George J. Allen v. Minister of National Revenue, [1989] 2 CTC 2093, 89 DTC 380

Garon, T.C.J.:—These are appeals from reassessments of income tax dated June 7, 1985, issued by the Minister of National Revenue for the 1980 and 1982 taxation years.

By his reassessments the respondent added to the appellant's income $10,000 for the 1980 taxation year and $14,960 for the 1982 taxation year on the basis that benefits in those amounts were conferred by Electrical Contacts Limited, a company of which the appellant was a shareholder and consequently such amounts were required to be included in the taxpayer's income by virtue of paragraph 15(1)(c) of the Income Tax Act.

The appellant was a resident of the Province of Ontario at all relevant times. From 1975 to the date of the hearing of these appeals, the appellant was the controlling shareholder and President of Electrical Contacts Limited (the "Company"), an Ontario corporation. That Company was incorporated and commenced business in that province in 1971.

The appellant explained that a company known as International Mogul Mines, a venture capital company, which had until some time in 1975 a 70 per cent interest in the shareholding of the Company, went into a type of receivership. As a result, the bank from which Electrical Contacts Limited had obtained its financing informed the appellant at that time that it was prepared to maintain the Company's existing line of credit only if the appellant could arrange to have $100,000 injected into the capital of the Company.

The appellant testified that he contacted a few friends and customers and finally two companies and one businessman agreed to advance $25,000 each for a total of $75,000. Although this amount was short of the requirements of the bank relating to the continuation of the Company's line of credit it was finally accepted by that bank. The companies in question were Hettinger Electrical Manufacturing Company ("Hettinger"), Llandaff Engineering Company Limited ("Llandaff") and the individual was Joseph G. Detzler ("Detzler") a plumbing and heating contractor. The appellant was on friendly terms with the persons running these three business entities. Each party in return for advancing $25,000 received 2,500 preference shares with a par value of $10 each. These shares were five per cent non-cumulative redeemable non-voting preference shares. Each of these three persons, also received 40 common shares without par value; these shares were owned by the appellant.

Some time prior to January 1980, Hettinger asked the appellant, to use the latter’s expression, for “their money back”. The Company used part of its line of credit to pay back Hettinger in respect of the purchase for cancellation of the preference shares. This purchase by the Company of Hettinger's preference shares was authorized by a resolution of the Board of Directors of the company dated January 2, 1980. By the same resolution the transfer to the appellant of 40 common shares of the capital stock of the Company owned by Hettinger was also approved. According to the appellant's testimony there was very little discussion between the Hettinger group and the appellant on behalf of the Company regarding the consideration to be paid to Hettinger for the purchase of preference and common shares. Concerning that transaction in 1980, the appellant explained that Hettinger was made up of three persons and there were certain difficulties among them at that juncture. Also the relationship between the appellant and the Hettinger group deteriorated to some extent at that point in time. Hettinger simply asked for the reimbursement, so to speak, of $25,000 and they were given what they asked for, to paraphrase the appellant's observations in this regard.

Later on during the same year, Mr. Detzler came to the appellant and indicated that he needed "his money back" because he was experiencing cash flow problems. The appellant then agreed that $10,000 should be paid to him in addition to the par value of the preferred shares owned by Detzler. The appellant also indicated in answer to the following question put by counsel for the appellant: ”. . . whether the payment to Mr. Detzler was in congruence with the understanding that was made at the time that he purchased that these would be the circumstances?” The appellant answered as follows:

Well, yes. All he wanted, he was helping us and what he wanted was his money back. He is very generous. I believe when we paid him back, that he didn't ask us for it all at once, we made some payments to him along the way.

This transaction between Detzler and the Company was approved by a resolution of the Board of Directors of the Company dated April 30, 1980. It is to be noted that the price of $35,000 was payable in 12 equal monthly instalments together with interest also payable in the same manner. The payment was to be secured by the Company's promissory note dated April 1, 1980 to Mr. Detzler. Accordingly, the certificate representing the preferred shares was surrendered and the shares were cancelled. The transfer from Detzler of 40 common shares to the appellant was also confirmed but the resolution in question does not mention any price for the common shares.

