Bouvry Exports Calgary Ltd. v. R., [1997] 1 CTC 2646, 97 DTC 859

Hamlyn J.T.C.C.: — The assessment under appeal is a Notice of Assessment of Non-Resident Tax, number A355179, dated December 14, 1993.

On December 14, 1993, the Minister of National Revenue (the “Minister”) assessed the Appellant for 15 per cent non-resident tax pursuant to Part XIII of the Income Tax Act (the “Act”) on the basis that the Appellant had conferred a benefit in the amount of $1,749,000 on Alain Bouvry (“Alain”) being 50 per cent of what the Minister assessed to be the fair market value of the shares of the Appellant on July 27, 1988. The Minister also assessed a penalty equal to 10 per cent of the amount of the Part XIII tax assessed to the Appellant. At the commencement of the hearing of the appeal, the parties agreed the fair market value of the shares in issue on July 27, 1988 was $1,425,000 and not as assessed. As a consequence the appeal must in any event be allowed to reflect this agree- ment.

FACTS TS

The Appellant was incorporated under the laws of Canada on January 15, 1982.

Claude Bouvry (“Claude”) is an individual resident in Canada for the purposes of the Act.

Alain is an individual who is resident in France and not resident in Canada for the purposes of the Act.

Claude and Alain are brothers. From 1975, the brothers shared equally in the returns in any business ventures they carried on together and their understanding was that each brother had an obligation to make an equivalent contribution to such business ventures.

The brothers caused the incorporation of the Appellant for the purpose of acquiring the horsemeat processing business of Louis Dreyfus Canada Ltd. (“Dreyfus”) in June 1982. The acquisition was an asset sale by Dreyfus to the Appellant and the Appellant was to make equal monthly payments with funds generated by the Appellant’s business (exhibit A-l).

Prior to the incorporation of the Appellant, Claude and Alain had been employed in the horsemeat business, Claude by Dreyfus (1975 to 1982) and Alain by customers of Dreyfus.

In 1977, Claude, Alain and U.A.B.D. S.A., an unrelated French corporation, incorporated Equus S.A. to carry on the horsemeat business in France. Each owned a 1/3 interest in Equus S.A. The purpose of this incorporation was to distribute the product throughout Europe.

In 1981, Claude and Alain acquired U.A.B.D.’s interest in Equus S.A. and became equal 50 per cent shareholders of Equus S.A.

In organizing the horsemeat processing business of the Appellant in 1982, Claude was responsible for managing the processing operations and the day-to-day management of the business of the Appellant. Alain was responsible for all aspects of sales, marketing, distribution and delivery of all the products.

Most of the Appellant’s customers are located in Europe.

From the evidence, it is clear it was the intention by both brothers that shareholding in the Appellant would be equal. Because of the shareholding restrictions in the Foreign Investment Review Act (“FIRA”) in 1982, Claude and Alain were advised that Alain should not acquire a 50 per cent interest in the Appellant at that time. The takeover of Dreyfus assets by the Appellant, the necessity of quick action in a critical time period for the Appellant and the need and pressure to generate income to meet the Dreyfus payments caused the brothers to take the following action in relation to FIRA.

With the advice with respect to Alain’s ownership of shares of the Appellant, the brothers agreed that only Claude would be issued shares of the Appellant in 1982 and that Alain would be issued an equal number of shares of the Appellant whenever the restrictions to his owing shares of the Appellant arising from FIRA were removed. This incorporation and share subscription agreement between the brothers was oral and did not have any documented formality but the existence of the agreement was acknowledged in writing by the Appellant’s solicitors (exhibit A-3) in 1985 and the viva voce evidence of Claude and his wife (Louise Bouvry) confirmed the equality understanding.

In 1982 Claude subscribed for and was issued 100 common shares of the Appellant at a total cost of $100.

