Citation: 2009 TCC 118
Date: 20090224
Docket: 2006-421(IT)G
BETWEEN:
HUSKY OIL LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
I. Introduction
[1]
The Appellant and
Balaclava Enterprises Ltd. (“Balaclava”), a significant shareholder of Mohawk
Canada Limited (“Mohawk Canada”), joined forces to complete a takeover of
Mohawk Canada. Balaclava transferred its interest in Mohawk Canada to a
corporation, HB Acquisition Inc. (“HB Acquisition”), formed by the Appellant
and Balaclava to complete the takeover. Balaclava received securities of HB Acquisition for its shares of Mohawk
Canada and significantly less cash than was offered to the other Mohawk Canada
shareholders.
[2]
Balaclava and the Appellant
agreed to allow Balaclava to acquire the Residual Assets (defined below) of
Mohawk Canada through the amalgamation of its subsidiary, Mohawk Lubricants Ltd.
(the owner of the Residual Assets) (“Mohawk Lubricants”), and a subsidiary of
Balaclava. The parties disagree on the impact of the amalgamation. The Appellant
argues that Mohawk Canada disposed of the shares of Mohawk Lubricants in a
tax-free rollover under subsection 87(4) of the Income Tax Act (Canada) (the “Act”). The Respondent, on the other
hand, submits that Mohawk Canada took back shares in the amalgamated entity
that were worthless as part of a plan to defer capital gains tax for
25 years. This plan was also followed by Balaclava, which allegedly received
worthless shares in HB Acquisition. As a result of these mutual promises
to accept worthless shares, the Respondent argues, Mohawk Canada should be
taxable on the disposition of the shares of Mohawk Lubricants for one or more of
the following reasons:
a) Mohawk Canada gifted the
value of its shares in Mohawk Lubricants for the benefit of its parent
corporation, HB Acquisition, and/or Mohawk Canada received non-share
consideration on the amalgamation involving Mohawk Lubricants, contrary to the
prohibition contained in subsection 87(4) of the Act.
b) HB Acquisition
appropriated the value of the Mohawk Lubricants shares for its own benefit contrary
to the prohibition in subsection 69(4) of the Act.
c) Subsection 56(2) applies
to the amalgamation.
II. Factual
background
[3]
At the outset of the
trial, the parties provided me with a Statement of Agreed Facts (the “Statement
of Agreed Facts”) along with supporting documents contained in a joint book of exhibits
(the “Joint Book of Exhibits”). The Appellant called three witnesses, Mr. Thomas
Lindsay, a senior vice-president of Balaclava and a director of Mohawk Canada,
Mr. Robert Kopstein, a tax partner with Ladner Downs in Vancouver at the time of the transactions, and Mr. Ian
McNair, who was the tax director at Husky Oil Limited (“Husky” or the “Appellant”).
The Respondent called two witnesses, Ms. Sandra Pereversoff, a tax
avoidance auditor with the Canada Revenue Agency (“CRA”) and Mr. Michael
Weevers, the appeals officer who considered the Appellant’s Notice of Objection.
I will quote from the Statement of Agreed Facts before summarizing the
witnesses’ testimony and reviewing the relevant documentary evidence.
A. The Parties
1. The Appellant, Husky Oil Limited (“Husky”) is a corporation
formed under the laws of Canada and is resident in Canada for the purposes of
the Income Tax Act, R.S.C. 1985 (5th Supp., c. 1 (the “Act”). On
January 1, 1999, Husky Oil Limited amalgamated with Mohawk Canada Limited.
Prior to August 25, 2000, Husky was continued into the Province
of Alberta. On August 25,
2000, Husky and Husky Oil Operations Limited and Renaissance Energy Ltd. were
amalgamated, with the resulting corporation being Husky Oil Operations Limited.
2. Husky Mohawk Long Term Ltd. (“HMLT”) is a corporation formed
under the laws of Canada on
October 17, 1996. At all times, Husky owned all the issued and outstanding
voting shares of HMLT. The terms of HMLT’s common and preferred shares are set
out in HMLT’s Articles of Amendment . . . .
3. HB Acquisition Inc. (“HB Acquisition”) was a corporation formed
on or about April 1, 1998 under the laws of Canada. HB Acquisition’s initial share capital consisted of common shares.
The characteristics of the common shares are set out in HB Acquisition’s
Articles of Amendment dated June 29, 1998 and September 18, 1998 . . . .
4. Balaclava Enterprises Ltd. (“Balaclava”), now known as Belkin
Enterprises Ltd., is a corporation formed under the laws of the Province of British Columbia and is resident of Canada for the purposes of the Act.
5. BEL Acquisition Inc. (“BAI”) is a corporation formed under the
laws of the Dominion of Canada and is resident in Canada for the purposes of the Act. BAI is a wholly-owned subsidiary of
Balaclava.
6. 3470750 Canada Inc. (“347”) is a corporation formed under the
laws of the Dominion of Canada on or about June 11, 1998, and is resident in Canada for the purposes of the Act. At all
material times 347 was a wholly-owned subsidiary of BAI.
7. Mohawk Canada Limited (“Mohawk Canada”) was a public corporation
formed under the laws of the Dominion of Canada and was resident in Canada for the purposes of the Act. Mohawk
Canada carried on the business of an automotive fuel retailer (the “Retail
Business”) and its common shares were listed on the Toronto Stock Exchange.
8. Mohawk Lubricants Ltd. (“Mohawk Lubricants”) was a corporation formed
under the laws of British Columbia on October 19, 1981 and continued under the Canada Business
Corporations Act on July 2, 1998, and it was resident in Canada for the purposes of the Act. Mohawk
Lubricants, a wholly-owned subsidiary of Mohawk Canada, carried on the business
of re-refining and distributing recycled oil. Mohawk Lubricants also owned
certain other assets (shares of Pound-maker Agventures Ltd. [the “Pound-maker
shares”], a certain Jade Royalty and certain Jade Inventory) [the “Jade
Investment”] and its recycled oil business and other assets are collectively
referred to as the “Residual Assets”.
9. At all times material to this Appeal, Husky and HB Acquisition
were not related to Balaclava, BAI, and 347, and Balaclava, BAI and 347 were
not related to Mohawk Canada and Mohawk Lubricants.
10. Prior to July 8, 1998 Husky and HB Acquisition were not related
to Mohawk Canada and Mohawk Lubricants.
11. Where the expression “related” is used in this Agreement, the parties
agree that the expression refers to its meanings in and for the purposes of
subsections 251(1) and 251(2) of the Act.
12. Upon HB Acquisition tendering its notice to take up and pay for
Mohawk Canada shares tendered to the joint bid, on July 6th, 1998,
as further particularized at paragraph 35 herein, Husky and HB Acquisition
became related to Mohawk Canada and Mohawk Lubricants.
B. Facts Relating to Mohawk and Events Leading up to Transaction
13. At all material times prior to July 8, 1998, a control block
comprising 42% of Mohawk Canada’s common shares was held directly or indirectly
by one shareholder, Hugh B. Sutherland (“Sutherland”), while a further 23% of
the common shares of Mohawk Canada (or debentures convertible into common
shares of Mohawk Canada) were owned by Balaclava. The remaining 35% of Mohawk
Canada common shares were widely held by the investing public, including common
shares owned directly or indirectly by employees of Mohawk Canada.
14. In June 1997, the board of directors of Mohawk Canada (the
“Mohawk Board”) established a special committee of the Mohawk Board (the
“Special Committee”) to assist the Mohawk Board in developing and evaluating
strategic alternatives available to Mohawk Canada to enhance shareholder value.
15. After considering a number of alternatives, the Mohawk Board
accepted the Special Committee’s recommendation that financial advisors be
retained to explore a sale, merger, or other business combination involving
Mohawk Canada’s Retail Business. CIBC Wood Gundy Securities Inc. (“Wood Gundy”)
was appointed as financial advisor to the Special Committee and Mohawk Canada
announced its strategic intentions in a press release to the public on or about
September 23, 1997.
16. From September 1997 through January 1998, Wood Gundy actively
solicited bids for the acquisition of the Retail Business of Mohawk Canada. By early
December 1997, Wood Gundy had received non-binding expressions of interest from
seven parties, including Husky, who had reviewed a confidential information
memorandum concerning Mohawk Canada’s Retail Business. On December 9, 1997, the
Mohawk Board allowed several of these parties, including Husky, access to data
rooms to allow them to engage in detailed due diligence investigation of the
Retail Business before being invited to make a final acquisition proposal.