The same day and by the same resolution the Board of Directors of the Company also approved the transfer of 40 common shares from Timothy Allen to the appellant. With respect to this transaction, the appellant stated that he had given these shares sometime before to his son Timothy in order to interest him in the Company's business. Events did not pan out as he had expected. The appellant's son left in a huff and the appellant paid $5,000 for these common shares in order to keep peace in the family.

Finally about two years later, Llandaff required its money back from the Company. In this connection, the appellant mentioned that at the time the Company sold its preference shares to Llandaff there was an understanding between the appellant and the President of Llandaff, Mr. Fred Jenkins, that the Company "would help him produce and manufacture powered metal and geoelectrical contacts". The appellant indicated that he tried to fulfill his commitment but in the end it turned out to be financially impossible. As a result, the preference shares were purchased by the Company for $42,500 as it appears from the resolution of the Board of Directors dated December 30, 1982. The consideration payable was broken down as follows:

$27,500 for the preference shares

$ 40 for the common shares and

$14,960 for its agreement to sell all the preferred and common shares in

question.

The transfer of the 40 common shares from Llandaff to the appellant was also authorized.

It is also worth noting that at all material times paragraph 5 of the Articles of Amendment of Electrical Contacts Limited, dated November 17, 1975, provided that the Company could at any time purchase for cancellation all or part of the outstanding preference shares "at the lowest price at which in the opinion of the directors, such shares are obtainable but not exceeding an amount equal to one hundred and ten per cent (110%) of the aggregate par value thereof”. The provisions of these Articles establishing an upper limit on the redemption price to be paid by the Company for the preference shares played no role in the discussions with Detzler and Llandaff regarding the purchase of their respective preference shares. No one had asserted that the Company had exceeded its power or otherwise impugned the validity of these transactions regarding the preference shares.

It is therefore necessary to review in detail the circumstances surrounding the transfer of the common shares in 1975 to each of the three groups involved and their return to the appellant in 1980 as to the shares transferred to Hettinger and Detzler and in 1982 as to the shares conveyed to Llandaff.

First of all, these common shares at the time of their transfer to Hettinger, Detzler and Llandaff were owned by the appellant himself. Concerning the ownership of these common shares, the following question was put to the appellant: "Why were the common shares registered in your name personally?" He replied as follows:

A. Well, I held the common shares for the time that we had to take over from International Mogul Mines. So I can — who else's name would they be in, I can’t answer that.

Q. Why didn't you put the common shares in the name of the company?

A. I don't know. I can’t answer that.

Apart from the appellant's testimony making clear that the common shares were registered in his name, there is the allegation in paragraph 3 of the notice of appeal stating, amongst other things, that during the year 1975 each of Hettinger, Detzler and Llandaff “acquired 40 common shares of the company from the appellant". This allegation in the notice of appeal was admitted by the respondent in his reply. On this question regarding the ownership of the common shares, paragraph 7 of the notice of appeal, also admitted by the respondent, is of some interest. Paragraph 7 reads thus:

At the end of 1976 the common shares of the Company were held as to 40 common shares by each of Hettinger, Detzler, Llandaff and Timothy Allen and the appellant held 840 common shares of the Company. The only other change in the common shareholdings except as noted above to the end of the year 1982 was that one (1) common share was transferred by the appellant to his wife during June of 1981.

