taxpayer's inventory has previously
been transferred. Thus, it was not necessary to apply the rule
set forth in paragraph 245(1.1)(b) of the Act in
order to disallow in such circumstances the capital gains
deduction provided for under section 110.6 of the Act.
[33] To illustrate the application of this new provision and
specifically of paragraph 245(1.1)(b), the technical notes
accompanying the introduction of subsection 245(1.1) refer to
tax-deferred transfers under the rollover provisions of the
Act followed by a sale of shares or other interests
acquired as a result of such transfers. However, other types of
situations were also covered, as indicated by the following
paragraph on page 140 of those notes:
New subsection 245(1.1) is also aimed at those cases where an
individual entitled to receive ordinary income rearranges
his affairs through a series of related transactions, the purpose
of which is to convert ordinary income that may reasonably be
considered to have accrued up to the time the series begins
into an exempt capital gain. The provision may apply where an
individual converts ordinary income such as dividends, rent or
interest into a capital gain through a series of transactions or
events. For example, if an individual sells shares
cum-dividend and following the dividend payment date
reacquires the shares, new subsection 245(1.1) may apply.
However, the provision will not ordinarily apply where an
individual converts one investment into another. For example, an
individual who substitutes his investment in a debt obligation
for a new investment in common shares.
(Emphasis added.)
[34] This part of the technical notes deals more specifically
with the application of paragraph 245(1.1)(a) of the
Act.
[35] It is clear from a reading of this provision that it is
appropriate to review the purpose of a series of transactions or
events only where there has in fact been a conversion into a
capital gain of an amount that would have been received by an
individual and included in computing his income under paragraph
3(a) of the Act but for one or more transactions or
events in the series. In my view, such wording indicates that the
provision is aimed at the conversion of an amount that an
individual avoided receiving through one or more transactions or
events in the series and that would have been income had it been
received; it would consequently be normal to include such amount
in computing that individual's income under
paragraph 3(a) of the Act. This interpretation
is moreover in keeping with the above-cited paragraph from the
technical notes. The example provided therein of the sale of
shares cum dividend and the reacquisition of the shares following
the dividend payment date illustrates particularly well the type
of conversion being targeted. However, in order to determine
whether an amount is covered by paragraph 245(1.1)(a), it
is first necessary to be able to say that an individual initially
had, in one capacity or another, some entitlement to receive the
amount in question as it is mainly the fact that this amount
would have been received, but for its conversion by one or more
transactions or events in the series, that gives rise to the
application of the provision.
[36] In the instant case, the appellant was not entitled to
receive any amount as "ordinary income" before the
series of transactions began. There was nothing that he might
have received in the way of salary, bonus or dividends because he
was not entitled on any basis to any amount that might have
accrued and that might have been received by him and included in
computing his income under paragraph 3(a) of the
Act.
[37] More particularly, the appellant was not entitled to
receive any dividend because no dividend had been declared. Since
it is JLB Ltée's surplus resulting from the sale
of the land that is specifically in question, and that counsel
for the respondent, like Revenue Canada auditor Pierre Jolin,
stated the appellant would have been entitled to receive, and
that would thus have been included in computing his income had it
been distributed in one way or another, it is my view that the
appellant was not entitled to receive such a surplus.
[38] The recent unanimous decision of the Supreme Court of
Canada in Neuman v. The Queen, 98 DTC 6297, strongly
confirms this point of view. That case involved the application
of subsection 56(2) of the Act in a situation where there
had been a selective declaration and payment of dividends on two
different classes of shares of the capital stock of a company in
accordance with a so-called "discretionary dividend"
clause in the company's articles of incorporation. Subsection
56(2) reads as follows:
A payment or transfer of property made pursuant to the
direction of, or with the concurrence of, a taxpayer to some
other person for the benefit of the taxpayer or as a benefit that
the taxpayer desired to have conferred on the other person shall
be included in computing the taxpayer's income to the extent
that it would be if the payment or transfer had been made to
him.
[39] In that case, the question was essentially whether the
dividends declared and paid with respect to a particular class of
shares (Class F) held exclusively by the appellant's spouse
should be attributed to the appellant who held the only voting
share and all of another class (Class G) of shares of the
company's capital stock. The appellant acquired the latter
class of shares through a transfer, under subsection 85(1) of the
Act, of the shares of another company with a fair market
value of $120,000. The shares of a different class held by his
spouse had been acquired for a nominal amount. The spouse was
elected the company's sole director. Following receipt of a
dividend of $20,000 on the shares that were held by the company
and that had been acquired in the rollover under subsection 85(1)
of the Act, the appellant's spouse, as director,
declared a dividend of $14,800 on the Class F shares she held and
a dividend of $5,000 on the Class G shares held by the appellant.
Upon receipt of the $14,800, the appellant's spouse loaned
him an equivalent amount guaranteed by a demand note. This brief
summary of the facts is sufficient for present purposes.
[40] In his analysis, Iacobucci J., writing for the Supreme
Court of Canada, acknowledged (paragraph 32 of his reasons) that
"in order for s. 56(2) to apply, four preconditions,
each of which is detailed in the language of s. 56(2) itself,
must be present". In the same paragraph, he sets out the
fourth precondition as follows:
the payment would have been included in the reassessed
taxpayer's income if it had been received by him or her.
[41] Referring in particular to the reasons of Dickson C.J. in
McClurg v. Canada, [1990] 3 S.C.R. 1020, Iacobucci J.
essentially concluded that dividend income did not satisfy this
condition because it assumes the existence of an entitlement to
the retained earnings of a company. In his view, a shareholder
has no such entitlement since, if dividends are not paid to a
shareholder, they remain part of the company's retained
earnings.
