John v. Cross v. Minister of National Revenue, [1989] 1 CTC 2398, 89 DTC 312

Brule, T.C.J.: —This appeal arises as a result of a reassessment of income tax for the appellant's 1982 taxation year in which the Minister has included as a table benefit the sum of $6,250 received by the appellant during 1982.

Facts

The appellant was a director and president of Philom Bios Inc., a Canadian-controlled private corporation. In March of 1982, he was allocated 125,000 shares at a value of $.05 per share allegedly for past services to the corporation as a director. The Minister reassessed the appellant by including the sum of $6,250 in the taxpayer's 1982 income as the value of a benefit from Philom Bios Inc.

Appellant's Position

While the Minister reassessed on the basis of subsection 15(1) of the Income Tax Act (the Act) the appellant argued that the allotment of shares to him was for past services as a director and not as a shareholder. He contended that section 7 of the Act should apply and that as a director he was performing duties as an employee and acting at arm's length with the corporation. The appellant also maintained that the shares had no value at the time of issue.

Minister's Position

The Court was told that the Minister reassessed the appellant on the basis that the shares were received by him as a shareholder of the Corporation. If this was not so and the shares were allotted to the appellant in his capacity as an employee of the corporation, the benefit of subsection 7(1.1) of the Act is not available because the appellant was not dealing at arm's length with the corporation immediately after the allotment, and therefore the value of the shares was correctly added to the income of the appellant for the year 1982 in accordance with paragraph 7(1)(a) of the Act.

Analysis

There are two questions to be determined here. First of all, does subsection 15(1) of the Act apply, and if not does the appellant obtain relief because of section 7 of the Act? Secondly, were the shares worth $.05 each or was the appellant correct in saying they had no value?

It is quite clear that even though an individual is a shareholder in a corporation he can receive a benefit other than as qua shareholder. See: M.N.R. v. Pillsbury Holdings Ltd., [1965] 1 Ex. C.R. 676; [1964] C.T.C. 294; 64 D.T.C. 5184. In this particular case, it is patently clear from the exhibits tendered to the Court that the allotment of shares was in consideration of part services provided by the appellant. Thus section 15 of the Act has no application.

Looking then at section 7, it is found that in order for the appellant to obtain the shares without tax consequences the individual employee must be dealing at arm's length with the corporation. This is found in subsection 7(1.1) which in 1982 read as follows:

Where after March 31, 1977 a Canadian-controlled private corporation (in this subsection referred to as "the corporation") has agreed to sell or issue a share of the capital stock of the corporation or of a Canadian-controlled private corporation with which it does not deal at arm's length to an employee of the corporation or of a Canadian-controlled private corporation with which it does not deal at arm's length at the time immediately after the agreement was made the employee was dealing at arm's length with

(a) the corporation,

(b) the Canadian-controlled private corporation, the share of the capital stock of which has been agreed to be sold by the corporation, and

(c) the Canadian-controlled private corporation of which he is an employee, paragraph (1)(a) does not apply in respect of the employee's acquisition of the share unless the employee disposes of the share, otherwise than as a consequence of his death, within two years from the date he acquired it.

The Minister has submitted that in this case the appellant was not dealing at arm's length with the corporation.

In the case of Michael K. Taylor v. M.N.R., [1988] 2 C.T.C. 2227; 88 D.T.C. 1571, Judge Rip set out at page 2233 (D.T.C. 1575-76):

Thus, although there may be a presumption that an employee who receives a benefit does so by virtue of his employment, the Court must look behind the form of the relationship and determine the true substance of the transaction. Unless there is substantive justification for deciding that a benefit accrues to an employee as a direct result of the services which he performs, or performed, as an employee it will not be regarded as having occurred “by virtue of employment".

Following this and examining the substance of the transaction involved it is noted that in one of the exhibits filed with the Court the corporation's accountants, Deloitte Haskins & Sells said, speaking of the directors who authorized the allotment,

. . . they realized that they personally would have to hold a significantly larger number of shares than was currently the case in order to maintain their level of ownership and participation in the company.

