Citation: 2007TCC404
Date: 20070718
Docket: 2005-1756(IT)G
BETWEEN:
ESTATE OF EDWARD REILLY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Mogan D.J.
[1] Since 1972, the
federal Income Tax Act (the “Act”) has imposed a tax on capital
gains. The scheme in the Act for taxing capital gains is found in
“subdivision c” (sections 38 to 55). Elsewhere in the Act, there are
exemptions for all or part of the gain realized on the disposition of certain
capital properties. In particular, there is an exemption for a “qualified small
business corporation share” which, in general terms, is a share in a Canadian-controlled
private corporation that uses all or substantially all of its assets to carry
on an active business in Canada.
[2] The provisions of
the Act permitting the above exemption are complex. In the interests of
brevity and simplicity, I will reproduce the three most relevant provisions
retaining only those words which I regard as relevant to the issue in this
appeal.
110.6(1) For the purposes of this
section,
“qualified small business corporation share” of an
individual … at any time (in this definition referred to as the
"determination time") means a share of the capital stock of a
corporation that,
(a) at the
determination time, is a share of the capital stock of a small business
corporation …
248(1) "small
business corporation", at any particular time, means, subject to
subsection 110.6(15), a particular corporation that is a Canadian-controlled
private corporation all or substantially all of the fair market value of the
assets of which at that time is attributable to assets that are
(a)
used principally in an active business carried on primarily in Canada by the particular corporation or by a corporation related
to it,
(b) …
110.6(2.1) In computing the
taxable income for a taxation years of an individual … who disposed of a share
of a corporation in the year … that, at the time of disposition, was a qualified
small business corporation share ... there may be deducted such amount as the
individual may claim not exceeding the least of
(a) the amount
determined by the formula in paragraph 2(a) in respect of the
individual for the year,
(b) …
(c) … and
(d) the amount that
would be determined in respect of the individual for the year under paragraph
3(b) … in respect of capital gains and capital losses if the only
properties referred to in paragraph 3(b) were qualified small business
corporation shares …
[3] The late Edward Reilly (“Mr. Reilly”) died on March
13, 2000. At the time of his death, he controlled a corporation which operated
four different businesses, all in Carberry, Manitoba: a Home
Hardware Store, a plumbing business, a carwash and a laundromat. At the time of
death, the businesses were owned as follows:
(i)
Mr. Reilly
owned all of the issued shares of 62490 Manitoba Ltd. (“Holdco”).
(ii) Holdco
owned all of the issued shares of Reilly Ventures Limited (“Ventures”).
(iii) Ventures
owned and operated the four family businesses: hardware store, plumbing,
carwash and, laundromat.
[4] When filing Mr.
Reilly’s terminal income tax return for the year of death (2000), the executrix
of his estate claimed a capital gains exemption in the amount of $273,200 with
respect to the value of his shares in Holdco and/or Ventures. When assessing
tax on the terminal income tax return, the Minister of National Revenue
disallowed the capital gains exemption on the assumption that neither the
shares of Holdco nor Ventures were “qualified small business corporation
shares”. The executrix of the estate has appealed from that assessment.
[5] The broad issue
before the Court is whether the shares in question satisfy the above provisions
of the Act to be regarded as qualified small business corporation
shares. The narrow issue is whether all or substantially all of the fair market
value of the assets of Ventures (in the 24 months preceding death) can be
attributed to assets used principally in an active business carried on
primarily in Canada.
[6] The focus of the
narrow issue is the balance sheet of Ventures as at May 31, 2000, within
90 days after the death of Mr. Reilly. Exhibits A-1 (Reference 7) and R-1 (Tab
4B) contain the unaudited financial statements of Ventures as at May 31, 2000
(plus comparable amounts for the four preceding fiscal periods). The assets on
the balance sheet of Ventures as at May 31, 2000 may be allocated among the following
four categories:
|
Assets per Balance Sheet
|
Balance
Sheet Value
|
%
|
|
1. Cash and Marketable Securities
|
$272,821
|
38.0
|
|
2. Accounts
receivable, inventory, taxes recoverable, prepaid expenses, and goodwill
|
256,240
|
35.5
|
|
3. Capital
properties (land, bldg. equipment, etc.)
|
90,022
|
12.5
|
|
4. Investment
in Home Hardware Franchise
|
95,509
|
14.0
|
|
Total Assets
|
$718,592
|
100%
|
[7] The Respondent
rests its case on the proposition that, according to the balance sheet of
Ventures as at May 31, 2000, only 62% of the book value of Ventures’
assets at
the time of Mr. Reilly’s death could be regarded as used principally in one or
more active businesses carried on in Canada. The Respondent regards the cash
and marketable securities as assets redundant to the active businesses carried
on by Ventures.
