Perrault v. The Queen, 78 DTC 6272, [1978] CTC 395 (FCA)

Le Dain, J:—This is an appeal from a judgment of the Trial Division dismissing an appeal from a decision of the Tax Review Board, which dismissed the appellant’s appeal from an assessment for income tax in respect of the 1965 taxation year.

The issue in the appeal is whether the sum of $350,005.50 paid as a dividend in November, 1965 by Montreal Terra Cotta Limited, a company of which the appellant Charles Perrault was the controlling shareholder, to Central Motor Sales Ltd and paid over by the latter in satisfaction of indebtedness to its controlling shareholder, the Estate of A H Rocheleau, and in consideration of which Central Motor Sales Ltd transferred its shares in Montreal Terra Cotta Limited to the appellant, should be included in the appellant’s income for the 1965 taxation year as a benefit to him within the meaning of paragraphs 8(1)(b), (c), subsections 16(1) or 137(2) of the Income Tax Act, RSC 1952, c 148, as amended. These provisions, as they applied to the 1965 taxation year, read as follows:

8.(1) Where, in a taxation year,

(a) a payment has been made by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction,

(b) funds or property of a corporation have been appropriated in any manner whatsoever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been conferred on a shareholder by a corporation,

otherwise than

(i) on the reduction of capital, the redemption of shares or the winding- up, discontinuance or reorganization of its business,

(ii) by payment of a stock dividend, or

(iii) by conferring on all holders of common shares in the capital of the corporation a right to buy additional common shares therein,

the amount or value thereof shall be included in computing the income of the shareholder for the year.

16.(1) A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to him.

137.(2) Where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatsoever is that a person confers a benefit on a taxpayer, that person shall be deemed to have made a payment to the taxpayer equal to the amount of the benefit conferred notwithstanding the form or legal effect of the transactions or that one or more other persons were also parties thereto; and whether or not there was an intention to avoid or evade taxes under this Act, the payment shall, depending upon the circumstances, be

(a) included in computing the taxpayer’s income for the purpose of Part I,

(b) deemed to be a payment to a non-resident person to which Part III applies, or

(c) deemed to be a disposition by way of gift to which Part IV applies.

Montreal Terra Cotta Limited (hereinafter referred to as the “Company”) was a well-established firm engaged in the. manufacture of products used in building construction. It operated plants at Pointe- Claire and Deschaillons, in the province of Quebec. It prospered in the years immediately after the Second World War, but during the 1950’s technological change in building construction caused it to lose the market for its principal product. The owners of the Company made efforts during the 1950’s and early 1960’s to find a buyer for the Company, but without success. In 1962, A H Rocheleau, who held his shares in the Company through Central Motor Sales Ltd, (hereinafter referred to as “Central Motor”) died leaving an estate that encountered the need of funds to meet debts and succession duties. About 1964 the appellant began to take a less active part in the Company because of ill-health. The Company was heavily indebted and in the fiscal year ending February 28, 1965, it suffered a loss after depreciation. In 1964 the plant at Pointe-Claire was closed down. Negotiations were carried out to sell the property at Pointe-Claire. Operations were continued on a reduced scale at the Deschaillons plant. The plan was to dispose of the existing inventory, pay the debts of the Company and wind up the business as soon as possible.

Mr L P Belair, a member of the Company’s firm of auditors and an executor of the Rocheleau Estate, was active throughout this period in attempting to find a buyer for the Company and in looking after the interests of the Estate. The Estate was in financial difficulties. When the Company succeeded in making arrangements for the sale of its property at Pointe-Claire, from which it was to realize some $465,000 in cash, Bélair conceived the plan of transferring some of these funds to the Estate Rocheleau. At that time the shares of the Company were held as follows: the appellant—273; Central Motor—193; Oscar Nomm—24. The plan was that the Company would pay the value of the shares held by Central Motor in the form of a dividend to the latter company, in return for which Central Motor would transfer its shares in the Company to the appellant. Bélair wrote out an offer to purchase to be signed by the appellant as follows:

Je, soussigné, offre de me porter acquéreur des actions de Montreal Terra Cotta Limited détenues par Central Motor Sales Co Ltd pour un dollar et autres valables considérations.

Comme autre considération, si mon offre est acceptée, je m’engage à faire verser à Central Motor Sales Co Ltd la somme de $350,000 après quoi, les 193 actions de Montreal Terra Cotta Limited devront m’être livrées dûment endossées.

