Les Entreprises Michèle L'Heureux Inc. v. The Queen, 94 DTC 1693, [1995] 1 CTC 2850 (TCC)

Dussault J.T.C.C.:—This is an appeal from an assessment for the appellant’s 1987 taxation year. The case essentially concerns the method used by the Minister of National Revenue (the "Minister") to determine the tax under Part IV of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") payable by the appellant for that year. For the purposes of the proceeding, the parties filed an agreement of facts which reads as follows:

(a) In 1987, the appellant was involved in a reorganization of the proportionate

distribution type, commonly called a "single-wing butterfly";

(b) the appellant and the other corporation involved in the butterfly-type reorganization, Investissement Heureux Inc. ("Investissement"), are connected corporations within the meaning of paragraph 186(4)(a) of the Income Tax Act;

(c) the appellant’s fiscal year ends on June 30 and that of Investissement ends on March 31;

(d) as a result of mutual redemptions of shares between the appellant and Investissement, the appellant and Investissement are deemed to have received respectively $576,698 and $437,989 in dividends during their 1987 taxation year pursuant to subsection 84(3) of the Income Tax Act;

(e) the sum of $576,698 was deducted by the appellant in computing its taxable income for the 1987 taxation year pursuant to subsection 112(1) of the Income Tax Act;

(f) for its 1987 taxation year,

(i) the appellant’s tax payable under Part IV was set at $40,028 by the notice of initial assessment dated March 28, 1988;

(ii) the appellant’s dividend refund was set at $45,964 by the notice of initial assessment dated March 28, 1988;

(g) the appellant’s refundable dividend tax on hand (RDTOH) at the start of his 1987 taxation year was nil, as stipulated in Exhibit D-1, "Calculation of Part IV Tax", filed at the hearing;

(h) at the end of the 1987 taxation year, the appellant had a refundable amount of the Part I tax of $5,936, as stipulated in Exhibit D-1, "Calculation of Part IV Tax" [paragraph 129(3)(a) of the Income Tax Act] ;

(i) the appellant’s minutes do not indicate a declaration of dividend totalling the sum of $22,000 paid to Michèle L’Heureux, contrary to the mention made in the appellant’s financial statements for its 1987 taxation year;

(j) the balance of Investissement’s refundable dividend tax on hand (RDTOH) at the start of its 1987 taxation year was $11,998, as stipulated in Exhibit D-1, "Calculation of Part IV Tax";

(k) at the end of the 1987 taxation year, Investissement had a refundable amount of the Part I tax of $6,525, as stipulated in Exhibit D-l, "Calculation of Part IV Tax" [paragraph 129(3)(a) of the Income Tax Act];

(l) in a notice of reassessment dated November 13, 1990, the Minister of National Revenue revised the appellant’s tax under Part IV to $128,020 and its dividend refund was revised to $109,497;

(m) the result of this reassessment was a net increase of tax payable of $24,459.

[Translation.]

The agreement also contains the following introductory paragraph:

The parties agree that the calculation appearing in Exhibit D-l filed at the hearing is mathematically correct. The point at issue is: Does the circular method of calculation apply in this case?

[Translation.]

Exhibit D-l is reproduced in the schedule to these reasons for judgment. [Not reproduced.]

In reality, the tax under Part IV payable by the appellant and by Investissement Heureux Inc. ("Investissement") was calculated through six successive calculations for each corporation. Since the reorganization occurred during the 1987 taxation year of each of the corporations, the dividends deemed payed upon the mutual redemptions of shares were also deemed to have been received by each of the corporations during the same year. A tax under Part IV was therefore payable by each of the corporations for its 1987 taxation year. Since each of the corporations was deemed to have received a dividend from a connected payer corporation, paragraph 186(1)(b) provides that the tax payable under Part IV is equal to 25 per cent of "four times the dividend refund of the payer corporation" for the same year. For the connected payer corporation, its refund for the year, pursuant to paragraph 129(l)(a) of the Act, is equal to the lesser of one- quarter of all taxable dividends paid in the year and its "refundable dividend tax on hand" at the end of the year. The "refundable dividend tax on hand" is a permanent account consisting of an amount of the tax under Part I payable for the year and for every previous year [paragraph 129(3)(a)] and of the aggregate of the taxes under Part IV payable for the year and for any previous taxation year [paragraph 129(3)(b)]. The account is reduced by the aggregate of refunds for the previous years.

