Industries S.L.M. Inc. v. Minister of National Revenue, [1996] 2 CTC 2572, 96 DTC 3215

Archambault J.T.C.C.: — Dissension reigned in 1979 among the four shareholders of Les Industries S.L.M. Inc. (“S.L.M.”), all of whose capital stock was held in equal parts by four investment companies. One of these investment companies, Gestion Prego Inc. (“Prego”), was held by Guy Godbout, who wanted S.L.M. to divest itself of its two subsidiaries, Manufacture St-Laurent Inc. (“St-Laurent”) and Les Industries Valcartier Inc. (“Valcartier”). To achieve this objective, Prego took steps in April 1980 to purchase the interests of its three co-shareholders and thus to take control of S.L.M. It subsequently found a purchaser for Valcartier. St- Laurent, which was experiencing financial difficulties, would be sold by S.L.M. for $1 to Georges Couture, who controlled one of the shareholders of S.L.M.

Tax experts recommended the steps to be taken. First, in August 1980, St-Laurent declared a $1,000,000 stock dividend, as a consequence of which the adjusted cost base of S.L.M.’s shares was increased by $1,000,000. S.L.M realized a $1,000,000 capital loss on the sale to Mr. Couture. A few weeks later, S.L.M. disposed of Valcartier’s shares for $9,000,000 to a subsidiary of the engineering firm S.N.C. (“S.N.C. Subsidiary”). This selling price would have enabled S.L.M. to realize a $4,910,000 gain if it had proceeded by way of an ordinary sale of Valcartier’s shares to S.N.C. Subsidiary. However, S.L.M. set up a tax arrangement that enabled it to be deemed to have received dividends of $3,910,000! [1] in 1981 and 1983, which left it with a capital gain of only $1,000,000. In computing its income, S.L.M. deducted from this gain the $1,000,000 capital loss realized in the sale of its St- Laurent shares. The dividends of $3,910,000 were deducted from S.L.M.’s taxable income un- der section 112 of the Income Tax Act (“Act”), which section permits the tax-free declaration of dividends between companies. Ultimately, as a result of the tax arrangement, S.L.M. reported no taxable gain arising from the sale of its two subsidiaries.

The Minister of National Revenue (“Minister”) made reassessments for the 1981 and 1983 taxation years in which he disallowed the deduction of the $1,000,000 capital loss on the sale of St-Laurent’s shares and added a capital gain of $3,910,000 to S.L.M.’s income. To this capital gain was added the amount of $406,666 paid by reason of the term granted for payment of the balance of the selling price. The Minister based this reassessment on subsection 55(1) of the Act, which applies where a taxpayer has disposed of property under circumstances such that he may reasonably be considered to have artificially or unduly reduced the amount of a gain from the disposition of the property or created a loss from the disposition.

In the alternative, the Minister contended that the provisions of subsection 55(2) of the Act applied so that the dividends of $3,910,000 and $406,666 received by S.L.M. were deemed not to be dividends.

The adjustments made by the Minister to the assessments for the 1981 and 1983 taxation years resulted in a refundable dividend tax on hand for S.L.M. The Minister fixed the tax payable by Prego under Part IV, that is, under paragraph 186(1 )(b) of the Act, which applied to the dividends that Prego received from S.L.M. in 1981 and 1983. He also fixed the dividend refund under section 129 of the Act for the 1981 to 1985 taxation years. Furthermore, on July 7, 1987, the Minister assessed Prego under section 160 of the Act. The outcome of Prego’s appeals depends entirely on that of S.L.M.’s appeals before this Court.

Facts

S.L.M. is a company governed by Part IA of the Quebec Companies Act. Its four equal shareholders since 1979 have been La Compagnie de Placement et de Gestion St-Laurent Ltée (“Gestion S.L.”), controlled by Mr. Couture, Fercal Inc. (“Fercal”), controlled by Charles Marquis, Armaco Holding Inc. (“Armaco”), controlled by André Monast, and Prego, controlled by Guy Godbout.

S.L.M.’s two subsidiaries, St-Laurent and Valcartier, are companies governed by Part IA of the Companies Act. St-Laurent’s president is Mr. Couture, while Valcartier’s is Mr. Godbout. In early 1980, S.L.M.’s four shareholders each held 1,000 shares of its capital stock. At that time, S.L.M. held 470 common shares of St-Laurent, as well as 80,000 common shares and 50,000 class A shares of Valcartier. The latter manufactures military and civilian ammunition, while the former makes skate blades.

In 1979, dissension reigned among S.L.M.’s four shareholders. Valcartier dismissed its president, Guy Godbout. Mr. Godbout wanted S.L.M. to sell the Valcartier shares and had been seeking a potential buyer for some time. However, this proposal was not enthusiastically received by the other three shareholders. The Remington and Bombardier groups were approached. On March 19, 1980, Spectrum West International Inc. (“Spectrum”) of California contacted Mr. Godbout to express its interest in Valcartier.

On April 7, 1980, Gestion S.L. granted Prego in writing a right of first refusal with regard to its S.L.M. shares, the purchase price being set at $1,600,000. This offer was also conditional on S.L.M.’s selling the St- Laurent shares to Mr. Couture for the sum of $1. On the strength of this right of first refusal, Mr. Godbout was in a position to offer Spectrum a 50 per cent interest in Valcartier a few weeks later.

On June 11, 1980, Prego negotiated a memorandum of understanding with Fercal, Armaco and Gestion S.L. (three co-shareholders) under which it would indirectly purchase all their shares for the sum of $1,363,500. The memorandum set out certain conditions, including that Prego would have to purchase all the shares of S.L.M., and Mr. Couture all the shares of St-Laurent, for a consideration of $1 and the discharge of all the endorsements provided by Armaco, Fercal, Prego and S.L.M., as well as those provided by Messrs Godbout, Marquis and Monast. S.L.M. would also have to refund the advances of $236,500 that it had received from Gestion S.L., Armaco and Fercal. The total of the selling price and the reimbursement of the advances came to $1,600,000. The memorandum of understanding provided that the purchase would be transacted in various stages in the most advantageous manner, from a tax standpoint, for the vendors. A scenario was described therein whereby the shares held by the three co-shareholders would be converted into preferred shares and redeemed at a premium by S.L.M. Lastly, the memorandum clearly stipulated that Prego would be able to sell the Valcartier shares at a profit.