17. Upon completion of this due diligence process described in . . .
paragraph 16, three parties, one of which was Husky, were invited by the Mohawk
Board to submit proposals for the acquisition of the Retail Business. By
February 11, 1998 the Mohawk Board, in consultation and with the recommendation
of Wood Gundy and legal counsel, decided to enter into exclusive negotiations
with Husky, as well as Balaclava, with a view to implementing a plan of arrangement under the Canada
Business Corporations Act whereby Husky would acquire the Retail Business.
18. At all material times Husky made it clear that it would not
participate in any transaction that would result in it acquiring the Residual
Assets. However, Balaclava was prepared to consider acquiring the Residual
Assets as Balaclava was engaged in a business complementary to the re-refining
business of Mohawk Lubricants that comprised the main part of the Residual
Assets.
19. On February 11, 1998, the Mohawk Board established an
independent committee (the “Independent Committee”) to examine and make
recommendations to the Mohawk Board on any proposal to acquire the Residual
Assets. The Independent Committee retained RBC Dominion Securities Inc. (“RBC
Dominion”) to assist the Independent Committee in its mandate and to provide a
fairness opinion in connection with any proposal to acquire the Residual Assets.
20. Initially, Husky was only prepared to pay $90 million for the
Retail Business of Mohawk Canada, but later increased it to $103 million.
21. As a result of the negotiations amongst the Mohawk Board,
including its Independent and Special Committees and their financial advisors,
and Balaclava, a transaction
structure (the “Structure”) was created that would see:
(a) Husky acquire the Retail Business for its stated (and firm)
acquisition price of $103 million;
(b) Balaclava acquire the Residual Assets; and
(c) Husky and Balaclava participate in a joint bid for the common shares of Mohawk Canada
at Husky’s acquisition price of $103 million.
22. By late April 1998, Husky advised the Special Committee that it
was prepared to explore the possibility of a joint acquisition of all the
common shares of Mohawk Canada through a joint takeover bid with Balaclava. The
Mohawk Board then expanded the mandate of the Independent Committee to review
and to make recommendations concerning any joint takeover bid made by Husky and
Balaclava (the “Joint Bid”).
The Independent Committee was assisted in assessing the Joint Bid by Wood Gundy
who were also retained to provide a fairness opinion from a financial
perspective to the shareholders of Mohawk Canada concerning a Joint Bid.
C. The Joint Bid
23. By early June 1998:
(a) Husky and Balaclava entered into a joint bid agreement (the
“Joint Bid Agreement”) for a takeover bid of all of the outstanding common
shares of Mohawk Canada not owned by Balaclava, BAI or HB Acquisition at a cash
price of $7.25 per share. The $7.25 cash offer (the “Offer”) was not available
to BAI as it was a joint bidder. It was a condition precedent to the Offer that
90% of the Mohawk Canada common shares be deposited to the Offer. . . .
(b) Sutherland, HB Acquisition as the offeror under the Joint Bid
Agreement, and Husky entered into an agreement (the “Lock-Up Agreement”) under
which Sutherland agreed to deposit, or cause to be deposited to the Offer, all
of his common shares (or debentures convertible into common shares) of Mohawk
Canada. . . .
(c) HB Acquisition, Husky, Balaclava, BAI, and Mohawk Canada entered
into an agreement (the “Support Agreement”) under which HB Acquisition agreed
to make the Offer and Mohawk Canada agreed to recommend to its shareholders
that they accept the Offer. . . .
(d) the Independent Committee received a fairness opinion from Wood
Gundy (the “Wood Gundy Fairness Opinion”) that the Offer contemplated under the
Joint Bid Agreement was fair, from a financial point of view, to the Mohawk
Canada shareholders . . . and,
(e) the Independent Committee received a fairness opinion from RBC
Dominion (the “RBC Dominion Fairness Opinion”) that Balaclava’s proposed
acquisition of the Residual Assets, and specifically the price offered by Balaclava in its acquisition of the
Residual Assets, was fair, from a financial point of view, to the Mohawk Canada
shareholders. . . .
24. If sufficient common shares of Mohawk Canada were deposited
under the Offer, Balaclava agreed, and was obligated, to convert all debentures
held by it into common shares of Mohawk Canada and to transfer to HB
Acquisition 2,854,267 common shares of Mohawk Canada. At the $7.25 per share
offer price, these shares were to be transferred in exchange for instruments totalling
$20,693,436.00 as follows:
(a) 9,565,402 shares of HB Acquisition at $1.00 per share;
(b) cash in the sum of $5,193,436.00, equivalent to $1.82 per Mohawk
Canada common share owned by Balaclava; and
(c) a promissory note by HB Acquisition payable to BAI in the sum of
$5,934,598.00.
25. Under the Joint Bid Agreement, Mohawk Canada, Balaclava, and BAI
negotiated an option and put agreement (the “Option and Put Agreement”)
pursuant to which Mohawk Canada granted an option to BAI to acquire the shares
of Mohawk Lubricants, which owned the Residual Assets, for consideration that
included a non-interest bearing promissory note in the amount of $9,565,402.00
maturing in 2023. In addition, under this agreement, BAI granted a put option
to Mohawk Canada under which BAI could be required to purchase the common
shares of Mohawk Lubricants for the same consideration. . . .
26. Husky was not a shareholder of Mohawk Canada when the Option and
Put Agreement was negotiated.
27. The Option and Put Agreement was amended by an agreement dated
July 7, 1998 amongst Mohawk Canada, Balaclava, BAI, and Husky (the “Amended
Option and Put Agreement”) which modified the Option and Put Agreement in the
following manner:
(a) Mohawk Canada, instead of receiving an [sic] non-interest
bearing promissory note issued to it for Balaclava’s acquisition of the
Residual Assets, would instead receive preferred shares issued pursuant to an
amalgamation of Mohawk Lubricants and 347; and
(b) BAI would receive preferred shares of HB Acquisition that were
redeemable for a non-interest bearing note maturing in 2023 as part of the
consideration for transferring its shares in Mohawk Canada to HB Acquisition,
instead of directly receiving a promissory note having the identical terms.
. . .
28. The Amended Option and Put Agreement was made after Husky and HB
Acquisition had entered into the Support Agreement and after they had mailed
the takeover bid.
29. Under both the Option and Put Agreement and the Amended Option
and Put Agreement BAI agreed it would not, prior to June 1, 2023 demand payment
of the principal of the promissory note of $5,934,598.00 from HB Acquisition
unless the amalgamation of Mohawk Lubricants did not occur by September 30,
1998 and Balaclava gave notice to redeem its 9,565,402 common shares at $1.00
per share.
D. Pre-Closing Transactions
30. On or about May 20, 1998, Balaclava transferred 2,286,086 common shares of Mohawk Canada and $2.5
million of convertible debentures issued by Mohawk Canada to BAI in exchange
for 100 common shares of BAI.
31. Balaclava and BAI jointly elected to have the provisions of
section 85(1) of the Act apply to the transfer described in paragraph 30. The
agreed amount was $11,128,034, which amount was equal to the adjusted cost base
(“ACB”) of the common shares to Balaclava.
32. On July 3, 1998, Mohawk Canada transferred all of the shares it
owned of Pound-maker Agventures Ltd., the Jade Royalty and the Jade Inventory
to Mohawk Lubricants in exchange for 2,538,740 preferred shares issued by Mohawk
Lubricants from treasury.
33. On July 5, 1998, Mohawk Lubricants declared a series of 48
separate dividends in the amount of $100,000 each. The dividends were paid by
the issuance of 4,800,000 preferred shares issued by Mohawk Lubricants from
treasury. As the issued and outstanding shares of Mohawk Lubricants had “safe income”
equal to or in excess of the declared dividends, the provisions of subsection
55(2) of the Act were not applicable.
34. As at July 5, 1998, Mohawk Canada owned 1 common share and
7,338,740 preferred shares of Mohawk Lubricants, the ACBs of which were
$2,552,441 and $7,338,740 respectively.
E. Closing Transactions
35. On July 6, 1998, 9,420,050, Mohawk Canada common shares
(excluding the Mohawk Canada common shares held by BAI) (the “Tendered
Shares”), were validly deposited pursuant to the Offer. In total, 98.2% of the
total outstanding Mohawk Canada common shares (held by BAI, Sutherland and the
investing public) were deposited pursuant to the Offer.
36. On July 6, 1998, Husky, through an indirect wholly-owned
subsidiary, Husky Mohawk Holdings Ltd., subscribed for 103,000,000 common
shares of HB Acquisition for $103,000,000 (“Husky Subscription”). Out of the
$103,000,000, HB Acquisition used $73,559,202 to acquire the Tendered Shares.
