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Citation: 2006TCC441
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Date: 20070222
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Docket: 2005-4286(IT)G
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BETWEEN:
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FORD CREDIT CANADA LIMITED,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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AMENDED REASONS FOR JUDGMENT
(These Reasons for Judgment are issued in
substitution for
the Reasons for Judgment signed on August 4,
2006)
Bowman,
C.J.
[1] These appeals are
from assessments for the 2001, 2002 and 2003 taxation years. The assessments
were made under Part I.3 of the Income Tax Act.
[2] The issue is
whether the appellant is required by subsection 181.3(3) of the Income Tax
Act to include the amount of its Class C retractable preferred shares in
its capital for the purposes of the Large Corporations Tax (“LCT”). The
appellant did not do so and says that it did not have to. The respondent says
that it should have.
[3] The parties filed a
statement of agreed facts and it is attached as Schedule A to these
reasons. In addition the appellant called an expert accounting witness.
[4] Subsection 181.1(1)
imposes a tax on certain types of corporations. The tax is a percentage of the
corporation’s “taxable capital employed in Canada in the year” less its “capital
deduction”.
[5] The appellant is prescribed
to be a “financial institution” for the purposes of Part I.3. The taxable
capital of a financial institution under subsection 181.3(2) is its capital for
the year less its investment allowance.
[6] Paragraph 181.3(3)(a)
reads as follows:
(3) The capital of a financial
institution for a taxation year is
(a) in the case of a financial
institution, other than an authorized foreign bank or an insurance corporation,
the amount, if any, by which the total at the end of the year of
(i) the amount of its
long‑term debt,
(ii) the amount of its capital stock
(or, in the case of an institution incorporated without share capital, the
amount of its members' contributions), retained earnings, contributed surplus
and any other surpluses, and
(iii) the amount of its reserves for
the year, except to the extent that they were deducted in computing its income
under Part I for the year,
exceeds the total of
(iv) the amount of its
deferred tax debit balance at the end of the year,
(v) the amount of any deficit deducted
in computing its shareholders' equity at the end of the year, and
(vi) any amount deducted under
subsection 130.1(1) or 137(2) in computing its income under Part I for the
year, to the extent that the amount can reasonably be regarded as being
included in the amount determined under subparagraph (i), (ii) or (iii) in
respect of the institution for the year;
[7] The relevant
portions of that provision are “(i) the amount of its long‑term debt,”
[and] “(ii) the amount of its capital stock ...”. The question is whether the amount
of the 1,170,000 Class C special shares issued by the appellant to Ford
Credit Canadian Lending LP fall within “the amount of its capital stock”.
Although, as set out below, the accountant treated the Class C shares as “debt”
for balance sheet purposes and, as an accounting matter, as long term debt,
they are not “long term debt” within the definition of that expression in subsection 181(1).
[8] Paragraphs 7, 8, 9
and 10 of the agreed statement of facts read:
7. On July 23, 2001, the issuance
of up to 1,400,000 Class C Special Shares was duly authorized by the Appellant
(the "Class C Special Shares"). The Class C Special Shares are
retractable at the option of the holder.
Joint
Book of Documents, Tab 3 at
pages
24-30
8. On July 25, 2001, Ford Credit
Canadian Lending, LP by its general partner, Ford Credit International, Inc.
subscribed for 1,170,000 of the Class C Special Shares at an amount of $1,000
per share.
Joint
Book of Documents, Tab 4 at
pages
31-32
9. Paragraph (b) of Note 5 to the
Appellant's financial statements for its 2001 fiscal year and
paragraph (c) of Note 6 to the Appellant's financial statements for
its 2002 and 2003 fiscal years state as follows:
On July 31, 2001, Ford Credit Canada
Limited issued l,170,000 authorized shares of non‑cumulative voting
redeemable retractable Class C special shares at $1,000 per share;
these shares are held indirectly by Ford Credit. The Class C special
shares are entitled to a non‑cumulative dividend of up to 10% of the
stated capital of the shares and as a class, have 10% voting rights of the
outstanding shares of the Company. Since the preferred shares are retractable
at the option of the holder at any time after July 31, 2002, they are
classified as a liability for financial reporting purposes.
