Danford Evan Eugene Bodrug and National Trust Company, Executors of the Estate of Evan Wesley Bodrug, Deceased v. Her Majesty the Queen in Right of Canada, [1991] 2 CTC 347

Stone, J.A. (Heald and Linden, JJ.A., concurring):—The issue raised by this appeal is a narrow though important one. It concerns the interpretation to be given to the phrase "cost to the taxpayer” in subparagraph 54(a)(ii) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). That subparagraph reads:

54. In this subdivision,

(a) "adjusted cost base” to a taxpayer of any property at any time means, except as otherwise provided,

(ii) in any other case, the cost to the taxpayer of the property adjusted, as of that time, in accordance with section 53, . . .

The subparagraph applies to the computation, pursuant to subparagraph 40(1)(a)(i) of the Act, of a taxpayer's gain from the disposition of property, which is to be "the amount, if any, by which his proceeds of disposition exceeds the aggregate of the adjusted cost base to him of the property immediately before the disposition . . .”.

The plaintiffs, personal representatives of Mr. Bodrug who died on January 10, 1980, bring this appeal from a judgment of the Trial Division rendered on September 6, 1990 (now reported as Bodrug (E.W.) Estate v. Canada, [1990] 2 C.T.C. 324; 90 D.T.C. 6251 (F.C.T.D.)). At his death, Mr. Bodrug owned the controlling block of shares in Canadian Hidrogas Resources Ltd. The issue in the Trial Division was whether damages of $1,320,000 awarded by the Alberta Court of Queen's Bench in an action brought by NIR Oil Limited and Noah Cohen against the deceased in December 1979, were properly treated by the Minister for income tax purposes when he refused to consider them to be part of the “cost to the taxpayer" of certain shares of that company. The learned trial judge, McNair, J., dismissed the appeal with costs for reasons to which I shall presently refer.

In 1973, Mr. Cohen entered into an employment contract with Hidrogas and in connection therewith Mr. Bodrug granted NIR an option to purchase from him 340,000 shares of Hidrogas at a price of 65 cents per share. The employment relationship was terminated by Mr. Cohen in 1975. In December 1976, after 30,000 shares had been acquired by NIR, Mr. Bodrug purported to cancel the agreement for the sale of the remaining 310,000 shares. This act precipitated a legal action in the courts of Alberta whereby NIR sought specific performance of the option agreement. A court order made in that action required that certificates representing the shares be deposited in the Court ending the outcome of the litigation. In August 1979, the parties to this litigation settled their differences by executing minutes of settlement dated August 21, 1979, pursuant to which Mr. Bodrug agreed to pay NIR, in two equal instalments on or before August 31, 1979, and on or before February 29, 1980, the sum of $1,300,000 in exchange for a release and surrender of all rights NIR held by virtue of the option agreement. At the same time, Mr. Cohen and NIR agreed to sell to Mr. Bodrug the 25,000 Hidrogas shares they had already acquired at the price of $7 per share payable on or before August 31, 1979. Shares of Hidrogas were trading on the Toronto Stock Exchange at approximately $7 per share in that month.

At the time the settlement agreement was entered into, Mr. Cohen was not aware of an impending takeover bid with respect to the shares of Hidrogas. That bid was reduced to writing by an agreement of August 23, 1979, between Mr. Bodrug and a third party, which fixed the price per share at $15.50. The settlement transaction was duly closed in accordance with its terms. In December 1979, however, Mr. Cohen and NIR brought an action for damages against Mr. Bodrug in the Alberta Court of Queen's Bench because of his failure to disclose the pending takeover bid before the parties arrived at the settlement. The claims as asserted were based both on common law and on breach of the insider trading provisions in subsection 112(1) of the Securities Act, R.S.A. 1970,

c. 333 (now subsection 115(1), R.S.A. 1980, c. S-6). Judgment, rendered in that action on June 22, 1983, awarded damages to NIR and Mr. Cohen in the amount of $2,247,500 and $200,000 respectively. It was affirmed by the Alberta Court of Appeal on May 1, 1985. These damages awards, the appellant now asserts, are to be treated for purposes of subparagraph 54(a)(ii) as part of the “cost to the taxpayer" of the Hidrogas shares which were deemed to be disposed of at Bodrug's death on January 10, 1980.