The resolution of the Board of Directors dated January 2, 1980 approving the purchase by the company of the preference shares from Hettinger contains in its preamble the following statement:

WHEREAS pursuant to an invitation to holders of the preference shares of the Corporation to submit tenders of preference shares for purchase for cancellation made by the President on behalf of the Corporation as authorized by a resolution of the Board passed on the 27th day of November, 1979, Hettinger Electrical Manufacturing Company had tendered the 2500 preference shares held by it at a price of $10.00 per share amounting in the aggregate to $25,000.00;

No reference is made in the preamble to the transfer of the common shares but in the operating portion of that resolution, approval is given to the purchase by the Company of the preference shares and the transfer of the common shares, as appears from the following:

1. The directors hereby approve the purchase for cancellation of 2500 preference shares from Hettinger Electrical Manufacturing Company at a price of $10.00 per share, being the lowest price at which in the opinion of the directors, such shares are obtainable.

2. Be it resolved that the transfer of 40 common shares from Hettinger Electrical Manufacturing Company to George Allen, be and the same is hereby approved and consented to.

A similar pattern was followed with respect to the transaction involving the acquisition by the company of the preferred shares from Detzler and the conveyance by Detzler to the appellant of 40 common shares. The key paragraphs in the preamble and in the body of the Resolution dated April 30, 1980 read as follows:

The chairman reported that in the exercise of his discretion pursuant to the resolution of the directors passed November 27th, 1979 and the consent of Ontario Development Corporation having been received, he had accepted the tender of Joseph G. Detzler of 2500 preference shares for purchase for cancellation at a price of $35,000.00 payable in 12 equal monthly instalments with interest in an aggregate amount of $1925.00 (also payable in 12 equal monthly instalments) the payment to be secured by a promissory note of the Corporation to Joseph G. Detzler in the face amount of $36,925.00 (which includes interest of $1925.00) payable in 12 equal consecutive monthly instalments commencing April 1, 1980. The said note dated April 1, 1980 having been executed and delivered to the said Joseph G. Detzler, the certificate representing the said 2500 shares was surrendered and the shares cancelled.

BE IT RESOLVED THAT:

the directors determine that (i) it is in the best interests of the Corporation to purchase for cancellation the 2500 preference shares tendered by Joseph G. Detzler at the price and on the terms reported by the President to this meeting; and (ii) the said price is, in the opinion of the directors, the lowest price at which the said shares are obtainable;

The following transfers of common shares in the capital of the Corporation were then presented to the meeting.

Timothy Allen to George J. Allen — 40 common shares

Joseph G. Detzler to George J. Allen — 40 common shares

UPON MOTION DULY MADE, seconded and carried unanimously the following resolution was passed;

BE IT RESOLVED THAT the following transfers of common shares in the capital of the Corporation be and the same are hereby approved and consented to.

Timothy Allen to George J. Allen — 40 common shares

Joseph G. Detzler to George J. Allen — 40 common shares

Paragraph numbered 6 in the Notes to the Company's financial statements for the year ended December 31, 1980 makes it clear that the total amount of $60,000 payable by the Company related exclusively to the preference shares acquired from Hettinger and Detzler. Paragraph 6 reads as follows:

CAPITAL STOCK

During the year, the Company purchased and cancelled 5,000 preference shares for cash consideration of $60,000.

The Minutes of the meeting of the Board of Directors held on December 30, 1982 show that a different approach was adopted when dealing with the purchase of preference and common shares from Llandaff as appears from the following extract from the body of the resolution adopted at that meeting:

NOW THEREFORE BE IT RESOLVED THAT:

(a) the Corporation purchase from Llandaff the 2500 preference shares in the capital of the Corporation for $27,500.00; and

(b) the said shares be cancelled; and

(c) the Corporation pay to Llandaff the sum of $14,960.00 as consideration for

its agreement to sell all its preferred and common shares as aforesaid.

UPON MOTION DULY MADE, seconded and carried unanimously the transfer of the 40 common shares from Llandaff Engineering Co. Ltd. to George J. Allen be and the same is hereby approved.

In the Notes to the Company's financial statements for the year ended December 31, 1982, the full amount of $42,460 (inclusive of $40 for common shares) paid by the Company is solely attributed to the redemption of the preference shares. Paragraph 9 of these Notes is couched in the following terms:

CAPITAL STOCK

During the year, the company redeemed all issued and outstanding preference shares for $16.984 cash per share. The excess of the redemption price over par value has been charged to retained earnings.