Joint
Book of Documents, Tabs 5, 6
and
7 at pages 43, 62 and 81
10. PricewaterhouseCoopers LLP
offered the following audit opinion in respect of the Appellant's consolidated
financial statements for its 2001 fiscal year:
In our opinion, these consolidated
financial statements present fairly, in all material respects, the financial
position of Ford Credit Canada Limited as at December 31, 2001 and 2000
and the results of its operations and its cash flows for the years then ended
in accordance with Canadian generally accepted accounting principles.
Joint
Book of Documents, Tab 8 at
page 88
[9] The same opinion
was expressed by PricewaterhouseCoopers LLP with respect to the appellant’s 2002
and 2003 fiscal years. Moreover, it is agreed by the parties that the balance
sheets for each of the 2001, 2002 and 2003 fiscal years were prepared in
accordance with generally accepted accounting principles (”GAAP”).
[10] Mr. Robert Lefrançois, FCA, was called by the appellant
as an expert accounting witness. He is a partner in the National Office of Deloitte
& Touche LLP.
[11] His report and oral testimony were comprehensive. He
was not cross‑examined. I shall describe his evidence somewhat more fully
below but its essence was that the treatment of the Class C special shares
on the consolidated balance sheet of the appellant as “debt” rather than
shareholders’
equity was in accordance with GAAP. The relevance of this conclusion within the
context of this case is found in subsection 181(3) of the Income Tax
Act which reads in part:
For the purposes
of determining the carrying value of a corporation's assets
or any other amount under this
Part in respect of a corporation's
capital, investment allowance, taxable capital or taxable capital employed in Canada for a taxation year or in
respect of a partnership in which a corporation has an
interest,
(a) the equity and consolidation methods of accounting
shall not be used; and
(b) subject
to paragraph (a) and except as
otherwise provided in this Part, the amounts reflected in the balance sheet
(i) presented to the
shareholders of the corporation (in the
case of a corporation that is
neither an insurance corporation
to which subparagraph (ii) applies nor a bank) or
the members of the partnership, as the case may be, or, where such a balance
sheet was not prepared in accordance with generally accepted accounting
principles or no such balance sheet was prepared, the amounts that would be
reflected if such a balance sheet had been prepared in accordance with
generally accepted accounting principles, ...
shall be used.
[12] In other words, the
balance sheet presentation must be accepted and if the balance sheet
presentation is not in accordance with GAAP the amounts must be as reflected on
a balance sheet as if it were prepared in accordance with GAAP.
[13] Mr. Lefrançois’s evidence was unequivocal
that the Class C shares had to be shown as debt and that an accountant
preparing the financial statements would have no option and no discretion to treat
the Class C shares in any other way, such as shareholders’ equity.
[14] The reason for this accounting treatment is, according
to Mr.
Lefrançois, that for
accounting purposes, substance prevails over form. His report sets out the
salient features of the Class C shares that in his view justify their balance
sheet treatment as debt. It is probably unnecessary to repeat the provisions —
the shares are redeemable and retractable — but the specific provisions will
make the accounting conclusions somewhat more meaningful. The following appears
in the expert’s report:
a) What are the
relevant features of the Company's Class C Special Shares as far as GAAP is
concerned?
A detailed description of the terms of the
1,400,000 Class C Special Shares authorized by the Company is found in the
Certificate of Amendment under the Canada Business Corporations Act,
dated July 24, 2001. As far as the appropriate presentation under
GAAP is concerned, their salient features are as follows:
* * *
6.3 Redemption − The
Corporation may from time to time upon prior written notice to the holders of
such shares to be redeemed, specifying the number of shares to be redeemed and
a date for such redemption not more than 30 days nor less than 5 days
following the giving of such notice, redeem on or after such date any or all of
the Class C Special Shares at the Redemption Price. If less than all of the
Class C Special Shares are to be redeemed, such shares shall be redeemed pro
rata according to the number of Class C Special Shares then held by each holder
or in such other manner as the directors determine with the consent of all
holders of Class C Special Shares. On and after such date for redemption a
holder of any such shares to be redeemed shall have no rights in respect of
such shares, irrespective of any prior record date, unless payment therefor
shall not be made as hereinafter provided in which case (in addition to any
other rights or remedies) the rights of such holder shall remain unimpaired,
except to receive payment of the Redemption Price, without interest, within 5
days following due presentation and surrender of certificates therefor at the
registered office of the Corporation.