[42] Here are Dickson C.J.'s comments on this point in
paragraphs 46 to 49 of his reasons:
46 This Court concluded that, as a general rule, s. 56(2)
does not apply to dividend income since, until a dividend is
declared, the profits belong to the corporation as retained
earnings. The declaration of a dividend cannot be said,
therefore, to be a diversion of a benefit which the taxpayer
would have otherwise received (at p. 1052). Dickson, C.J.
explained the ruling as follows (at p. 1052):
While it is always open to the courts to "pierce the
corporate veil" in order to prevent parties from benefitting
from increasingly complex and intricate tax avoidance techniques,
in my view a dividend payment does not fall within the scope of
s. 56(2). The purpose of s. 56(2) is
to ensure that payments which otherwise would have been received
by the taxpayer are not diverted to a third party as an
anti-avoidance technique. This purpose is not frustrated because,
in the corporate law context, until a dividend is declared, the
profits belong to a corporation as a juridical person: [B.
Welling, Corporate Law in Canada (1984), at pp. 609-10].
Had a dividend not been declared and paid to a third party, it
would not otherwise have been received by the taxpayer. Rather,
the amount simply would have been retained as earnings by the
company. Consequently, as a general rule, a dividend payment
cannot reasonably be considered a benefit diverted from a
taxpayer to a third party within the contemplation of
s. 56(2).
[Emphasis added.]
47 Although not explicitly stated, Dickson, C.J.'s
preceding comments concern the fourth precondition to the
application of s. 56(2): that the payment would have been
included in the reassessed taxpayer's income if it had been
received by him or her. In essence, dividend income does not
satisfy this prerequisite to attribution since the reassessed
taxpayer would not have received the income had it not been paid
to the shareholder. In effect, this Court implicitly interpreted
the fourth precondition to include an entitlement requirement;
entitlement is used in the sense that the reassessed taxpayer
would have otherwise received the payments in dispute. This was
correctly noted by Rothstein, J. at the Federal Court, Trial
Division in similar terms where he acknowledged that Dickson,
C.J.C. qualified the application of s. 56(2) by requiring
that the payment in issue "would otherwise have been
obtained by the reassessed taxpayer" (p. 164).
48 An entitlement requirement in the sense I have described is
consistent with the stated purpose of s. 56(2), which is to
capture and attribute to the reassessed taxpayer "receipts
which he or she otherwise would have obtained"
(McClurg, at p. 1051). Dividend income cannot pass the
fourth test because the dividend, if not paid to a shareholder,
remains with the corporation as retained earnings; the reassessed
taxpayer, as either director or shareholder of the corporation,
has no entitlement to the money.
49 This is the only interpretation which makes sense and which
avoids absurdity in the application of s. 56(2), as noted by
Dickson, C.J. (at p. 1053):
. . . but for the declaration (and allocation), the dividend
would remain part of the retained earnings of the company. That
cannot legitimately be considered as within the parameters of the
legislative intent of s. 56(2). If this Court were to find
otherwise, corporate directors potentially could be found liable
for the tax consequences of any declaration of dividends made to
a third party . . . this would be an unrealistic
interpretation of the subsection consistent with neither its
object nor its spirit. It would violate fundamental principles of
corporate law and the realities of commercial practice and would
"overshoot" the legislative purpose of the section.
[43] One of the conditions for the application of paragraph
245(1.1)(a) is that an individual have converted into a
capital gain "an amount that would but for one or more [. .
. ] transactions or events in the series, [. . . ] otherwise have
been received by the individual and included in computing his
income under paragraph 3(a)". In my view, while such
wording may have some similarity to that in subsection 56(2) in
that it establishes as a condition that the taxpayer would have
received an amount as income in the absence of the transactions
in question, it enunciates even more explicitly than subsection
56(2) of the Act the condition respecting the existence of
an unequivocal entitlement to an amount that would have been
received and included in computing income but for the conversion
carried out through one or more transactions or events in the
series.
[44] This confirms my conclusion that paragraph
245(1.1)(a), as worded, could only apply to an amount that
an individual was entitled to receive but which he avoided
receiving by converting it into a capital gain through a series
of transactions or events. Prior to the commencement of the
series of transactions or events, the appellant had no
entitlement to the surpluses or retained earnings of
JLB Ltée since no dividend had been declared at that
time. Nor was he entitled to receive any amount as salary, or
bonus, or any other amount of income on any basis whatsoever.
[45] While subsection 245(1.1) must be analyzed by
disregarding one or more transactions in a series, it is not
permissible in my view to add one or more transactions that never
occurred in order to argue that an individual would have been
entitled to an amount that would have been received and included
in computing his income but for one or more transactions or
events in the series.[4] Therefore one cannot attribute to the appellant an
entitlement that he did not have by assuming the existence of a
transaction (like the declaration of a dividend) that never
occurred through which he could have acquired an entitlement to
receive an amount as "ordinary income".
[46] I therefore find that subsection 245(1.1) and more
specifically paragraph 245(1.1)(a) cannot be applied
so as to disallow the capital gains deduction claimed by the
appellant under section 110.6 of the Act for his 1990
taxation year.
[47] For the above reasons, the appeal is allowed and the
assessment is referred back to the Minister of National Revenue
for reconsideration and reassessment on the basis that the
appellant is entitled to the capital gains deduction under
section 110.6 of the Act for his 1990 taxation year; the
whole with costs.
Signed at Ottawa, Canada, this 31st day of July 1998.
"P. R. Dussault"
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]
Translation certified true on this 30th day of September
1998.
Erich Klein, Revisor
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