Canada v. Citibank Canada, 2002 DTC 6876, 2002 FCA 128

Date: 20020405

Docket: A-73-01

Neutral citation: 2002 FCA 128

CORAM:        RICHARD C.J.

EVANS J.A.

MALONE J.A.

BETWEEN:

                                                        HER MAJESTY THE QUEEN

                                                                                                                                                       Appellant

                                                                                                                                               (Respondent)

                                                                                 and

                                                               CITIBANK CANADA

                                                                                                                                                   Respondent

                                                                                                                                                     (Appellant)

                                            Heard at Toronto, Ontario, on February 5, 2002.

                                     Judgment delivered at Ottawa, Ontario, on April 5, 2002.

REASONS FOR JUDGMENT BY:                                                                               MALONE J.A.   

CONCURRED IN BY:                                                                                                       RICHARD C.J.

                                                                                                                                                   EVANS J.A.

Date: 20020405

Docket: A-73-01

Neutral citation: 2002 FCA 128

CORAM:        RICHARD C.J.

EVANS J.A.

MALONE J.A.

BETWEEN:

                                                        HER MAJESTY THE QUEEN

                                                                                                                                                       Appellant

                                                                                                                                               (Respondent)

                                                                                 and

                                                               CITIBANK CANADA

                                                                                                                                                   Respondent

                                                                                                                                                     (Appellant)

                                                        REASONS FOR JUDGMENT

MALONE J.A.

[1]                 This is an appeal from a judgment of Mogan, J.T.C.C. dated Jan 15, 2001, which allowed the appeal of Citibank Canada, a Schedule II chartered bank ("Citibank"), against the Minister of National Revenue's ("the Minister") assessment of income tax for the 1990 taxation year under the Income Tax Act ("the Act") (reported as [2001] T.C.J. No. 14).

Issue

[2]                 The sole issue is whether dividends received by Citibank in 1990 under certain preference shares ("the preference shares") acquired from two publicly traded Canadian corporations, B.C. Gas Inc. and Le Groupe Vidéotron Ltée., were deductible under subsection 112(1) of the Act. The Minister maintains that the dividends are not deductible because the preference shares are "term preferred shares" as that phrase is used in subsection 112(2.1) and defined in subsection 248(1) of the Act. Dividends received from such preference shares are ineligible for a deduction.

Facts

[3]                 The facts necessary to decide this appeal are easily summarised. In its 1990 taxation year, Citibank acquired 25 "Cumulative Redeemable Perpetual First preference Shares" in the capital stock of B.C. Gas Inc. (the "B.C. Gas shares") at a price of $500,000 each, and 10 "Cumulative Redeemable Convertible Auction Perpetual First Preferred Shares, Series C" in the capital stock of Le Groupe Vidéotron Ltée. (the "Vidéotron shares") at a price of $1,000,000 each.

[4]                 The B.C. Gas shares were offered as a private placement, without prospectus, to raise $25 million. The issue price was $500,000 per share with a minimum subscription of $1 million. The initial term was just over five years (January 22, 1990 to March 31, 1995) with dividends payable during that term in an amount equal to 8.50% per annum. At the end of the five-year initial term, the B.C. Gas shares could be converted into common shares in accordance with the following formula:

Each holder of Perpetual First Preference Shares shall have the right, at the end of the Initial Term, to convert the Perpetual First Preference Shares into Common Shares at the Conversion Ratio in effect on the Date of Conversion. Conversion Ratio means, at any date, the quotient obtained by dividing $500,000 by the greater of:

(i) the Minimum Conversion Price ($1.00); and

(ii) the Current Market Price per Common Share determined as at such Date.

Current Market Price per Common Share, at any date, means the weighted average price at which the Common Shares have traded on the TSE during the 20 most recent trading dates immediately preceding the second trading date before such date.

Notice of Conversion shall set forth the date proposed by the holder on which the conversion is to be effected (Date of Conversion) which date shall be a trading day which falls:

(i) at least 60 days after the date of sending of such notice; and

(ii) at least 2 and not more than 5 business days before a Settlement Date or a Dividend Payment Date.