6.4 Retraction — Any holder of Class
C Special Shares may from time to time upon prior written notice to the
Corporation after July 31, 2002, specifying the number of shares to
be redeemed and a date for such redemption not more than 30 days nor less
than 5 days following the giving of such notice, require the Corporation
to redeem any or all of the Class C Special Shares then held by such holder at
the Redemption Price. On and after such date for redemption such holder shall
have no rights in respect of such shares to be redeemed, irrespective of any
prior record date, unless payment therefor shall not be made as hereinafter
provided in which case (in addition to any other rights or remedies) the rights
of such holder shall remain unimpaired, except to receive payment of the
Redemption Price, without interest, within 5 days following due presentation
and surrender of certificates therefor at the registered office of the
Corporation.
* * *
6.6 Dissolution − In the event
of the liquidation, dissolution or winding-up of the Corporation, whether
voluntary or involuntary, or any other distribution of the assets of the
Corporation among its shareholders for the purpose of winding up its affairs,
each holder of Class C Special Shares shall be entitled, after payment or
provision for payment of the debts and other liabilities of the Corporation and
the amounts payable in such event to the holders of Class A Special Shares and
Class B Special Shares, but before any distribution to the holders of Common
Shares, to payment of an amount equal to the aggregate stated capital of all
Class C Special Shares then held by such holder together with all unpaid
dividends declared on such shares, but shall not be entitled to share in any
further distribution of the assets of the Corporation. If the amount available
for payment is not sufficient to pay all holders of Class C Special Shares in
full, such holders shall share ratably in the amount available in proportion to
the amounts which would be paid to such holders, respectively, if the amounts
otherwise payable to such holders were paid in full.
6.7 Redemption Price − For the
purposes of the foregoing provisions, "Redemption Price" means an
amount per Class C Special Share redeemed equal to the stated capital per Class
C Special Share, plus an amount equal to any unpaid dividends declared thereon,
at the date of payment for such share.
[15] The Class C
shares having the characteristics described above must, according to the expert
witness, under GAAP be treated as liabilities and not as equity on the balance
sheet. The Handbook of the Canadian Institute of Chartered Accountants (the
“CICA”) that was in effect in the years in question contained the following
definitions:
DEFINITIONS
The following terms are
used in this Section with the meanings specified:
(a) A
financial instrument is any contract that gives rise to both a financial
asset of one party and a financial liability or equity instrument of another
party.
(b) A financial
asset is any asset that is:
(i) cash;
(ii) a
contractual right to receive cash or another financial asset from another
party;
(iii) a
contractual right to exchange financial instruments with another party under
conditions that are potentially favourable; or
(iv) an
equity instrument of another entity.
(c) A
financial liability is any liability that is a contractual obligation:
(i) to
deliver cash or another financial asset to another party; or
(ii) to
exchange financial instruments with another party under conditions that are
potentially unfavourable.
(d) An
equity instrument is any contract that evidences a residual interest in
the assets of an entity after deducting all of its liabilities.
(e) Monetary
financial assets and financial liabilities (also referred to as monetary
financial instruments) are financial assets and financial liabilities to be
received or paid in fixed or determinable amounts of money.
PRESENTATION
Liabilities and equity
The
issuer of a financial instrument should classify the instrument, or its
component parts, as a liability or as equity in accordance with the substance
of the contractual arrangement on initial recognition and the definitions of a
financial liability and an equity instrument.
[JAN. 1996]
The substance of a
financial instrument, rather than its legal form, governs its classification on
the issuer’s balance sheet. While substance and legal form are commonly
consistent, this is not always the case. For example, some financial
instruments take the legal form of equity but are liabilities in substance and
others may combine features associated with equity instruments and features
associated with financial liabilities. The classification of an instrument is
made on the basis of an assessment of its substance when it is first
recognized. That classification continues at each subsequent reporting date
until the financial instrument is removed from the entity’s balance sheet.
