Construction Napoléon Brochu Ltée v. Minister of National Revenue, [1986] 2 CTC 2317, 86 DTC 1776

Taylor, T.C.J. [Translation]:—This case was heard on December 4, 1985 at Québec, Quebec.

1. Issue

The issue is whether the appellant was associated with Napoléon Brochu Inc. during the 1977 taxation year for purposes of computing the $31,500 tax credit claimed as a small business deduction.

The respondent argues that the 1,000 common shares of the appellant were held by Napoléon Brochu Inc in 1977. The company sold them to a certain Achille Houde who subsequently transferred them to the appellant. In substance, the latter argues that this was merely done to safeguard rights in respect of loans made by Napoléon Brochu Inc, in part because of a transfer of shares of an approximate value of $3.4 million to the appellant.

2. The Burden of Proof

2.01 The appellant has the burden of showing that the respondent's assessments are incorrect. This burden of proof results not from a particular section of the Income Tax Act, but from several judicial decisions, including a judgment of the Supreme Court of Canada in Johnston v. M.N.R., [1948] S.C.R. 486; [1948] C.T.C. 195; 3 D.T.C. 1182.

2.02 The facts relied on by the respondent are set out in subparagraphs (a), (b), (c), (d), (e), (f), (g), (h) and (i) of paragraph 8 of the reply to the respondent's notice of appeal. This paragraph reads as follows:

8. In assessing the appellant for the 1977 taxation year, the respondent relied, inter alia, on the following facts:

(a) The appellant is a business corporation, constituted pursuant to the Canada Business Corporations Act, SC 1974-75-76, c. 33;

(b) The appellant’s taxation year commenced on October 1 and ended on September 30, as did the taxation year of Napoléon Brochu Inc.;

(c) During its 1977 taxation year, Napoléon Brochu Inc. was controlled by Mr.

Napoléon Brochu who was its president and principal shareholder;

(d) On March 29, 1977, Napoléon Brochu Inc. transferred a substantial share of its assets to the appellant for $3,390,425; this consideration was to be paid through the acceptance of existing debts and promissory notes and by the issuance of 1,586,625 preferred shares of the appellant company to Napoléon Brochu Inc.;

(e) The above-mentioned preferred shares carried no voting rights “except

the exclusive right for the holders of such shares to elect a director . . . ,

(f) On March 29, 1977, Napoléon Brochu Inc. also acquired 1,000 common shares issued by the appellant with full voting rights; these 1,000 shares were the total common capital stock of the appellant;

(g) Subsequently, Napoléon Brochu Inc. sold the 1,000 common shares mentioned above to one Achille Houde;

(h) Napoléon Brochu Inc. and the appellant were associated with each other during their first taxation year, 1977, since the first company controlled the second at a particular time in the said taxation year;

(i) Napoléon Brochu Inc. did not control the appellant in order to safeguard its rights in respect of loans which it may have made or shares which it may have owned;

3. Facts

3.01 The appellant is a corporation legally constituted under the Canada Business Corporations Act, S.C. 1974-75-76, c. 33, on March 14, 1977. The appellant’s place of business is located at 440 Holliday Street, Sept-lles, Quebec.

The appellant’s authorized capital stock consists of 10,000 common shares and 1,586,625 preferred shares, all with a par value of nil. The preferred shares yield a three per cent cumulative dividend up to September 30, 1985 and four per cent from October 1, 1985 to September 30, 1989 (Exhibit A-2). The appellant’s business is that of a general contractor.

3.02 The appellant’s taxation year is from October 1 to September 30.

3.03 During the 1977 taxation year, the appellant acquired a substantial share of the working capital of Napoléon Brochu Inc. The latter was operating as a construction business with its registered office also at Sept-lles.

Mr. Napoléon Brochu was at that time the principal shareholder of Napoléon Brochu Inc.

On January 25, 1977, a memorandum of agreement (Exhibit I-1, pp 32 et seq.) was signed by Mr. Napoléon Brochu and Mr. Achille Houde, Engineer, who later became the appellant’s president. This memorandum reads as follows:

WHEREAS NAPOLEON AND ACHILLE intend to form a company under the name of Napoléon Brochu (1976) Ltée or Napoléon Brochu (1977) Ltée or other similar corporate name including "Napoléon Brochu” (hereinafter called "BROCHU (1976) LTEE”) for the purpose of acquiring certain assets from BROCHU INC. which would sell [sic] the said assets at prices, terms and conditions as hereinafter provided;

THEREFORE the parties have agreed as follows:

