Citation: 2011 TCC 286
Date: 20110602
Docket: 2010-2840(IT)I
BETWEEN:
SAFORA REZAYAT,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
McArthur J
[1]
This is an appeal from
the decision of the Minister of Revenue (Minister) to include in the
Appellant’s income the value of shares she received in the 2007 taxation year
from Bermuda based Tyco International Ltd. (International).
[2]
In this case, I am
faced with identical facts and issues decided previously by three colleagues.
The most recent of the three judgments is Yang v. Her Majesty the Queen.
The other two
are Capancini v. Her Majesty the Queen
and Hamley v. Her Majesty the Queen. The facts of
these three cases arose out of the same Tyco transactions. In Capancini,
Bowie J. found that International never owned the shares of Electronics Ltd.
(Electronics) and Covidien Ltd. (Covidien) as they existed upon transfer to the
Appellant.
Hershfield J. (in Hamley) and Sheridan J. (in Yang) found that it
did. I believe similar appeals will follow. An eventual decision from the
Federal Court of Appeal would be a blessing.
[3]
The Minister’s position
is that the shares the Appellant received in Tyco Electronics and Covidien were
dividends in kind, the value of which was to be included income. This creates
an unfortunate situation for the Appellant who states, in part, in her notice
of objection:
“…the value of the
stock, before and after the reverse split, is the same . . . due to current
market conditions. I stand to lose more than half the stock value and have to pay
an additional $4,000 – in taxes and penalties on the income I’ve never received.
. . .”
[4]
Unfortunately,
section 86.1 of the Income Tax Act ( the Act), which offers
relief from taxation in similar circumstances, does not apply to exempt the
dividends from income because the companies were incorporated in Bermuda, which
does not have a tax treaty with Canada. The Appellant does not contest this.
[5]
She held 700 shares in
International before June 29, 2007. On that date, International took two
subsidiary corporations public: Electronics and Covidien. All three are
incorporated in Bermuda. A document prepared for the United States Securities
and Exchange Commission (USEC), released on July 3, 2007 states in part:
Distribution of the Common Shares of Tyco Electronics Ltd. and
Covidien Ltd.
On June 29, 2007, Tyco International Ltd. (“Tyco International”)
completed the distribution of common shares of Tyco Electronics, and Covidien Ltd.
to the shareholders of Tyco International. Tyco International, Tyco
Electronics, and Covidien are now three wholly independent, publicly-traded companies.
Each Tyco International shareholder received one common share of
Covidien and one common share of Tyco Electronics for every four common shares
of Tyco International held by such Tyco International shareholder at the close
of business on June 18, 2007 (the record date).
. . . Tyco International has received private letter rulings from
the Internal Revenue Service (the “IRS”) substantially to the effect that the
distribution will qualify as tax-free for U.S. federal income tax purposes . . .
One-for-Four-Reverse Stock Split
Immediately following the distribution of the common shares of Tyco
Electronics and Covidien, every four common shares of Tyco International were
converted into one common share of Tyco International as the result of a one-for-four
“reverse stock split.”
[6]
This plan involved two
stages. First, shareholders in International were given ¼ of a share in each of
Electronics and Covidien for every share they held in International.
Immediately after the distribution, there was a 4:1 stock consolidation
(reverse-split) on shares in International. Collectively, these transactions
are referred to as the “Tyco transactions.” The parties dispute the underlying
nature of these transactions.
[7]
The Appellant received
175 shares in each of Electronics and Covidien. She states that immediately
after that distribution, her 700 shares in International were replaced by 175
new shares in International. The Respondent characterizes the 175 shares in
International as a 4:1 stock consolidation, and not as an exchange for new
shares.
[8]
Her broker, RBC Direct
Investing Inc., issued a T5 slip indicating that she received $14,665.35 US
($15,760 CAD) for her 175 shares of Electronics and 175 shares of Covidien,
that being the market value of these two sets of stocks on the date of issue.
On the basis of that T5 slip the Minister reassessed the Appellant, adding this
value to her income for the 2007 taxation year.
