Gosselin v. R., [1997] 2 CTC 2830

Dussault T.CJ.:

This is an appeal from an assessment made pursuant to s. 160 of the Income Tax Act (the “Act”) on August 26, 1993, numbered 9844.

The assessment, which was for $14,426.01, was made pursuant to a transfer of property to the appellant by the payment of a dividend in the amount of $31,620 by Gestion Farrell & Gosselin Inc. (“Gestion Farrell & Gosselin”), which had a tax debt of $14,426.01 at the time of the assessment.

For the purposes of this assessment the Minister of National Revenue (the “Minister”) assumed inter alia the facts set out in subparagraphs (a) to (p) of paragraph 11 of the Reply to the Notice of Appeal, which read:

[TRANSLATION]

(a) Gestion Farrell & Gosselin Inc. is a management company incorporated pursuant to the Canada Business Corporations Act;

(b) the financial year of the corporation ends on May 31 of each year;

(c) on January 29, 1990 the Minister issued a notice of assessment to Gestion Farrell & Gosselin Inc. for its 1989 taxation year in the amount of $9,419.10, namely $8,167 in tax, $602.69 in interest on instalments and $649.41 in interest on arrears;

(d) during the fiscal year ending May 31, 1989, Gestion Farrell & Gosselin Inc. declared and paid a dividend of $63,240 to its Class A shareholders;

(e) at the time the dividend was paid, the appellant and Normand Farrell were directors of Gestion Farrell & Gosselin Inc. and each held 50 percent of the Class A shares in that company;

(f) in his tax return for the 1989 taxation year the appellant reported the receipt of a dividend from Gestion Farrell & Gosselin Inc. in the amount of $31,620 before gross-up, that is, 50 percent of $63,240;

(g) a TS reporting a dividend in the amount of $31,620 before gross-up was issued to the appellant by the company for the appellant’s 1989 taxation year;

(h) Gestion Farrell & Gosselin Inc. was wound up on June 6, 1990;

(i) despite several attempts, the Minister has not been able to gain access to the minute book or records of Gestion Farrell & Gosselin Inc.;

(j) the said corporation’s tax debt totalled $14,626.01 on August 26, 1993; [1]

(k) on August 26, 1993, the Minister assessed the appellant in the amount of $14,626.01 pursuant to subss. 160(1) and (2) of the Act in respect of the dividend paid, while the figure for company’s tax, including interest to that date, was this same $14,626.01, which was still unpaid; [2]

(l) at the time the property was transferred, Gestion Farrell & Gosselin Inc. and the appellant were not dealing at arm’s length;

(m) the fair market value of the property transferred was the same as the cash value of the dividend, namely $31,620;

(n) at the time the property was transferred, the fair market value of the consideration given by the appellant for the property was $0;

(o) the total of all the amounts which the transferor was liable to pay under the Act in or in respect of the taxation year in which the property was transferred or any preceding taxation year was $14,426.01;

(p) payment of the $63,240 dividend made the company insolvent.

Counsel for the appellant first challenged the sufficiency of the allegation in subparagraph 11(1) of the Reply to the Notice of Appeal that [TRANSLATION] “at the time the property was transferred, Gestion Farrell & Gosselin Inc. and the appellant were not dealing at arm’s length” as a basis for the assessment under s. 160, since such a statement represents a conclusion of law rather than a statement of the facts on which it is based. In support of this argument he referred to the rules set out inter alia in Johnston^ [3] and Pillsbury Holdings.* [4]

On this point, counsel for the respondent argued that subparagraph(l) should be read together with the other paragraphs (d), (e), (f), (i) and (j), which in her view state the other points required for the conclusion that the parties were not dealing at arm’s length. I agree with this position. The statement of the relevant facts is sufficient. It is not necessary to restate the tests developed by the courts in the Reply to the Notice of Appeal in order to conclude that there is a de facto non-arm’s length relationship.

First, it is plain that the appellant, a 50 percent shareholder not related to the other shareholder, did not control Gestion Farrell & Gosselin, and so the parties were not related persons. Accordingly, there is no presumption of non-arm’s length dealing under para. 251(l)(a) of the Act. Second, para. 251(1)(b) provides that “it is a question of fact whether persons not related to each other were at a particular time dealing with each other at arm’s length”. Counsel for the respondent considered that the facts set out in the aforementioned subparagraphs provide a sufficient basis for the conclusion that the parties were not dealing at arm’s length at the time of the transfer, that is, when the dividend was paid.

While counsel for the appellant acknowledged that the facts stated in the subparagraphs set out in paragraph 11 of the Reply to the Notice of Appeal are not in dispute, he argued that the parties were dealing at arm’s length. He based this argument on the testimony of the appellant himself and of Jean-Pierre Mercille, a CMA, who had worked for the companies controlled by the appellant and Mr. Farrell, on which he relied to show how the two individuals’ opinions and interests differed regarding the conduct of the businesses respectively controlled by them in the field of mining exploration and the public financing of the activities of the companies.

According to the testimony, while the appellant and Mr. Farrell had common interests at the start of their business partnership in 1987, these interests gradually diverged until their relationship broke down in 1990, leading to the winding up of Gestion Farrell & Gosselin. The main reasons given were, first, the shrinking markets for new financing and the personal interest Mr. Farrell had in separate businesses which had nothing to do with mining exploration. The appellant was only interested in mining exploration and the financing of such activities and accordingly, unlike Mr. Farrell, he devoted all or almost all of his time to that. It can also be concluded from the testimony that the appellant’s training in geology and Mr. Farrell’s training in management might lead to differences of opinion on certain aspects of the activities of the companies controlled by them, and in particular Gestion Farrell & Gosselin. It was also clear from the testimony that the two directors took an equal part in decision-making, so it was not possible to say that one controlled the other. Lastly, the appellant himself did not leave any doubt as to the fact that he participated in the decision to declare and pay the dividend in 1989.