[5]                 The parties agreed that the conversion formula for the Vidéotron shares was essentially the same as for the B.C. Gas shares, and accordingly this appeal will resolve the deductibility issue for all of the preference shares. The conversion formula for the preference shares may be summarised as follows:

Each holder of a [preference Share] has the right at the end of the initial five-year term to convert that share into common shares of [B.C. Gas / Vidéotron] at the ratio obtained by dividing $500,000 by the current market price of a common share at the date of conversion.

[6]                 The effect of this provision was that when the holder exercised the right to convert she or he became entitled to common shares that at the time of conversion had the same market value as the face value of the preferred shares. Accordingly, if the common shares were trading at $15.00 at the end of the initial five-year term, and if Citibank exercised the right to convert at that time, Citibank would receive 33,333 common shares (that is, $500,000 divided by $15.00). Citibank would receive on conversion more than 33,333 common shares if the market price of a common share was less than $15.00. Likewise, Citibank would receive on conversion less than 33,333 common shares if the market price of a common share was greater than $15.00.

[7]                 In its 1990 taxation year, Citibank received dividends of $509,672 on the Vidéotron shares and $998,727 on the B.C. Gas shares. These amounts were included in computing its income pursuant to the provisions of paragraph 12(1)(j) and subsection 82(1) of the Act. However, in computing its taxable income for the 1990 taxation year, Citibank relied on subsection 112(1) of the Act to deduct from its income an amount equal to the dividends.

[8]                 The Minister denied the deduction on the ground that the preference shares were "term preferred shares" and an exception to the normal deduction allowed under subsection 112(1). The Minister asserted that the conditions attached to the preference shares granted Citibank the right to convert such shares into common shares at a ratio set at the time of conversion, thus "guaranteeing" that Citibank would receive common shares equal in value to a fixed dollar amount without regard to market fluctuations, thus creating for the holder a level of protection against loss.

[9]                 According to the Minister, if the conversion formula was such that the value of the preference shares rose and fell with the common shares, then the preference shares would not be an investment in "term preferred shares" taxed by subsection 248(1). In reaching this conclusion, the Minister relied on the definition of "term preferred share" in that subsection, the relevant portions of which read as follows:

The Tax Court Decision

[10]            Mogan, J.T.C.C. held that the essential question before him was whether the conversion formula for the preference shares provided Citibank with "any form of guarantee, security or similar indemnity or covenant" for the purpose of subparagraph 248(1)(a)(iii) ("the disputed words"). In his interpretation, the Tax Court Judge applied the analysis articulated by Gonthier J. in Corporation Notre-Dame de Bon-Secours v. City of Québec et al, [1994] 3 S.C.R. 3, in order to decide whether the disputed words have an ordinary dictionary meaning or a more technical meaning derived from the law as it applies to commerce in general and public listed companies in particular.

[11]            Applying the Bon-Secours analysis, the Tax Court Judge concluded that the proper interpretation of the disputed words was found in their legal meaning imported from the specific, specialized context to which it applied. He found that the definition of "term preferred share" applies to a relatively small community of sophisticated taxpayers which includes publicly listed companies like B.C. Gas Inc. and Le Groupe Vidéotron Ltée., as well as financial institutions like Citibank. Looking at the disputed words in their entire context, he concluded that those words have the more technical meaning derived from the law applicable to commerce and publicly listed companies. Accordingly, he applied the contextually appropriate legal definitions of guarantee, security, indemnity and covenant as found in Black's Law Dictionary, 7th ed. (St. Paul, Minn.: West, 1999), concluding that the conversion formulae with respect to the preference shares fell short of "any form of guarantee, security, or similar indemnity or covenant" as required by subparagraph 248(1)(a)(iii).

Basis of Appeal

[12]            The Minister submits that the learned Tax Court Judge erred in applying "the narrow and most technical interpretation possible" to the disputed words. Relying on the Supreme Court of Canada's analysis in Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622, the Minister urged in written argument that the Courts have a duty to simply apply the clear and unambiguous terms of a provision of the Act to a taxpayer's transaction. In the Minister's view, by analysing each word in isolation and by relying on technical meanings that belong in the context of debtor/creditor law, the Tax Court Judge, in effect, disregarded the ordinary meaning of the words used by Parliament and applied contextually inappropriate meanings to the words used in the definition of "term preferred share."