On July 4, 1980, Prego submitted bids in due form to each of its three co-shareholders. The conditions of those bids were essentially similar to those of the memoranda of understanding. The bids were accepted that same day.

On July 21, 1980, Létourneau Stein, solicitors for the three coshareholders, transmitted to Leduc, Guay, Martel et Lebeuf, Prego’s solicitors, a summary description of the terms and conditions put forward with a view to enabling Prego to acquire all the S.L.M. shares. In that letter were envisaged, in particular, the following transactions:

1 St-Laurent would reorganize its capital by creating a new class of shares, that is, an unlimited number of class B preferred shares;

2. St-Laurent would declare a dividend of about $1,000,000 payable through the issue of 1,000,000 class B preferred shares with a paid-up capital of $1,000,000;

3. Valcartier would reorganize its capital through the creation of class B preferred shares with a nominal value of $1;

4. Valcartier would declare a dividend of about $3,400,000 in favour of S.L.M. payable in class B preferred shares;

5. S.L.M. would reorganize its capital through the creation of an unlimited number of class B preferred shares and class C preferred shares;

6. the three co-shareholders would each convert their 1,000 S.L.M. common shares into 1,000 class B shares, Prego would convert its 1,000 S.L.M. common shares into 1,000 class A shares and the three co-shareholders would each exchange their 1,000 class B shares for 1,000 S.L.M. class B preferred shares; these 1,000 class B preferred shares were redeemable for $1,363,500; Prego would subscribe 4,800,000 S.L.M. class C preferred shares with a par value of $1 each;

7. S.L.M. would redeem the 1,000 class B preferred shares held by each of the three co-shareholders for $1,363,500.

8. S.L.M. would refund to Fercal and Armaco their respective advances of $236,500 plus interest accrued since June 30, 1980; the amount owed to Mr. Couture was $73,000;

9. Mr. Couture would obtain a release with regard to all guarantees and endorsements made in favour of St-Laurent by Prego, Fercal, Armaco, Valcartier and S.L.M., as well as those made by Messrs Godbout, Marquis and Monast;

10. S.L.M. would dispose of its 470 common shares and 1,000,000 class B preferred shares of St-Laurent to Mr. Couture in consideration of the sum of $1 and the release from the aforementioned obligations.

All these transactions described in the letter of July 21, 1980, from Létourneau Stein were carried out as planned between August 5 and 8, 1980. [2]

Henri-Louis Fortin, who was a tax specialist with Létourneau Stein at the time and who took part in the tax arrangement with regard to the sale by the three co-shareholders, testified at the hearing of this case. He explained the reasons for which St-Laurent and Valcartier had respectively declared dividends of $l,000,000 [3] and $3,300,000. Mr. Fortin pointed out that the Honourable Allan MacEachen, then Minister of Finance, had reintroduced on April 21, 1980, certain measures from the budget of December 11, 1979. Resolution 21 announced the adoption of subsection 55(2) of the Act. This measure provided that, under certain circumstances, a dividend deductible under section 112 of the Act could be deemed to be a capital gain for the company receiving that dividend after December 11, 1979, where one of the purposes was to reduce significantly the part of the capital gain that was not attributable to income earned after 1971 (protected income).

When planning the steps to be taken to bring about the sale of the three co-shareholders’ shares with the fewest possible tax consequences, the tax specialists did not know what interpretation the Department of National Revenue would adopt for calculating protected income. It was not known whether S.L.M.’s protected income could be calculated on a consolidated basis. To avoid needless risks, the tax specialists recommended proceeding with the declaration of dividends by the subsidiaries so that the protected income would be in S.L.M. While not certain, Mr. Fortin believed that this suggestion had come from the three co-shareholders’ lawyers.

On July 15, 1980, Mr. Godbout made arrangements to obtain a loan of $4,800,000 from C.I.B.C. so that Prego could subscribe S.L.M.’s 4,800,000 class C preferred shares and thus enable S.L.M. to redeem the shares of the three co-shareholders. As of July 15, 1980, Prego had not yet found a purchaser for Valcartier’s shares. Starting on August 8, 1980, Guy Godbout, through Prego, held 100% of S.L.M., which in turn held 100% of the Valcartier shares. The shares that S.L.M. held in Valcartier were as follows: 80,000 common shares, 50,000 class A preferred shares, [4] and 3,300,000 class B preferred shares.

A few days after the shares of the three co-shareholders were redeemed, that is, on August 11, 1980, the S.N.C. group transmitted to Guy Godbout an offer to purchase all the Valcartier shares for $9,000,000, of which $7,000,000 was to be payable in cash and $2,000,000 out of the accumulated net income over the three fiscal years ending after March 31, 1980. The method described in the letter of August 11, 1980, was as follows:

The net profit after tax of I.V.I.’s next three years of operation starting as of March 31, 1980, will be accumulated. The final purchase price will be the accumulated net profit of these three years of operation. However, it is also agreed that this final price shall not be less than seven (7) million dollars nor more than nine (9) million dollars;

Before going ahead with the sale of its shares to the S.N.C. group on September 15, 1980, Valcartier proceeded with a reorganization of capital on August 27, 1980, as follows:

(a) Valcartier ratified the conversion of 78,000 common shares into 78,000 class A shares with a paid-up capital of $390,000, of 1,000 common shares into 1,000 class B shares with a paid-up capital of $5,000 and of 1,000 common shares into 1,000 class C shares with a paid-up capital of $5,000. The main distinction among these three classes of shares is that the 1,000 class B shares were convertible to 1,000 class C preferred shares and the 1,000 class C shares were convertible to 1,000 class D preferred shares.