The above evidence respecting the transfer of the preferred and common shares by Llandaff is completed by a statutory declaration by the President of Llandaff, Frederick Benjamin Jenkins. This statutory declaration is hereafter reproduced save as to its heading and jurat:

1. I have been the President of Llandaff Engineering Co. Ltd. ("Llandaff") from November 1, 1975 to date and as such have personal knowledge of the matters herein deposed to.

2. In November, 1975, Llandaff purchased from George J. Allen ("Allen") 40 Common Shares and 1,405 Preference Shares of Electrical Contacts Limited ("E.C.L.") and purchased 1,095 Preference Shares from the Treasury of E.C.L.

3. Llandaff paid Allen $14,050.00 for the said Preference Shares purchased from him and Llandaff paid E.C.L. $10,950.00 for the Preference Shares purchased from E.C.L.'s Treasury.

4. Llandaff had agreed to pay Allen $40.00 as consideration for the purchase of the said 40 Common Shares of E.C.L. but this amount was not in fact paid.

5. In December, 1982, E.C.L. purchased the said Preference Shares for cancellation for an aggregate price of $42,450.00.

6. On or about the same time as the said Preference Shares were redeemed by E.C.L., I returned to Allen the said 40 Common Shares of E.C.L. for which I had never paid him and which I therefore considered to belong to him.

7. I was never paid any money by Allen in respect of the return to him of the said Common Shares of E.C.L.

8. I have always considered that the premium of $17,460.00 paid by E.C.L. to Llandaff in excess of the par value of $25,000.00 of the said Preference Shares was exclusively related to E.C.L.'s purchase of the said Preference Shares and had nothing to do with the return of the Common Shares to Allen.

This declaration was filed in Court on behalf of the appellant with the qualified consent of Counsel for the respondent. The qualification was that it should be given little weight since Mr. Jenkins, who resides in Wales, was not available for cross-examination.

Analysis

As set out in paragraph 6 of the reply to the notice of appeal, the main submission of the respondent is that the appellant pursuant to subsection 15(1) of the Income Tax Act received a benefit or advantage from a corporation in which he was a shareholder by having common shares for which the corporation paid in full, or substantially in full, transferred to him.

The short answer to this submission is that, on the evidence, nothing was paid by the Company for the transfer to the appellant in 1980 and 1982 of the common shares in question as I will attempt to demonstrate.

First of all, it is not disputed that the 40 common shares that were transferred in 1975 to each of Hettinger, Detzler and Llandaff were owned by the appellant immediately prior to each transfer. The sale price for these common shares was not, on the basis of the evidence, really discussed at the time of the 1975 transfer by the appellant of the common shares to Hettinger, Detzler and Llandaff. It would appear at best to be nominal, that is, $1 for each share if anything at all was paid. Regarding the purchase by Hettinger of 40 common shares, there is no direct evidence if consideration was given for the acquisition of the shares. As far as the purchase by Llandaff of 40 common shares is concerned, the statutory declaration of Frederick Benjamin Jenkins, the President of Llandaff indicated that Llandaff agreed to pay $40 for the 40 common shares but that the amount was not in fact paid. In the Detzler's testimony nothing is said specifically if at the time of transfer in 1975 consideration was paid to the appellant by Detzler for the common shares. However, the thrust of his evidence is that he had loaned $25,000 to Electrical Contacts Limited which amount corresponds to the par value of the preferred shares and he was reimbursed, in a manner of speaking, five years later with a $10,000 bonus. In cross-examination, when asked why he gave 40 common shares to each of Hettinger, Detzler and Llandaff, the appellant replied in substance that if the Company went on and prospered "there would be something in it for them." On the whole of the evidence, I construe these transfers of common shares to Hettinger, Detzler and Llandaff in 1975 to be either a gesture of appreciation on the appellant’s part towards these persons for advancing money to the Company at a critical time or alternatively the appellant wanted to facilitate the Company's transactions with these three persons by transferring to them these common shares. There is no evidence as [to] the value of these common shares at the time of their transfer in 1975 to Hettinger, Detzler and Llandaff.