Cette offre est valable jusqu’au 15 août 1965 a midi, date limite où la succession devra l’accepter en contresignant la présente lettre. A compter de cette date, la somme de $350,000 devra être versée dans un délai de 90 jours.

Comme gage de ma bonne foi, j’inclus un chèque de $10,000 à l’ordre de la succession. Ce cheque devra m’être remis lors de la finalisation de la transaction.

This offer was signed by the appellant on July 28, 1965 and accepted on behalf of the Estate of A H Rocheleau by Belair and the other executor on August 12, 1965. Belair also obtained the signatures of all the heirs. It was not signed on behalf of Central Motor. Belair retained the only copy of the offer.

In September, 1965, the Company sold to Elysee Realties Ltd part of its property at Pointe-Claire for a price of $465,000, of which $15,000 was paid in cash at the time of sale, and another part of the said property to the City of Pointe-Claire for a price of $435,000 cash. It was from the proceeds of the latter sale that the dividend was to be paid to Central Motor.

In November and December, 1965, the following transactions were put through:

1. On November 1st the appellant issued a cheque for $1.00 to the Estate of A AH Rocheleau;

2. On November 11th the appellant purchased the shares of the Company held by Oskar Nomm for the sum of $50,000;

3. On November 15th a meeting of the board of directors of the Company was held at which a dividend of $1,813.50 per share was declared and the appellant and Nomm renounced their right to the dividend;

4. On the same day a cheque for $350,005.50 was issued by the Company to Central Motor and endorsed on behalf of the latter by Belair for deposit into the account of the Estate Rocheleau;

5. On or about the same day the shares of the Company held by Central Motor were transferred to the appellant;

6. On December 30th the Company issued a cheque payable to Nomm in the amount of $50,000 in payment for the shares sold to the appellant. This amount was charged to the appellant’s account and written off when the Company was liquidated.

On December 1, 1966, the Company sold the plant at Deschaillons to a newly incorporated company, Montreal Terra Cotta (1966) Ltd, and the Company was liquidated around the end of 1966 or the beginning of 1967. On liquidation the appellant, as the sole beneficial shareholder, received (a) $60,000 in cash or credit (of which $50,000 had been used to pay for the shares of Nomm); (b) shares in the new company which had been issued for $7,000; (c) a mortgage of $400,000 on the Deschaillons property and (d) the balance of the property at Pointe-Claire which had been repossessed upon default by Elysee Realties Ltd.

The appellant was assessed in respect of his 1965 taxation year by inclusion of the sum of $350,005.50 as a benefit conferred on him by the Company. The assessment was confirmed by the Minister on the basis of subsection 8(1) of the Income Tax Act. An appeal to the Tax Review Board was dismissed, also on the ground that the payment by the Company of the said sum to Central Motor conferred a benefit or advantage on the appellant within the meaning of subsection 8(1). An appeal from this decision to the Trial Division was dismissed on the ground that the benefit was one within the terms of subsection 16(1) of the Act.

The learned trial Judge found that the sum of $350,005.50 was a “fair and realistic price’’ for the shares. He further observed that the total value of the shares held by the appellant in the Company, including those acquired from Central Motor, had necessarily been reduced by this amount. But after stating at one point that the value of the shares acquired by the appellant was to be determined as of the date of their acquisition and that what happened subsequently to the Company was irrelevant, the trial Judge concluded from a comparison of the financial statements of the Company for the fiscal years ended February 28, 1965 and 1966 respectively that there had been an in- crease in shareholders’ equity and that the appellant had therefore failed to show that he did not receive a benefit by the acquisition of the shares. This conclusion is contained in the following passages from the reasons of the trial Judge:

The balance sheet of Montreal Terra Cotta Limited as of February 28, 1965, showed Shareholders Equity of $967,779.43 which included the paid up capital of $49,000 and capital surplus of $100,182.07. The 490 shares therefore had a book value of somewhat under $2,000 each. Oskar Nômm was paid $50,000 for the 24 shares which plaintiff bought from him—a generous payment to a long-time employee. The amount of $1,813.50 paid by way of a dividend declaration for acquisition by plaintiff of Central Motor Sales Ltd’s shares appears to be a fair and realistic price.

After the dividend declaration and payment the next balance sheet of the company as of February 28, 1966, shows Shareholders Equity of $1,122,912.14. The capital surplus figure has now been eliminated but accumulated earnings have gone up from $818,597.36 to $1,073,912.14. It is apparent that, with plaintiff now being the sole shareholder, the shareholders’ equity, far from being reduced, has increased.