The critical feature in
differentiating a financial liability from an equity instrument is the
existence of a contractual obligation on one party to the financial instrument
(the issuer) either to deliver cash or another financial asset to the other
party (the holder) or to exchange another financial instrument with the holder
under conditions that are potentially unfavourable to the issuer. When such a
contractual obligation exists, that instrument meets the definition of a
financial liability regardless of the manner in which the contractual
obligation will be settled. A restriction on the ability of the issuer to
satisfy an obligation, such as lack of access to foreign currency or the need
to obtain approval for payment from a regulatory authority, does not negate the
issuer’s obligation or the holder’s right under the instrument.
When a financial
instrument does not give rise to a contractual obligation on the part of the
issuer to deliver cash or another financial asset or to exchange another
financial instrument under conditions that are potentially unfavourable, it is
an equity instrument. Although the holder of an equity instrument may be
entitled to receive a pro rata share of any dividends or other distributions
out of equity, the issuer does not have a contractual obligation to make such
distributions. Thus the terms and conditions of certain preferred shares may be
such that they meet the definition of an equity instrument and are classified
accordingly.
When a preferred share provides
for mandatory redemption by the issuer for a fixed or determinable amount at a
fixed or determinable future date or gives the holder the right to require the
issuer to redeem the share at or after a particular date for a fixed or
determinable amount, the instrument meets the definition of a financial
liability and is classified as such. A preferred share that does not establish
such a contractual obligation explicitly may establish it indirectly through
its terms and conditions. For example, a preferred share that does not provide
for mandatory redemption or redemption at the option of the holder may have a
contractually provided accelerating dividend such that, within the foreseeable
future, the dividend yield is scheduled to be so high that the issuer will be
economically compelled to redeem the instrument. In these circumstances,
classification as a financial liability is appropriate because the issuer has
little, if any, discretion to avoid redeeming the instrument. Similarly, if a
financial instrument labelled as a share gives the holder an option to require
redemption upon the occurrence of a future event that is highly likely to
occur, classification as a financial liability on initial recognition reflects
the substance of the instrument.
[16] Mr. Lefrançois traced the evolution since
1996 of the accounting rules with respect to the balance sheet presentation of
financial instruments such as the Class C special shares. Nothing in the
changes that have taken place over the years casts any doubt on the proposition
that the treatment of these shares as debt in the years in question in the
balance sheet not only was in accordance with GAAP but was the only treatment
permissible under GAAP.
[17] The treatment under GAAP is hardly surprising. It is similar
to what the courts have recognized for over half a century that the position of
preference shareholders is in many respects economically if not legally more
closely approximated to that of debenture holders.
[18] In In re The Isle of Thanet Electricity Supply Co.
Ld., [1950] 1 Ch. 161 at 175, Evershed M.R. said at
p. 175:
I think, for myself, that
during the sixty years which have passed since Birch v. Cropper (6) was
before the House of Lords the view of the courts may have undergone some change
in regard to the relative rights of preference and ordinary shareholders, and
to the disadvantage of the preference shareholders, whose position has, in that
interval of time, become somewhat more approximated to the role which Sir
Horace Davey attempted to assign to them, but which Lord Macnaghten
rejected in Birch v. Cropper (6), namely, that of debentureholders.
[19] Mr. Erlichman argues
with considerable force that notwithstanding the wording of subsection 181(3)
“capital stock” in paragraph 181.3(3)(a) means capital stock and the
fact the share capital in the form of the redeemable retractable Class C special
shares is treated for balance sheet purposes as debt is of no consequence. I
would agree with Mr. Erlichman were it not for subsection 181(3). I see
nothing in the cases cited by Mr. Spiro under the heading in his written
submissions “The Judicial Interpretation of Provincial Capital Tax Legislation
without the Equivalent of Subsection 181(3)” that would support the view that
without subsection 181(3) “capital stock” should not be given its ordinary
legal meaning. Without subsection 181(3) the Class C special shares would
be capital stock notwithstanding the fact that as a matter of economic
substance, accountants may treat them as debt. It is true that undefined
accounting concepts should generally be given a meaning that accountants would
assign to them: Canfor Limited v. Minister of Finance for British Columbia, [1976]
C.T.C. 429 at 431; [1977] C.T.C. 269; [1978] 1 S.C.R. 1047; Upper Lakes
Shipping Ltd. v. M.N.R., [1998] 3 C.T.C. 281; Reford v. M.N.R., 71 DTC
5053. Nonetheless, the principles stated in those cases do not, in the absence
of specific statutory direction, allow accounting treatment to prevail over the
legal meaning of words in the Income Tax Act. In other words, accounting
concepts are to be given in appropriate circumstances a meaning that is
familiar to accountants. This is not, however, the same as saying that if words
have a clear meaning in law, the fact that accountants may, on the substance
over form principle, treat them as having a different meaning, the legal
meaning can be ignored. If, however, Parliament wishes us to do just that, it
is clearly within its power to do so.