(b) Class C and class D preferred shares were created and the main features of these two classes of preferred shares were as follows:

(i) the class C preferred shares were redeemable starting on June 30, 1981, at a price equal to the par value of the shares plus a premium of $2,000 per share, plus a premium of eight per cent per year on that premium, calculated from the day of issue until the day of redemption, plus all dividends declared and not paid; a non- cumulative dividend could be paid out of available profits at a rate of eight per cent per year on the paid-up amount of the shares; otherwise those shares did not receive a share in profits; each of them granted entitlement to 20 votes;

(ii) the class D preferred shares carrying entitlement to payment out of available profits of a non-cumulative dividend of eight per cent of the paid-up amount of the shares each time the company’s board of directors declared such dividend; otherwise these shares did not receive a share of Valcartier’s profits; they conferred no voting right on their holder; the class D preferred shares were redeemable on June 30, 1981, at a redemption price equal to par value plus a premium of $1,750 per share, plus an extra premium of $160, plus the dividends declared and not paid.

On August 29, 1980, S.L.M.’s directors approved the by-law authorizing the creation of class D preferred shares with a par value of $10,000 redeemable on June 30, 1981, at par value plus all dividends declared and not paid and a premium of $880.68 per share.

On September 4, 1980, S.N.C. Subsidiary subscribed 176 class D preferred shares of S.L.M. for a total consideration of $1,760,000.

On September 15, 1980, S.N.C. Subsidiary purchased from S.L.M. 78,000 class A shares, 50,000 class A preferred shares, and 3,300,000 class B preferred shares (contract shares) for the sum of $5,240,000 in cash, i.e. $3,300,000 for the class B preferred shares and $1,940,000 for the 78,000 class A shares and the 50,000 class A preferred shares of Valcartier. These 50,000 class A preferred shares were redeemable for the sum of $50,000. In the purchase agreement of September 15, 1980, the parties acknowledged that S.N.C. Subsidiary, “in consideration of the purchase of the contract shares”, had subscribed 176 class D preferred shares of S.L.M. for the sum of $1,760,000. It was further acknowledged therein that S.L.M. had obtained prior to the purchase agreement 1,000 class C preferred shares and 1,000 class D shares of Valcartier “in anticipation of the sale of the contract shares”. However, according to the documents filed with the Court, this purchase of the class C and class D preferred shares did not occur until the next day, that is, on September 16, 1980.

The 176 class D preferred shares of S.L.M., the 1,000 class C preferred shares and the 1,000 class D shares of Valcartier were subject to the conditions of a redemption agreement appended to the purchase agreement. That redemption agreement stipulated that the redemption of the 176 class D preferred shares of S.L.M., the 1,000 class C preferred shares and the 1,000 class D preferred shares was one of the essential conditions of the purchase agreement. The redemption agreement provided that Valcartier would redeem the 1,000 class D preferred shares on June 30, 1981, for a total of $1,915,000, provided S.L.M. had previously redeemed the 176 class D preferred shares for the total sum of $1,915,000. Furthermore, if for any reason at all S.L.M. did not redeem the 176 class D preferred shares, it would be required to sell its 1,000 class D shares of Valcartier to S.N.C. Subsidiary for the sum of $1. Likewise, S.N.C. Subsidiary would have to sell the 176 class D preferred shares of S.L.M. to Prego for the sum of $1. This redemption agreement also set out the method for determining the redemption price of the 1,000 class C preferred shares, as follows:

The purchase price of all the 1,000 class C preferred shares will be the total of (i) their par value of $5,000, (ii) plus a premium, where applicable, not exceeding $2,000,000, which will be equal to the sum of I Vi’s CUMULATIVE AND ADJUSTED NET INCOME for the fiscal years ending on March 31 of 1981, 1982 and 1983 (the whole as specified below in paragraph 2.5) in addition to the basic amount of $7,000,000 (on which no premium will be payable), (iii) plus an extra premium of 8% of the said premium per year from the day of their issue until March 31, 1983.

[Translation.]

To guarantee the performance of its obligations, on September 15, 1980, S.L.M. placed in the hands of General Trust of Canada as security its endorsed blank certificates for the 1,000 class C preferred shares and the 1,000 class D preferred shares.

On June 29, 1981, Valcartier approved the redemption of the 1,000 class D preferred shares for $1,915,000. On June 30, 1981, S.L.M. redeemed its 176 class D preferred shares for $1,915,000.

On June 30, 1983, Valcartier redeemed the 1,000 class C preferred shares held by S.L.M. for $2,406,666, $406,666 of which represented the premium on the $2,000,000 premium for a period of 30 1/2 months, i.e. from September 15, 1980, to March 31, 1983.

In computing its taxable income for 1981, S.L.M. claimed the deduction provided for in section 112 of the Act in respect of the deemed dividend of $1,910,000 on the redemption of the 1,000 class D preferred shares and of $2,401,666 on the redemption of the class C preferred shares. By reason of the rule stated at subparagraph 54(h)(x) of the Act pursuant to which the deemed dividend is excluded from the proceeds of disposition of the shares redeemed by Valcartier, S.L.M. realized no capital gain from those redemptions.

As to the calculation of the capital gain from the sale by S.L.M. of the 78,000 class A shares, 50,000 class A preferred shares and 3,300,000 class B preferred shares, S.L.M. deducted from the proceeds of disposition of $5,240,000 an adjusted cost base of $4,240,000, for a capital gain of $1,000,000. In computing its income, S.L.M. claimed a $1,000,000 loss from the sale of its 470 common shares and 1,000,000 class B preferred shares of St-Laurent for which it had an adjusted cost base of $1,000,001, but proceeds of disposition of only $1.

