Royal Trust Corporation of Canada v. Her Majesty the Queen, [1982] CTC 79, 82 DTC 6076

Jérome, ACJ:—This appeal from the decision of the Tax Review Board, dated November 5, 1980, involving the 1972-73-74 and 1975 taxation years of Royal Trust Corporation of Canada came on for hearing at Toronto on June 26, 1981. The plaintiff Royal Trust Corporation of Canada was formed as a result of the amalgamation in 1977 of two companies, one of which was United Trust Company (hereafter United Trust). In 1972, United Trust issued 325,000 shares for sale to the public and in doing so, entered into an agreement with Pitfield, MacKay, Ross & Company Limited (hereafter Pitfield), as underwriter. All issues in this case relate to the United Trust share issue and in particular the dispute concerns the interpretation to be placed upon Pitfield’s charge of .54¢ per share.

The agreement between United Trust and Pitfield was executed on September 7, 1972 and it is common ground that this agreement constituted sale by United Trust and purchase by Pitfield of 325,000 shares with a par value of $5. The agreement recites a price of $8 per share and a commission of .54€ per share and pursuant to the agreement, two purchases were made by Pitfield: the first upon the date of the agreement for 300,000 shares for which Pitfield issued a cheque payable to United Trust for $2,400,000; the second, in October, 1972, for the remaining 25,000 shares for which Pitfield issued a cheque payable to United Trust for $200,000. On the date of the first transaction, United Trust issued a cheque to Pitfield in payment of the 54€ commission in the amount of $162,000, and for the same purpose, issued a cheque in the amount of $13,500 on the date of the second transaction.

On the basis that these payments represented the cost of issuing the shares to the public, United Trust in filing its 1972-73-74 and 1975 returns, treated the amounts as eligible capital expenditures within the meaning of paragraph 14(5)(b) of the Income Tax Act and claimed 10% of one-half of $175,000 as a deduction in those years. Paragraph 14(5) (b) reads as follows:

14. (5) Definitions. In this section,

(b) “Eligible capital expenditure”. — “eligible capital expenditure” of a taxpayer in respect of a business means the portion of any outlay or expense made or incurred by him, as a result of a transaction occurring after 1971, on account of capital for the purpose of gaining or producing income from the business, other than any such outlay or expense

(i) in respect of which any amount is or would be, but for any provision of this Act limiting the quantum of any deduction, deductible (otherwise than under paragraph 20(1 )(b)) in computing his income from the business, or in respect of which any amount is, by virtue of any provision of this Act other than paragraph 18(1)(b), not deductible in computing such income,

(ii) made or incurred for the purpose of gaining or producing income that is exempt income, or

(iii) that is the cost of, or any part of the cost of,

(A) tangible property of the taxpayer,

(B) intangible property that is depreciable property of the taxpayer,

(C) property in respect of which any deduction (otherwise than under paragraph 20(1 )(b) ) is permitted in computing his income from the business or would be so permitted if his income from the business were sufficient for the purpose, or

(D) an interest in, or right to acquire, any property described in any of clauses (A) to (C),

but, for greater certainty and without restricting the generality of the foregoing, does not include any portion of

(iv) any amount paid or payable, as the case may be, to any creditor of the taxpayer as, on account or in lieu of payment of any debt or as or on account of the redemption, cancellation or purchase of any bond or debenture,

(v) where the taxpayer is a corporation, any amount paid or payable, as the

case may be, to a person as a shareholder of the corporation, or

(vi) any amount that is the cost of, or any part of the cost of,

(A) an interest in a trust,

(B) an interest in a partnership,

(C) a share, bond, debenture, mortgage, hypothec, note, bill or other similar property, or

(D) an interest in, or right to acquire, any property described in any of clauses (A) to (C).

In disallowing the deduction, the Minister contended that United Trust had never actually made an outlay or expense and that the .54¢ per share was simply a discount or reduction in the purchase price.

Two other submissions were made on behalf of the Minister which can be dealt with quite briefly. The first is that if the Court were to find that the .54¢ is a genuine commission which might be deductible pursuant to paragraph 20(1 )(e) the deduction is, in these circumstances, not available to the taxpayer because the commission is paid to the purchaser of the shares and therefore precluded by subparagraph 20(1 )(e)(iii). The relevant sections were as follows:

20. (1) .

