In the Matter of the Trust Deed of Arthur Sturgis Hardy, [1955] CTC 138, [1955] DTC 1062

Ferguson, J.:—This is a motion by the Trustee of Arthur Sturgis Hardy for opinion and advice. The question propounded for the Court’s opinion and advice is as follows:

1 Does the Thirty-one thousand one hundred and sixty-eight dollars ($31,168) representing the proceeds in respect of the share of Arthur Sturgis Hardy and payable to the Trustees of the Trust Deed of the said Arthur Sturgis Hardy on the redemption of 31,168 preferred shares, being part of the redemption of 260,000 preferred shares of G T. Fulford Co. (Limited) issued by way of stock dividends out of the tax paid undistributed income of the company following an election by the company to exercise rights under Section 95A(1) of the Income Tax Act, S.C. 1948, c. 52, constitute income or capital in the hands of the trustees?’’

Arthur Sturgis Hardy, when twenty-three years of age on August 7, 1928, entered into an irrevocable trust deed under which he settled 85% of his interest in the estate of his grandfather, the Honourable George Taylor Fulford, and the estate of his mother, unto the Toronto General Trusts Corporation to hold, among other purposes, not here relevant, the said property upon trust to pay to himself during his lifetime the net annual income derived from the trust estate. For a period of twenty-one years after his death he directed that certain of the income be paid to his wife and to his children, and after the said period to such persons as he might by his will appoint, and, failing such appointment, to his next of kin.

G. T. Fulford (Limited) is a private company incorporated under the Dominion Companies Act on December 15, 1905, with an authorized capital of 10,000 common shares of the par value of $100 each, and 500,000 non-cumulative redeemable preference shares of the par value of $1 each. On March 22, 1953, the trustees held 1,199 common shares fully paid up and non-assess- able in trust under the said trust deed of Arthur Sturgis Hardy.

The company by resolution of the directors dated October 30, 1952, elected to invoke the provisions of Section 95A(1) of the Income Tax Act. This resolution reads as follows:

1 Moved by Mr. A. S. Hardy and seconded by Mr. W. G. Watson, and resolved, that the G. T. Fulford Co. (Limited) hereby elects under subsection (1) of Section 95A of the Income Tax Act to be assessed and to pay tax on an amount equal to its undistributed income at that time.”

The resolution was duly forwarded to the Department of National Revenue and the tax paid, leaving in the hands of the company a tax paid undistributed distributable surplus in the amount of $266,953.98. The company duly enacted a by-law authorizing the issuance of a stock dividend, and by resolution passed in pursuance of the by-law and dated January 26, 1952, it authorized the issue of and did issue 10,000 non-cumulative redeemable 3% preference shares of the par value of $1 each, on the basis of one preference share for each common share held by a shareholder of record as of January 21, 1953. Immediately following the resolution authorizing the issuance of the 10,000 redeemable shares above referred to, the company redeemed the said 10,000 preference shares. At that date the trustees held 1,193 common shares of the company, and in pursuance of the resolution redeeming the said 10,000 preference shares the trustees were paid $1,193 on the redemption of the preference shares held by it. On April 10, 1953 the company, pursuant to its by-law authorizing the issuance of a stock dividend authorized an issue and issued 250,000 non-cumulative redeemable 3% preference shares of the par value of $1 each on the basis of 25 preference shares for each common share held by a shareholder of record as of April 10, 1953 ; and by a second resolution passed on the same day immediately following the resolution authorizing the issue of the said 250,000 preference shares, the company then authorized their redemption at par.

Pursuant to the redemption of the said 250,000 preference shares, the trustees received $29,975, or a total of $31,168 from both redemptions. The question before the Court is : Is the money which was received by the trustee income or capital ? In introducing the resolutions authorizing the issue of the preference shares and their redemption, the chairman of the meeting stated :

4 It was never the intention of the company to use the issued preference shares as part of the capital structure of the company, but that the creation of preference shares was taken with the sole view to immediately redeeming the preference shares when such preference shares were issued as stock dividends. This was to take advantage of the provisions of Section 95A of the Dominion Income Tax Act, whereby the company paid the flat tax, in this case amounting to $47,109.51, and then getting the balance of the undistributed surplus directly into the hands of the various shareholders. To comply with the company’s intention of effecting payment in cash by way of income of the tax-paid undistributed income to the shareholders, it was now in order and desirable to redeem the preference shares authorized to be issued pursuant to the resolution of the company as in this meeting passed.’’