37. On July 7, 1998, BAI sold 2,854,267 common shares of Mohawk
Canada to HB Acquisition in exchange for $5,193,436 in cash (on hand as a
result of the Husky Subscription), a non-interest bearing demand promissory
note in the amount of $5,934,598 (the “BAI Note”) and 9,565,402 common shares
issued by HB Acquisition from treasury at a value of $1 per common share.
The 9,565,402 common shares represented 8.5% of all the issued and outstanding
common shares of HB Acquisition. . . .
38. BAI and HB Acquisition jointly elected to have the provisions of
subsection 85(1) of the Act apply to the disposition described in paragraph 37.
The agreed amount was $11,128,034, which amount was equal to the adjusted cost
base (“ACB”) of the Mohawk Canada common shares to BAI.
39. On July 7, 1998:
(a) Husky, Husky Mohawk Holdings Ltd., Balaclava, BAI and HB
Acquisition entered into a Shareholders’ Agreement, under which the parties
agreed to not transfer any common shares of HB Acquisition other than in the
manner contemplated in the Shareholders’ Agreement and the Amended Option and
Put Agreement. . . .
(b) Husky, Balaclava, BAI and Mohawk Canada entered into the Amended Option and Put
Agreement . . . under which BAI was granted an option to acquire all of the
common shares of Mohawk Lubricants pursuant to an amalgamation of Mohawk
Lubricants and 347. Under the terms of the Amended Option and Put Agreement,
BAI could assign its option to any person affiliated or associated with BAI.
40. On July 8, 1998:
(a) BAI exercised its option under the Amended Option and Put
Agreement to acquire the shares of Mohawk Lubricants by way of amalgamation
(the “Amalgamation”);
(b) 347, Mohawk Lubricants, Mohawk Canada, Husky and Balaclava
entered into an amalgamation agreement (the “Amalgamation Agreement”), under
which 347 and Mohawk Lubes would amalgamate to form Mohawk Lubricants Ltd.
(“Lubes Amalco”). . . .
(c) Upon the Amalgamation, Mohawk Canada received 7,338,740 Class A
preferred shares of Lubes Amalco for the preferred shares it held in Mohawk
Lubricants and 8,161,260 Class B preferred shares and one Class C preferred
share of Lubes Amalco for the common shares it held in Mohawk Lubricants;
(d) Upon the Amalgamation, BAI received one common share of Lubes
Amalco in exchange for its common share of 347; and
(e) the share capital of Lubes Amalco is described in the Certificate
and Articles of Amalgamation dated August 1, 1998 . . .
41. Following the Amalgamation, the shareholders of Lubes Amalco
were as follows:
|
Shareholder
|
Common
|
Class A Preferred
|
Class B Preferred
|
Class C Preferred
|
|
|
|
|
|
|
|
Mohawk Canada
|
nil
|
7,338,740
|
8,161,260
|
1
|
|
|
|
|
|
|
|
BAI
|
1
|
nil
|
nil
|
nil
|
F. Post-Closing Transactions
42. On September 29, 1998, BAI transferred 9,565,403
common shares of HB Acquisition to HMLT in exchange for 9,565,403 preferred
shares of HMLT issued from treasury. BAI and HMLT jointly elected to have the
provisions of subsection 85(1) of the Act apply to the transfer.
43. The terms of HMLT’s preferred shares described in paragraph 42
are set out in HMLT’s articles of Amendment . . . .
44. On September 30, 1998, HMLT transferred 9,565,403 common shares
of HB Acquisition to Husky in exchange for 9,565,403 preferred shares of Husky
issued from treasury. HMLT and Husky jointly elected to have the provisions of
subsection 85(1) of the Act apply to the transfer.
45. On November 30, 1998:
(a) Lubes Amalco gave notice that it would redeem and did redeem the
7,338,740 Class A preferred shares owned by Mohawk Canada. The redemption price
was paid by the issuance by Lubes Amalco of a non-interest bearing promissory
note due in 2023 in the amount of $7,338,740 (the “Mohawk Note”). . . .
(b) HB Acquisition and Mohawk Canada entered into an Assignment and
Assumption Agreement pursuant to which Mohawk Canada agreed to pay the BAI Note
in consideration for which HB Acquisition gave Mohawk Canada a promise to pay
$5,934,598 on demand to Mohawk Canada. . . .
(c) BAI and Lubes Amalco entered into an agreement pursuant to which
BAI assigned its rights under the BAI Note to Lubes Amalco in consideration for
which Lubes Amalco gave BAI a non-interest bearing promissory note due in 2023
in the amount of $5,934,598 (the “Assignment Note”). . . .
(d) Mohawk Canada and Lubes Amalco agreed to set off and cancel the
BAI Note and the Mohawk Note with Lubes Amalco issuing in favour of Mohawk
Canada a new non-interest bearing promissory note due in 2023 in the amount of
$l,404,142 (the “Set-off Note”). . . .
G. Other
. . .
H. Assessments, Reassessments and Objections Leading to the Appeal
47. The assessment under appeal was made by Notice of Reassessment
under the Act dated February 26, 2004 with respect to the Appellant’s taxation
year ending December 31, 1998. The Appellant filed a Notice of Objection
in a timely fashion. The Minister confirmed the assessment under appeal by
Notification of Confirmation made November 10, 2005.
[4]
I will be using the
defined terms from the Statement of Agreed Facts throughout my reasons for judgment
unless I indicate otherwise.
Mr. Lindsay’s Evidence
[5]
Mr. Thomas Lindsay
was called as a witness to provide the Court with an overview of the
circumstances that gave rise to the acquisition of Mohawk Canada.
[6]
Mr. Lindsay testified that
the Mohawk Canada board members (the “Board”) met to discuss the low trading
range of the Mohawk Canada shares in the spring of 1997. The stock was thinly
traded on the TSX and the Board felt that the trading price did not reflect
Mohawk Canada’s inherent value.
[7]
He explained that a low
stock price meant that Mohawk Canada’s cost of capital was higher than its competitors’,
making it expensive for Mohawk to raise capital for the purpose of refurbishing
its 360 service stations.
[8]
A special committee (the
“Special Committee”) of the Board was set up to review strategic options and to
make recommendations to the Board as to how shareholder value could be
maximized. The options considered by the Special Committee included the
rearrangement of Mohawk Canada’s capital structure and the sale or merger of
Mohawk Canada’s Retail Business.
[9]
Mr. Lindsay
testified that the Board spent three months reviewing the strategic
alternatives. The Special Committee finally recommended to the Board that
Mohawk Canada hire financial advisors to guide it through a sales process. CIBC
Wood Gundy and First Capital were hired to assist the Board. The financial
advisors prepared a book on Mohawk Canada that was given to interested parties
who were likely to submit expressions of interest. Husky was identified as an interested
party as it had made overtures to acquire Mohawk Canada in the past.
[10]
Mr. Lindsay explained
that Mohawk had a very good footprint in Western Canada with 360 service
stations, and the Board was confident that the process would result in an offer
at a substantial premium over Mohawk Canada’s trading range of $3.50 to $4.50
per share.
[11]
However, the task of selling
Mohawk Canada was not without its own unique set of challenges. A preliminary
analysis had indicated that all of the likely buyers would be interested in
making offers for some or all of Mohawk Canada’s Retail Business. They were not
interested in the Residual Assets.
[12]
In January of 1998, Mohawk
Canada’s financial advisors recommended to the Board that Mohawk Canada should
enter into exclusive negotiations with Husky. Husky had made an initial offer
of $90 million to acquire the Retail Business in an asset-based
transaction. This was the best offer received.
[13]
Mr. Lindsay
testified that he worked on several plans to deal with the Residual Assets that
included keeping these assets in Mohawk Canada after the Retail Assets had been
sold or transferring the assets to a new corporation that would be transferred
to Mohawk Canada’s shareholders as a dividend in kind, thus paving the way for
a sale of the shares of Mohawk Canada. The latter option was preferred as it
would have resulted in the lowest amount of corporate taxes having to be paid.
It became quickly apparent that neither option would work.
Mr. Sutherland’s desire for an all‑cash transaction in the $7.50 per
share range could not be met. Additionally, the investment bankers advised the
Board that the new public corporation would be too small to attract public
shareholder interest.
[14]
Mr. Lindsay came
up with the final plan, under which Balaclava would end
up owning Mohawk Lubricants (being the main asset) the Jade Inventory and the
Pound‑maker shares (previously defined as the Residual Assets). Husky
would purchase Mohawk Canada, which would continue to own the Retail Business,
the Minnedosa Ethanol Plant and an insurance policy. This plan meant that
Mr. Sutherland and the public shareholders would receive an all-cash
payment for their shares while Balaclava would receive a much smaller cash
payment and the Residual Assets for its interest in Mohawk Canada. As Balaclava was a significant shareholder of Mohawk Canada, an
independent committee of the Board was appointed to oversee the fairness of the
transaction, with RBC acting as its financial advisor to provide a fairness
opinion on the related-party transaction.