S.L.M.’s fiscal year ends on March 31. S.L.M. and the Minister agreed on the amount of S.L.M.’s protected income at July 21, 1980, [5] and September 15, 1980: $2,945,133 and $422,630 respectively. The protected income earned in 1981 amounted to $4,978,710.

POINTS AT AT ISSUE

Relying on subsection 55(1) of the Act, the Minister disallowed the deduction of the $1,000,000 capital loss arising from the sale of the 470 common shares and of the 1,000,000 class B preferred shares held by S.L.M. in St-Laurent. That subsection reads as follows for the 1981 [6] taxation year:

For the purposes of this subdivision, where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatever is that a taxpayer has disposed of property under circumstances such that he may reasonably be considered to have artificially or unduly

(a) reduced the amount of his gain from the disposition,

(b) created a loss from the disposition, or

(c) increased the amount of his loss from the disposition,

the taxpayer’s gain or loss, as the case may be, from the disposition of the property shall be computed as if such reduction, creation or increase, as the case may be, had not occurred.

According to the Minister, S.L.M. artificially or unduly created a loss of $ 1,000,000.

The Minister also relied on the same provision in treating the alleged dividends of $1,910,000 in 1981 and $2,401,666 in 1983 as capital gains because, in his view, S.L.M. had artificially or unduly reduced the amount of the gain from the disposition of the Valcartier shares.

In the alternative, the Minister argued that subsection 55(2) of the Act applied. As applicable in 1981, that subsection reads as follows:

Where a corporation resident in Canada has after April 21, 1980 received a taxable dividend in respect of which it is entitled to a deduction under subsection 112(1) or 138(6) as part of a transaction or event or a series of transactions or events (other than as part of a series of transactions or events that commenced before April 22, 1980), one of the purposes of which (or, in the case of a dividend under subsection 84(3), one of the results of which) was to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at fair market value of any share of capital stock immediately before the dividend and that could reasonably be considered to be attributable to anything other than income earned or realized by any corporation after 1971 and before the dividend was received, notwithstanding any other section of this Act, the amount of the dividend (other than the portion thereof, if any, subject to tax under Part IV)

(a) shall, except for the purpose of computing the corporation’s cumulative deduction account (within the meaning assigned by paragraph 125(6)(b), be deemed not to be a dividend received by the corporation;

(b) where a corporation has disposed of the share, shall be deemed to be proceeds of disposition of the share except to the extent that it is otherwise included in computing such proceeds; and

(c) where a corporation has not disposed of the share, shall be deemed to be a gain of the corporation for the year in which the dividend was received from the disposition of a capital property.

For 1983, this subsection reads as follows: [7]

Where a corporation resident in Canada has after April 21, 1980 received a taxable dividend in respect of which it is entitled to a deduction under subsection 112(1) or 138(6) as part of a transaction or event or a series of transactions or events (other than as part of a series of transactions or events that commenced before April 22, 1980), one of the purposes of which (or, in the case of a dividend under subsection 84(3), one of the results of which) was to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at fair market value of any share of capital stock immediately before the dividend and that could reasonably be considered to be attributable to anything other than income earned or realized by any corporation after 1971 and before the transaction or event or the commencement of the series of transactions or events referred to in paragraph (3)(a), notwithstanding any other section of this Act, the amount of the dividend (other than the portion thereof, if any, subject to tax under Part IV that is not refunded as a consequence of the payment of a dividend to a corporation where the payment is part of the series of transactions or events)

(a) shall, except for the purpose of computing the corporation’s cumulative deduction account (within the meaning assigned by paragraph 125(6)(b), be deemed not to be a dividend received by the corporation;

(b) where a corporation has disposed of the share, shall be deemed to be proceeds of disposition of the share except to the extent that it is otherwise included in computing such proceeds; and

(c) where a corporation has not disposed of the share, shall be deemed to be a gain of the corporation for the year in which the dividend was received from the disposition of a capital property.

ANALYSIS

Deemed Dividends

The burden is on the Minister to prove the relevant facts necessary for the application of subsection 55(2) of the Act. Furthermore, that subsection raises the question of the application of the transitional rule. This section does not apply to a transaction or an event that is part of a series of transactions or events that commenced prior to April 22, 1980. Believing that the series of transactions at issue here commenced before April 22, 1980, the Minister did not apply this subsection when making the assessment. He changed his interpretation before the Court and contended that the series of transactions commenced on July 21, 1980, that is, the date of the tax arrangement set up by Létourneau Stein.

Subsection 55(1) of the Act states an anti-avoidance rule of general application, whereas subsection 52(2) states an anti-avoidance rule of more limited application. The latter applies when a capital gain is transformed into a non-taxable dividend. As far as possible, the Court must favour the rule of limited application over the rule of general application. In the circumstances of this appeal, subsection 55(2) could apply, provided the series of transactions did not begin prior to April 22, 1980. It therefore seems to me necessary to decide first whether subsection 55(2) applies to the redemptions of Valcartier’s class C and class D preferred shares.

It must be determined whether the redemption of the 1,000 class D preferred shares on June 29, 1981, and of the 1,000 class C preferred shares on June 30, 1983, were part of a series of transactions or events that commenced before April 22, 1980. The Act does not define what constitutes a series of transactions or events [8] . Before analyzing the concept of “series of transactions or events”, it must be observed that it is used not only for the purposes of the transitional rule, but also for the purposes of the application of subsection 55(2) to the share redemptions in 1981 and 1983. For the 1983 redemption, as noted above, the calculation of protected income must be made “after 1971 and before . . . the commencement” of the series of transactions or events referred to in paragraph 55(3)(a). [9] As regards the 1981 and 1983 redemptions, it is necessary to identify the series of transactions the result of which would have been the disposition of property to a person with whom the transferor was dealing at arm’s length.