These rules, applied to the present situation, mean that the tax under Part IV payable by the appellant in 1987 depends on Investissement’s dividend refund for the same year. That refund is the lesser of one- quarter of the taxable dividends paid by Investissement [subparagraph 129(l)(a)(i)] or its own "refundable dividend tax on hand" [subparagraph 129(l)(a)(ii)]. This latter amount consists partly of the tax under Part IV payable by Investissement, which in turn depends on the refund obtained by the appellant in respect of the dividends which it had paid. The calculation is circular as long as the refund to a corporation is based on its "refundable dividend tax on hand" because it appears that this amount is the lesser of the two amounts provided at subparagraphs 129(l)(a)(i) and (ii) of the Act. However, the circle is broken and the calculation becomes final when the refund is no longer dependent on the amount of the "refundable dividend tax on hand", but rather on the amount which represents one-quarter of the taxable dividends paid, that amount then being the lesser of the two amounts mentioned in those subparagraphs. This situation occurs at the fifth calculation of the refund which the appellant may claim in this situation, so that it then becomes possible to make a final determination of the tax under Part IV payable by Investissement, its "refundable dividend tax on hand" and its dividend refund for 1987. The last stage then consists in determining the tax under Part IV payable by the appellant for the year based on the final amount of Investissement’s dividend refund for the same year.

The position of counsel for the appellant was simple: the circular calculation with which the Minister proceeded in order to determine the amount of tax under Part IV is not provided for in the Act and therefore cannot be used. According to her, it results solely from the fact that Investissement had an amount of "refundable dividend tax on hand" at the start of its 1987 taxation year. Counsel for the appellant therefore contended that the use of a circular calculation to determine the tax under Part IV payable by the appellant was unfair and inequitable in the circumstances.

Counsel for the respondent contended that the provisions of sections 129 and 186 are clear and that they must be applied, having regard to the transactions conducted. According to him, the reorganization in which the appellant and Investissement were involved was relatively complex and was subject to a rule of exception found at paragraph 55(3)(b) of the Act. Referring to various writings on the subject, [1] he contended that the problem of the circular calculation is known and that there are a number of ways of avoiding it, in particular by creating a subsidiary or by making share redemptions during different taxation years for each of the corporations. However, since the appellant and Investissement chose to proceed in the manner in which they did, out of ignorance or for some other reason, counsel for the respondent argued that the tax must be calculated on the basis of the transactions that were realized, not as they could have or should have been realized in order to avoid the problem. He concluded by saying that, when a legislative enactment is clear, the Court must simply apply it and not seek to substitute itself for the legislator.

Counsel for the respondent based his arguments on the following decisions:

—Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 5059;

-The Queen v. Antoine Guertin Ltée, [1988] 1 C.T.C. 117, 87 D.T.C. 5458 (F.C.T.D.);

—City of Vancouver v. B.C. Telephone Co. et al., [1951] S.C.R. 3, [1950] 4 D.L.R. 289.

At the end of the arguments and since the counsel for the parties had not referred thereto, the Court asked them to submit written comments on the possible application of the two decisions of the Supreme Court of Canada in Bickle (M.N.R. v. Bickle et al., [1966] S.C.R. 479, [1966] C.T.C. 207, 66 D.T.C. 5179, reversing the Exchequer Court decision reported in [1964] C.T.C. 208, 64 D.T.C. 5134 (Ex. Ct.)) and Malloch (M.N.R. v. F. David Malloch Memorial Foundation, 70 D.T.C. 6285, reversing the Exchequer Court decision reported in 69 D.T.C. 5033), in which the cause of action was a circular calculation method used by the Minister to make assessments under the Estate Tax Act, S.C. 1958, c. 29. At the relevant time, for the purpose of determining the aggregate taxable value of property passing on death, paragraph 7(1 )(d) of that Act provided that the net value of a gift to a charitable organization meeting the conditions stated in that provision could be deducted. The last part of paragraph 7(1 )(d) thus provided that the deduction was limited to the value of the gift minus any succession duties or estate tax, including any tax under that Act payable on the gift pursuant to the provisions of the will itself, any statute imposing duties or relating to the administration of estates or payable by the donee as a condition of the making of such a gift. In Bickle, supra, the Supreme Court found in a majority judgment that the estate tax was in fact payable on property bequeathed to a charitable organization so that the net value of the gift itself had to be determined on the basis of the last part of paragraph 7(1 )(d). Judson J., writing for the majority, described the problem in the following terms (S.C.R. 482, C.T.C. 208, D.T.C. 5180):

The difficulty of the problem is that the value of the charitable gift is, by definition, the value of the gift minus duty where there is a direction to pay duty out of the charitable gift. One cannot ascertain the amount of the charitable gift without first knowing the estate tax payable, and, in turn, the amount of the estate tax payable depends upon the amount of the charitable gift.