1. NAPOLEON and ACHILLE mutually undertake as follows and he [sic] promise as follows:

(a) Formation of a private corporation pursuant to the Canada Business Corporations Act under the name of Napoléon Brochu (1976) Ltée, whose capital structure and corporate organization shall be as set out in SCHEDULE A annexed hereto; consent by BROCHU INC. to the incorporation of Napoléon Brochu (1976) Ltée and promise by BROCHU INC. to change its name;

(b) Subscription by BROCHU INC. for $1000 in common shares in the capital

stock of BROCHU (1976) LTEE and isuance of the said shares to BROCHU INC.;

(c) Sale by BROCHU INC. to BROCHU (1976) LTEE of assets of BROCHU INC. in accordance with the prices, terms and conditions of a draft agreement to be concluded between BROCHU INC. and BROCHU (1976) LTEE, a copy of which is annexed hereto as SCHEDULE B, and this agreement must be signed no later than March 31, 1977, the sale of the said assets to be made by rollover pursuant to s. 85 of the Canada Income Tax Act and the corresponding section of the Quebec Income Tax Act.

(e) Sale by BROCHU INC. to ACHILLE of all the common shares issued in the capital stock of BROCHU (1976) LTEE for a total price of $1,000 payable in cash;

2. NAPOLEON and ACHILLE also promise to sign an agreement on the signing of the SCHEDULE B agreement, and this agreement shall provide as follows:

(d) An agreement whereby NAPOLEON will grant ACHILLE an option to purchase all or part of the promissory notes and/or the preferred shares included in the price of the assets of BROCHU INC. sold to BROCHU (1976) LTEE at the following prices;

(i) with regard to the promissory notes, the capital amount of the said promisory notes plus accrued interest;

(ii) with regard to the preferred shares, $1 a share plus accumulated dividends.

3. NAPOLEON and ACHILLE also undertake to sign and promise that, as soon as possible after this agreement has ben signed, an agreement will be signed whereby BROCHU (1976) LTEE will acquire for the total price of $1 all rights, titles and interests in the shares of the subsidiaries of BROCHU INC. currently being formed for the purpose of acquiring in the near future the rights, titles and interests of BROCHU INC. in the transportation permits currently used by BROCHU INC. for the purposes of its activities and its transportation operations and NAPOLEON and ACHILLE hereby undertake, as soon as this agreement has been signed, to take all appropriate steps to obtain as soon as possible the consent or approval of the Quebec Transport Commission or any other governmental authority having jurisdiction over the transfer of the said permits to the said subsidiaries, and for these purposes NAPOLEON and ACHILLE undertake that an agreement will be signed at the same time whereby the said subsidiaries will acquire the rights, titles and interests held by BROCHU INC. in the said transportation permits for the total sum of $1, which agreement will describe the said permits and will be conditional on obtaining such consent or such approval from the Quebec Transport Commission or any other governmental authority having jurisdiction; until the said permits are so transferred or in the event that the said Transport Commission or the said government authority refuse their consent or approval in whole or in part, NAPOLEON and ACHILLE promise and undertake that an agreement will be signed between BROCHU INC. and BROCHU (1976) LTEE or any other company to be designated by BROCHU (1976) LTEE so that BROCHU (1976) LTEE may continue its operations in a normal manner, in its best interests and at the least possible cost for BROCHU (1976) LTEE.

7. It is agreed that, notwithstanding the signing of this agreement, all contracts, agreements and documents provided for hereunder must be prepared to the complete satisfaction of the parties before they are signed and take effect.

3.04 According to Schedule A of the above-mentioned memorandum of agreement (Exhibit 1-1, pp 40 et seq.), it appears that the preferred shares received in payment for the assets will be redeemable by the appellant. Part of this agreement is couched in these terms:

. .. compulsorily by the company at their nominal value plus accrued and unpaid dividends thereon according to the numbers and amounts hereinafter indicated:

September 30, 1983	186,625
September 30, 1984	200,000
September 30, 1985	200,000
September 30, 1986	250,000
September 30, 1987	250,000
September 30, 1988	250,000
September 30, 1988 [sic]	250,000

Moreover, according to Schedule A, it appears that:

Preferred shareholders will have the exclusive right to elect one of their number as a director of the company and the shares will not carry voting rights for any other purpose;

3.05 Following the appellant’s incorporation in March 1977, it appears from the minutes of a meeting of the appellant’s board of directors, held on March 29, 1977 (Exhibit 1-1, pp 42 et seq.), that Napoléon Brochu Inc. had subscribed for 1,000 common shares of the appellant. The said shares were fully paid in the name of Napoléon Brochu Inc.