Furthermore, this notion of a series of transactions appears in numerous other provisions of the Act, including a number of anti- avoidance provisions, and in particular the new section 245, which states the general anti-avoidance rule applicable as of September 13, 1988. [10] Except where the context indicates otherwise, this expression must always be construed in the same way. In Thomson v. Canada (Agriculture), [1992] 1 S.C.R. 385, Cory J. restates this rule of interpretation, at page 400:

The word is used in other provisions of the Act. Unless the contrary is clearly indicated by the context, a word should be given the same interpretation or meaning whenever it appears in an act.

This is all the truer when the expression is used in the same section.

What is a series of transactions? In Le Robert, a number of meanings are given for the French word “série” (“series”) but the most relevant is the

following:

2. (Fin XVIIIe). Cour. Suite déterminée et limitée de choses de même nature formant un ensemble, ou considérées comme telles. . . . Rem. Série est parfois employé au sens imprécis de suite. [(Late 18th c.). Determinate and limited succession of like things forming a whole, or considered as such. . . . N.B. Series is sometimes used in the imprecise sense of succession.]

Among the meanings given the French word “suite” (“succession”) in the same dictionary is the following: “5.b (1538) choses, personnes qui se succèdent dans le temps” (“things, persons that succeed one another in time”).

In The Shorter Oxford English Dictionary, “series” is defined as follows:

2. A number of things of one kind (chiefly immaterial) following one another in temporal succession, or in the order of discourse or reasoning . . . 3. A succession, sequence, or continued course (of action or conduct).

The following definition appears in The Random House Dictionary.

Series: 1. a group or a number of related or similar things, events, etc., arranged or occurring in temporal, spatial, or other order or succession; sequence.

These definitions do not help us a great deal in clarifying the scope of the notion of series, apart from the last one, which acknowledges the existence of a certain connection among the various transactions.

A literal application of these definitions of the word series could lead us to adopt a very broad definition so that numerous events following one another and having a certain connection among them could be part of a series of transactions or events. As the Quebec Court of Appeal noted in Motel Pierre Inc. v. Cité de Saint- Laurent, [1967] B.R. 239, at page 240. in the absence of compelling reasons to the contrary, the scope of general words must be limited to the objects of the act. This approach seems to me the wisest. This was moreover the one adopted by Judge Sarchuk of this Court in 454538 Ontario Ltd. v. Minister of National Revenue, [11] in commenting on the expression “series of transactions or events” as used in

subsection 55(2) of the Act:

The phrase “series of transactions or events” must be read in its grammatical and ordinary sense reflecting the context in which it is found, the scheme and object of the Act and the intention of Parliament. Bearing this stricture in mind it seems reasonable to conclude that in order for the events to form part of a series they must follow each other in time and must somehow be logically or reasonably connected to one another. Furthermore the Appellant and 539 themselves must intend that the series of transactions be linked together to achieve the specific result in this case being the disposition of the shares of Tri-M to 461 in the circumstances and in the manner previously described. This approach is consistent with the dictionary definitions of the words, “series”, “transaction” and “event”.

In that case, a quarrel pitted two shareholders (the Mazzoccas) against a third (Manley). Around the end of 1979, the Mazzoccas asked an accountant to either put in place the necessary financing to purchase Manley’s shares or to find a third person to purchase them. At least one contact had been made on March 11, 1980; others followed in May and July 1980. Ultimately, the Mazzoccas were unable to find financing for the purchase of Manley’s shares nor had Manley been able to buy up those of the Mazzoccas. The Mazzoccas and Mr. Manley had to resign themselves to selling all their shares to a third party in the fall of 1980. The case turned on the question of whether the series of transactions and events had commenced prior to April 22, 1980, and Judge Sarchuk held that the series had not commenced before April 22 for the following reason:

The interpretation placed upon the provisions of subsection 55(2) of the Act by counsel for the Appellant is strained and artificial. The connection that counsel is attempting to establish between the shareholder disputes which took place at various times from 1975 to 1980 is too tenuous and nebulous to be reasonably described as a link between those events and the disposition of the Tri-M shares.

It was relatively easy for Judge Sarchuk to conclude that the series of transactions had not commenced prior to April 22 since the sale by the Mazzoccas to the third party had not even been considered before April 22, 1980. There had merely been a preliminary step taken toward solving a problem among the three shareholders. In the instant case, Prego wanted S.L.M. to dispose of the Valcartier shares. The redemption of the three co-shareholders’ shares represented only the first stage in the execution of this plan, which did in fact come to fruition on September 15, 1980. There was therefore a closer connection here between the right of first refusal granted on April 7, 1980, and the sale of September 15, 1980. But was it sufficient?

A number of authors have considered the meaning of the expression “series of transactions” [12] in the context of the new section 245. Most of them have drawn on English and American case law. In Mr. Tiley’s lecture are stated, at page 8:3, a number of tests for determining the scope of a series of transactions:

When we return to the question “What is a series?” we find that if the term “series” is to mean anything other than a simple temporal sequence it must denote some element of consequentiality. What factors will make two transactions part of a series? How can it be proved that the transactions constitute a series? Three criteria seem to stand out. First, there must be an intention that the second transaction should follow the first. Apart from direct evidence in the correspondence, there is an obvious challenge: what other purpose lay behind the first transaction apart from the expectation that the second would follow? It is well to remember the old legal saw that a person is taken to intend the reasonable and probable consequences of his acts. Second, a close sequence in time invites the conclusion that the two transactions are a series (although not necessarily, as the case of AG v. Cohen shows). The point has its own converse, however: transactions that are far apart in time are less likely to be treated as a series. The problem will be how wide the gap must be before the first transaction can be said to be “old and cold.” There seems to be nothing in subsection 248(10) to invite any restriction along these lines, which is worrisome. Third, one might suppose that transactions that relate to the same subject matter may be more likely to form a series. In the recent UK cases the transactions related to the same property. AG v. Cohen could be raised in this context: the purchases dealt with different pieces of real estate.