[8] The Appellant
claims that the cash and marketable securities were necessary to permit a
smooth transfer of the operating businesses from Mr. Reilly to the next
generation. Mr. Reilly and his wife, Carole, had three children: Christina (daughter)
born in 1964, Sandy (daughter) born in 1967, and Richard Jay (son) born in
1972. Mr. Reilly and Carole separated in 1985 and divorced in 1992 but remained
on good terms throughout the years. The last Will and Testament of Mr. Reilly
dated November 5, 1980 (Exhibits A-1, Reference 11 and R-1, Tab 1) appointed
his wife Carole as the sole executrix of his estate and named her as the sole
beneficiary if she survived him. There was no subsequent Will after the
separation and divorce.
[9] Carole did survive
Mr. Reilly and became the sole executrix of his estate. She testified at the
hearing of this appeal and stated that, just before he died in March 2000, he
told her that he knew she would do what was right. Carole knew that Mr. Reilly
wanted their children to continue to operate the businesses which he had
started in his lifetime. In January 1995, five years before his death, Mr. Reilly
became seriously ill and had one leg amputated. He thereafter qualified for a
disability tax credit. His disabling illness forced him to make other
arrangements for parts of his business like plumbing which he could no longer
carry on himself.
[10] In the years
preceding Mr. Reilly’s death, and in particular after 1995 when he became
disabled, his son Richard Jay took over the management of the plumbing, carwash
and laundromat portions of the business; and his elder daughter Christina
worked part-time in the Home Hardware business. After Mr. Reilly’s death,
Carole left these businesses under the management of Richard Jay and
Christina, respectively. By 2005, the plumbing, carwash and laundromat had become
Richard’s current livelihood. Christina testified at the hearing and described
herself as the owner/manager of the Home Hardware store in Carberry, with four
fulltime employees.
[11] The balance sheet of
Ventures as at May 31, 2000 (Exhibits A-1, Reference 7 and R-1, Tab 4B) showed
comparable amounts for the four preceding fiscal periods. I will summarize in
the table below those comparable amounts showing in the last line of the table the
respective percentage of the value of the cash and marketable securities to the
value of all assets on the balance sheet.
|
|
1996
|
1997
|
1998
|
1999
|
|
Cash and
Marketable Securities
|
$162,484
|
$211,070
|
$247,405
|
$246,664
|
|
Accounts receivable, inventory, etc.
|
275,510
|
247,230
|
239,703
|
247,496
|
|
Capital Properties
|
102,562
|
101,871
|
97,719
|
92,753
|
|
Home Hardware Franchise Deposit
|
59,276
|
67,921
|
77,768
|
88,285
|
|
Total Assets
|
$599,832
|
$628,092
|
$662,592
|
$675,198
|
|
Cash and Marketable Securities
as percent of total assets
|
27%
|
33%
|
37%
|
36%
|
[12] The tables in
paragraphs 6 and 11 above show that, in each fiscal period from 1996 to 2000
inclusive, the value of Ventures' cash and marketable securities as a percent
of the book value of all Ventures’ assets was never less than 27% and, in the
year of death, was 38%. In these circumstances, can it be said that all or
substantially all of the fair market value of Ventures’ assets were used
principally in active businesses? Were the cash and
marketable securities essential to or redundant to Ventures’ businesses?
[13] In Ensite Limited
v. The Queen, [1986] 2 S.C.R. 509, the issue was whether interest received
from certain U.S. dollar deposits in the Philippines was income from property
or from property used in the course of carrying on a business. The corporate
taxpayer argued that the interest in question was only income from property.