3.06 At the same meeting of March 29, 1977, the purchase by the appellant of shares of Napoléon Brochu Inc. totalling $3,390,425 payable by the assumption of debts amounting to $790,425, leaving a balance owing of $2.6 million was approved. The latter amount is itself payable in the form of promissory notes ($1,013,375 from 1977 to 1983) and the redemption of preferred shares ($1,586,625 from 1983 to 1989) (Exhibit I-1, pp 49 et seq.)

3.07 Also at the same meeting of March 29, 1977, the acquisition by the appellant from Napoléon Brochu Inc. of 200 Class A shares each of the capital stock of 80827 Canada Ltée and 80828 Canada Ltée at $1 a share was approved, with the purchase of the said shares resulting in the acquisition of the transportation system. The complex agreements of the said transportation systems are also dated March 29, 1977 (Exhibit 1-1, pp 59 et seq. and pp 65 et seq.). 80827 Canada Ltée is involved in bulk transport and 80828 Canada Ltée in general transport.

3.08 On the same day, March 29, 1977, an agreement was also signed (Exhibit 1-1, p 78) whereby Napoléon Brochu Inc. transferred the appellant’s 1,000 common shares to Achille Houde for $1,000.

3.09 Details of the assets sold by Napoléon Brochu Inc. to the appellant under the March 29,1977 agreement (Exhibit 1-1, pp 48 ff) are as follows:

Accounts receivable, at

(a)

September 30, 1976,

	Schedule I-A hereto:	$1,128,610
(b)	Tools and equipment at
	September 30, 1976, described
	in Schedule 1-B hereto:	1,781,814
(c)	Lands, described in
	Schedule 1-C hereto:	80,000
(d)	Buildings, property of vendor,
	at September 30, 1976,
	described in Schedule 1-C hereto:	350,000
(e)	Rental contracts, described
	in Schedule 1-D hereto:	50,000
(f)	Goodwill and client lists	1
	total price:	$3,390,425

The transfers of the said assets to the appellant, as with the other assets, was made retroactive to October 1, 1976, since the appellant began to operate the business on that date.

3.10 Finally, the appellant promised to be responsible for and to pay all sales taxes arising out of that transaction.

3.11 The evidence was that the parties to the transaction, Mr. Napoléon Brochu, Napoléon Brochu Inc., the appellant and Mr. Achille Houde had hired experts including accountants, lawyers and tax experts to plan and prepare all the documents required for the transaction.

3.12 The evidence was also that Mr. Achille Houde was not a shareholder of Napoléon Brochu Inc. and had no other connection of any kind with it.

3.13 In filing his tax return for 1977, the appellant proceeded on the assumption that it was not associated with Napoléon Brochu Inc. and claimed the small business deduction provided for in subsection 125(1) of the Income Tax Act. On February 22, 1982, the respondent issued a notice of reassessment disallowing the deduction and alleging that the appellant was associated with Napoléon Brochu Inc.

4. Act — Case Law — Analysis

4.01 Act

The main provisions of the Income Tax Act involved in this appeal are paragraph 256(1 )(a) and subsections 256(3) and (6). They read as follows:

256.(1) For the purposes of this Act one corporation is associated with another in a taxation year if at any time in the year,

(a) one of the corporations controlled the other,

(3) Where one corporation (hereinafter in this subsection referred to as the “controlled corporation’’) would, but for this subsection, be associated with another corporation in a taxation year by reason of being controlled by the other corporation or by reason of both of the corporations being controlled by the same person at a particular time in the year (which corporation or person so controlling the controlled corporation is hereinafter in this subsection referred to as the “controller”), and it is established to the satisfaction of the Minister that

(a) there was in effect at the particular time an agreement or arrangement enforceable according to the terms thereof, under which, upon the satisfaction of a condition or the happening of an event that it is reasonable to expect will be satisfied or happen, the controlled corporation will

(i) cease to be controlled by the controller, and

(ii) become controlled by a person or group of persons, with whom or with each of the members of which, as the case may be, the controller was at the particular time dealing at arm’s length, and

(b) the chief purpose for which the controlled corporation was at the particular time so controlled was the safeguarding of rights or interests of the controller in respect of

(i) any loan made by the controller the whole or any part of the principal amount of which was outstanding at the particular time, or

(ii) any shares of the capital stock of the controlled corporation that were owned by the controller at the particular time and that were, under the agreement or arrangement, to be redeemed by the controlled corporation or purchased by the person or group of persons referred to in subparagraph (a)(ii),

the controlled corporation and the other corporation with which it would otherwise be so associated in the year shall be deemed, for the purpose of this Act, not to be associated with each other in the year.

