Drummond Coal Company Limited v. Minister of National Revenue, [1972] CTC 2250, 72 DTC 1217

Roland St-Onge:—This appeal was heard at Halifax, NS on July 5, 1971 by the Tax Appeal Board as it was then constituted.

The appellant is a coal-mining company and its president, Mr Henry R Thompson, also president of Stephens Investments Limited, has no interest whatsoever in Scotia Bond Company Limited, a corporation which he and the appellant used for the purpose of selling and buying back shares of International Power Company Limited (hereinafter referred to as “International”).

On January 1, 1965 Mr Thompson was the owner of 300 common shares of International. Mr Harry Hills of Royal Securities came to his residence at New Glasgow and offered him $425 per share. On March 5, 1965 he received from International a letter telling him that the said company was to give a dividend in kind to be paid on April 30, 1965. This dividend consisted of shares in subsidiary companies of International situated in South Africa and which were worth about $350 each. On March 9, 1965 he received another letter from Royal Securities offering $430 each for the same shares. Following this correspondence, he contacted his legal adviser, Mr Gordon S Cowan, and his accountant, Mr H A Renouf, and Mr Cowan decided to ask International for its ‘financial statement. On March 27, 1965 they received an answer and Mr Cowan was instructed to sell and, in fact, sold the shares to Scotia Bond Company Limited on April 15, 1965, with an option to buy them back. Mr Thompson said that the purpose of this course of action was to minimize the tax. Questioned by his lawyer, he explained that he sold to Scotia Bond Company Limited because International had forced him to sell the said shares to that company at a price of $450 per share.

On May 18, 1965 the appellant company purchased the shares from Scotia Bond Company Limited for $26,980.20 but on November 25, 1965 the appellant received a notice from International that some common and preferred shares in South American companies would be given as dividend in kind as well as some cash money to its shareholders. Following this notice, the appellant company gave instructions to Mr Cowan to sell the shares to Scotia Bond with the same option of repurchasing them, and the appellant received as the first payment a cheque for $30,000 and later on a cheque in the amount of $54,300. These cheques were deposited to the account of Drummond Coal Company on December 30, 1965 and February 3, 1966 respectively. Then Stephens Investments Limited repurchased the shares at $1 each and Mr Thompson’s wife purchased from Scotia Bond Company Limited the shares of the South American companies, paying $53,284.41 for them by cheque dated January 31, 1966.

On August 30, 1969 Mr Thompson was offered by Scotia Bond Company Limited $700 per share for his 300 International shares, provided that the shares held by his wife in the South American companies be included in the deal. According to Mr Thompson, this offer was more in line with the price he had asked originally. On September 19, 1969 Mr Thompson received the information pertaining to the value of his International shares which Mr Cowan had asked for in 1965. On September 26, 1969 two letters were sent by Canadian International Power Company Limited: one to Stephens Investments Limited and the other to Mrs Thompson, offering them for their shares a total price of $700 per share. Before accepting this offer, Mr Thompson tried to find out the tax consequences from the Department of National Revenue, but before he received anything definite from them Canadian International Power Company Limited withdrew its offer because of trouble with some of its companies. Subsequently, a 30-day offer was made by Canadian International to buy all the shares at a price of $30,000. At the time of the hearing, Stephens Investments Limited held 300 shares of International and Mrs Thompson held the same shares of the foreign companies which she had purchased in 1966.

It is in evidence that Canadian International Power Company Limited was the parent company of International Power Company Limited, the former holding 99% of the shares; and that Mr Thompson knew that he was not entitled to a dividend tax credit in respect of the dividend when he sold the shares to Scotia Bond. Upon cross-examination, Mr Thompson admitted: that from the letter from Mr Cowan dated March 27, 1965 he learned that the value of the International shares was greater than $430 each; that following discussion with Mr Cowan, he gave him instructions to sell the shares in order to get him back stripped of the dividend; that he got back the shares by paying $430 each minus the amount Scotia Bond Company realized on the dividend ($350.07 on each share); that the steps to register the 300 International shares in the name of the appellant company were taken by Scotia Bond Company; and that the appellant company paid $89.93 per share which is the difference between $430 and $350.07 plus $10 for each share representing the fees to Scotia Bond Company for its services in carrying out this transaction.

On April 21, 1965 Mr Renouf wrote a letter to Mr Thompson, the relevant parts of which read as follows:

I am of the opinion, and Gordon Cowan concurs, that the repurchase may be construed by Income Tax officials as a wash sale. If such a conclusion is reached, it may be possible for them to attack the transaction, under Sections dealing with artificial transactions and tax avoidance.

. . . Such being the case, I wonder if the cash equivalent of your stock dividend ($350) would not provide a better growth if it was invested in the shares of taxable Canadian companies.