Mr. Tiley further cites, on the same page, the American notion of step transactions as a source of guidance in determining what constitutes a series:

. . . First, let us turn to the US notion of step transactions. Ever since Mintz and Plumb’s famous articleô it has been a commonplace to discern three different formulations. The first is the binding- commitment test: steps will be integrated (that is, they will be treated as a series) if a binding commitment to take the later steps is made when the first step is taken. I imagine there is little difficulty in regarding such steps as a series without recourse to subsection 248(10). The second is the mutual interdependence test: steps will be integrated if they are so interdependent that the legal relations created by the one trans- action would have been fruitless without a completion of the series. One assumes that the completion of the series is contemplated, and therefore subsection 248(10) will bring them in in any event, but, for those able to use the grandfather clause, will this be enough to amount to a series? I assume that it is, but Revenue Canada appears to think otherwise. Words of this abstraction gain real meaning only when they are applied to the facts. The third, and widest, is the end result test: ‘purportedly separate transactions will be amalgamated . . . when it appears that they were really component parts of a single transaction intended from the outset to be taken for the purpose of reaching the ultimate result.’ Again, the language seems to describe a series, but I may be out of step with Revenue Canada. I suspect that practitioners may be using these tests frequently as they attempt to persuade the ministry to accept the second formulation while it prefers to use the third.

On the strength of these comments, let us try to determine the scope of this notion of series of transactions. First of all, let us address the objectives pursued by subsection 55(2) of the Act. This subsection is an antiavoidance provision designed to prevent an artificial or undue reduction of the capital gain that a taxpayer would have realized if he had simply sold his shares at their fair market value. For a better understanding of its scope, let us analyze its application in the context of the facts of this appeal. In 1980, S.L.M. held all of Valcartier’s shares. Since their acquisition, their value had increased considerably. Part of this appreciation may be explained by the accumulation of profits by S.L.M. Subsection 55(2) recognizes that a taxpayer may eliminate the capital gain attributable to that accumulation. However, if part of the appreciation of Valcartier’s shares represented, for example, an increase in the value of Valcartier’s goodwill or an unrealized appreciation of the assets held by that company, Valcartier could not make it disappear by declaring dividends.

In this case, the most appropriate time for calculating the protected income appears to me to be when the shares were disposed of to S.N.C. Subsidiary, that is, on September 15, 1980, the date on which some of S.L.M.’s shares were transferred to it. If S.L.M. had simply sold all its shares to that company on September 15, 1980, it would have realized a capital gain of $4,910,000. S.L.M.’s protected income on that date amounted to $422,630. If Valcartier had declared a dividend corresponding to this amount before the sale to S.N.C. Subsidiary, S.L.M. could have reduced its capital gain by an equivalent amount.

Having regard to these objectives of subsection 55(2), what scope can be given to the expression “series of transactions” and when did this series of transactions commence? In my view, the expression series of transactions must have a meaning that is sufficiently broad to enable tax authorities to prevent an artificial or undue reduction, but that, at the same time, is as narrow as possible so as not to penalize a taxpayer needlessly. I am thinking in particular of the application of this expression in 1983. On the redemption of S.L.M.’s class C preferred shares, it was necessary to go back to “the commencement” of the series of transactions in order to determine the amount of protected income available. If the series of trans- actions began prematurely, the taxpayer would have lost part of the protected income that he was entitled to report as a dividend in order to avoid realizing the capital gain. If for the purposes of the redemption of the shares in 1983, the commencement of the series was set at April 7, 1980, S.L.M. could not have had the benefit of a protected income of $422,630 since Valcartier had accumulated profits in excess of $2,196,088 ((161/365) X $4,978,710) between April 7 and September 15, 1980.

If the commencement of the series is set at August 27, 1980, and the end at June 30, 1983, there was during this period a set of transactions each of which was essential to the realization of the objective pursued by S.L.M. and S.N.C. Subsidiary, that is, the purchase by the latter of all Valcartier’s shares while enabling S.L.M. to effect this disposition and at the same time minimize as far as possible the tax consequences.

The first stage was to put in place, on August 27, 1980, the shares for the redemptions of June 29, 1981, and June 30, 1983. Valcartier converted 2,000 of its 80,000 common shares into 1,000 class B shares and 1,000 class C shares. On September 16, 1980, the 1,000 class B shares were converted into 1,000 class C preferred shares, and the 1,000 class C shares into 1,000 class D preferred shares. The class D preferred shares were redeemed on June 29, 1981, at a predetermined price, and the class C preferred shares on June 30, 1983, at a price set in accordance with a predetermined formula.

In the second stage, S.N.C. Subsidiary subscribed S.L.M.’s 176 class D preferred shares on September 4, 1980. In the third stage, it purchased the contract shares. The redemption of the class D preferred shares on June 29, 1981, and of the class C preferred shares on June 30, 1983, completed the payment by S.N.C. Subsidiary of the purchase price of all the Valcartier shares.

Apart from these two redemptions, the transactions in question were very close in time. The deferral of the redemption of the class C and D preferred shares can be easily explained. Valcartier had to accumulate some protected revenue after September 15, 1980, so that it could claim to have enough protected income on the date of the redemption of the shares to reduce its capital gain. The formula for establishing the redemption price of the class C preferred shares represents an earnout provision, generally indicative, at least in part, of a business’s goodwill.