The Supreme Court overruled the Exchequer Court and approved the method used by the Minister in order to determine the tax by proceeding with ten successive calculations. Judson J. expressed the Court’s opinion on this point in the following terms (S.C.R. 483, C.T.C. 209, D.T.C. 5180-81):

The Minister arrived at his figure as a result of ten successive calculations. Under the scheme of this Act you cannot determine the value of the charitable gift until you have determined the amount of duty. It should be possible to state the Minister’s proposition in such a way that an actuarial training is not needed to understand it. First of all, you have a charitable fund of determined amount which is not taxable but from which must be deducted the amount of estate duty. You first calculate the amount of the estate duty on the balance of the estate ignoring the charitable fund. This gives you the first figure that must be deducted from the charitable fund but it is not the final figure. This first calculation of duty must be transferred from the charitable fund to the taxable portion of the estate. This calculation was repeated ten times until the tenth calculation showed little or no difference from the ninth. This then was the amount of estate duty which had to be deducted from the value of the charitable gift. This is the figure that the Minister contended for and, in my opinion, the mode of calculation is correct and the one required by the Act. The evidence also indicates that the same result may be obtained by the application of an elaborate algebraic formula.

Spence J. dissenting reached a different conclusion, holding that the tax was not payable on assets bequeathed to the charitable organization so that, in his view, the last part of paragraph 7(1 )(d) was not applicable. However, he clearly suggested that, if that part of paragraph 7(1 )(d) had been applicable, the method used by the Minister to determine the tax payable would have been the right one.

In Malloch, supra, the Supreme Court unanimously overruled the Exchequer Court again respecting the application of the last part of paragraph 7(1 )(d) of the Estate Tax Act and confirmed that the method of successive calculations used by the Minister for the purpose of determining the tax payable was correct.

In his additional arguments, counsel for the respondent also relied on these decisions, deeming that the problem, in the instant appeal, was similar and that the circular calculation or successive calculations method was the only one that could be applied in order to determine the tax under Part IV payable by the appellant for its 1987 taxation year.

Counsel for the appellant disputed this view and claimed that the difficulty was not of the same kind in that the problem of the circular calculation caused by the application of paragraph 7(1 )(d) of the Estate Tax Act was provided for in one and the same provision and that it was unavoidable having regard to the terms of the wills in the cases decided by the Supreme Court. Counsel for the appellant further argued that paragraph 7(1 )(a) "provided for the calculation by successive approximations". [2] She claimed that the difficulty in the instant case arose from the application of two different provisions of the Act (sections 129 to 186) and that the circular calculation is not provided under those provisions. However, she admitted that there were at least two other ways to proceed with the reorganization involving the appellant and Investissement, which should have made it possible to avoid the circular calculation problem. [3]

I cannot accept the appellant’s position. First, I believe the problem is of the same nature as that raised in Bickle, supra, and Malloch, supra, and that it is hardly important whether it results from the application of two parts of the same provision or from two different provisions. Paragraph 7(1 )(d) of the Estate Tax Act did not provide in any way for the successive approximation calculation method, although the application of the last part of the paragraph, in my view, logically led to the use of such a method. The application of this last part of paragraph 7(1 )(d) could be avoided by bequeathing a gift of a net amount, not of an amount on which tax would have to be paid. Likewise, it was possible for the taxpayers involved in the instant case, including the appellant, to plan the reorganization so as to avoid the circular calculation problem which was known. However, the tax cannot be determined in the manner the appellant would like, as though the difficulty had been circumvented. It has not been. Referring to the Supreme Court decision in Bronfman Trust, supra, I shall merely recall here the remarks of Dickson C.J. concerning the Act’s application with respect to what a taxpayer might have done (S.C.R. 55, C.T.C. 129, D.T.C. 5067-68):

It would be a sufficient answer to this submission to point to the principle that the courts must deal with what the taxpayer actually did, and not what he might have done: Matheson v. The Queen, [1974] C.T.C. 186, 74 D.T.C. 6176 (F.C.T.D.), per Mahoney J., at page 6179 (C.T.C. 189).

Since the Act provides that the tax under Part IV payable by a corporation on taxable dividends received from a connected payer corporation depends directly on the refund obtained by the latter, it seems logical to me to proceed by successive calculations when the two corporations are deemed to have paid and received such dividends in the same year. The refund to the payer corporation is set at the lesser of its "refundable dividend tax on hand" and one- quarter of the dividends paid. Since the amount of the dividends deemed to be paid and received by both parties is a fixed amount, the successive calculations cease and the amount may be finally determined once the refund to a payer corporation is equal to one- quarter of the dividends paid, that amount being less than that of its "refundable dividend tax on hand". Unlike the situations analyzed by the Supreme Court in Bickle, supra, and Malloch, supra, it is no longer necessary here to push the calculations further since the tax may finally be determined on the basis of a fixed element. In the circumstances, I am of the view that the Minister correctly applied the provisions of sections 129 and 186 of the Act.

For these reasons, the appeal is dismissed with costs to the respondent.

Appeal dismissed.