On the evidence, it would appear that the amounts paid by the Company in 1980 and 1982 — $25,000 to Hettinger, $35,000 to Detzler and $42,450 to Llandaff — related exclusively to the value of the preferred shares. In the Hettinger case it simply represents the par value of the preferred shares, nothing more, nothing less. In the transaction involving Mr. Detzler, the latter treated this transaction as a loan of $25,000 and the $10,000 that he received was considered by him as interest for the use of that money by the Company over approximately a five-year period. This view of the Detzler transaction in 1980 is clearly supported by the evidence of both the appellant and Detzler.

With respect to the Llandaff transaction in 1982, the resolution dated December 30, 1982, indicates that in the contract between Llandaff and the Company an additional amount of $14,960 was to be paid, as mentioned earlier, as consideration for its agreement to sell all its preferred and common shares in addition to an amount of $27,500 to be paid for the preference shares and $40 for the common shares. There is no evidence as to the portion of that amount of $14,960 that has to do with the preferred shares and the amount that relates to the common shares. On the other hand, the Notes to the financial statements clearly set out as mentioned earlier, that the total consideration was given for the purchase of the preference shares. Also Mr. Jenkins' statutory declaration confirms that no part of the $14,960 is to be ascribed to the common shares. Furthermore, the evidence given by the appellant suggests that the value of the preference shares was the only factor considered in arriving at an aggregate price to be paid by the Company to Llandaff.

To sum up, the better view of the evidence is that nothing was paid by the Company for arranging in 1980 and 1982 the transfer of the common shares to the appellant, if it can be said on the evidence that the Company was instrumental in having the common shares transferred to the appellant. It has not been suggested by Counsel for the respondent that a benefit could have been conferred on the appellant by the Company in some other manner if the latter Company has not made in 1980 and 1982 any payments in respect of the common shares. The reassessments in dispute were clearly made on the basis that the benefits assumed to be conferred on the appellant resulted from payments made by the Company for the subsequent acquisition of the common shares in 1980 and 1982.

The transactions in 1975, 1980 and 1982 regarding the preference and common shares could be looked at from another angle. These common shares were owned by the appellant prior to their transfer in 1975. As a result of separate contracts between the appellant and Hettinger, Detzler and Llandaff, each of them became the owner of 40 common shares. These shares were returned to the appellant in 1980 by Hettinger and Detzler and in 1982 by Llandaff for a nominal consideration or for no consideration. Viewed in this way, it could be said that although these common shares were transferred at the same time as the preference shares, they were the subject of distinct contracts between the appellant and each of Hettinger, Detzler and Llandaff while the preference shares were of course, the subject matter of three contracts between the Company and Hettinger, Detzler and Llandaff. The Company was not a party to the contracts relating to the common shares. On that view of the contractual arrangements for the common shares, it is apparent that no benefit could be conferred by the Company on the appellant.

In the result, whether the transactions for the common shares in issue were part and parcel of the overall contractual arrangements between the Company and each of Hettinger, Detzler and Llandaff, which hypothesis assumes that the appellant had made the common shares available to the Company in some fashion some time in 1975 prior to each transfer to Hettinger, Detzler and Llandaff, or whether these common shares were part of a separate contract between the appellant acting independently and each of these other parties, it is clear that no benefit was conferred by the Company on the appellant in the course of the transactions in 1980 and 1982 involving the transfer to the appellant of the common shares in question.

For these reasons, the appeals are allowed, with costs, and the assessments for the 1980 and 1982 taxation years are referred back to the Minister for reconsideration and reassessment on the basis that no benefit was conferred by Electrical Contacts Limited on the appellant in those two years.

Appeals allowed.