(e) Expenses of issuing or selling units, interests or shares or borrowing money. — an expense incurred in the year

(i) in the course of issuing or selling units of the taxpayer where the taxpayer is a unit trust, interests in a partnership or syndicate by the partnership or syndicate, as the case may be, or shares of the capital stock of the taxpayer, or

(ii) in the course of borrowing money used by the taxpayer for the purpose of earning income from a business or property (other than money used by the taxpayer for the purpose of acquiring property the income from which would be exempt),

including a commission, fee or other amount paid or payable for or on account of services rendered by a person as a salesman, agent or dealer in securities in the course of issuing or selling the units, interests or shares or borrowing the money, but not including any amount paid or payable as or on account of the principal amount of the indebtedness or as or on account of interest;

20. (1) ...

(e) an expense incurred in the year,

but not including any amount in respect of

(iii) a commission or bonus paid or payable to a person to whom the shares were issued or sold or from whom the money was borrowed, or for or on account, of services rendered by a person as a salesman, agent or dealer in securities in the course of issuing or selling the shares or borrowing the money, or

For reasons which I will indicate, I am of the view that Pitfield was not acquiring these shares for its own account but clearly was acting in the capacity of a distributor to the public. That cannot alter the fact, however, that this distribution was achieved by the initial step of transferring title in the shares from United Trust to Pitfield in a valid transaction of purchase and sale and that, therefore, any deduction for a commission, pursuant to paragraph 20(1)(e) is clearly prohibited by subparagraph 20(1 )(e)(iii).

The second matter was raised by counsel for the defendant at the conclusion of the evidence when leave was sought to argue that even if an actual outlay or expense had been made by the plaintiff, the plaintiff should be denied the benefit of it within the terms of paragraph 14(5)(b) on the grounds that it was not made “for the purpose of gaining or producing income from the business”. This matter had not been pleaded and at that stage of the trial I refused the Crown’s application for leave to amend the Statement of Defence. There is evidence that the plaintiff was anxious to achieve wide distribution among institutional shareholders with a view toward expanding its clientèle so that in addition to the normal expectation that the revenue would be for the ongoing purposes of the business, there was an element of business promotion. I therefore find that the issue of these shares by United Trust in 1972 was for the purpose of gaining or producing income from the business, which leaves the matter to be decided on the validity of the Minister’s initial interpretation that the amount in issue was not an expense or outlay incurred by the taxpayer since it was a discount or reduction in the share price.

Evidence consisted of the testimony of three witnesses, Mr George S Mann, the President of United Trust during the material time, Mr Douglas E MacKay, Vice-Chairman of Pitfield, and Mr Lorie Waisberg, solicitor in the underwriting transaction for United Trust. No oral testimony was called by the defendant. A book of some twenty-two documents was filed.

The evidence discloses that in 1972, United Trust had carried on negotiations with more than one broker but, ultimately, negotiated an agreement with Pitfield to underwrite an issue of 325,000 shares at a price of $8 each, with a commission of .54€ per share. Both the share price and the commission were arrived at after extensive negotiations between the parties. The purpose of the transaction was, beyond any question, to achieve a distribution of the shares to the public and there is some evidence that the plaintiff had requested, even insisted on as broad as possible a distribution, particularly to financial institutions with the intents of increasing its potential clientèle. In response to this request, Pitfield wrote on September 8, 1972, to United Trust in the following terms:

With respect to the public offering of 325,000 shares of United Trust Company, we hereby confirm to you that we shall endeavour to achieve a broad public distribution of the shares by asking our Banking Group members to limit sales to approximately 500 shares per purchaser on a best efforts basis. We also wish to confirm to you that it would be our intention to limit institutional placements to approximately 30% including the sale of 50,000 shares to Cemp Investments Limited. the foregoing, of course, will be subject to our judgment of market conditions as they develop during the course of the offering.