Even though the redemptions in question occurred more than nine months and 33 months after the September 15 sale, they took place in accordance with the undertakings described in the contract of September 15, 1980, and in the redemption agreement appended thereto. The interdependence of these transactions clearly appears from these documents. For example, it is stipulated that S.L.M. was purchasing the class C and D preferred shares in “anticipation of the sale of the contract shares”. The redemption agreement of September 15, 1980, indicated the redemption price of those preferred shares and provided protection mechanisms for S.L.M. in case the redemptions did not take place. [13]

This interdependence may be observed with respect to other transactions in this series. Thus, as of September 4, 1980, S.L.M. had at its disposal the sum of $1,760,000 following the subscription of the 176 class D preferred shares by S.N.C. Subsidiary. If this amount of $1,760,000 is added to the proceeds of $5,240,000 which it received on September 15, 1980, for the contract shares, S.L.M. had at its disposal $7,000,000, which is the amount stipulated in the agreement of August 11, 1980. When the 1,000 class D preferred shares held by S.L.M. were redeemed by Valcartier for $1,915,000, the shares held by S.N.C. Subsidiary in S.L.M. were also redeemed for $1,915,000. In ingenious fashion, the sum of $1,760,000 was able to be remitted to S.L.M. on September 4, 1980, without that sum being part of the proceeds of disposition of the 1,000 class D shares prior to June 29, 1981.

From the analysis of this series of transactions, it may be seen that it is not necessary to go back to a date prior to August 27, 1980, in order to conclude that S.L.M. conducted a series of transactions the effect of which was to reduce the capital gain that would have been realized if it had disposed of its shares at fair market value. This date of August 27, 1980, is also very close to September 15, 1980, which is the date on which S.N.C. Subsidiary acquired ownership of all Valcartier’s common shares.

The fact that Prego obtained a right of first refusal from Gestion S.L. on April 7, 1980, was not part of the series of transactions in the course of which the sale of the contract shares and the redemptions of the class C and class D preferred shares took place. The purpose of the right of first refusal was entirely different from that of the sale between S.L.M. and S.N.C. Subsidiary: it concerned the shares of S.L.M.’s capital stock, whereas the sale between S.N.C. Subsidiary and S.L.M. involved Valcartier’s shares. Furthermore, on April 7, 1980, Prego did not know whether S.L.M. could find a purchaser for the Valcartier shares. Even on July 15, 1980, S.L.M. did not yet have a purchaser for those shares.

As to the date of July 21, 1980, put forward by the Minister in his argument before the Court, it must be ruled out since the object of the brief prepared by Létourneau Stein was to describe the stages of the takeover of control of S.L.M. by Prego and had nothing to do with the sale of the Valcartier shares by S.L.M.

In conclusion, as the series of transactions began after April 21, 1980, it is subject to subsection 55(2) of the Act.

Let us analyze the conditions for the application of subsection 55(2) in relation to the facts of the instant case, beginning with the redemption on June 29, 1981, of the 1,000 class D preferred shares. The redemption price was $1,915,000. These shares had a paid-up capital and an adjusted cost base (ACB) of $5,000. Under subsection 84(3) of the Act, S.L.M. is deemed to have received a dividend of $1,910,000 at the time of the redemption. In accordance with subparagraph 54(h)(x) of the Act, the result of this was to reduce the proceeds of disposition of those shares by $1,910,000, thus eliminating the capital gain. Under subsection 112(1) of the Act, S.L.M. was entitled to deduct this deemed dividend of $1,910,000 from its taxable income. As indicated above, this dividend thus had the effect of significantly reducing (and, in this case, entirely eliminating) the capital gain of $1,910,000 that would have been realized on the disposition of those shares at their fair market value immediately prior to their redemption.

Paragraph 55(3)(a) of the Act provides that subsection 55(2) does not apply to a dividend received by a corporation unless such dividend was received as part of a transaction or a series of transactions that resulted in a disposition of any property to a person with whom that corporation was dealing at arm’s length or in a significant increase in the interest in any corporation of any person with whom the corporation that received the dividend was dealing at arm’s length. These conditions were met in the instant case since the redemption was part of a series of transactions whereby S.N.C. Subsidiary purchased all the Valcartier common shares on September 15, 1980. Furthermore, S.N.C. Subsidiary was dealing at arm’s length with S.L.M.

It remains to be determined whether the capital gain of $1,910,000 could reasonably be considered to be attributable to anything other than income earned or realized by any corporation after 1971 and before the dividend was received. If the class D preferred shares had been sold at their fair market value on June 29, 1981, could the capital gain that would have been realized at that time have been attributable to anything other than protected income?

Counsel for S.L.M. claimed that the proceeds of the redemption of the shares came out of the company’s retained earnings accumulated up to June 29, 1981, the date of the deemed dividend. I do not believe that this interpretation of counsel for the appellant is correct. On June 29, 1981, the value of those shares was $1,915,000. The ACB was $5,000. There was therefore an unrealized capital gain of $1,910,000. This unrealized gain had existed since September 16, 1980, on which date those 1,000 preferred shares were issued upon the conversion of the 1,000 class C shares. The class D preferred shares were not participating shares and the dividend on those shares was not cumulative. Is it reasonable then to attribute this gain to protected income earned after September 16, 1980? I do not believe so. The profits realized after September 16, 1980, were probably used to pay the redemption price, but did not cause the value of those shares to increase. It is therefore not reasonable to attribute those profits to the capital gain that might have been realized on a simple sale of those shares to third parties.

At September 15, 1980, the protected income amounted to $422,630. If that sum is allocated to the 78,000 common shares and 2,000 class C and D preferred shares, we are left with a sum of $5,283 representing the portion of the protected income attributable to the 1,000 class D preferred shares. One conclusion in escapable: the capital gain at June 29, 1981, was attributable to something other than protected income. All the conditions for the application of subsection 55(2) and paragraph 55(3)(a) having been met, the amount of the dividend of $1,910,000 is therefore deemed to be a capital gain realized upon the disposition of the 1,000 class D preferred shares.

Subsection 55(2) was amended for the 1983 taxation year so as to make it necessary to determine whether the capital gain that would have been realized on the class C preferred shares if there had been a disposition at fair market value prior to the redemption of those shares, could reasonably be considered to be attributable to anything other than protected income after 1971 and before the commencement of the series of transactions referred to in paragraph 55(3)(a) of the Act. This was the series of transactions the result of which was a disposition of property to a person with whom S.L.M. was dealing at arm’s length.