[9]
She was represented by
her spouse who, very understandably, asserts that she is being taxed on an
amount that is not income to her but simply what she already owned, but in a
different form. Her 175 shares in each of the three corporations on
June 29, 2007 represented exactly the same ownership interest in exactly
the same businesses as did her former 700 International shares on June
28, 2007. Her spouse added that since the value of her investment was unchanged
after the Tyco transactions occurred there was no economic benefit, and she
should not be taxed on the value of the shares in Electronics and Covidien. She
in effect broke even yet the Minister added approximately $14,000 to her
taxable income. He concluded:
. . . My argument is it’s not a dividend in kind because there was
no profit sharing. There was a return in capital and Mrs. Rezayat did receive
the new shares but did give something back and that was the portion of Tyco
Electronics that balances off that value she received.
[10]
The Respondent replies in
part that the shares received were dividends-in-kind, because they were
property of a corporation distributed to shareholders on a pro rata
basis.
[11]
In an earlier case, Morasse
v. Her Majesty the Queen,
C. Miller J. considered whether shares created and distributed under Mexican
law were a dividend. The Appellant owned 400 shares of Telmex. That corporation
spun-off its mobile telephone business under a Mexican legal process called
“escisión,” and transferred assets to a newly created corporation, América Móvil
(AM). Shares in AM were then given to shareholders in Telmex. At no time prior to
the distribution were shares in AM available for purchase or trade, as those
shares did not legally exist until they were issued to Telmex shareholders.
[12]
The Minister assessed
the value of the AM shares as investment income. The Appellant argued that the
shares were not taxable under section 86.1, and alternately, that the
shares were a non-taxable capital receipt. C. Miller J. held that
section 86.1 did not apply but found the shares were not taxable in any
event.
[13]
He concluded that
Telmex did not legally own the shares in AM before they were distributed, so
they could not be a dividend-in-kind. AM shares could not be taxed as a
stock-dividend since they were not capital stock of Telmex. He described the “escisión”
as a unique process which allowed some of the value of Telmex to be transferred
into AM. Since the subsequent loss in value of the Telmex shares was almost
equal to the value of the new shares in AM, the Court held that the transaction
was not a distribution of profits, but rather a distribution of assets into a
new corporation, and allowed the appeal.
[14]
Morasse was applied to the fact situation in the
present matter in the three prior decisions referred to. In Capancini the
Court held that the transactions were not taxable. Bowie J. concluded that the
facts before him were indistinguishable from that in Morasse and for
similar reasons the shares in Electronics and Covidien were not taxable as
dividends-in-kind. Although this is an equitable decision when considering the
effect of a dismissal of the appeal on the innocent taxpayer, with the reasons
that follow, I favour the Minister’s position.
Legislation
[15]
The Act defines
“dividends” and “stock dividends” (in section 248) as follows:
“dividend” includes a stock dividend (other than a stock dividend
that is paid to a corporation or to a mutual fund trust by a non-resident
corporation);
“stock dividend” includes any dividend (determined without reference
to the definition “dividend” in this subsection) paid by a corporation to the
extent that it is paid by the issuance of shares of any class of the capital
stock of the corporation;
[16]
Subsection 52(2) of the
Act prescribes the cost of property given as a dividend-in-kind:
Where any property has after 1971, been received by a shareholder of
a corporation at any time as, on account or in lieu of payment of, or in
satisfaction of, a dividend payable in kind (other than a stock dividend) in
respect of a share owned by the shareholder of the capital stock of the
corporation, the shareholder shall be deemed to have acquired the property at a
cost to the shareholder equal to its fair market value at that time, and the
corporation shall be deemed to have disposed of the property at that time for
proceeds equal to that fair market value.
Analysis
[17]
Again, the broad
question is whether International’s distribution of shares in Electronics and
Covidien was a dividend and therefore income to the Appellant. The definition of
“dividend” in the Act has a large scope. It includes a distribution to a
shareholder, whether cash or shares of a different corporation. A brief review
of tabs 2, 3, 4 and 5 of the Respondent’s Book of Documents leads one to
conclude that the shares in Electronics and Covidien were owned by
International prior to distribution and the receipt of those shares by the
Appellant is a dividend-in-kind. The documents show a parent corporation
distributing shares it held in wholly-owned subsidiaries. The timing of the
distribution indicates that the Appellant received the shares prior to the
consolidation of the parent company’s shares, eliminating the possibility that
the transactions were an exchange or redemption.
[18]
Further, the Appellant
did receive an economic benefit from the transactions. By applying
subsection 52(2) of the Act, she obtained an increase in the
adjusted cost base (ACB) of her investment, which would reduce capital gains if
the shares are later sold at a profit.