Mr Thompson explained that he did not comply with the above- mentioned advice because at the time he received the letter, he had already given instructions to sell the shares and had made arrangements to repurchase them. He also stated that he kept control of his 300 shares even when he sold them to Scotia Bond Company because of the redeemable clause; that previous to December 30, 1965 he learned that another cash dividend of $106 per share and a dividend in kind of $175.61 would be paid and, consequently, he resorted to the same scheme to strip the dividends; and that finally when the appellant company bought the shares for $26,000 there was a corresponding increase in Mr Thompson’s loan account in the books of the appellant company. It is interesting to note that 299 of the 300 common shares of Stephens Investments Limited, which bought the shares of International for $1 each, were owned by Mr Thompson.

Mr Renouf testified that, in conjunction with Mr Gordon S Cowan, he advised Mr Thompson on how to proceed with respect to the transaction under discussion. He admitted that one of the reasons for selling the shares to Scotia Bond Company was the tax consequence of the receipt of a taxable dividend. In his opinion, the second distribution of dividends was part of a series of transactions initiated by Canadian International Power Company Limited to obtain the splinter shares outstanding. There were three alternatives open to Mr Thompson, namely: (1) accept the offer ‘and sell the shares — thus realizing a capital asset; (2) refuse the offer, wait to receive the dividend and be fully taxed on it; (3) sell the shares to a broker and then buy them back ex dividends. As previously stated, this last alternative was followed by Mr Thompson and the appellant company. Mr Renouf did not negotiate the arrangement with Scotia Bond Company — this was done by Mr Cowan. He also stated that, according to the arrangement, these shares would be transferred to Scotia Bond Company before the record date so that the latter could become the shareholder of record and receive the dividend, and they would be transferred back from Scotia Bond Company to Mr Thompson or his nominees for a price equal to the original price less the amount realized on the sale of the shares received as a dividend in kind. At this juncture, the Board would have to decide whether this transaction was a sale or a transfer of shares. He also testified that he did not recommend that Mr Thompson accept the offer made by Royal Securities on behalf of Canadian International Power Company for the price mentioned because it would be a straight sale, whereas the other alternative was an arrangement negotiated between Mr Cowan and Scotia Bond Company wherein the latter would simply obtain a profit of $10 per share and Mr Thompson or his nominee would then be entitled to buy back for at that time an undisclosed amount of dollars the residual shares of the transaction. It appears from this procedure that Mr Thompson or his nominee would never lose control of the shares (rider attached). However, there is a technicality herein because in the period when Mr Thompson was not the registered shareholder he had, according to the Companies Act, lost control of his shares. As may be seen, Mr Thompson had to take a chance. He had confidence in Mr Cowan and knew that everything would go well for him with respect to getting the shares back stripped of the dividends.

Mr J W Ritchie, president of Scotia Bond Company Limited, who had dealings with Mr Cowan on many occasions on a client-company relationship prior to the transaction at stake, explained how he was involved in the said transaction. Mr Cowan had approached him and suggested an arrangement whereby Scotia Bond Company would purchase 300 International Power Company common shares, then would in turn attempt to sell the in-kind distribution of shares which they knew to be forthcoming. Then he would be bound to sell back tne 300 shares of International Power Company to Mr Thompson or his nominee at $430 net per share. For this transaction, he would get a profit of $10 per share ($3,000). Apparently at that time there was no market for the said shares. Following this proposition, Mr Ritchie sought the advice of his accountant, Mr Hugh Spencer, in order to find out the tax implications that might arise for Scotia Bond Company. He suggested that everything should be done in writing in order to prevent Scotia Bond Company from incurring a loss on this transaction. He also stated that it should be well understood that Mr Thompson or his nominees would get the shares back for an amount equal to the original price of the International shares, less the amount realized on the sale of the shares received as a dividend in kind in order for Scotia Bond Company to net only a commission and not to be taxed on the dividend in kind received. He explained that in the first transaction between Mr Thompson and Scotia Bond Company the latter succeeded in selling to International the shares received as dividend but did not succeed in doing so with respect to the second transaction involving the appellant company, which explained why the South American companies’ shares were sold to Mrs Thompson for $53,284.41. He also stated that in the first transaction Scotia Bond Company had to borrow the money from the Royal Bank to pay for Mr Thompson’s shares and that, following an agreement between Mr Cowan and the bank, it was decided that the cheque would be issued to Mr Cowan in trust, to be held as such until the arrangement was completed; and that Scotia Bond Company would not have bought these shares unless $10 per share would be earned.

It is also in evidence that at one time Canadian International Power Company made an offer to Scotia Bond Company to but their shares at $210 each but Mr Thompson requested $250, and on May 8, 1970 the company cancelled its offer because they were no longer interested in buying the shares; and that at one time the proceeds from a transaction were deposited as a term savings deposit at 30 days, which apparently is not a normal procedure in that kind of transaction.

Mr Cowan’s wife, Mrs Joan E Cowan, also has 7 shares of International in trust for her children, and the same procedure used with respect to the 300 International shares owned by Mr Thompson was used for those 7 shares.