There is nothing therefore to indicate that plaintiff did not in fact receive a benefit by acquiring the additional shares without paying for same personally.

The appellant attacked this conclusion on the ground that the trial Judge misunderstood the significance of the apparent appreciation in value reflected in the financial statements. He argued that the increase in the shareholders’ equity was an increase in the book value of the physical assets resulting from the transactions involving the real property which took place in 1965 and the effect of which was taken into account in determining the price to be paid for the shares.

In my opinion there is much force in the appellant’s contention that in the circumstances he did not gain much, if anything, in value by the acquisition of the shares of Central Motor when, as a result of the payment of the dividend, the shareholders’ equity was reduced by $350,000. But this does not exhaust the question of whether the appellant received a benefit from the payment that was made by the Company to Central Motor. By the offer to purchase, which was accepted by the Estate Rocheleau, the appellant became legally obliged to cause the sum of $350,000 to be paid to Central Motor. The payment of this sum by the Company to Central Motor in the form of a dividend extinguished the appellant’s obligation and to this extent conferred a benefit upon him of the value of $350,000.

Counsel for the appellant sought to diminish the legal significance and effect of the agreement between the appellant and the Estate Rocheleau by suggesting that it did not reflect the true intention of the appellant. He contended, on the basis of the testimony of the appellant and Bélair, that the appellant was not interested in purchasing the shares of the other shareholders but was rather interested in selling the Company or liquidating it; that the sole purpose of the scheme was to assist the Estate Rocheleau in its financial difficulties and that it was never intended to confer a benefit on the appellant; and that what was done could be likened to a reduction of capital or a redemption of the shares, by the Company, or a distribution to the Estate Rocheleau of its share of the assets of the Company as a first Step in the winding-up of its business. The testimony tends to support certain aspects of this view of what was generally contemplated by the parties, but it cannot alter the language of the agreement that was actually signed. The agreement creates an obligation on the part of the appellant to cause the sum of $350,000 to be paid to Central Motor, as clearly indicated by the words “je m’engage à verser à Central Motor Sales Co Ltd la somme de $350,000’’. I do not see how we can ignore this language, however regrettable it may be for the appellant, and adopt the position that the parties to the agreement never really intended that the appellant should incur a legal obligation to cause this payment to be made. The agreement is unambiguous, but even if full weight be given to the testimony in an attempt to interpret its terms, the testimony falls. short of establishing that the appellant did not intend to bind himself by the offer he signed. Whatever may have been the understanding of the appellant as to the nature and purpose of the plan proposed by Bélair, the appellant gave his free consent to the agreement to purchase and he is bound by its terms.

The appellant argued that the transaction was essentially one of payment of a dividend and that it should be taxable as such or not at all. The dividend did not attract tax in the hands of Central. Motor because deduction of it as an inter-corporation dividend was. permitted by section 28 of the Act. In effect, the appellant contended that the same payment should not give rise to taxability as a dividend and as a benefit since this would be a form of double taxation. As I see it, if a shareholder chooses to take payment in the form of 2 dividend for a-sale of his shares to another shareholder under an agreement such as the one in this case then h:s must be the result, however excessive from the fiscal point ot view it may appear. There is no basis on which the selling shareholder can be said not to have received a dividend within the meaning of section 6, and there is no basis on which the purchasing shareholder can be said not to have received a benefit. The selling shareholder has received a dividend; the purchasing shareholder has received a benefit in that the payment of the dividend has satisfied his obligation to pay the price of the Shares. It is not the payment of the dividend but its effect that constitutes the benefit. It is undeniable that a payment by a corporation, whatever its form, which has the effect of extinguishing a debt or obligation of a shareholder must be considered to be a benefit conferred on him. See, for example, MNR v Bisson [1972] FC 719 at 726-7 and 728-9; [1972] CTC 446; 26 DTC 6374. The value of what he acquired in consideration of the debt or obligation is really irrelevant.