(6) Where, for the purposes of any provision of this Act, one corporation resident in Canada (in this subsection referred to as the “controlled corporation”) would, but for this subsection, be regarded as having been controlled by another corporation resident in Canada (in this subsection referred to as the “controller”) at a particular time and it is established to the satisfaction of the Minister that

(a) there was in effect at the particular time an agreement or arrangement enforceable according to the terms thereof, under which, upon the satisfaction of a condition or the happening of an event that it is reasonable to expect will be satisfied or happen, the controlled corporation will

(i) cease to be controlled by the controller, and

(ii) become controlled by a person or group of persons, with whom or with each of the members of which, as the case may be, the controller was at the particular time dealing at arm’s length, and

(b) the chief purpose for which the controlled corporation was at the particular time so controlled was the safeguarding of rights or interests of the controller in respect of

(i) any loan made by the controller the whole or any part of the principal amount of which was outstanding at the particular time, or

(ii) any shares of the capital stock of the controlled corporation that were owned by the controller at the particular time and that were, under the agreement or arrangement, to be redeemed by the controlled corporation or purchased by the person or group of persons referred to in subparagraph (a)(ii),

the controlled corporation shall be deemed, for the purposes of that provision, not to have been controlled by the controller at the particular time.

4.02 Case law

Counsel for the respondent submitted the following case law to the Court:

1. The Queen v. Imperial General Properties Limited, [1985] 2 S.C.R. 288; [1985] 2 C.T.C. 299; 85 D.T.C. 5500;

2. Renown Steel & Service Limited v. M.N.R., [1969] Tax A.B.C. 678; 69 D.T.C. 497 (T.A.B.);

3. Lou's Service (Sault) Limited v. M.N.R., 37 Tax A.B.C. 113; 64 D.T.C. 825 (T.A.B.); [1968] 1 Ex C.R. 251; [1967] C.T.C. 315; 67 D.T.C. 5201;

4. M.N.R. v. Fritz Werner Ltd., [1972] C.T.C. 274; 72 D.T.C. 6239 (Federal Court, Trial Division);

4.03 Analysis

4.03.1 The issue is not the quantum and computation of the deductions claimed per se, but the control of the appellant by Napoléon Brochu Inc. and hence their association, a factor which influences both computation and quantum. Such association affects the computation of the business limit and accordingly the deduction.

4.03.2 To begin with, there is no doubt that at a particular time in the appellant's 1977 taxation year, the appellant was controlled by Napoléon Brochu Inc. within the meaning of paragraph 256(1)(a) cited above. The evidence is uncontradicted and it was even admitted that Napoléon Brochu Inc. purchased on March 29, 1977 the only common shares issued by the appellant (i.e. 1,000 shares) for $1,000 (supra, para. 3.05). The fact that on the same day, March 29, 1977, Napoléon Brochu Inc. transferred the same shares at the same price to Mr. Achille Houde in no way alters the fact that at a particular time in 1977, Napoléon Brochu Inc. controlled and was therefore associated with the appellant.

It remains to be determined, however, whether the saving provisions with regard to control and hence association, provided for in subsections 256(3) and 256(6) (supra) apply.

4.03.3 Subsection 256(3) is a saving provision in respect of association between two corporations, while subsection 256(6) is a saving provision relating to control. Control of one corporation by another, in fact, may have tax consequences other than association and its attendant consequences. In any event, the conditions for giving effect to one or the other of these saving provisions are similar and are set out in paragraphs (a) and (b) of the said subsections.

4.03.4 Since subsections 256(3) and 256(6) are saving provisions, they must be strictly construed in that, if there is any doubt as to their application, they will not be held to apply.

The Tax Appeal Board, taking a strict constructionist stance in Renown Steel & Service Limited (para. 4.02(2) ), did not feel that a guarantee could be considered a loan.

In Lou's Service (Sault) Limited (para. 4.02(3)), the Tax Appeal Board decided that “an agreement or arrangement enforceable according to the terms thereof ..(paragraph 256(3)(a) ) could not include an oral agreement to the effect that the preferred shares would be redeemed. The Exchequer Court confirmed this ruling and held that nothing in the oral agreement and the written agreement between the shareholders in question demonstrated the existence of an obligation on the part of one of them not to vote his preferred shares. Therefore, they maintained control.

The Trial Division of the Federal Court in Fritz Werner Ltd. (para. 4.02(4)), also applied a strict constructionist approach and concluded that there was not an “enforceable arrangement” within the meaning of paragraph 256(3)(a) when it appeared from an agreement that it was reasonable for a company to become the majority shareholder, but this agreement must still be formally approved by the company's directors.