[13]            The Minister argues that Mogan, J.T.C.C. should have interpreted the operative words of subparagraph 248(1)(a)(iii), i.e., guarantee, security, indemnity and covenant, in the broadest possible manner and in their ordinary meaning as defined in the Oxford English Dictionary. The Minister asserts that the inclusion of the words "any form of" and "similar" with the operative words of subparagraph 248(1)(a)(iii) further indicates that Parliament intended that the disputed words be given a large, non-technical meaning. For ease of reference, the essential words of this subparagraph can be further summarized as follows:

[14]            According to the Minister, the ordinary meaning of the operative words, when read in context, reveals a common feature of a "term preferred share" which signals Parliament's true intent, namely, the existence of protection against loss:

a.         Guarantee: The Minister urges that this word expressly contemplates the possibility that a guarantee may be made not merely by a third party, as suggested by the Tax Court Judge, but by the issuing corporation as well, and the use of the words "any form of" indicates a wide interpretation is intended. In the result, the conversion formula provides a "guarantee" insofar as it secures Citibank against or from risk or injury as defined in the Oxford English Dictionary.

b.         Security: The Minister suggests that this word does not refer to a pledge of property to support the fulfilment of an obligation, as suggested by Mogan, J.T.C.C., but rather the condition of being protected from danger. Thus, the Tax Court Judge is said to have erred in failing to recognise that the protection offered by the conversion formula is sufficient to meet the definition of term preferred share, even if the common shares cannot subsequently be sold for the amount at which they were valued when the right to convert was exercised.

c.         Similar indemnity or covenant: According to the Minister, the proper definition of "indemnity" here is not a duty to make good on a loss, as held by the Tax Court Judge, but rather a duty to secure or protect against contingent hurt, damage, or loss. This meaning, in essence, mirrors that of "security" above. Further, the words "similar indemnity or covenant" are said to refer to an agreement which protects against loss, and that presence of such an agreement engages the definition of "term preferred share."

[15]            Using this broad interpretive approach, the Minister asserts that the definition of "term preferred share" denotes a debt instrument or anything analogous to a debt instrument. In his submission, by enabling the holder to convert the preferred shares into common shares of the same total value, the functional effect of the conversion formula is to make the preferred shares analogous to a debt instrument. During the term of the shares, their value does not rise and fall like that of ordinary shares. While the formula does not give the issuer the complete liquidity of money at the end of the term, it provides the next best thing: freely marketable common shares of the same value as the preferred shares.

[16]            The Minister argues in the alternative that, even if the Tax Court Judge correctly gave the legal or technical meaning to the disputed words, the result is the same. Following the ejusdem generis rule of statutory interpretation, the proper approach must be to treat "guarantee" and "security" as specific words which are broadened and clarified by the more general words "similar indemnity or covenant." This analysis, the Minister asserts, would indicate that Parliament's intention was for the Courts to apply the common feature within the enumerated words, that is, protection against loss. Thus the Tax Court Judge erred in applying the narrow and most technical interpretation possible to the disputed words, since his interpretation does not reflect this common feature.

Analysis

[17]            During oral argument, counsel for the Minister acknowledged that there is ambiguity in the disputed words. The issue, therefore, is whether Parliament intended the broad definition, proposed by the Minister, or, the more narrow meaning appropriate to the commercial context, as urged by Citibank?

[18]            In my opinion, the Tax Court Judge correctly applied to the facts of this case the interpretive directive established by the Supreme Court of Canada in the Bon-Secours decision. In essence, Bon-Secours stands for the proposition that the interpretation of tax legislation follows the ordinary rules of interpretation. It made clear that there is only one approach to the interpretation of legislation, be it tax legislation or otherwise, namely the following principle formulated in E. A. Driedger, Construction of Statutes, 2nd ed. (Toronto: Butterworths, 1983) at 87:

". . . the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament."