[15]
Mr. Lindsay
testified that while Balaclava was in the solid waste recycling business, it did
not have experience operating an oil recycling plant. Balaclava was willing to acquire the Residual Assets in order to allow the
broader transaction to proceed. Mr. Lindsay explained that this was a
better alternative to a failed transaction in which Balaclava would be left holding
a significant interest in a company whose stock was thinly traded at prices
significantly below what Mr. Lindsay believed was Mohawk Canada’s inherent
value.
[16]
Mr. Lindsay
testified that as a board member he was well aware of his fiduciary duties to
maximize value for all shareholders. In light of that, he delegated the role of
negotiating the transaction for Balaclava to Mr. Gordon Pow, the CFO of
Balaclava. He expected that Mr. Pow would consult with him only if he had
a problem negotiating the terms of the transaction with the independent
committee and its advisors. He did not get involved in the design of the
structure nor in the details leading to its implementation. His CFO turned to
Balaclava’s legal counsel, Ladner Downs, for commercial and tax advice. KPMG, Balaclava’s auditors also played a role in the transaction.
Mr. Kopstein’s Evidence
[17]
Mr. Kopstein
testified that his firm was approached by Mr. Pow to advise Balaclava on how
a joint bid could be structured between Balaclava and Husky using a transaction
structure which would allow Husky to acquire the Retail Business and Balaclava
the Residual Assets.
[18]
Mr. Kopstein
testified that Husky’s initial proposal to acquire the Retail Business through
an asset purchase was unacceptable to the Mohawk Board. An asset-based
transaction would have given rise to a significant tax liability resulting in a
significant corporate tax liability for Mohawk Canada. The financial and tax
model showed that with such a transaction structure the shareholders of Mohawk Canada
would end up with a net cash purchase price significantly below Mr. Sutherland’s
desired price of $7.25 per share.
[19]
Mr. Kopstein
explained that Balaclava was unwilling to surrender part of its interest
in Mohawk Canada for the Residual Assets as this would lead to capital gains
tax. Since Balaclava was to receive significantly less cash than the public and
Mr. Sutherland, he was instructed to come up with a transaction structure
which would allow Balaclava to defer its gain.
[20]
The first part of the
transaction structure (the “Initial Transaction”) called for Balaclava to sell
its interest in Mohawk Canada for the consideration described in paragraph 24
of the Statement of Agreed Facts, consisting of 9,565,402 common shares of
HB Acquisition, cash in the amount of $5,193,436 and a non‑interest‑bearing
promissory note issued by HB Acquisition in the amount of $5,934,598 (the
“HB Acquisition Promissory Note”). The second leg of the transaction
structure called for Balaclava or an authorized subsidiary of Balaclava to
acquire Mohawk Lubricants and the other Residual Assets for $15.5 million
payable through the issue of two non-interest-bearing promissory notes in the amounts
of $9,565,403 (the “First Promissory Note”) and $5,934,598 (the “Second
Promissory Note”) respectively, payable in 25 years. This transaction step
would be concluded only after the takeover bid was completed. The
HB Acquisition Promissory Note and the Second Promissory Note would be offset
and cancelled, leaving Balaclava (or its subsidiary) holding 9,565,402 common
shares in HB Acquisition and Mohawk Canada holding the First Promissory
Note. To complete the transaction, Balaclava would
exchange the common shares of HB Acquisition for preferred shares of a
Husky affiliate. While the preferred shares were retractable at the option of
the holder, Husky could cause Balaclava (or its subsidiary) to accept the First
Promissory Note in full and final payment of the redemption price.
[21]
Mr. Kopstein
testified that at that point he believed he had completed his main tax mandate.
Under the Initial Transaction structure, Husky would have paid
$103 million for all of the common share interest in Mohawk Canada. Balaclava would own the Residual Assets as well as 9,565,402
preferred shares in a Husky affiliate. The capital gain on Balaclava’s interest
in Mohawk Canada would be deferred until Balaclava asked for a retraction of
the preferred shares, and HB Acquisition and Mohawk Canada could be
amalgamated with Husky. While the sale of the Residual Assets to Balaclava would take place in a taxable transaction,
Mr. Kopstein was told that Mohawk Canada would have a sufficient tax
shelter to offset the gain.
[22]
The Initial Transaction
structure was reflected in the Joint Bid Agreement signed between Husky and
Balaclava, and in the purchase and sale agreement and the Option and Put
Agreement, both appended as schedules to the Joint Bid Agreement. The Option
and Put Agreement and the purchase and sale agreement were to be executed by
Mohawk Canada after completion of its takeover, as the Board was not
responsible for overseeing potential post-closing transactions. These
post-closing transactions would be approved by the new board of directors
controlled by Husky. Husky Oil and Balaclava provided, in
the Joint Bid Agreement, undertakings to give effect to each of the
aforementioned agreements.
[23]
Mr. McNair called
Mr. Kopstein in early July, after the offering circular had been mailed to
the Mohawk Canada shareholders, to tell him that Mohawk Canada was more
profitable than expected and that Mohawk Canada would incur tax liability on
the sale of the Residual Assets. Mr. Kopstein testified that
Mr. McNair was frustrated with the fact that Mohawk Canada was going to have
to pay tax on the sale, which was an outcome that Husky had not bargained for.
Mr. Kopstein suggested to Mr. McNair that the capital gain could be
avoided by simply substituting preferred shares for the promissory notes that
Mohawk Canada was to receive under the Initial Transaction structure. However, Mr.
Kopstein explained that he needed his client’s approval to begin work on a
revised plan. Mr. Kopstein called Mr. Pow of Balaclava, who approved
the new initiative provided it would not prejudice Balaclava’s position.
[24]
Mr. Kopstein
worked with his corporate and securities partners to come up with the details
of the revised plan. After completing their analysis of the tax, corporate and
securities law considerations, a revised structure was proposed (the “Revised
Structure”) under which Mohawk Lubricants, the owner of the Residual Assets,
would amalgamate with 347, an indirect subsidiary of Balaclava. Mohawk Canada would receive preferred shares of Lubes Amalco as
described in paragraph 41 of the Statement of Agreed Facts. The Revised
Structure called for the redemption of the 7,338,740 Class A preferred shares received
by Mohawk Canada for a non-interest-bearing promissory note in the amount of
$7,338,740 payable on June 1, 2023. Following this redemption, Mohawk
Canada was left holding 8,161,260 Class B preferred shares and one
Class C preferred share in Lubes Amalco. The Revised Structure was
reflected in the Amended Option and Put Agreement executed after completion of
the sale of Mohawk Canada and was fully implemented after the completion of the
planned amalgamation.
Mr. McNair’s Testimony
[25]
Mr. McNair
testified that he was part of the Husky team involved in the Mohawk Canada
transaction. His primary responsibility was quarterbacking the tax due
diligence and reviewing the plans for the acquisition of Mohawk Canada and the
disposition of the Residual Assets by this corporation. He was not involved in
the preparation of the tax plan as this was Mr. Kopstein’s responsibility.
Initially, his tax due diligence showed that Mohawk Canada would not be taxable
on the sale of the Residual Assets in light of the information obtained from
Mohawk Canada’s tax advisors, Ernst and Young.
[26]
By early June, as
summarized in his memorandum of June 3, 1998, Mr. McNair
had discovered that Mohawk Canada was more profitable than expected and would pay
approximately $1.5 million in tax as a result of the sale of the Residual
Assets. He corroborated Mr. Kopstein’s testimony on the circumstances
leading to the Revised Structure. His understanding of the Revised Structure is
that both Mohawk Canada and BAI would be able to defer tax until the preferred
shares they hold are redeemed. This event would likely occur only in 2023,
which is the maximum deferral period built into the terms and conditions of the
preferred shares.
Ms. Pereversoff’s Evidence
[27]
Ms. Pereversoff
testified that she was asked to review the Mohawk Canada transaction by the CRA
large case auditor assigned to the Husky audit. She found it peculiar that two
unrelated parties could avoid capital gains tax by taking back similar
preferred shares. She concluded that the amalgamation violated the exception in
subsection 87(4) of the Act (the “87(4) Exception”).
[28]
The admissibility of
her testimony was challenged by Mr. Crump, counsel for the Appellant, on
the grounds that she was not qualified to give an opinion on the fair market
value of the shares of Mohawk Lubricants and Lubes Amalco. She acknowledged
that she was not qualified to do so but pointed out during her testimony that
the value that she ascribed to the shares of Mohawk Lubricants was the value
used by the parties to the transaction.