The financial equality relationship between Claude and Alain in the business of the Appellant was evidenced by the payment of broker fees to Alain and bonuses to Claude. Exhibit A-2 schedules the payments:

When Alain Bouvry became a shareholder:

Further, Claude and Alain did not draw out all monies credited to them; equally, they left 75 per cent of the monies with the Appellant to allow the Appellant to carry on business. While the schedule does not show exact equality between Claude and Alain, the evidence was that the differences were as a result of currency exchanges and other variables.

In 1987, when FIRA was repealed, Claude and Alain were advised that the restrictions on the ownership of shares of the Appellant by Alain had been removed.

By Director’s Resolution of the Appellant passed by Claude as the sole director of the Appellant in July 1988, the Appellant issued 100 common shares to Alain.

Upon the issuance of the shares of the Appellant to Alain in 1988, the Appellant ceased paying broker fees to him and Alain became an employee of the Appellant.

Claude’s wife (Louise Bouvry) gave evidence on behalf of the Appellant and further confirmed the basis of operating and in all business matters the brothers acted in concert on a fifty-fifty basis.

As indicated, the substance of the arrangement, as indicated, was never formalized in documentation. Nor was the arrangement characterized in formal terms. The accountant for the Appellant and the solicitor advising the Appellant confirmed the word “option” was not used until 1988 (exhibit A-5).

The solicitor stated the transaction was structured (1982) so it was not reviewable by FIRA. However, he also confirmed the brothers’ intentions were Clear that when appropriate the shares were to be issued to Alain.

Issues

The issues are the following:

1. Were the common shares issued to Alain pursuant to a right issued to Alain in 1982?

2. If so, was the benefit received by Alain from the Appellant on account of the right received in 1982 or in 1988 when the shares were issued?

3. Did Alain receive a shareholder benefit when the shares were issued to him pursuant to subsection 15(1) of the Act?

4. If so, was the Appellant liable to withhold and remit tax pursuant to Part XIII of the Act?

5. If so, was the Appellant liable to pay a penalty for not doing so pursuant to subsection 227(8) of the Act?

Analysis

In summary, the Appellant was incorporated as a federal corporation on January 15, 1982, and is engaged in the horsemeat processing business. At that time Claude, a resident of Canada, owned 100 shares in the Appellant costing $100 and representing 100 per cent of its capital stock. At the time of incorporation of the Appellant, Claude and his brother Alain (a resident of France and a non-resident of Canada) intended that they would each contribute equally to the success of the Appellant and would participate equally in its profits. Due to the restrictions of FIRA, however, Alain was advised not to become a 50 per cent owner of the corporation. Further, in 1982, there was an agreement between the brothers that when the restrictions under FIRA were lifted 100 shares at a cost of $100 would be issued to Alain. In 1985 FIRA was replaced by the Investment Canada Act and the restrictions on the ownership of shares in the Appellant by Alain were lifted. On July 27, 1988, 100 shares in the Appellant were issued to Alain for $1.00 a share. The fair market value of the shares at that time was $1,425,000.

In the present case, I find that in 1982 a contractual right was given by the Appellant to Alain to subscribe for 100 shares of the Appellant for $100. This right, to have the shares issued, accrued and became absolute in 1982. Thus, for the purposes of determining the value of any benefit which may have been conferred on Alain by the granting of the contractual right, the valuation date of the right was the date that the contractual right arose and not the date the shares were issued. The existence of this contractual right was adequately proven by the oral testimony of Claude and his wife and by correspondence (exhibits A-4 (1985) and A-5 (1989)) between the Appellant and its solicitor referring to the arrangement granted to Alain. The granting of this contractual right is in accordance with the understanding between Alain and Claude that the rewards of any business venture that they jointly entered into were to be shared equally.

It was suggested by the Respondent that if a right was given by the Appellant to Alain, such a right must necessarily be void by operation of FIRA. Under FIRA the granting of this right was a transaction which required an application to the Federal Government. This was not done. At that time, FIRA provided for penal sanctions for non- compliance where a corporation was found guilty of an offence and under certain circumstances further court action could be initiated to nullify investments not in compliance with FIRA.