If I were untrammelled by authority I would find the $31,168 paid to the trustees constitutes capital of the estate and not income. The real problem I have had to decide is whether this case can be distinguished from Re Fleck, [1952] O.R. 113 ; [1952] C.T.C. 196, affirmed in the Court of Appeal (Re Fleck, [1952] O.R. 260; [1952] C.T.C. 205), without any discussion of the principles involved appearing in the reasons for judgment. Hogg, J.A., in Re Fleck held that money paid in similar circumstances was capital. In Re Mills, [1953] O.R. 97; [1953] C.T.C. 115, Gale, J., felt bound to follow that decision.

The company involved in Re Fleck, the Booth Lumber Limited, was incorporated under the Dominion Companies Act, as was the company concerned in Re Mills. In Re McIntyre, [1953] O.R. 910; [1953] C.T.C. 372, involved the Ontario Jockey Club, incorporated under the Ontario Companies Act, and in that case McRuer, C.J.H.C., distinguished Re Fleck on the difference in the wording of the two Acts with respect to the redemption of shares, and held money paid to redeem shares in circumstances similar to the case at bar constituted capital and not income. Re McIntyre has been followed by McLennan, J., in Re Waters, [1954] O.W.N. 649; [1955] C.T.C. 126, that case also involving an Ontario company.

I have read and re-read these cases and the authorities referred to. I must confess that a perusal of the authorities mentioned in Re Fleck leads me to a conclusion contrary to the result of that case. Although I am, respectfully, unable to follow the distinction drawn by the Chief Justice of the High Court in deciding Re McIntyre, I would have arrived at the same result as in Re McIntyre had I thought the way clear to do so.

Whether the money paid to redeem the shares is capital or income in the hands of the trustees does not, to my mind, depend on the wording of the statutes as they now read, nor on the nature of the assets disposed of to raise the money for redemption, nor on the time which elapses between the creation of the redeemable shares and their redemption, but solely on whether in fact its profits have been converted into capital. The authorities seem to me to establish this, particularly those referred to by the Chief Justice of the High Court in Re McIntyre. The form of a company’s resolution and instruments must be their substance, otherwise company law becomes meaningless and the principles expressed in such fundamental cases as Salomon v. Salomon, [1897] A.C. 22 will be reduced to a relic of an unenlightened age. In deciding as a fact whether the profits have been capitalized, I should think directors who have done everything necessary in a corporate way to convert the profits into capital must be estopped from hypocritically asserting the contrary. Gale, J., expressed the opinion that the ‘‘intricate procedure invoked by (the company) furnishes further incontrovertible proof of that intention, because it was the only way by which its undistributed income could reach the shareholders as income without rendering them liable to tax’’. Let me say, with respect, that it was the only way the monies could reach the shareholders so that it would not be income and as such liable to be taxed. Surely if it is income it is liable to be taxed under the Income Tax Act, and clearly it is not so liable under that Act.

A block of shares of G. T. Fulford Limited was held by the Trustees, applying on this motion as executor of the G. T. Fulford Estate. They received certain monies from the company in redemption of their shares, as they did as trustees of Sturgis Hardy, and applied to Schroeder, J., for the Court’s opinion and advice as to whether the money received was income or capital. By a judgment dated February 21, 1953, he followed Re Fleck and declared the money to be income. I think the judgment of Schroeder, J., which deals with the same company, the same resolution and the same stock, apart altogether from Re Fleck, is binding upon me, and therefore I am bound to declare the money in the hands of the trustees to be income. It was once said by Lord Cottenham in Lozon v. Pryse, 4 Myl. & Cr. 600 at 617, that it is generally considered more important that the rule of law should be settled than that it should be theoretically correct.

It was argued on behalf of the Official Guardian, whom I appointed to represent unborn children and unascertained persons, as he, in my view, sufficiently and adequately represented them, that the trustees in this case had committed a breach of trust in taking steps to come within Re Fleck. He argued that they had taken sides. They had 4 ‘slanted” things in favour of one beneficiary to the detriment of another, as it appears that the trustees have full control of the board of the company. I do not consider that problem to be before me. It seems to me that if the Official Guardian is serious in this contention, it must be disposed of in an action. The judgment on this motion may be without prejudice to the Official Guardian’s rights in this respect.

There will be judgment declaring the money in the hands of the trustees income. All parties are entitled to their costs out of the monies in the hands of the trustees.