[19]
A finding that the International
shares were consolidated and not replaced is supported by the Form 8-K as
referred to earlier.
[20]
That statement does not refer to
new shares of International being created. Further, International held all the
shares of Electronics on June 29, 2007. The filings with the USEC further show,
as of March 20, 2007, the common stock of Electronics and Covidien had been
issued at some point prior, but the shares were not publicly traded.
International distributed the shares it held in each corporation to
International shareholders on June 29, 2007.
[21]
Both Electronics and
Covidien had net revenue in 2007 in excess of one billion dollars. For example,
Covidien’s net sales in 2007 were $10.170 billion and it is described as a
leading Global Health Care Products company. It was incorporated in Bermuda in 2000 as a wholly-owned subsidiary of International.
[22]
Electronics net sales were $13.5
billion in the same year. After the spin-off, Electronics shares traded on the
New York Stock Exchange. Electronics was also incorporated in Bermuda in 2000
as wholly-owned subsidiary of International.
[23]
It is clear from forms
8-K and 10-K
that the shares in Electronics and Covidien existed well before the June 29,
2007 distribution and they were owned by International. The transactions were
structured as a disbursement of shares and then a subsequent share consolidation,
rather than a share-swap. There is no evidence that these shares were somehow a
return of capital to the shareholders. International labelled the distribution
as a dividend (albeit, tax free in the US).
Since the property given was not cash it is a dividend-in-kind and is deemed
income based on fair market value, pursuant to subsection 52(2).
[24]
The timing of the
transaction is relevant. The effect of the share distribution and subsequent
consolidation was that the shareholder did not redeem their shares of
International to receive the shares in Electronics and Covidien, so it can be
argued that they gave nothing of value to receive them.
[25]
Further, by subsection
52(2), the new shares are deemed to have been received at fair market value.
For the Appellant, this means their ACB on the received shares was $6,994.75
for Electronics and $7,596.75 for Covidien, for a total ACB in those shares of
$14,591.50. The subsequent share consolidation reduced the quantity of
International shares held by the Appellant, but there was no evidence that it
reduced her total ACB of those shares.
[26]
In the future, when
these shares are sold, the increase in ACB will result in lower capital gains
(or greater capital losses), which is an economic benefit to the Appellant.
[27]
International tried to
prevent this result by insuring there would be no negative tax consequences to U.S. shareholders.
In Canada, section 86.1 can stop
subsection 52(2) from applying, giving much the same effect. It does not
in this case however, because as referred to earlier, the corporations involved
are resident in Bermuda, with whom Canada has no tax
treaty and the distribution cannot come under subsection 86.1(2).
[28]
The prior case law
showing differing results between Bowie J. in Capancini and Hershfield J.
in Hamley should be examined in light of this analysis. Again, it is the
differing interpretation of Morasse that causes the disparate findings.
In Capancini, it was held that the facts in that case were
indistinguishable from the facts in Morasse. While it is not clear
exactly how the facts were presented in Capancini, I believe that the
Tyco transactions are distinguishable from the circumstances in Morasse.
[29]
In Morasse, the
share transactions were executed based on the concept of “escisión”, and the shares
distributed were in a newly created corporate entity. In the present case, the
shares distributed were those of wholly-owned subsidiary corporations, which
had existed before the shares were distributed. This disparity was recognized
by Hershfield J. in Hamley. He stated that he had no evidence that the International
distributions were of the same effect as those in Morasse, and he did
not follow that decision.
[30]
In Yang, Sheridan J. stated at paragraph 15 the following which applies
equally to the present case:
[15] All of the above works to distinguish the facts
of the present matter from Capancini and Morasse where, in each
case, the Court found that the shares received by the taxpayer had never been
owned by the distributing parent company and did not, therefore, come within
the meaning of “dividend in kind”. Here, the documentary evidence does nothing
to refute the Minister’s assumption that Tyco International did own the Tyco
Electronics and Covidien shares it ultimately distributed, thus putting the
Appellant’s case on the same factual footing as Hamley and bringing it
within Justice Hershfield’s analysis set out above at paragraph 7 of these
Reasons. In these circumstances, there is no justification for the Court to
interfere with the Minister’s reassessment.
[31]
For these reasons, the
appeal is dismissed, without costs.
Signed at Ottawa,
Canada, this 2nd day of June 2011.
“C.H. McArthur”
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