The issue before the Trial Division was whether the Minister of National Revenue was correct in refusing to treat these damages as part of the adjusted cost base of the Hidrogas shares, although he had treated the amount paid upon settlement of the specific performance action to be part of the adjusted cost base of those shares. In upholding the Minister's reassessment, McNair, J. applied the principle enunciated by Pratte, J.A. in The Queen v. Stirling, [1985] 1 C.T.C. 275; 85 D.T.C. 5199. At pages 9-11 of his reasons for judgment he stated:

The question therefore is simply this: can the damages awards in question properly be considered part of the “cost to the taxpayer" of the Hidrogas shares?

In Stirling, supra, Pratte, J.A., rendering the judgment of the Federal Court of Appeal from the bench, interpreted the word "cost" in relation to the computation of capital gains as follows:

The only issue on this appeal is whether the Trial Division was right in holding that, in computing his capital gain from the disposition of gold bullion, the respondent could deduct, as part of his cost, interest on the unpaid portion of the price of the bullion and safekeeping charges that he had incurred in respect of the period during which he had held the bullion.

In deciding that those interest and charges could be deducted, the learned trial judge did not rely on any provision of the Income Tax Act but, rather, on what, in his view, would have been the intention of Parliament had it given consideration to that question. We cannot agree with that approach.

In trying to support that judgment, counsel for the respondent argued in substance that capital gain should be computed according to the same rules as income from a business or property. That argument, while attractive, does not find any support in the Income Tax Act which provides special rules for the computation of capital gain. Under those rules, as they are found in subparagraph 40(1)(c)(i) and section 54, the interest and safekeeping charges here in question could be deductible only if they were part of the cost of the bullion. In our opinion, they were not. As we understand it, the word "cost" in those sections means the price that the taxpayer gave up in order to get the asset; it does not include any expense that he may have incurred in order to put himself in a position to pay that price or to keep the property afterwards.

[Emphasis added.]

I have no problem with the submission of counsel for the plaintiffs that the cost of an asset is not restricted to the actual purchase price paid therefor. It seems clear that the cost of property may include brokerage fees, legal fees, commissions and other expenses incurred in connection with the acquisition of the property. In my view, the decision in Stirling does not necessarily restrict such an extended definition of the term “cost’’. However, I am of the opinion that it is clear authority for the proposition that the cost of an asset for the purposes of capital gains computation is limited to the costs of acquisition of that asset or, as Pratte, J. put it, "the price that the taxpayer gave up in order to get the asset”.

In the present case, I am unable to see how the damages awards in question could possibly be regarded as part of the acquisition costs of the Hidrogas shares to the deceased. The deceased was found liable for those damages as a result of his use of confidential information relating to the Hidrogas shares. His title to those shares was not in issue in the action brought by Cohen and NIR. In their amended statement of claim, the plaintiffs sought only damages, and made no claim for specific performance. Whether the deceased's liability and the award of damages were fixed in 1979, or in 1983 or 1985 when the judgments of the Alberta Court of Queen's Bench and the Court of Appeal were rendered, is immaterial. The entire lawsuit having nothing to do with the deceased's title to the shares perse, it is my opinion that the damages for which the deceased was adjudged liable cannot be regarded as part of the price he had to give up in order to get the shares. The decisions in Dominion Natural Gas and British Columbia Power, supra, dealing with the deduction of legal expenses incurred in preserving capital assets or title thereto, in my view, have no bearing in the circumstances of the present case.