Counsel for the appellant referred to the judgment of the Federal Court, Trial Division in Cundill? [5] a judgment affirmed by the Federal Court of Appeal [6] , in which the Court accepted the tests set out by Revenue Canada in Interpretation Bulletin IT-419R as being those generally used by the courts to determine whether there is a de facto relationship. These tests are:

(a) the existence of a common mind which directs the bargaining for both parties to a transaction,

(b) parties to a transaction acting in concert without separate interests,

and

(c) de facto control.

He argued that neither the first nor the last test can be applied to the circumstances of the instant case in view of the evidence presented. I should say at once that I agree with this position.

On the application of the second test, he pointed out that on the evidence presented the appellant’s and Mr. Farrell’s interests differed and were therefore necessarily separate. In his submission, there are two parts to the second test mentioned, namely acting together or in concert and having no separate interests. Accordingly, he argued, the parties must in fact be dealing at arm’s length if each of them has a separate interest even though they acted in concert.

While I agree with the statement of the principle, my conclusions differ as to whether two facts are present in the circumstances of the instant case. First, the issue is in fact whether the appellant and Gestion Farrell & Gosselin, and not the appellant and Mr. Farrell, were dealing at arm’s length at the time of the transfer. The fact that the appellant and Mr. Farrell acted in concert is clearly relevant, since they were the only two shareholders, in equal proportions, and were also the only two directors of the company. Second, the situation in which the parties were must be analysed in terms of a specific transaction, not in very general terms, since the test refers precisely to “parties to a transaction acting in concert”. This transaction, involving the declaration and payment of a cash dividend, resulted in a transfer of property from the company’s assets to the shareholders’.’ [7] As directors acting for the company, the appellant and Mr. Farrell transferred to the shareholders, that is to themselves, and only to themselves, property owned by the company, representing a portion of its undistributed profits. If we consider a company’s ultimate interests to be actually the interests of its shareholders or, if you like, of its owners, through the shares in its capital stock that they hold, it is hard to see any separate interests where there are only two shareholders who hold shares of the same class with the same rights and in equal proportions. This is the meaning of the decision which I rendered in Fournier, [8] the facts in which were similar to those of the instant case.

The final argument raised by counsel for the appellant concerns the consideration for the transfer allegedly given by the appellant in the form of services rendered. The argument is based on the decision of Judge McArthur of this Court in Davis^ [9] in which he concluded, in view of the circumstances, that the dividends had been declared and paid in return for consideration in the form of services rendered, there having been a prior agreement to this effect. [10] Counsel for the appellant noted that the evidence in the instant case was that the appellant had devoted much more time and energy than Mr. Farrell to the conduct of the company’s affairs and that his services constituted valuable consideration for the transfer. Without raising the question of the actual value of the services rendered, counsel for the respondent argued that the facts in Davis, supra, are not the same as those of the instant case, especially in view of the fact that there was a prior agreement in Davis, supra, and there was none here.

The two cases can certainly be distinguished on a factual basis, but that is not all. How can the argument be made that the dividends were declared and paid in consideration for services rendered when the evidence shows that the services rendered by the appellant and Mr. Farrell respectively were unequal but the amount of the dividends they each received was equal? In my view, the argument collapses of its own accord and we have to return to the fundamental principles of comparative law or company law.

The declaration of a dividend is essentially the allocation of a company’s undistributed profits to its shareholders in proportion to the shares held by them and in accordance with the rights attached to those shares. Payment of the dividend is the act by which the dividends so allocated by the directors in their discretion, and in compliance with the principles of company law and the specific rules laid down in this regard, distribute to the shareholders the dividend allocated to each class of shares. In addition to the rules regarding solvency of the company there is the rule of equality of shares in the same class in terms of the privileges and limitations attached to shares in that class.

The appellant and Mr. Farrell each received a dividend of the same amount because they each held 50 percent of the shares, which entitled them to this equal dividend. The right to a dividend is a right to share in a company’s profits. With respect for those who hold the contrary view, that right arises from only one source: the ownership of shares that carry the right, and nothing else. The dividend is income from “property” and is not pay or compensation for services rendered. The fact that dividends are given favourable tax treatment when they are received by individuals, under the gross-up and tax credit provisions, is because they represent the result of this very division of a company’s profits, profits which have already, in theory at least, been taxed at this initial stage, and on which the purpose is to limit or reduce the impact of double taxation when they are received by individuals. This scheme clearly does not apply to payment for services rendered in whatever form; depending on the nature of the relationship between the parties, such payment generally constitutes “employment income” or “business income”, or even in exceptional cases simply “income from a source” within the meaning of s. 3 of the Act. [11] These distinctions are at the very heart of our company law system and our tax law system and must be observed. I would simply add that I am satisfied, having regard to his activities and his experience in the field of mining law, that the appellant himself is certainly in a position to distinguish the concepts, especially as he received a bonus from the company in 1988 and dividends in 1989.

In view of the foregoing, the appeal is dismissed.

Appeal dismissed.