This was a part of a plan to have Philom Bios Inc. become a public company.

The accountants went on to say that the goal may have been accomplished by way of a stock split but there was no evidence presented as to the number of shares held by each director prior to the allotment, nor was this procedure followed.

Dealing with the matter of the transaction being at arm's length it is difficult to comprehend that when a person who is a shareholder, director and president of a company receives shares, even though he abstained from voting on the issuance to him of the shares, can be considered to be dealing at arm's length. This is more evident when it is pointed out in the minutes of the corporation that he participated in voting for the allocation of shares to others in similar positions.

The Minister referred the Court to the cases of:

M.N.R. v. Sheldon's Engineering Ltd., [1955] S.C.R. 637; [1955] C.T.C. 174; 55 D.T.C. 1110.

M.N.R. v. Estate of Thomas Rodman Merritt, [1969] 2 Ex. C.R. 51; [1969] C.T.C. 207; 69 D.T.C. 5159.

Swiss Bank Corporation v. M.N.R., [1971] C.T.C. 427; 71 D.T.C. 5235; [1972] C.T.C. 614; 72 D.T.C. 6470;

Darlene Grant et al v. M.N.R., [1987] 1 C.T.C. 2055; 87 D.T.C. 16.

In all of these there is a discussion of arm's length transactions and those in control of corporations not dealing in such a manner. The same situation applies in the present case. The directors involved were in a controlling position. They allocated shares to themselves to maintain control before outside investors purchased shares. Thus they could not be said to be dealing at arm's length when the true substance of the transaction was considered. The result is that the appellant cannot avail himself of the provisions of section 7 of the Act.

As to the value of the shares at the time of issue, it was stated and put forth in a letter by the accountants that the shares had no value. One must look to what took place. The minutes of the corporation reflecting the issue read in part as follows:

BE IT RESOLVED THAT

2. The directors of the Corporation hereby fix the consideration for the allotment and issuance of the said Class "A" shares at $.05 per share and determine that in lieu of cash payment for such shares, such shares be issued to the above- mentioned allottees in consideration of part services provided to the Corporation by each such person.

It would seem redundant to say the shares had no value when a consideration for past services was mentioned.

In the appellant's notice of appeal, it was stated that the directors were allotted shares at a value of $.05 per share and that the appellant received 125,000 shares, thus giving rise to the Minister including the sum of $6,250 in the taxpayer's 1982 income. There is no mention that the value was being disputed in the said notice.

This would seem to be a case where and [sic] the appellant and his fellow directors proceeded differently, there may have been a different result.

The matter was well explained by Walsh, J. in the case of Lakeview Gardens Corporation v. M.N.R., [1973] C.T.C. 586; 73 D.T.C. 5437 where it is set out at page 591 (D.T.C. 5440):

However, as has been frequently pointed out, it is not what the taxpayer might have done to minimize taxation that determines the issue but the taxpayer must abide by the position which it has taken. This principle was set out in the frequently cited judgment of Lord Simon in Commissioners of Inland Revenue v. Wesleyan and General Assurance Society, 30 T.C. 11, when he said at page 25:

It may be well to repeat two propositions which are well established in the application of the law relating to Income Tax. . . .

Secondly, a transaction which on its true construction is of a kind that would escape tax is not taxable on the ground that the same result could be brought about by a transaction in another form which would attract tax. As the Master of the Rolls said in the present case: less "in dealing with Income Tax questions it frequently happens that there are two methods at least of achieving a particular financial result. If one of those methods is adopted tax will be not be payable. . . . The net result from the financial point of view is precisely the same in each case, but one method of achieving it attracts tax and the other method does not. . . .”

This transaction by the appellant does not fall within the letter of the law and the appeal is, accordingly, dismissed.

Appeal dismissed.