It follows, therefore, that I am unable to accept the submission of plaintiffs’ counsel that the sum of $1,320,000 paid by the deceased to NIR pursuant to the settlement agreement and the damages awards should be treated similarly for income tax purposes. In my opinion, these two payments are entirely dissimilar in nature. The payment of $1,320,000 by the deceased to NIR formed one of the conditions of the settlement agreement dated August 21, 1979 and was made in consideration for the release and surrender by NIR of all of its rights under the option agreement of 1973. In essence, the deceased paid this sum to regain his rights to the Hidrogas shares and, presumably on that basis, the Minister saw fit to increase the latter's adjusted cost base accordingly. The damages, on the other hand, were paid by the plaintiffs to satisfy a personal judgment against the deceased, and I cannot see that their tax treatment is in any way affected by the Minister's addition of the $1,320,000 to the adjusted cost base of the shares.

In the action in the Alberta Court of Queen's Bench, the plaintiffs alleged that they would not have executed the settlement agreement had they known, as did Mr. Bodrug, that at the time it was entered into there was an impending takeover bid with respect to the shares of Hidrogas. The statutory remedy sought was that provided for in subsections 112(1) and (2) of the Securities Act, which read:

112. (1) Every insider of a corporation or associate or affiliate of such insider, who, in connection with a transaction relating to the capital securities of the corporation, makes use of any specific confidential information for his own benefit or advantage that, if generally known, might reasonably be expected to affect materially the value of such securities, is liable to compensate any person or company for any direct loss suffered by such person or company as a result of such transaction, unless such information was known or ought reasonably to have been known to such person or company at the time of such transaction, and is also accountable to the corporation for any direct benefit or advantage received or receivable by such insider, associate or affiliate, as the case may be, as a result of such transaction.

(2) An action to enforce any right created by subsection (1) may be commenced only within 2 years after the date of completion of the transaction that gave rise to the cause of action.

In his reasons for judgment, the Judge of the Alberta Court of Queen's Bench, D.C. McDonald, J., stated at page 32:

For my opinion is that in circumstances such as the present, the insider trading provisions of the Securities Act dictate that to avoid liability, Mr. Bodrug should not nave proceeded with the settlement of the litigation on August 16, because he knew full well that he was in possession of information that Mr. Cohen did not have, and that that information might reasonably be expected to affect materially the value of the securities some of which, pursuant to the settlement, were being sold by Mr. Cohen to Mr. Bodrug, and some of which Mr. [Cohen] was foregoing any further right to purchase.

And, at pages 45-47, he added:

What is the direct loss suffered by the plaintiffs? If Mr. Bodrug had disclosed the true facts to Mr. Cohen, NIR Oil Limited could have bought the 310,000 shares for 65 cents a share and ultimately sold them for $15.50 a share, which is the price that Mr. Barkwell offered orally on August 17 and agreed to by Mr. Bodrug and the Board of Directors of Hidrogas, resulting in the execution of a written agreement between Norcen and Hidrogas on August 23 agreeing to the sale of all issued shares at that price. A press release announcing the agreement was issued that day.

However, in fact Mr. Bodrug paid the equivalent of $4.25 a share. So at most the loss represents the difference between $4.90 and $15.50 a share. The latter figure should be reduced to $15.00, because that was the offer of Norcen as of August 16. It should further be reduced to $14.25 a share because, once Mr. Cohen became aware, on August 23, of the press release that had been issued that day, he could, within the following week, have purchased 310,000 shares on the market. On the Toronto Stock Exchange on August 24 the closing price was $14.25, and on August 28 the lowest price was $14.25. Those were the lowest prices during the period from August 24, when trading resumed, and August 31. There is no evidence before me as to prices beyond that date. I think the figure of $14.25 should be used as the figure at which the plaintiffs could have mitigated their loss.

Is the direct loss suffered by the plaintiff NIR Oil Limited to be the difference between $4.90 a share and $14.25 a share? I think not. As at August 16, the value of the shares to NIR Oil Limited, in its ignorance of the true facts, was not $4.90 a share but $7.00 a share. For that was the price Mr. Cohen was prepared to take for the 25,000 shares which he owned outright and were not in dispute. The difference between $4.90 and $7.00 can reasonably be regarded as what Mr. Cohen, and therefore NIR Oil Limited, thought was the price they had to pay to settle the litigation. I do not agree with Mr. Cohen that the money payment, worked out at $4.90 a share, gave him everything he could have wanted. If he had obtained a settlement completely in his favour, NIR Oil Limited would have received $7.00 a share for the 310,000 shares in dispute, less 65 cents a share which NIR Oil Limited would have had to pay to acquire them. I think the base figure to be ‘used in calculating the direct loss in regard to the 310,000 shares ought to be $7.00.