The appellant further argued that there were several ways in which this operation or transaction could have been carried out so as not to attract tax liability for the appellant, but we must determine the issue of taxability on the basis of what was in fact done. The operation was not a reduction of capital nor a redemption of shares by a com- pany nor a distribution on the winding-up or discontinuance of the company’s business. As to the last, the appellant contended that the payment to Central Motor for the benefit of the Estate Rocheleau was simply a step in the winding-up of the company, and he cited in support of this proposition the decision of the Supreme Court of Canada in Smythe v MNR, [1970] SCR 64 at 71; [1969] CTC 558; 23 DTC 5361, in which Judson, J, delivering the judgment of the Court, adopted the reasoning of MacLean, J of the Exchequer Court of Canada in Merritt v MNR, [1941] Ex CR 175 at 181-2 [1940-41] CTC 226; 2 DTC 513 and held that “there was a winding-up and a discontinuance of the business of the old company, although it is apparent that there was no formal liquidation under the Winding-up Act or the winding-up provisions of the Ontario Companies Act". In both these cases the result of the transactions in issue was that the companies no longer had any assets with which to carry on business. The same cannot be said of the Company in the present case after the payment of the dividend to Central Motor. Although the intention may well have been to wind-up or discontinue the business of the Company in the near future, it continued to carry on business at the Deschaillons plant, albeit on a reduced scale, through 1966. After the payment of the dividend the Company still had assets with which to carry on business and did in fact do so. I would conclude, therefore, that the payment of the dividend was not part of the winding-up or discontinuance of the Company so as to exclude the application of subsection 8(1) of the Act or to make subsection 81(1) applicable, as it was in the Smythe case.

The appellant contended that there were other bases on which the payment could have been made subject to tax, in particular, section 138A with respect to dividend stripping, which might have been applied to the receipt of the payment by the Estate Rocheleau, assuming it involved a distribution of income. Although the Estate Rocheleau was the recipient of the benefit it was not assessed in respect of it. It is this aspect of the case that is understandably disturbing to the appellant: that the Estate Rocheleau should escape taxation in respect of a payment that was clearly made for its benefit, and that the appellant should be subject to taxation in respect of it because of the form in which the transaction was carried out. I have much sympathy with this view but I do not see how this consequence can be avoided without ignoring the plain terms of the agreement to purchase and doing violence to the language of the applicable provisions of the Income Tax Act. Whether the Estate Rocheleau was taxable on the basis of section 138A or some other provision of the Act I do not know, but assuming that it was, this is again the argument with respect to double taxation which the appellant raised with reference to the taxability of the payment as a dividend in virtue of section 6. It is once again the question whether, as a matter of principle, a single payment should be capable of being treated under different provisions of the Act as income in the hands of two taxpayers. Where the payment is received by one but has the effect of conferring a benefit on the other then it involves two distinct transfers or receipts, each of which may be sub- ject to taxation on a separate basis. It is not being taxed twice in the hands of the same person. The appellant’s argument in essence is that the economy and spirit of the Act require that the payment be taxed once. I find nothing in the Act which dictates this result. The incidence of taxation depends on the manner in which a taxpayer arranges his affairs. Just as he may arrange them to attract as little taxation as possible, so he may unfortunately arrange them in such a manner as to attract more than is necessary.

Finally, the appellant argued that if he was to be taxed in respect of the payment it should be as the receipt of a dividend with the benefit of the dividend tax credit. The payment was not the payment of a dividend to the appellant. It was the payment of a dividend to Central Motor. It was the effect of the payment under the agreement to purchase that conferred a benefit on the appellant. There is no way that the receipt of that benefit can be considered to be the receipt of a dividend.

The Crown relied on both subsections 8(1) and 16(1) as the basis for including the benefit in the income of the appellant. The appellant contended, citing MNR v Pillsbury Holdings Limited [1965] 1 Ex CR 676 at 682-3; [1964] CTC 294; 18 DTC 5184, that subsection 8(1) does not apply to payments by way of dividend. The answer to that contention, for the reasons indicated above, is that the benefit conferred on the appellant was not by way of dividend but by the satisfaction of the appellant’s debt or obligation as a result of the payment of a dividend to a third person. As such it is a benefit conferred on a shareholder by a corporation within the meaning of paragraph 8(1)(c) of the Act. In so far as subsection 16(1) is concerned, I am doubtful that the payment by the Company to Central Motor should be considered to be a “payment or transfer of property” within the meaning of that section even if it could be said to have been made “pursuant to the direction of, or with the concurrence of’ the appellant, who although only one of the three directors required to approve the payment of the dividend was the controlling shareholder of the Company and thus able to make his will ultimately prevail. The “payment or transfer of property” in this case was by way of dividend, and the reasoning which the appellant directed to subsection 8(1) would appear to have application here. I doubt whether these words were. intended to apply to the payment of a dividend, which is governed by section 6 of the Act.

For the foregoing reasons I would dismiss the appeal with costs.

Hyde, D J:—For the reasons given by Mr Justice Le Dain I would dismiss this appeal with costs.