[20] The only basis upon
which the Appellant can succeed is subsection 181(3).
[21] The Appellant
reproduced subsection 181(3) as follows:
For the purposes of
determining the carrying value of a corporation’s assets or any other amount
under this Part in respect of a corporation’s capital, investment allowance,
taxable capital or taxable capital employed in Canada for a taxation year ...,
(a) the equity and
consolidation methods of accounting shall not be used; and
(b) subject to
paragraph (a) and except as otherwise provided in this Part, the amounts reflected
in the balance sheet
(i) presented to the
shareholders of the corporation ... prepared in accordance with generally
accepted accounting principles ...
shall be used.
[22] I have reproduced
subsection 181(3) in its entirety above and I think the deletion of portions can
be a little misleading. The deletions leave the impression that the words
“prepared in accordance with generally accepted accounting principles” modify
the words “balance sheet” in subparagraph (b) that immediately precedes clause
(i). It may be a necessary inference from reading subsection 181(3) as a whole
that that is what is meant, on the basis that the balance sheet presented to
the shareholders is prepared in accordance with GAAP because if it is not we
have to hypothesize how the amounts would have been presented if the balance
sheets were prepared in accordance with GAAP. It may come to the same thing but
there is a subtle change in emphasis from “prepared in accordance with GAAP” to
“presented to the shareholders”. (“les montants ... soit ceux qui figurent au bilan présenté aux
actionnaires ...”).
[23] At all events we have here a balance sheet that is
clearly prepared in accordance with GAAP and the “amount” of the Class C
special shares is shown as debt (but not “long‑term debt” as defined in
section 181) not as capital stock.
[24] Mr. Erlichman has put forward every argument that is
available but I do not think, with respect, that he can overcome the fact that
Parliament has in this instance given a role to the accountants and to GAAP
that neither Parliament nor the courts have seen fit to do absent a specific
provision. Generally speaking the Canadian courts in tax matters show little
deference to GAAP (see Ikea Limited v. The Queen, 94 DTC 1112 (TCC), 96
DTC 6526 (FCA), 98 DTC 6092 (SCC). In Part I.3 they are required to do so. Mr. Erlichman
in paragraph 23 of his written argument said:
If the Court accepts that the Class
C Special Shares are excluded by operation of subsection 181(3) of the Act and
that deference should be given to accounting principles even when terms are not
specific to accounting, it is respectfully submitted that the effect would be
to surrender the determination of the fiscal base of the LCT to a non-elected
group of accountants.
[25] This prospect may be a little upsetting to lawyers and
judges but I think that that is precisely what Parliament has said should be done,
and what this court and the Federal Court of Appeal have done.
[26] We are not, in Part I.3, dealing with the computation
of income, a function that courts have jealously guarded to themselves. We are
dealing with a tax on capital and the base upon which the tax is to be computed.
It is not surprising if Parliament were to direct us to look to the manner in
which accountants measure that base. As Archambault J., said in Oerlikon Aérospatiale
Inc. v. The Queen, [1998] 4 C.T.C. 2821 at 2838 :
. . . I believe that accounting
principles must be used to determine not only the value, but also the nature of
the elements set out in subsection 181.2(3) of the Act. The value
appearing in a balance sheet has meaning only when it is linked to a specific
heading.
[27] At 2834, he said:
As to the scope of the term
“reserves”, it should be noted that the Act provides a definition of
this term in section 181. However, that definition contains the very word that
is to be defined, “reserves” being stated to mean “the amount of all of the
corporation’s reserves”. This definition specifically states however that
the word “reserves”, as used in Part I.3, includes “provisions” and “any
provision in respect of deferred taxes”, but not allowances for depreciation or
depletion.