Mr. Weevers’ Evidence
[29]
Mr. Weevers
testified that he disagreed with Ms. Pereversoff’s basis for denying rollover
treatment to Mohawk Canada for the purposes of subsection 87(4) of the Act.
He believed that Ms. Pereversoff had wrongly concluded that a “benefit”
had been conferred on HB Acquisition within the meaning of the 87(4)
Exception because she believed that HB Acquisition had been relieved of an
obligation to pay cash for the shares disposed of by BAI. Apparently, she wrote
this in a letter that was not provided in evidence. Mr. Weevers believed
that rollover treatment should be denied on the grounds that Mohawk Canada
received non-share consideration on the amalgamation. Mr. Weevers had
difficulty explaining his position on this issue during his cross‑examination.
He finally agreed that the non-share consideration that he identified when he
reviewed the file was BAI’s agreement to accept common shares of
HB Acquisition which were subsequently exchanged by BAI for preferred
shares of HMLT.
[30]
Mr. Weevers’
decision to add subsections 56(2) and 69(4) as alternative grounds for his
confirmation of the reassessment was made because he had received directions
from a CRA department in Ottawa to do so.
III. Issues
to be decided by the Court
[31]
The issues for determination in
this appeal were framed by the pleadings as follows:
(i)
Whether the FMV of the shares of Lubes Amalco received by Mohawk Canada
on the amalgamation of Mohawk Lubricants and 347 was less than the FMV of the
Mohawk Lubricants shares prior to their disposal by Mohawk Canada and whether
it is reasonable to regard all or a part of the excess . . . as a benefit which
Mohawk Canada wished to confer on HB Acquisition so that the exception in s. 87(4)
of the Act applies to deny rollover treatment;
(ii)
Whether Mohawk Canada received non-share consideration for its
disposition of its shares of Mohawk Lubricants on the amalgamation of Mohawk
Lubricants and 347 so that the rollover provision in s. 87(4) of the Act does
not apply;
(iii)
Whether property owned by Mohawk Canada represented by its shares of
Mohawk Lubricants, was appropriated for the benefit of HB Acquisition with Mohawk
Canada receiving consideration in the form of preferred shares of Lubes Amalco
having a FMV less than the shares of Mohawk Lubricants, so as to engage the
provisions of s. 69(4) of the Act; and
(iv)
Whether Mohawk Canada intended to confer a benefit to HB
Acquisition when BAI’s shares of Mohawk Canada were transferred to HB
Acquisition so as to engage the provisions of s. 56(2) of the Act.
IV. Positions of the parties
Appellant’s
position
Evidentiary
objections
[32]
The Appellant objects
to the testimony of both Mr. Weevers and Ms. Pereversoff on the
grounds that their testimony was inadmissible because both witnesses were being
asked to provide expert valuation evidence on the fair market value of the
shares of Mohawk Canada and Lubes Amalco. The Appellant also argues that Mr. Weevers
and Ms. Pereversoff were being asked to provide lay opinions on the
application of the law to the facts herein, a matter that should be dealt with
only in argument and ruled on by me in my judgment. Lastly, the objection was
raised that the witnesses’ testimony violated the parol evidence rule insofar
as their evidence constituted an invitation to the Court to conclude that
Mohawk Canada and Balaclava made mutual promises to exchange worthless shares
for the benefit of being able to defer their respective taxable capital gains
for 25 years. Mr. Crump argues that the agreements that give effect
to the transactions were unambiguous and the parol evidence rule bars the
witnesses from inferring that so-called mutual promises existed.
87(4)
Exception
[33]
Mr. Crump submits that in
order for me to find that the 87(4) Exception applies to the facts herein, I
must conclude that all of the following conditions have been met, which the Appellant
disputes:
a) The fair market value of Mohawk
Canada’s shares in Mohawk Lubricants exceeded the fair market value of Mohawk
Canada’s shares in Lubes Amalco. On this point, the Appellant argues that the
evidence of Mr. Lindsay in examination-in-chief and in cross-examination
is sufficient to make out a prima facie case that the Respondent’s
assumption that the shares in Lubes Amalco were worth less than
$15.5 million is wrong. As the Respondent failed to call an expert
witness, I must conclude, according to Mr. Crump, that the Respondent has
failed to make its case on this point.
b) It is reasonable to conclude that
Mohawk Canada intended to confer a benefit on HB Acquisition as alleged by
the Respondent in its pleadings. On this point, counsel argues that
Ms. Pereversoff identified the benefit as the removal of HB Acquisition’s
obligation to pay BAI $7.25 in cash per share. Ms. Pereversoff’s analysis
on this point is contradicted, says counsel, by documentary evidence that
clearly establishes that no such obligation existed.
c) Mohawk Canada was
related to HB Acquisition at the time that the benefit was conferred. The Appellant’s
submission on this point is that the benefit was conferred when Mohawk Canada
signed the support agreement on June 1, 1998, as that agreement set in
motion the transactions which gave rise to the amalgamation. At that time,
HB Acquisition and Mohawk Canada were not related.
Only
share consideration was received
[34]
The Appellant submits that the Respondent’s
allegation that non-share consideration was received by Mohawk Canada on the
amalgamation is summarized in the read-in from the Appellant’s examination for
discovery of Mr. Weevers, as follows:
The non-share
consideration received by Mohawk Canada Limited in the course of disposing of
Mohawk Lubricants Ltd. shares was BEL Acquisition Inc.’s promise to accept
9,565,402 common shares and a promissory note bearing a face value of
$5,934,598 from HB Acquisition Inc. in the course of BEL Acquisition Inc.’s
disposition of Mohawk Canada’s [sic] Limited shares.
[35]
Furthermore, Mr. Crump points
out that Mr. Weevers admitted in cross‑examination that the
non-share consideration identified by him was provided for under an agreement that
took effect on July 7, 1998 pursuant to which BAI transferred its shares
in Mohawk Canada to HB Acquisition. This agreement predates the execution
of the amalgamation on July 8, which took effect on August 1. Counsel
argues that Mohawk Canada received only shares in Lubes Amalco on August 1
and that past consideration, if any exists, cannot be considered to be
consideration received on the amalgamation. Moreover, Mr. Crump further
submits that the plain words of subsection 87(4) require that the non-share
consideration be received from the corporation resulting from the amalgamation
and not from a third party.
No
appropriation under subsection 69(4)
[36]
The Appellant argues that
subsection 69(4) does not apply to the facts herein because the Respondent failed
to identify the appropriator in its pleadings and Ms. Pereversoff wrongly
concluded that the benefit received by HB Acquisition was the removal of
an obligation to pay BAI $7.25 in cash for each of its shares in Mohawk Canada.
Subsection
56(2) not applicable
[37]
Counsel points out that the
Minister failed, for the reasons mentioned earlier, to establish that
HB Acquisition received a benefit. A benefit is an essential condition for
the application of subsection 56(2).
Respondent’s
position
Evidentiary
objections
[38]
Mr. Gibson, counsel for the
Respondent, rejects the Appellant’s argument that the testimony of
Ms. Pereversoff and Mr. Weevers is inadmissible. These witnesses were
called to explain why the CRA denied tax-free rollover treatment and reassessed
Husky in respect of the disposition by Mohawk Canada of shares in Mohawk
Lubricants. Counsel also argues that the parol evidence rule does not apply to
third parties, such as the Respondent, who are not parties to the documents
signed by the parties to the transaction. What the parol evidence rule is
designed to do is stop one party to a contract in written form from introducing
evidence other than the written contract that is inconsistent with the wording
of that written contract.
87(4)
Exception
[39]
Mr. Gibson argues that the
only way the Appellant could rebut a technical assumption as to the fair market
value of the shares of Mohawk Lubricants and Lubes Amalco was to call a
recognized expert in the valuation field. The Appellant’s witnesses were not
qualified to provide expert testimony, in much the same way that the
Respondent’s witnesses were not qualified to do so. Therefore, the Minister’s
assumption as to the fair market value of the shares made in the pleadings must
stand. Secondly, Mr. Gibson argues that Ms. Pereversoff used the
value agreed to by the parties for the Mohawk Lubricants shares, as evidenced
by the reference in the offering circular to the fact that the Residual Assets
were to be purchased for $15.5 million.
[40]
Mr. Gibson also takes issue
with the allegation that Ms. Pereversoff concluded that the benefit
conferred on HB Acquisition was the removal of its obligation to pay $7.50
per share. Ms. Pereversoff did not testify on this point in her examination-in-chief.