The direct loss suffered by the plaintiff NIR Oil Limited was therefore the difference between $7.00 a share and $14.25 a share, for 310,000 shares. The plaintiff NIR Oil Limited will therefore recover damages from the defendants in the sum of $2,247,500.00.

The direct loss suffered by the plaintiff Cohen was also the difference between $7.00 a share and $15.00 a share, for 25,000 shares. The top figure to be used is that of the offer outstanding as of August 16. The plaintiff already had the shares. There was nothing he could do after August 23 to mitigate his loss. He will recover damages in the sum of $200,000.00.

The essence of the appellant's submission is that in order to settle the specific performance action and re-acquire all rights in the Hidrogas shares, Mr. Bodrug negotiated and executed the settlement agreement; that, in doing so, he incurred an additional liability to NIR and Mr. Cohen pursuant to the Securities Act; and that the quantum of damages awarded by the Court of Queen's Bench sought, essentially, to provide NIR and Mr. Cohen with the same "purchase price" for the Hidrogas shares as they could reasonably have been expected to extract from Mr. Bodrug had they been made aware of the pending takeover bid before the settlement agreement was executed.

The appellant asserts as a long-established principle that the tax consequences of a damage award are dependent upon an analysis of the underlying liability, and relies in support on the views expressed by the President of the Exchequer Court of Canada in Imperial Oil Limited v. M.N.R., [1947] Ex. C.R. 527; [1947] C.T.C. 353; 3 D.T.C. 1090, at page 373 (D.T.C. 1099-1100; Ex. C.R. 546):

It is no answer to say that an item of expenditure is not deductible on the ground that it was not made primarily to earn the income but primarily to satisfy a legal liability. This was the kind of argument that was expressly rejected by the High Court of Australia in the Herald and Weekly Times, Ltd. case (supra), and it should be rejected here. In a sense, all disbursements are made primarily to satisfy legal liabilities. The fact that a legal liability was being satisfied has, by itself, no bearing on the matter. It is necessary to look behind the payment and enquire whether the liability which made it necessary—and it makes no difference whether such liability was contractual or delictual—was incurred as part of the operation by which the taxpayer earned his income.

In my view, the principles which apply to the determination of ordinary income for income tax purposes are not in play. We are concerned with the computation of a capital gain within a particular statutory regime. As I see it, the appellant can succeed only if it is able to bring itself within the relevant language.

The appellant was unable to persuade the trial judge that the damages awards of June 22, 1983, are to be regarded as part of that cost when viewed realistically. Of importance to him was that the action in which those damages were awarded was not in the least concerned with title to the Hidrogas shares but, rather, with the use made by Mr. Bodrug of confidential information contrary to subsection 112(1) of the Securities Act. The amounts which were paid pursuant to the settlement agreement were viewed as having been paid to gain the release and surrender of all rights in the 1973 option agreement or, essentially, to regain title to the Hidrogas shares.

Despite counsel's skilful argument, I too am unable to view the damages awards as part of the cost to Mr. Bodrug of the shares in question. Like the trial judge, I view the "cost" of those shares as something which was quite separate ana quite distinct from the liability which was subsequently imposed on Mr. Bodrug's estate by the June 22, 1983, judgment. That liability was based upon a provincial statute and lay outside the settlement agreement. Mr. Bodrug bargained for the surrender of all rights and interests of NIR and Mr. Cohen in the Hidrogas shares in exchange for the payment of money. Clearly, he paid precisely for that which he bargained. The damages awards, not being part of that bargain, are not a "cost" of re-acquiring the Hidrogas shares. In my view, the learned trial judge correctly applied the principle of Stirling, supra.

In the result, I would dismiss this appeal with costs.

Appeal dismissed.