Gonthier J. in Bon-Secours, supra, also noted that in performing this analysis, substance should be given precedence over form to the extent that this is consistent with the wording and objective of the statute. In the event that ambiguity cannot be resolved, the issue will be resolved by reference to the "residual" presumption in favour of the taxpayer.

[19]            I agree that it is possible that the words "any form of guarantee, security, or similar indemnity or covenant" can be interpreted to denote an instrument reasonably regarded as or analogous to a debt instrument. The phrase can be interpreted in this general manner when one ascribes meaning to the words "any form of" and "similar" as those words are found in subparagraph 248(1)(a)(iii). However, as indicated in Bon-Secours, once ambiguity becomes an issue, the legislative provision should be given a strict or liberal interpretation depending on the purpose underlying the provision. That purpose must be identified in light of the context of the statute, its objective and the apparent legislative intent. Hence, it is necessary to canvass the purpose and intent underlying the definition of "term preferred share."

[20]            The record in this case reveals that in the 1970s, certain corporations, which for various reasons were non-taxable, could obtain needed capital at a lower cost if they issued preference shares to a lending institution. These shares carried annual dividends about one percent greater than the after-tax portion of interest paid on borrowed money. The capital could be obtained by the corporation at a cost lower than standard interest rates, and the lending institution gained a benefit as well, since it could earn slightly more than if it had lent at prevailing annual interest rates. The scheme was successful where dividends from the preference shares were free of tax in the hands of the lending institution, and the deduction of interest on borrowed money was irrelevant to the corporation because it was not taxable.

[21]            By 1978, this method of after-tax corporate financing had become prevalent in Canadian capital markets and Parliament attempted to curtail it by excluding subsection 112(2.1) dividends received by a financial institution on a "term preferred share", thus greatly reducing the benefits to be obtained from such financing schemes. As Mogan J.T.C.C. notes, Arthur R.A. Scace, a leading tax practitioner, described the context in which the definition of "term preferred share" arose. At the 1979 Annual Conference of the Canadian Tax Foundation, Mr. Scace outlined the purpose of the new term preferred share:

My topics today are the new concept of a term preferred share and the changed definition of an income debenture. These represent the government's response to a form of financing which had become particularly widespread during the 1970s. Thereby, corporations which were unable to utilize an interest deduction because of losses, deductible dividends, capital cost allowance or resource write-offs would issue either a retractable preference share or an income debenture to a bank or other financial institution. Although any dividend or interest paid on such securities was not deductible to the payor, it was also not taxable to the recipient because a deduction was provided under section 112 or subsection 138(6) of the Income Tax Act. Consequently, lenders were prepared to offer a rate which was substantially less than the normal interest cost (often 1 per cent or 2 per cent above ½ of prime). This not only increased the lender's rate of return; at the same time, it improved the borrower's cash flow. Therefore, on the face of the transaction, everyone benefited with the possible exception of the Department of National Revenue.

...

Under Bill C-17, both financial institutions and certain non-financial institutions are subject to the new regime which, essentially, is enforced by the non-deductibility of certain dividends under section 112 ...

[22]            Thus, the definition of "term preferred share" was clearly designed to combat a particular activity prevalent among specific actors in a specific setting, that is, financing transactions between a small group of specified financial institutions as defined in subsection 248(1) and corporations which were, for a variety of reasons, unable to utilize interest deduction provisions. Accordingly, in my view, it is clear that the definition of "term preferred share" arises from a narrow and particular context and applies to a specific and sophisticated segment of taxpayers. Therefore, the Tax Court Judge was correct, in my opinion, to conclude that the legal or commercial understandings of the disputed words are the appropriate contexts in which to interpret them.

[23]            Nor do I think that the words "any form of" and "similar" in subparagraph 248(1)(a)(iii) necessarily indicate that the words guarantee, security or indemnity are to be given a broad, generic meaning. In my analysis, the words "any form of" may be intended to emphasize that the instrument need not be a formal guarantee, security, or similar indemnity, but must be one of those four instruments in substance. Further, the words "or similar indemnity or covenant" serve to narrow the scope which will be given to the substance of "guarantee" or "security," meaning that instruments which bear the substantive features of an indemnity, that is, protection against loss, will be included in the definition of "term preferred share."