In addition, counsel for the Respondent did not cross‑examine her on the
point. All that counsel for the Respondent did was read an excerpt from
Mr. Weevers’ examination for discovery that established what
Mr. Weevers believed Ms. Pereversoff had identified as being the
benefit for the purposes of the 87(4) Exception. Mr. Weevers concluded
that Mohawk Canada could be reassessed on a different basis: he believed that
Mohawk Canada received non‑share consideration for the shares it gave up
in Mohawk Lubricants.
Non-share
consideration
[41]
Mr. Gibson argues that there
were mutual promises given by BAI on the one hand and Mohawk Canada on the
other to exchange shares for worthless shares and that these mutual promises
constitute non-share consideration received by Mohawk Canada on the
amalgamation of Mohawk Lubricants.
Subsection
69(4)
[42]
Mr. Gibson submits that
Husky, through its control of HB Acquisition, caused HB Acquisition
to direct Mohawk Canada to enter into the amalgamation in order to fulfil a
promise made to Balaclava that it would end up owning the Residual Assets when
the transactions were finally completed. He argues that there was nothing for
Mohawk Canada in the amalgamation; it gave up shares in Mohawk Lubricants worth
$15.5 million for preferred shares in Lubes Amalco that were worthless.
This constituted an appropriation by HB Acquisition, or Husky Oil for that
matter, of property belonging to its subsidiary in much the same way that the Appellant
in Boardman v. R., 1985 CarswellNat 452, appropriated property, although
the property was not transferred to him.
Subsection
56(2)
[43]
The Crown argues that the actions
that trigger the application of subsection 69(4) of the Act are the
same actions that trigger the application of subsection 56(2).
V. Analysis
Evidentiary
objections
[44]
I allowed Ms. Pereversoff
and Mr. Weevers to testify subject to the reservation that I would rule on
the admissibility of their testimony, and on the weight, if any, I should give
to it, prior to dealing with the substantive matters at issue.
[45]
On cross-examination, both
witnesses admitted that they were unqualified to give expert opinion on the
fair market value of the shares of Mohawk Lubricants and Lubes Amalco. However,
this does not mean that I must discard all of their testimony.
Ms. Pereversoff testified that she believed that the shares of Mohawk
Lubricants were worth $15.5 million based on the value used in the
transaction documents by the parties. She also testified that she assumed the
preferred shares taken by Mohawk Canada in Lubes Amalco were worthless in view
of the terms and conditions of the shares. In addition, Ms. Pereversoff
believed that Mohawk Canada intended to confer a benefit on HB Acquisition
in accepting the worthless shares. These findings are the assumed facts that
are listed in subparagraphs 17 (bbb), (ccc) and (ddd) of the
Respondent’s Reply to the Notice of Appeal. These were the facts that prompted
Ms. Pereversoff to issue the reassessment on the basis that the
amalgamation violated the 87(4) Exception.
[46]
I admit the witnesses’ testimony
for the purpose only of establishing the facts that the Appellant has the
initial burden of demolishing by presenting a prima facie case to the
contrary. I also find that Mr. Weevers, in confirming the reassessment,
believed that Mohawk Canada received non-share consideration for the
disposition of its interest in Mohawk Lubricants and that property of Mohawk
Canada, being the shares in Mohawk Lubricants, was appropriated for the benefit
of HB Acquisition.
[47]
I do not agree with Mr. Crump
that the parol evidence rule prohibits the Respondent from alleging that
Balaclava and Husky entered into mutual promises to transfer property for
shares of much less value as a scheme to avoid capital gains tax.
Mr. Justice Hugessen, writing for the Federal Court of Appeal in Urichuk
v. Canada, [1993] 1 C.T.C. 226, dismisses the application of this rule as
follows:
. . . We
also reject the Appellant's attempt to invoke the parol evidence rule to object
to evidence of the circumstances leading up to the making of the agreement; the
Minister, not being a party to that agreement, is entitled to rely on any
available evidence to support his characterization of the payments in a
manner different from that employed by the former spouses in the agreement
itself. In our view the trial judge correctly examined the agreement and all
its surrounding circumstances and applied thereto the proper criteria . . . .
[Emphasis added.]
[48]
Mr. Crump argues that the
onus of proof as regards the question of the value of the shares had shifted to
the Respondent. He bases this on the testimony of Mr. Lindsay and on his
analysis of the Supreme Court of Canada’s decision in Hickman Motors Ltd. v.
Canada, [1997] 2 S.C.R. 336.
[49]
What exactly did Mr. Lindsay say during his examination-in-chief
and on cross-examination? Mr. Lindsay said that Husky initially was interested
only in Mohawk Canada’s Retail Assets. Balaclava had identified five assets
that Husky was unwilling to take. Mr. Sutherland, for this part, was
interested in an all-cash bid. After extensive negotiations, Husky agreed to
take two of the Residual Assets, namely the Minnedosa Ethanol Plant and a life
insurance policy, and increased its initial offer from $90 million to $103
million. Following the amalgamation of Mohawk Lubricants, Balaclava would end
up owning the Residual Assets consisting of the Pound-maker shares, the Jade
Inventory and the oil refinery in British
Columbia. On cross-examination,
Mr. Lindsay testified as follows:
Q MR. GIBSON: So, the figure of 15.5 million that we’ve heard about
and that you were asked about by Justice Hogan earlier, how did that figure
come about?
A Which 15.5 number are you talking about?
Q 15.5. The value of residual assets, portion of the residual
assets.
A Is that all the residual assets? The number would be a lot bigger
that that.
JUSTICE HOGAN: I said it was 103 plus 15.5 was the residual that you
took, minus debt, and that give you a full share value, because in the 103
Husky was picking up the other residuals.
A Yeah, they’d already picked up Minnedosa, that was the second most
valuable asset after ‑ -
JUSTICE HOGAN: Plus the insurance policy.
A Yeah. I mean, that number, you know . . .
Q MR. GIBSON: The Crown thinks that Mohawk Lubes was worth 15.5 million.
A I’m not sure if that’s correct or if that included jade and the
Poundamaker [sic]. Are you sure of that? Someone would have to show
me the breakdown. I believe, and I stand to be corrected, is would it not be
more like 13 million and two and a half million?
JUSTICE HOGAN: 15.5 was for all the residual that they bought - -
A All three of them. Well, you know, I believe the numbers were
something like 13, 2.2 and a million or something, you know, to get to 15.5,
but I’m somewhat guessing from recollection on that make of 15.5.
[50]
As Mohawk Lubricants owned all of the Residual Assets acquired
indirectly by BAI at the time of Mohawk Lubricants’ amalgamation, the value of its
shares should be $15.5 million based on Mr. Lindsay’s recollection. It
would be hard for Mr. Lindsay to recollect otherwise. In the offer to
purchase mailed to the Mohawk Canada shareholders, the parties declare that
shares of Mohawk Lubricants are to be acquired for a purchase price of $15.5
million as follows:
Option
Agreement
. . .
Under
the Option Agreement, BAI will be granted an option (the “Option”) to purchase
all of the issued and outstanding shares of Lubricants (the “Lubricants Shares”).
BAI or any of its affiliates or associates will be entitled to exercise the
Option at any time during a 20 day period (the “Option Period”) following the
date of the Option Agreement. Mohawk will have the right at any time during the
Option Period to require the exercise of the Option by BAI. If the Option is
exercised, the purchase price for the Lubricants Shares will be $15.5 million,
subject to a working capital adjustment. The purchase price for the Lubricants
Shares will be evidenced by the issuance by the purchaser of a promissory note,
and BAI will be required to surrender its common shares of the Offeror in
exchange for non‑voting preferred shares of the Offeror.
[51]
Mr. Crump presents a novel
argument. He submits that a reasonable person apprised of the fact that the
Amended Option and Put Agreement had been entered into would reduce the value
of the Mohawk Lubricants shares to nil. I do not accept this argument. Mohawk
Canada is a shareholder of Mohawk Lubricants. The fact that it has entered into
the Amended Option and Put Agreement does not affect the value of the shares of
its subsidiary, Mohawk Lubricants. Mohawk Canada could be compelled to give
effect to the agreement or face a lawsuit for damages, both being actions that can
be directed against it and not its subsidiary, Mohawk Lubricants. I note that the
Amended Option and Put Agreement may affect the value of Mohawk Canada’s shares
as it is giving up Mohawk Lubricants, worth $15.5 million according to the
Respondent, to accept shares of Lubes Amalco, which the Respondent says are
worthless. It does not, however, affect the value of Mohawk Lubricants.
[52]
If I were to accept Mr. Crump’s
submission on this point, bona fide estate freezes would no longer need
to be implemented with the protection of valid price adjustment clauses. For
example, based on this argument, a father could cause his holding corporation
to grant a long-term option, for example, to his son to purchase assets from
the corporation at their current price or a lower price. On his death, the
father’s estate could claim that the holding corporation’s value is impaired
because of the option, thus avoiding, for both the shareholder and the entity, tax
on shares that have since increased in value.