The major difference with respect to the 1981 redemption is that it must therefore be asked whether the capital gain that S.L.M. would have realized if it had simply sold the 1,000 class C preferred shares before the redemption could reasonably be considered to be attributable to anything other than protected income realized before August 27, 1980. The proceeds of disposition at June 30, 1983, were $2,406,666. The paid-up capital and ACB were $5,000. The deemed dividend was thus $2,401,666. If at that time there had been a simple disposition at fair market value (instead of a redemption) of these class C preferred shares, there would have been a capital gain of $2,401,666, i.e. the difference between $2,406,666 and $5,000.

Could the capital gain of $2,401,666 be attributable to anything other than protected income realized before August 27, 1980? If I subtract from the protected income at September 15, 1980, i.e. $422,630, the amount of income for a 19-day period, being the number of days between August 27, 1980, and September 15, 1980, the protected income comes to $163,464. If the same approach had been adopted as for the class D preferred shares, only the sum of $2,043 would have been attributable to the 1,000 class C preferred shares.

Having regard to the size of the capital gain of $2,401,666 relative to the protected income of $2,043, it is clear that S.L.M. significantly reduced the capital gain that it would have realized prior to the redemption of the class C preferred shares and that this capital gain could reasonably be considered to be attributable to something other than the protected income at August 27, 1980. Consequently, the dividend of $2,401,666 is deemed not to be a dividend and represents the capital gain realized on the redemption of those 1,000 class C preferred shares.

CAPITAL LOSS OF $1,000,000

Before St-Laurent declared a $1,000,000 stock dividend in August 1980, S.L.M.’s four shareholders had already agreed that Gestion S.L. would purchase St-Laurent’s shares for the sum of $1. These four shareholders were dealing with each other at arm’s length. It therefore seems reasonable to believe that this price represented the fair market value of those shares. The declaration of this $1,000,000 dividend had the effect of creating an ACB of $1,000,000 for the shares issued as a dividend by St-Laurent, that is, the 1,000,000 class B preferred shares. When S.L.M. sold its 470 common shares and the said 1,000,000 class B preferred shares to Mr. Couture for $1, it thus realized a capital loss of $1,000,000.

For the existence of this loss to be disregarded, the result of these transactions must be that S.L.M. disposed of the shares under circumstances such that it may reasonably be considered to have artificially or unduly created a loss.

I believe that the French expression “de façon à” (corresponding to “such that” in subsection 55(1)) can have two meanings. The first is “afin de” (“in order to”), which means [14] “pour, dans le but de, en vue de” (“for, for the purpose of, with a view to”). On this point, one could contend that the taxpayer had to have the intention of artificially or unduly creating a loss. “De façon à” could also mean “de manière à faire” (“so as to do”) something. In this case, the applicable provision does not require a particular intent on the taxpayer’s part. It is therefore useful to analyze the English version of subsection 55(1) of the Act in order to clarify its scope. There is nothing in the English wording to indicate a requirement of intent: “where the result of one or more...transactions...is that a taxpayer has disposed of property under circumstances such that he may reasonably be considered to have artificially or unduly...created a loss”. This wording appears to require that this assessment be made on the basis of the “result” of one or more transactions rather than on the basis of an intention that the taxpayer might have had. In other words, the point to be determined is whether, under the circumstances, S.L.M. can reasonably be considered to have artificially or unduly created a loss?

These words “unduly” and “artificially” appear in the old section 245 of the Act and have been commented upon in a number of decisions including Don Fell Ltd. v. R., 81 D.T.C. 5282. In that case, Cattanach J. of the Federal Court, Trial Division, gave the following meaning to these expressions, at page 5292:

The word “unduly” relates to quantum and means “excessively” or “unreasonably” and “artificially” means “not in accordance with normality”.

I believe that these definitions fit quite well the meaning of these words as used in subsection 55(1) of the Act. Now, did S.L.M. act “excessively” or “abnormally” so as to create a loss?

If S.L.M. had only disposed of the 470 common shares that it owned, it would have realized neither a gain nor a loss. The fact that it declared a $1,000,000 stock dividend had the effect of increasing the ACB by $1,000,000. The sale of these class B preferred shares thus generated a loss of $1,000,000. Did this $1,000,000 loss reflect the economic reality of the transaction? On the facts of this case, I must answer in the negative. Before the dividend was declared, all the St-Laurent shares were worth $1, and afterward, still $1. S.L.M. did not realize a financial loss on this disposition. It did not pay $1,000,000 for these shares. As there were more than $1,000,000 of retained earnings, this sale for $1 represented a shortfall in earnings of at least $1,000,000, but not a loss of $1;000,000.

Under section 54 the ACB of the shares received as a stock dividend may be increased by the amount of that dividend so as to avoid the realization of a capital gain upon a subsequent disposition. Without an increase in the ACB, a taxpayer could realize a gain upon the resale of those shares. The purpose of this rule is thus to prevent a gain from being subject to double taxation, once as a dividend and a second time as a capital gain. Its purpose is not to permit a taxpayer to realize a capital loss on valueless shares declared as a dividend. This kind of loss is in keeping with neither the object nor the spirit of this provision of the Act. [15]

In my view, under the particular circumstances of this case S.L.M. may reasonably be considered to have disposed of 1,000,000 class B preferred shares so as artificially or unduly to create a loss. By declaring a stock dividend and disposing of the valueless class B preferred shares, S.L.M. acted excessively or abnormally so as to create a tax loss that was not consistent with economic reality. Subsection 55(1) applies to the sale of S.L.M.’s shares to Mr. Couture.

For these reasons, S.L.M.’s appeals for the 1981 and 1983 taxation years are dismissed. The appeals by Prego from the assessment of July 7, 1987, and from the assessments for the 1981 to 1985 taxation years are also dismissed.

Appeals dismissed.