[24]            Accordingly, I do not agree that the subparagraph contemplates that a guarantee may be provided by the issuer, and that therefore Parliament cannot have intended the word "guarantee" to have its technical meaning. The subparagraph is coherent if Parliament is taken to have intended that a guarantee, which can only be given by a person other than the principal obligee, could be given only by "any other person or partnership."

[25]            Admittedly, "covenant" is a more general word, and can include any contractual promise. However, its scope is limited by the statutory context in which it is used: it must be a promise similar to a guarantee, security or indemnity as I have interpreted those words. The common feature of those words is that they are protections against a loss, whether a primary obligee's failure or refusal to pay or in the case of an indemnity, a loss resulting from a range of causes, including as personal injury or damage to property. On the facts of the case at bar, the right to convert is not exercisable to mitigate or cancel an accrued loss with respect to the preference shares. If the issuer was in financial difficulty, or the value of its stock falling, the holder would generally not be better off by converting them into common shares.

[26]            In my analysis, Parliament intended to tax arrangements which were, in substance, debt arrangements. Hence, the question is whether the present arrangement is, at its core, a debt financing arrangement or a capital investment by Citibank in the issuers of the shares. Upon my review of the documents on the record, it is clear that the present arrangement more closely resembles a capital investment. Upon investment, Citibank does not receive any instrument providing for repayment, but has made a permanent contribution to the paid-up capital of the issuing corporation. There are no provisions in the documents on the record for structured repayment of the investment, and there are no provisions for suing the issuing corporations under a note or debenture for recovery of the investment in the event of default. Citibank can neither bind nor seize property of the issuing corporations, since none has been pledged to secure a debt. In short, Citibank has none of the recourse traditionally associated with debt instruments, especially those enumerated in subparagraph 248(1)(a)(iii). Citibank simply has the right to convert its preferred shares into common shares bearing the same value at a determined date.

[27]            If, after conversion, the price of Citibank's shares falls, Citibank loses part of its investment, with no other avenue for recovery. The converse is equally true; if the share price rises, Citibank obtains the benefit. In any case, Citibank is exposed to market risks like any other shareholder. However, in attempting to sell the uncommonly large number of shares in its possession, Citibank might well depress the market price, and thereby lose the opportunity to recover its investment. As the May 17, 2000 report of Mr. Denys Calvin, the Citibank expert, indicated, "the common equity market is remarkably effective at discerning when a large shareholder is a ‘motivated seller' and will discount the share price to take advantage of such a ‘buying opportunity.'"

[28]            When one considers these factors together, the balance clearly weighs in favour of viewing the transaction not as a debt arrangement, but as share purchase financing. Thus, an analysis of the nature of the instruments in this case bolsters my conclusion that they do not constitute "any form of guarantee, security, or similar indemnity or covenant," and are thus not "term preferred shares" by virtue of subparagraph 248(1)(a)(iii).

[29]            The foregoing analysis is also buttressed by another recent Supreme Court of Canada authority. In Will-Kare Paving & Contracting v. Canada, [2000] 1 S.C.R. 915 at para 30 it was held that legislation aimed at a narrow commercial context invites an interpretation of its provisions consistent with their accepted meaning within that context (see also Resman Holdings Ltd. v. The Queen, [2001] 3 C.T.C. 441 at 453 (FCA), leave to appeal denied February 22, 2001 [2001] S.C.C.A. No. 404); Unwin v. Hanson, [1891] 2 Q.B. 115 at 119). Each of these authorities supports the proposition put forward by Citibank, namely that where legislation applies to a narrow commercial context, Parliament must make clear its intention to apply a meaning other than that ascribed by settled commercial law. Based on these authorities, the ordinary meaning put forward by the Minister must be discarded in favour of a definition of the operative words guarantee, security, indemnity and covenant as applied in the commercial context.

[30]            The parties spent considerable time in argument attempting to create business models of conversion ratios and formulae that might or might not be permitted under subparagraph 248(1)(a)(iii); an exercise that approaches an "economic realities" analysis so roundly criticised by the Supreme Court of Canada in the Shell decision, supra, at paragraph 30. Be that as it may, even if I were to accept that the disputed words were to be given a meaning other than their accepted commercial meaning, the Minister's argument appears not to be viable.