This is one aspect of the services rendered in this transaction by the broker Pitfield but, in my opinion, there were many others. These included provision of expertise in the analysis of the price and the market possibilities, as well as the public commitment of Pitfield to the value of the shares at $8 each. There can be no doubt that for a junior company involved in its first public share offering, the quality of the broker involved in the underwriting commitment is a significant factor. The broker’s service in bringing about actual sales to the public is also quite considerable and clearly upon the evidence includes the purely mechanical aspect of receiving the shares in one certificate from United Trust and accomplishing the actual distribution to the purchasers, as well as, obviously, the promotional aspect of locating the purchasers and finalizing the sales. It is the usual brokerage practice not to enter into an underwriting agreement unless confident, if not certain, of adequate sales and in this case, the agreement between the parties contained the usual clause that up to the moment of closing, the broker could release itself from the obligation to proceed if, for any reason, it felt that the issue could not be marketed. I accept the evidence of Mr MacKay that recourse to that escape clause almost never happens and indeed a broker’s reputation is based on its skill in placing a value on the shares which will produce the maximum return for the seller and meet the necessary acceptance in the market. Repeated association with transactions in which this process has not been done skillfully would severely damage any broker’s reputation. It is my view that as a result of the rendering of all of these services by Pitfield, an agreement was entered into whereby United Trust shares were sold at $8 and that the intention of the parties for immediate re-sale by the broker was an element of the agreement from the beginning and in this case, was fully achieved since the issue was largely presold. Equally, the negotiations for the rate of payment to Pitfield produce a figure which is of considerable significance to the buying public since it also becomes an expression of the broker’s confidence in the issue and by law must appear on the face page of the prospectus. The whole structure of securities regulations which demands the issue of a prospectus containing the share price of the underwriting and the commission on the face page is for the protection, not of the vendor or the broker, but of the buying public which is further evidence that the very nature of this transaction is the issue of shares to the public not just to the broker. The .54$ was, upon the evidence of Mr MacKay, regarded by his company as a commission and interestingly, exhibit 11 which is a receipt for the $162,000 portion of the payment, reads as follows:

TO UNITED TRUST COMPANY

Pitfield, MacKay, Ross & Company Limited hereby acknowledges receipt from you of the sum of $162,000 being the commission payable to us with respect to the sale by us of 300,000 shares of United Trust Company (the “Company”) as set forth in the prospectus of the Company dated September 7, 1972.

DATED this 25th day of September, 1972.

PITFIELD, MACKAY, ROSS & COMPANY LIMITED

by

I emphasize the words in the third line “with respect to the sale by us”. It was also Mr MacKay’s evidence that the entire industry would have no other concept of the charge than that of a commission, and in my view, there is nothing in the evidence which justifies any other interpretation of it. It falls squarely within the language of paragraph 20(1)(e) “a commission, fee or other amount paid or payable for or on account of services rendered by a person as a salesman, agent or dealer in securities in the course of issuing or selling the units, interests or shares”. For reasons which I indicated earlier, it cannot be claimed by the taxpayer under paragraph 20(1 )(e) but, in my opinion, it remains nevertheless a clear cost associated with the share issue.

I reject entirely the notion that ownership of the shares was acquired by Pitfield as in an ordinary transfer from one owner to another so that the .54¢ constitutes some kind of discount. This was a payment for the entire range of services I have outlined above and which went far beyond the simple undertaking to purchase and in that respect, this case is readily distinguishable from those precedents which deal with commissions which became payable upon nothing more than the taking up of a commitment to purchase. In this regard, counsel for the Crown referred to a decision of the Privy Council confirming a finding of the Supreme Court of New South Wales in Australian Investment Trust, Limited v Strand and Pitt Street Properties, Limited, [1932] AC 735, that, in a factual situation very close to the present one, the commission paid the underwriter constituted a discount from the share value and was, accordingly, ultra vires the issuing company. It must be observed immediately that the law under consideration here lies in the field of taxation rather than corporate capacity. Furthermore, the Australian Case appears to deal with the issue of shares at nominal or par value and turns very much on whether the relevant New South Wales legislation authorizes such a transaction. In the Australian example, therefore, there was no element of the broker’s expertise in setting a value upon the shares, as is the case here. Nor was there the element of acceptance of that value by the public which, in my opinion, is an extremely significant aspect of the case before us since we are no longer dealing with nominal values, but rather real values, as established in the marketplace. Finally, of course, we are not dealing with a question of corporate capacity to issue shares at what might be construed as a reduction from par value, but with the question of costs of issuing shares within the specific provisions of a Canadian taxing Statute.

Returning then to paragraph 14(5)(b), I find that United Trust, in 1972, issued 325,000 shares all of which were purchased by the public at $8 per share, a capital transaction entered into for the purpose of gaining or producing income from the business. In connection with the share issue, United Trust entered into an agreement with Pitfield, pursuant to which Pitfield served as a distribution vehicle by taking title from United Trust in two certificates and issuing new certificates to the individual purchasers but which involved a number of other services to United Trust including advice in establishing the $8 price, public identification as underwriter at that price and a successful sales promotion, as a result of which the issue was fully taken up by the public. The .54€ per share commission negotiated between the parties constituted compensation to Pitfield for all such services rendered and was therefore a cost of the share issue, and as such, an expense to United Trust in 1972, in the amount of $175,500, clearly an eligible capital expenditure within the meaning of paragraph 15(4)(b).

Accordingly, the appeal is allowed and the matter is referred back to the Minister for the appropriate reassessment for the taxpayer’s 1972-73-74 and 1975 taxation years. The plaintiff is entitled to costs.