4.03.5 In the case at bar, the condition described in subparagraphs 256(3)(a)(i) and (ii) is satisfied, in my opinion, in the memorandum of agreement of January 25, 1977 (para. 3.03), in the resolutions passed by the appellant's board of directors' meeting of March 29, 1977 (paras. 3.05, 3.06, 3.07 and 3.08) and in the contracts that followed, all contained in Exhibit 1-1.

They all show an enforceable arrangement to the effect that on the acquisition of assets etc. (“. . . the satisfaction of a condition . ..”) (Paragraph 256(3)(a)), Napoléon Brochu Inc. will transfer the 1,000 common shares (“. . . will cease to be controlled by the controlling party . 7) (subparagraph 256(3)(a)(i) ) to Mr. Achille Houde who is at arm's length with Napoléon Brochu Inc. (paragraph 256(3)(a)(ii) of the Act and para. 3.12 cited above).

4.03.6 The requirements of paragraph 256(3)(b) must also be satisfied. They are as follows:

256(3) . . .

(b) the chief purpose for which the controlled corporation was at the particular time so controlled was the safeguarding of rights or interests of the controller in respect of

(i) any loan made by the controller the whole or any part of the principal amount of which was outstanding at the particular time, or

(ii) any shares of the capital stock of the controlled corporation that were owned by the controller at the particular time and that were, under the agreement or arrangement, to be redeemed by the controlled corporation or purchased by the person or group of persons referred to in subparagraph (a)(ii),

4.03.7 Loan or claims of the vendor

According to the appellant's argument, no cash was paid at the time of the agreement except in the form of promissory notes and redeemable preferred shares. According to counsel, it is clear that the promissory notes are a loan.

The Court believes, however, that this is a vendor's claim. Although the loan agreement contains requirements similar to those prescribed by a vendor, such as mortgages, promissory notes and guarantees, a loan agreement and a sales agreement are two different kinds of contracts. Accordingly, they require special consideration when the word “loan” is interpreted in a saving provision of a taxing Act.

In this respect, the appellant’s argument regarding the loan must be rejected.

4.03.8 According to paragraph 256(3)(b), the safeguarding of the rights of Napoléon Brochu Inc. is not only in respect of loans but also in respect of shares.

Subparagraphs 256(3)(b)(i) and (ii) are the relevant provisions. At first glance, this condition seems to be satisfied since the appellant’s preferred shares belonged to Napoléon Brochu Inc. on March 29, 1977. The issue is whether these shares were to be redeemed by the appellant or by Mr. Achille Houde.

On the one hand, according to paragraph (1)(b) (cited in para. 3.03) of the memorandum of agreement of January 25, 1977, the parties undertook that Napoléon Brochu Inc. would subscribe for the appellant’s 1,000 common shares and, on the other hand, according to paragraph (e) (cited in para. 3.03), the parties undertook that Napoléon Brochu Inc. would sell the said shares to Mr. Achille Houde.

With regard to the common shares, the Court therefore concludes that the condition is satisfied, that is, that the shares were to be redeemed.

4.03.9 As for the preferred shares, paragraph (2)(d) (cited in para. 3.03) of the memorandum of agreement of January 25, 1977 is less peremptory because it says that “an agreement whereby NAPOLEON will grant ACHILLE an option to buy all or part of the promissory notes and/or the preferred shares .. .”

Furthermore, Schedule A of the memorandum of agreement of January 25, 1977 is clearer on the appellant’s obligation to redeem the preferred shares (para. 3.04). The same is true with regard to paragraph (1)(c) of the memorandum of agreement of March 29, 1977 since the appellant’s redemption of the preferred shares is part of the payment of the balance of the sales price of $2.6 million. Paragraph (c) of the memorandum of agreement reads as follows:

(c) the balance of the sales price of $2,600,000 will be payable in the following manner:

(i) promissory notes payable to the Vendor, . . .

(ii) by the issuance to the VENDOR of 1,586,625 preferred shares at $1 a share, redeemable in accordance with the numbers and dates hereinafter indicated . . .

The numbers and dates are the same as those in paragraph 3.04.

The Court concludes that the appellant is obliged to redeem the preferred shares on the dates and for the amounts provided for in Schedule A of the memorandum of agreement of January 25, 1977, cited above in paragraph 3.04.

The Court believes that the option, provided for in paragraph (2)(d) of the memorandum of agreement of January 25, 1977, which is not peremptory, is really an option for the appellant to redeem the said preferred shares in advance, prior to the times provided that were cited above in paragraph 3.04.

5, Conclusion

For these reasons, the appeal is allowed with costs, and the matter referred back to the respondent for reconsideration and reassessment.

Appeal allowed.