The definition does not
specify what a reserve is for the purposes of Part I.3. We must therefore
look to the ordinary meaning of this term as it is used in accounting. The
Canadian Institute of Chartered Accountants, as well as the Ordre des experts
comptables de France and the Institut des Réviseurs d'Entreprises de Belgique have collaborated
in preparing the Dictionnaire de la comptabilité et de la gestion financière
(Dictionnaire de la comptabilité), which gives, at page 631, three
meanings for the English term "reserve", two of which are relevant
here:
[28] The Tax Court of Canada’s decision was upheld in the
Federal Court of Appeal [1999] 4 C.T.C. 358.
[29] In Manufacturers Life Insurance Company v. The Queen,
[2000] 1 C.T.C. 2481, O’Connor J. of this court held that the Minister of
National Revenue was bound to accept the characterization in the balance sheets
for the purpose of determining the taxpayer’s capital base. In upholding this
decision, Rothstein J. of the Federal Court of Appeal, said at page 175:
Nonetheless, the Minister argues that some more general definition
of reserves or surpluses should govern. The only basis for this argument seems
to be a reference in Oerlikon Aérospatiale Inc. c. R., (1999), 99 D.T.C. 5318 (Alta. C.A.),
where an "advance" was to be reflected in capital because it
contributed to "the financial resources available to the
appellant". The Minister says unamortized realized gains are
financial resources available to the respondent in this case. However, the
Minister's argument ignores precisely what was said by Noël J.A. in Oerlikon:
The effect of an advance, be it in the
sense of a payment on account or a loan, is to make the amount of money it
represents available to the person or corporation which receives
it. In the instant case, the advances were an integral part of the
financial resources available to the appellant at the end of its 1989 fiscal
year according to the financial statements it filed, and nothing either in the
legislation or the tax policy which led to its enactment indicates that
Parliament intended to exclude advances from the tax under Part I.3.
In the present case, unamortized realized gains were not
shown as financial resources available to the respondent according to its
financial statements.
[30] To the same effect, Bowie J. of this court in PCL
Construction Management Inc. v. The Queen, [2001] 1 C.T.C. 2132 at page
2147, said:
Subject to specific
direction to the contrary elsewhere in Part I.3 of the Act, GAAP applies
to determine “amounts”. That seems a strong indication that if not GAAP then at
least “the language accountants speak” must govern the characterization of
amounts for the purposes of this Part.
[31] In Royal Trust Company v. The Queen, [2001] 3 C.T.C.
2268, Sarchuk J. said at pages 2291 to 2292:
I am satisfied that the appropriate characterization to
be given to the undefined term "tangible property" is dependent upon
the context of the surrounding text and upon Part I.3 of the Act as a
whole. This part of the Act relies on balance sheets and GAAP in the
determination of a corporation's "taxable capital employed in Canada". It seems only reasonable to conclude that the
technical terms referable to the balance sheet ought to be defined and
characterized for the purposes of Part I.3 of the Act by reference to
accounting terminology. Accordingly, the Appellants were correct in not
including the carrying values of the Assets in their respective "taxable
capital employed in Canada" because each Appellant had no
"tangible property" for the purposes of subsection 181.3(1).
[32] The effect of these decisions and indeed of the plain
meaning of subsection 181(3) is that the accounting characterization of
terms in the balance sheet is to be accepted in determining the components of a
corporation’s capital for the purposes of Part I.3. In specifically giving a
function to accounting principles that is somewhat unique in income tax
matters, Parliament intended that deference be given to the accounting
characterization in the balance sheet of items that make up a corporation’s
capital.
[33] The appeals are allowed with costs and the assessments are
referred back to the Minister of National Revenue for reconsideration and
reassessment on the basis that the amount of $1,170,000,000 in respect of the Class C
special shares that is reflected in the balance sheets as a liability is not to
be included in the appellant’s capital for the purposes of Part I.3 of the Income
Tax Act.
Signed at Ottawa,
Canada, this 22nd day of February 2007.
Bowman,
C.J.
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