When deciding against the corporate taxpayer, the Supreme Court of Canada
stated at paragraphs 14 and 15:
14 … A business purpose for the
use of the property is not enough. The threshold of the test is met when the
withdrawal of the property would "have a decidedly destabilizing effect on
the corporate operations themselves": March Shipping Ltd. v. Minister
of National Revenue, supra, at p. 374. This would distinguish the
investment of profits from trade in order to achieve some collateral purpose
such as the replacement of a capital asset in the long term (see, for example, Bank
Line Ltd. v. Commissioner of Inland Revenue (1974), 49 T.C. 307 (Scot. Ct. of Session))
from an investment made in order to fulfill a mandatory condition precedent to
trade (see, for example, Liverpool and London and Globe Insurance Co. v.
Bennett, [1913] A.C. 610 (H.L.), and Owen
v. Sassoon (1951), 32 T.C. 101 (Eng.
H.C.J.) Only in the latter case would the withdrawal of the property from that
use significantly affect the operation of the business. The same can be said
for a condition that is not mandatory but is nevertheless vitally associated
with that trade such as the need to meet certain recurring claims from that
trade: see, for example, The Queen v. Marsh & McLennan, Ltd., supra,
and The Queen v. Brown Boveri Howden Inc., 83 D.T.C. 5319 (F.C.A.)
15. It is true that in this case
the taxpayer could have done business and fulfilled the Philippine requirement
that foreign currency be brought into the country by a means not involving the
use of property. It could have borrowed the U.S. currency
abroad and brought it into the Philippines. But this consideration is irrelevant to our
inquiry. The test is not whether the taxpayer was forced to use a particular
property to do business; the test is whether the property was used to fulfill a
requirement which had to be met in order to do business. Such property is then
truly employed and risked in the business. Here the property was used to fulfill
a mandatory condition precedent to trade; it is not collateral, but is employed
and risked in the business of the taxpayer in the most intimate way. It is
property used or held in the business.
[14] Skidmore v. The
Queen, [2000] F.C.J. No. 276 is a decision of the Federal Court of Appeal
on facts much closer to this current appeal. Mr. and Mrs. Skidmore owned
the shares of a family corporation carrying on an active business but with substantial
cash reserves. When Mr. and Mrs. Skidmore sold their shares in the family
corporation to a company owned by their children, they claimed a capital gains
exemption under subsection 110.6(2.1) of the Act. In this Court, Sarchuk
J. decided against the individual taxpayers citing the decision in Ensite. The
Federal Court of Appeal affirmed the decision of Judge Sarchuk. Sexton J.A.,
writing for the Court stated at paragraphs 9 and 10:
9 The Tax Court Judge held
that the Appellants had failed to demonstrate that "all or substantially
all of Birchill" assets were used in an active business within the meaning
of Section 248(1) of the Act.
10 He found that the
Appellants had failed to prove that the cash reserves which Birchill kept were
reasonably required as backup assets or that Birchill relied on the term
deposits as an integral aspect of its business operation. He heard
the evidence of the Appellants and was unable to conclude that there existed a relationship
of financial dependence of some substance between the amounts in issue and the
seedling nursing business. He found that Birchill had never had to
draw upon the reserves and that the possibility of the reserves being drawn
upon to sustain Birchill's business was remote.
[15] I conclude that the
appeal by the Reilly Estate is on all fours with the decision in Skidmore.
There is no evidence that the cash and marketable securities held by Ventures
were necessary or even important for the carrying on of its small active
businesses. Or in the words of Ensite, there is no evidence that the
cash and marketable securities were held “to fulfill a mandatory condition
precedent to trade”.
[16] In the five years
from 1996 to 2000, the fair market value of the cash and marketable securities
as a percentage of the total book value of all Ventures’ assets was never less
than 27% and, in the year of Mr. Reilly’s death (2000), was 38%. On these
facts, I cannot find that all or substantially all of the fair market value of
the assets of Ventures was attributable to assets used principally in an active
business. I find that Ventures was not a “small business corporation” within the
meaning of subsection 248(1) of the Act. And, if Ventures was not a
“small business corporation”, then the shares of Ventures or Holdco could not
be “qualified small business corporation shares” within the meaning of
subsection 110.6(1). The appeal is dismissed, with costs.
Signed at Ottawa, Canada, this 18th
day of July, 2007.
“M.A.
Mogan”
Email this Content