[53]
After review of the evidentiary objections
raised by the Appellant, I conclude that the Minister’s assumption that the
shares of Mohawk Lubricants are worth $15.5 million must stand. Equally, the Appellant
has failed to make a prima facie case rebutting the Minister’s
assumption that the preferred shares of Lubes Amalco were worthless. To rebut
this assumption the Appellant would have had to call an expert witness to
provide the Court with an opinion on the fair market value of the Lubes Amalco
preferred shares.
Analysis of the substantive
issues
87(4) Exception
[54]
Rollover treatment may be disallowed under the 87(4) Exception, which
reads as follow:
. . . except
that, where the fair market value of the old shares immediately before the
amalgamation exceeds the fair market value of the new shares immediately after
the amalgamation and it is reasonable to regard any portion of the excess (in
this subsection referred to as the “gift portion”) as a benefit that the
shareholder desired to have conferred on a person related to the shareholder,
the following rules apply . . .
[55]
When this exception applies, the shareholder of the predecessor corporation
is deemed to have disposed of the shares (the “Old Shares”) of the predecessor
corporation for an amount equal to the lesser of (i) the total of the adjusted
cost base of the Old Shares and the gift portion, defined in that subsection as
the amount by which the value of the Old Shares exceeds the value of the new
shares, and (ii) the fair market value of the Old Shares immediately before the
amalgamation.
[56]
In order for the 87(4) Exception to apply in the instant case, I must
find that all of the following conditions are met:
a)
the fair market value of Mohawk
Canada’s shares of Mohawk Lubricants exceeded the fair market value of Mohawk Canada’s
shares of Lubes Amalco;
b)
it is reasonable to regard any
portion of the excess as a benefit that Mohawk Canada desired to confer on HB Acquisition;
and
c)
Mohawk Canada was related to HB
Acquisition at the time the benefit was conferred.
[57]
The preferred shares
held by Mohawk Canada in Lubes Amalco give no dividend entitlement. The
redemption price of the shares can be paid by Lubes Amalco through the issuance
of a non‑interest‑bearing promissory note maturing on June 1,
2023. It is incontrovertible that an arm’s length purchaser of the preferred
shares would place a significant discount on the principal amount of the note.
The Appellant failed to lead evidence on this point. As a result, the
Minister’s assumption that the Lubes Amalco preferred shares had a nil value must
stand.
[58]
Why did Mohawk Canada
agree to accept the preferred shares in Lubes Amalco in exchange for the shares
it gave up in Mohawk Lubricants? The short answer is that Mohawk Canada had no
independent say in the matter. The evidence shows that Husky wanted the Retail
Business. It was unwilling to purchase the Residual Assets. Balaclava wanted to liquidate its position in Mohawk Canada and
was willing to accept the Residual Assets in lieu of an additional cash payment
of $15.5 million provided that the Residual Assets could be acquired on a
pre-tax basis. Mohawk Canada was compelled to give effect to the amalgamation
and exchange its shares in Mohawk Lubricants for the preferred shares in Lubes
Amalco, because the amalgamation was the means by which the Residual Assets could
be transferred to Balaclava, supposedly on a tax-free basis. The amalgamation
was a condition sine qua non that paved the way for HMLT’s and Husky’s
acquisition of Mohawk Canada. Both of these entities gave undertakings to Balaclava that they would cause Mohawk Lubricants to amalgamate
with 347 and Mohawk Canada gave effect to this promise for the benefit of HB
Acquisition and Husky. In my opinion, the 87(4) Exception is designed to
prevent this very result by providing that the shareholder of the predecessor
corporation must act in its own interest and not for the benefit of a related
party, such as a controlling shareholder.
[59]
It should also be noted
that the amalgamation benefited HB Acquisition and Husky in another way. Under
the Amended Option and Put Agreement, HB Acquisition could have been compelled
to acquire the securities it issued to BAI for $15.5 million if the
Residual Assets were not transferred to Balaclava through the completion of the
amalgamation on or before September 29, 1998. HB Acquisition’s obligation to
pay this amount was supported by a guarantee given by Husky. Both of these
contingent obligations were terminated on completion of the amalgamation.
Following the amalgamation, BAI was compelled to exchange its common shares of
HB Acquisition for preferred shares in HMLT, which have terms and
conditions similar to securities held by Husky in Lubes Amalco. I infer from
the fact that BAI exchanged the shares in HB Acquisition for preferred shares
in HMLT that provided no annual return to it that it was satisfied that it had received
the $15.5 million of value attributable to the Residual Assets through the
completion of the amalgamation.
[60]
Mr. Crump argues
that Mr. Weevers failed to properly identify the benefit required to
trigger the application of the 87(4) Exception. He makes his point in a
roundabout way by referring me to Mr. Weevers’ testimony on discovery.
Mr. Weevers testified that Ms. Pereversoff invoked the 87(4)
Exception because she had wrongly concluded that HB Acquisition was
relieved from paying $7.50 per share in cash only with respect to the shares
disposed of by BAI in favour of HB Acquisition. The evidence shows that
HB Acquisition did not have an immediate obligation to make an additional
$15.5 million cash payment to BAI. This obligation would arise only if
HB Acquisition failed to cause Mohawk Canada to complete the amalgamation
on or before September 29, 1998. I am not sure whether
Ms. Pereversoff grasped this distinction. The question was not put to her
when she testified. In any event, what Ms. Pereversoff believed is not
important, as my review of the evidence has led me to conclude that Mohawk
Canada gave up shares worth $15.5 million for worthless preferred shares
because its shareholders, HB Acquisition and Husky, agreed to these terms
as part of their bargain with Balaclava. As a result, a benefit was conferred on
HB Acquisition and, indirectly, on Husky.
[61]
That being said, there
is nothing offensive, in my view, about the parties ending up with cross‑shareholdings
allowing a potential 25-year deferral of capital gains tax. Mohawk Canada,
however, could not benefit from a rollover under subsection 87(4) because it ran
afoul of the 87(4) Exception.
[62]
I suspect that
Mr. Kopstein faced a significant quandary in designing the terms and
conditions of the preferred shares issued by Lubes Amalco to Mohawk Canada. His
client, Balaclava, had instructed him that it was prepared to accommodate
Husky’s desire that Mohawk Canada not pay taxes in connection with the
disposition of the Residual Assets provided that Balaclava’s commercial
objectives were not prejudiced thereby. To make the tax plan more robust from a
rollover standpoint, the preferred shares could have been made retractable for
fair market value consideration. An annual dividend entitlement could have been
added to the shares. These features would have been consistent with what the
CRA generally demands in the case of an estate freeze. I assume that the former
feature was inconsistent with Balaclava’s desire to benefit from a 25-year
deferral. If the Lubes Amalco shares had been made redeemable for fair market
value consideration, Husky could have demanded the immediate redemption of
these shares. This meant that BAI would have been compelled to do the same for
its shares in HMLT, otherwise it would assume the risk associated with a
continued investment in HMLT, while at the same time having no return on its
investment. I assume that this consideration prompted Mr. Kopstein to
design the terms and conditions of the Lubes Amalco preferred shares so as to
ensure that Husky would retain its investment for as long as BAI desired to
benefit from a rollover. I infer from the evidence that this was achieved by
providing that the redemption price would be paid through the issue of a non‑interest‑bearing
note maturing in June 2023. I suspect that the annual dividend feature was
also rejected because Lubes Amalco would incur Part VI.1 tax if it paid a
dividend to Husky. HMLT would incur the same tax when it paid a matching
dividend back to BAI. It seems that Balaclava’s legitimate commercial
considerations prevailed over Husky’s desire for a tax-free rollover. This is
an understandable result in the circumstances.
[63]
The Appellant argues
that the words “reasonable to regard” used in the 87(4) Exception require
an objective review of the evidence. I agree with this proposition and I
believe that this is what I have done. However, I do not agree with Mr. Crump’s
second proposition that I must consider the overall impact of all of the
transactions entered into by the parties. This is what Mr. Crump is inviting
me to do in arguing that Mr. Lindsay testified that from an overall standpoint
each party ultimately ended up owning what that party bargained for.