Specifically, subsection 20(1) of FIRA states as follows:

20(1) Where a non-eligible person...has made an actual investment in circumstances in which

(a) a demand has been served by the Minister under subsection 8(3)...

(b) the Governor in Council has, by order, refused to allow the investment, or

(c) although the Governor in Council has, by order, allowed the

investment...the terms and conditions on which the investment has been made vary materially from those disclosed...

a superior court, on application on behalf of the Minister, may make such order as, in its opinion, is required in the circumstances, to the end that the investment shall be rendered nugatory....

In some circumstances, the making of contract which contravenes an express statutory prohibition provision can render a contract void [1] . In this case I cannot conclude that the granting of the right was beyond the lawful capacity of the Appellant. It should have been the subject of an application under FIRA and failure to receive approval for it could have made the Appellant and the transaction subject to sanctions. However, there was no prohibition to such a transaction although under certain circumstances a court could nullify the investment. Here the preconditions for nullifying the contractual right which are listed in paragraphs 20(1 )(a) to (c) have not been met. I conclude that notwithstanding that the contractual right in the context as defined by the understanding or agreement between Claude and Alain was caught by FIRA, this right did not constitute an illegality leading to a void contract.

Alternatively, if I had accepted the Appellant’s contention that the right granted was an option (which I have not) the result in terms of the assessment would be the same. This conclusion follows the reasoning in Del Grande v. R., (sub nom. Del Grande v. Canada) [1993] 1 C.T.C. 2096, 93 D.T.C. 133 (T.C.C.). In that case, the taxpayer was given an option to purchase shares in a corporation of which he was an officer and a shareholder at a time when the shares were almost worthless. When he exercised the option, the shares were of substantial value. Judge Bowman held that the shareholder benefit was received at the time the shares were issued but that the taxpayer was in no better economic position than he was before the exercise of the option. At page 2102 (D.T.C. 137) he finds:

Paragraph 15(l)(c) requires that a benefit or advantage be conferred on a taxpayer qua shareholder. No benefit or advantage is conferred when a corporation does no more than honour a commitment previously given in a bona fide transaction. In the honouring of that commitment the option holder’s status as a shareholder plays no part. The holder gives up a valuable right, the option, and receives for it the shares. The corporation issues the shares and is relieved of the obligation to honour the option agreement. The value of the option is measured by the value of the shares which the option holder is entitled to receive less the price he must pay. Following the exercise of the option he is in no better economic position than he was before.

Paragraph 15(1)(c) contemplates the conferral of a genuine economic benefit upon the shareholder. The word “confer” implies the bestowal of bounty or largesse, to the economic benefit of the conferee and a corresponding economic detriment of the corporation. Such was not the case here.

In response to the option argument, the Respondent relied upon Robertson v. R., (sub nom. Robertson v. Canada), (sub nom. Robertson v. The Queen) [1990] 1 C.T.C. 114, 90 D.T.C. 6070 (F.C.A.), leave to appeal to S.C.C. refused, (sub nom. Robertson v. Minister of National Revenue) (1990), 113 N.R. 319 (note) to submit the valuation of the shares should be the date the option was exercised. In Robertson (supra) the option was held to have been a benefit of employment under paragraph 6(l)(a). In my opinion, Robertson (supra) does not apply to the present case for the reasons set out in Del Grande (supra) by Bowman J., at pages 2105-07 (D.T.C. 140).

Given the foregoing, I do not need to deal with the other issues in this case. The basis of the Minister’s assessment was that a benefit given by the Appellant was a benefit conferred to Alain on the 25th of June 1988. Given the finding herein, that a contractual right was conferred on Alain when Claude subscribed for his shares in 1982 and that all of the contractual rights passed to Alain as of that date, the assessment therefore fails. No benefit was conferred by the Appellant to Alain in June 1988.

DECISION

The appeal is allowed in full and the assessment is referred back to the Minister of National Revenue on the basis that no benefit was conferred under subsection 15(1) of the Act to Alain Bouvry in 1988. The Appellant is entitled to its costs.

Appeal allowed.