[31]            The Minister asserted that a right of conversion does not provide a guarantee or security if the ratio is established at the date the preference shares are issued, but will provide a guarantee if the ratio is established at the date the preference shares are converted. It is clear that both the Citibank conversion model and the model favoured by the Minister afford the holder the possibility to recoup some but not all of the amount invested. It is also true that in the Citibank conversion formula, the issuing corporations agreed to issue a number of shares on conversion, but Citibank had no assurance as to the value it would realise when the shares were sold. Like any common share holder, Citibank would be subject to the vagaries of the market and tied to the economic fortunes of the issuers upon conversion of the preferred shares into common shares.

[32]            Another difficulty with the Minister's argument that the disputed words should be interpreted broadly as including any arrangement that renders protection against loss is that, if accepted, it would appear to render subparagraph 248(1)(a)(iv) inoperative. This is so because subparagraph (iv), supra, at paragraph [9], expressly authorizes conversion of a preferred share into a share which is not a term preferred share as defined. If the disputed words mean the ability to recoup a portion of the amount invested by converting to common shares, neither the Minister's nor Citibank's model would satisfy the statute. Given the Minister's position that a conversion formula which represents some protection against loss would trigger the definition, it is impossible to envision an acceptable conversion formula unless the conversion formula provides for a loss at the date of conversion. No commercially acceptable conversion formula would remain to be dealt with under subparagraph 248(1)(a)(iv). Indeed, it appears that there is no conceivable conversion formula that would create a converted share which is not a term preferred share, and accordingly subparagraph 248(1)(a)(iv) would be rendered meaningless.

[33]            The Minister's proposed interpretation ignores the commercial context of subparagraph 248(1)(a)(iii) and would deem the Citibank conversion formula to be impermissible simply because the Minister views the possibility of Citibank's recovery as being better than under another model. In my analysis, no such limitation can reasonably be attributed to the words in the definition. The Supreme Court of Canada has consistently warned against finding unexpressed Parliamentary intent in detailed and clearly worded provisions in the Income Tax Act: Shell, supra, at para 30; Canada v. Antosko, [1994] 2 S.C.R. 312 at 326-7; Friesen v. Canada, [1995] 3 S.C.R. 103 at para 11; Alberta (Treasury Branches) v. Canada (MNR), [1996] 1 S.C.R. 963 at para 15. In my analysis, Mogan, J.T.C.C. adopted the correct approach when he wrote:

I refuse to read into the statutory definition of "term preferred share" any fresh words or to draw any inference with respect to legislative intent which will permit the Minister to capture one share because it has a certain conversion formula but release another share because it has a different conversion formula.

[34]            I would dismiss the appeal with costs.

                                                                                              "B. Malone"                 

                                                                                                              J.A.

"I agree

J. Richard

C.J."

"I agree

John M. Evans

J.A."             

                          FEDERAL COURT OF APPEAL

    NAMES OF COUNSEL AND SOLICITORS OF RECORD

DOCKET:                   A-73-01

STYLE OF CAUSE:

        HER MAJESTY THE QUEEN and CITIBANK CANADA

PLACE OF HEARING:                                   TORONTO, ONTARIO

DATE OF HEARING:                                     FEBRUARY 5, 2002

REASONS FOR JUDGMENT :                                MALONE J.A.

CONCURRED IN BY:                                                                                        RICHARD C.J.

                                                                                               EVANS J.A.

DATED:                      APRIL 5, 2002

APPEARANCES:

Ms. Alexandra K. Brown

Mr. David E. Spiro

FOR THE APPELLANT

Mr. Warren J.A. Mitchell

Mr. John R. Owen

Ms. Stephanie A. Wong

FOR THE RESPONDENT

SOLICITORS OF RECORD:

Mr. Morris A. Rosenberg

Deputy Attorney General of Canada

Ottawa, Ontario

FOR THE APPELLANT

Thorsteinssons

Toronto, Ontario          FOR THE RESPONDENT