[64]
The 87(4) Exception is
designed to prevent related parties from shifting equity values around, much as
paragraph 85(1)(e.3) does in the case of a rollover of property for
shares, and subsections 86(2) and 51(2) do in the case of an exchange of
securities of an issuer for new shares of the same issuer. Without these
provisions it would be easy for related parties to avoid personal tax or
corporate tax by directing the shareholder of an amalgamating corporation to
take back securities of lesser value. A butterfly transaction structured to
comply with subsection 55(2) or a bump transaction structured to comply with
paragraph 88(1)(c) can lead to the avoidance of tax by the
corporate entity, but neither of these provisions could have been made to work
in the case at bar. In my opinion, the 87(4) Exception must be tested solely at
the level of Mohawk Canada and not by reference to the overall result of all of
the transactions as suggested by Mr. Crump. The words of the 87(4) Exception
limit one, in identifying the benefit conferred, to a search conducted at the level
of the disposing shareholder. This is clear from the reference in that
provision to the fair market value of the shares before and after the
amalgamation.
[65]
The last point in the Appellant’s
argument is that the benefit arose as a result of agreements entered into at a
time when HB Acquisition (and Husky for that matter) and Mohawk Canada
were not related. Therefore, the 87(4) Exception cannot apply. I find nothing
in the agreement that supports this view. The Joint Bid Agreement was entered
into by Husky and Balaclava. The Option and Put Agreement is attached
as a schedule to the Joint Bid Agreement. Husky and Balaclava were committed to
execute the Option and Put Agreement after the takeover closed. Mohawk Canada, being
the object of the Joint Bid Agreement, was not obliged to give effect to the
Option and Put Agreement. Mohawk Canada did sign the support agreement, but
there is nothing in that agreement that deals with the transfer of the Residual
Assets to Balaclava. The board of Mohawk Canada could not
agree to the transfer of the Residual Assets without knowing whether its
shareholders would agree to tender their shares pursuant to HB Acquisition’s
offer. The Amended Option and Put Agreement was executed by the new board after
the takeover transaction closed and at a time when HB Acquisition, Husky
and Mohawk Canada were related. This is consistent with what happens after a
takeover is completed. A new board is appointed to allow the new owners of the
corporation to implement their plans for the target entity, including post-closing
reorganizations. Therefore, I conclude that the 87(4) Exception applies to
the disposition by Mohawk Canada of its shares of Mohawk Lubricants that
occurred on amalgamation.
Non-share
consideration
[66]
As noted earlier, Mr. Weevers
took issue with the basis on which Ms. Pereversoff concluded that the 87(4)
Exception applied so as to deny rollover treatment. He recommended an alternative
basis for the reassessment under subsection 87(4) of the Act. Mr. Weevers
concluded that Mohawk Canada received non-share consideration, which violated
the prohibition in the preamble to that subsection. Subsection 87(4) also denies
rollover treatment if the shareholder of the predecessor corporation receives
non-share consideration for the shares of the predecessor corporation.
[67]
I disagree with
Mr. Weevers’ analysis. Mohawk Canada received only preferred shares of
Lubes Amalco on the amalgamation. Balaclava received more than the securities
of HB Acquisition when it agreed to transfer to that entity the shares of
Mohawk Canada. Balaclava got an undertaking by Husky and HB Acquisition
to cause Mohawk Canada to complete the amalgamation. This may be consideration
to Balaclava. It is not, however, consideration received by Mohawk Canada.
Mohawk Canada simply gave effect to the amalgamation; this freed HB Acquisition
from the risk of having to pay cash to BAI for the securities that it held in
HB Acquisition and released Husky from its guarantee of this obligation. The
amalgamation also removed the risk, for both parties, of a claim by BAI for damages
if the amalgamation was not completed as agreed.
Subsection 69(4)
[68]
The Respondent also argues that
the amalgamation gives rise to the application of subsection 69(4) of the Act.
That subsection reads as follows:
69(4) Shareholder
appropriations — Where
at any time property of a corporation has been appropriated in any manner
whatever to or for the benefit of a shareholder of the corporation for
no consideration or for consideration that is less than the property’s fair
market value and a sale of the property at its fair market value would have
increased the corporation’s income or reduced a loss of the corporation, the
corporation shall be deemed to have disposed of the property, and to have
received proceeds of disposition therefor equal to its fair market value, at
that time.
[Emphasis added.]
[69]
This provision is much broader
than the 87(4) Exception. Property can be appropriated in many ways outside the
case of a rollover. For example, a shareholder could cause property of a
corporation to be transferred to it for consideration less than fair market
value. A controlling shareholder could cause a corporation to transfer property
to someone else to relieve that corporation of an obligation or, in this case, to
free HB Acquisition, or Husky for that matter, from the risk of having to
pay cash to BAI for the securities issued by HB Acquisition.
[70]
The transactions carried out by
Husky, HB Acquisition, Balaclava and BAI in the present case are a more sophisticated
version of the following basic plan presented here to illustrate the
application of subsection 69(4):
a) Seller A owns a subsidiary
corporation (Target Corporation) that it wants to sell.
b) Purchaser B wants to acquire the Target
Corporation.
c) Both parties wish to reduce their
respective tax bills.
d) Seller A agrees to reduce the
purchase price it is willing to receive for the Target Corporation on condition
that Purchaser B will cause the Target Corporation to transfer an asset to it
at a discount equal to the agreed‑upon reduction in the purchase price
for the Target Corporation.
e) Seller A pays less tax, Purchaser B
conserves cash and the Target Corporation pays less tax.
[71]
In the present case, a similar result
occurs under a more sophisticated plan. HB Acquisition agreed to cause
Mohawk Canada (Target Corporation) to transfer Mohawk Lubricants for
consideration worth less than the fair market value of the Mohawk Lubricants
shares. As a result, HB Acquisition conserves cash. Following the
amalgamation, HB Acquisition could no longer be compelled to buy back for
$15.5 million the securities it issued to BAI. To complete the
transaction, BAI, having obtained the full present value of the Residual
Assets, transferred the shares it held in HB Acquisition in exchange for
preferred shares in HMLT that had a similar impaired value. I am of the opinion
that, in the instant case, Mr. Kopstein’s plan was designed to defer tax while
the plan described above is aimed at avoiding tax. Subsection 69(4) prevents both
plans from working by providing that the Target Corporation must pay tax on the
full value that has been appropriated for the benefit of its shareholder
HB Acquisition.
[72]
The Appellant argues that the Respondent
did not properly identify the appropriator in its Reply to the Notice of Appeal.
The documentary evidence submitted to me in the Joint Book of Documents has enabled
me to conclude that the appropriators are HB Acquisition and Husky, the
parties that directed Mohawk Canada to enter into the amalgamation for their
benefit. The transactions that give rise to the application of subsection 69(4)
are the very same ones that give rise to the application of the 87(4)
Exception.
Subsection 56(2)
[73]
The Respondent invokes subsection
56(2) as an alternative basis for the reassessment. That provision reads as
follows:
56(2) Indirect
payments — 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 (other
than by an assignment of any portion of a retirement pension pursuant to
section 65.1 of the Canada Pension Plan or a comparable provision of a
provincial pension plan as defined in section 3 of that Act or of a
prescribed provincial pension plan) shall be include in computing the
taxpayer’s income to the extent that it would be if the payment or transfer
had been made to the taxpayer.
[Emphasis added.]
[74]
In Neuman v. M.N.R., the Supreme Court of Canada reduced
the application of subsection 56(2) to its essential characteristics as
follows:
(1) the
payment [transfer of property] must be to a person other than the reassessed
taxpayer;
(2) the
allocation must be at the direction or with the concurrence of the reassessed
taxpayer;
(3) the
payment [transfer of property] must be for the benefit of the reassessed
taxpayer or for the benefit of another person whom the reassessed taxpayer
wished to benefit; and
(4) the
payment [transfer of property] would have been included in the reassessed
taxpayer’s income if it had been received by him or her.
[75]
Mr. Weevers testified that
someone in the head office suggested that subsection 56(2) should be thrown
into the mix in the event that the Court concluded that the amalgamation
qualified for rollover treatment under subsection 87(4) and that subsection
69(4) did not apply. The four conditions listed above require that a person
other than the transferor direct that the transfer take place, thus making that
person taxable provided that the person would otherwise be taxable if the
transfer was made directly to him or her. Subsection 56(2) could have applied
to HB Acquisition, the party that benefited from the amalgamation, in much
the same way that subsection 15(1) could have been invoked. The amalgamation
was not carried out for the benefit of Mohawk Canada, as it gave up shares that
had a greater value than the Lubes Amalco shares it received. Finally, subsection
56(2) cannot be applied to the owner of the transferred property, Mohawk Canada,
because it would not have been subject to tax on property that it already owned
and thus the requirement of the fourth condition is not met. For these reasons,
subsection 56(2) does not apply to the transactions herein.
[76]
For all of these reasons, the Appellant’s
appeal is dismissed, with costs to the Respondent.
Signed at Ottawa, Canada, this 24th
day of February 2009.
"Robert J. Hogan"
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