Heard as a witness, Mr Cowan corroborated the main facts in this appeal and stated that the transactions under discussion were sales; that Scotia Bond Company had acted as principal and not as agent; and that the moneys received by Scotia Bond Company were not commissions but profit.

In argument, counsel for the appellant raised the following points:

(1) That it is still the law that a taxpayer may arrange his affairs so as to attract the minimum of taxation.

(2) That a realization on an investment is a capital gain and does not give rise to income and is consequently not taxable under the Income Tax Act.

(3) That the initial approach was made by Canadian International Power Company to obtain the splinter shares outstanding and the transactions under discussion were simply actions to protect the appellant’s investments.

(4) That the amounts were not received from a corporation of which the appellant was a shareholder, and were not dividends but return of capital.

(5) That an investor may sell his shares before the record date of dividend.

(6) That the ownership and registration on the record date is very important.

(7) That subsection 137(2) should not be used by the Minister to convert a capital gain into income. In this respect he referred to two Supreme Court cases as follows: Wilbour Lee Craddock v MNR, [1969] CTC 566; 69 DTC 5369, and Smythe et al v MNR, [1969] CTC 558; 69 DTC 5361.

(8) That according to the above two cases the Minister, in order to apply subsection 137(2) of the Income Tax Act, must first bind the taxpayer under a section of Part I, Part III or Part IV, subsection 137(2) being an independent taxing section.

On the other hand, counsel for the respondent argued:

(1) That in determining the essence of the transactions one must look not only at the form but also at the substance of the transactions by taking into account all the surrounding circumstances. In this respect he referred the Board to The Horse Co-operative Marketing Association, Limited v MNR, [1956] Ex CR 393; [1956] CTC 115.

(2) That Scotia Bond Company was acting much more in the nature of agent than principal because it was not at liberty to do whatever it pleased with these shares, as in The Palmolive Manufacturing Company (Ontario) Limited v His Majesty the King, [1933] SCR 131, wherein the Ontario company was not free to sell the Palmolive products to outsiders, and it was not regarded as a principal but as an agent.

(3) That Scotia Bond Company was not acting beneficially in its own behalf, and consequently it must be found to act as an agent for its principal. He referred the Board to MNR v Mary Ada Cox (H Cox Estate), [1971] CTC 227; 71 DTC 5150.

(4) That the activities of Mr Thompson in agreeing to have the proceeds of the sale deposited in a trust account or in a term deposit for a period of 30 days was consistent with his aiding and assisting Scotia Bond Company in carrying out the transactions and, by the same token, Scotia Bond Company was aiding and assisting Mr Thompson in carrying out his expressed intention which was to strip the shares of dividends without the incidence of tax.

(5) That the evidence of Mr Ritchie was to the effect that the depositing of a substantial amount of money in trust for a long period of time was not consistent with normal practice and did not show a normal principal relationship.

(6) That the parties were not dealing at arm’s length, which indicates that these transactions were not bona fide transactions.

(7) That one must look at the whole series of transactions because of the wording of subsection 137(2) and decide whether or not the transactions resulted in the conferral of a benefit.

(8) That the parties in this appeal intended to embark upon a stripping scheme to avoid the incidence of tax. See Smythe et al (supra).

At the end of the hearing both parties agreed that the result of this appeal will apply to the appeals of Joan E Cowan and Hugh R Cowan.

The Board is of the opinion that most of the above arguments are true in law, but to discover the true nature of the above transactions we must look at all the circumstances as a whole. I have taken great care in narrating all the facts of this appeal and, from scrupulous examination of these facts, it appears that the transfer of shares could, in no way whatsoever, be branded as a sale of shares between the immediate parties involved. It is true that, pursuant to the Companies Act, the transaction duly transferred the shares to the transferee, allowing it to get the dividend, but these transactions are nothing more than that since Scotia Bond Company Limited was not free to act on its own behalf as an independent trading unit with respect to the said shares, but had a very precise course of conduct to follow. In other words, it was acting much more in the capacity of an agent than a principal since it was not acting as an owner or a freeholder would under such circumstances.

Mr Thompson should not be greatly surprised at the outcome of the appellant’s appeal because when International offered to buy his shares, he was presented with three alternatives by his advisers, Mr Cowan and Mr Renouf, and he chose the one which would allow him to avoid the incidence of tax. Also, on April 21, 1965, Mr Renouf, with Mr Cowan concurring, wrote him a letter stating that “the repurchase may be construed by Income Tax officials as a wash sale”. Granted, the transactions were in progress, but it would have been easy for him at that time to resort to one of the other two alternatives.

Consequently, it is ruled that the amount was received by Scotia Bond Company Limited as nominee or agent on behalf of the appellant in accordance with paragraph 6(1 )(a) of the Income Tax Act.

For the above reasons, the appeal is dismissed.

Appeal dismissed.