Date:
20120713
Docket:
A-188-11
Citation: 2012 FCA 207
CORAM: BLAIS
C.J.
LÉTOURNEAU
J.A.
SHARLOW
J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
and
PETER SOMMERER
Respondent
REASONS
FOR JUDGMENT
SHARLOW
J.A.
[1]
The
respondent Peter Sommerer was assessed under the Income Tax Act, R.S.C.
1985, c. 1 (5th Supp.) for the years 1996 to 2000 to include in his
income, pursuant to subsection 75(2) of the Income Tax Act, the taxable
portion of capital gains realized by an Austrian private foundation on the sale
of corporate shares it had purchased from Mr. Sommerer. An appeal by Mr.
Sommerer to the Tax Court of Canada was successful (2011 TCC 212). Justice
Campbell Miller concluded that subsection 75(2) of the Income Tax Act
did not apply to the facts of this case and even if it did, Article XIII (5) of
the Canada-Austria Income Tax Convention, 1980, S.C. 1980-81-82-83, c.
44, Part II, precludes Canada from taxing in the hands of Mr. Sommerer any gain
realized by the Austrian private foundation. The Crown has appealed that
judgment. For the reasons that follow, I would dismiss the appeal.
Background
[2]
This
case arises from certain transactions in the years 1996 to 1998 involving Peter
Sommerer and the Sommerer Privatstiftung (the “Sommerer Private Foundation”), a
private foundation established by Peter’s father, Herbert Sommerer, on October
3, 1996 under a statute of the Republic of Austria entitled “Privatstiftungsgesetz”
(the “Austrian Private Foundations Act”).
[3]
In
lengthy and cogent reasons, Justice Miller resolved a number of factual and
legal issues that are no longer in dispute between the parties. The facts that
are relevant to the issues in this appeal are few and are set out below under
the heading “Facts”. The facts are best understood in the light of the relevant
Austrian law, summarized in the next section.
Austrian private
foundations
[4]
The
record contains a copy of the Austrian Private Foundations Act as
enacted in German, and an English translation. The English translation is
appended to Justice Miller’s reasons. Two witnesses, Dr. Hellwig Torggler and
Dr. Willibald Plesser, gave evidence about the law of Austria relating to the Austrian Private Foundations Act. They agree on the
principles of Austrian law that I consider relevant to this appeal.
[5]
A
private foundation is created under the Austrian Private Foundations Act
by a “Stifter” (translated as “founder”). There may be more than one founder.
However, a person cannot become a founder by contributing to an existing
private foundation.
[6]
A
private foundation is established when a founding deed is accepted for filing
in the Austrian Register of Corporations. The founding deed must be executed by
the founder or founders, it must be notarized, and it must contain the
information required by the Austrian Private Foundations Act. Among the
required information is proof that the founder or founders have endowed the
private foundation with money in at least the amount required by the Austrian
Private Foundations Act. In 1996, the required endowment was 1,000,000
Austrian shillings, then equal to approximately $126,000. The required
information also includes the name and address of the founder or founders, the
name of the private foundation, its purpose, its intended duration, and the
address of its head office, which must be in Austria.
[7]
An
Austrian private foundation is a juridical person, in the same category in
Austrian law as a corporation. It has its own legal personality and the legal
capacity to own property in its own right, which it holds and manages for the
purposes stated in its constating documents.
[8]
A
private foundation may be established for any lawful purpose, including a
charitable purpose or any purpose for the benefit of the public at large, or it
may be established for the purpose of benefitting designated persons, such as
the members of a family. Generally, a private foundation
may engage in investment activities
that are consistent with its purposes, but it may not engage in commercial
activities other than as a secondary activity, assume the management of a
commercial corporation, or be registered as the personally liable shareholder
of a partnership or an incorporated commercial company.
[9]
A
private foundation must have a “Stiftungsvorstand” (translated sometimes as
“board of directors” and sometimes as “executive board” – in these reasons I
use the term “board”). The board is responsible for conducting the affairs of
the private foundation. Each member of the board must perform his or her
responsibilities frugally and with the prudence of a conscientious manager.
[10]
There
must be at least three members of the board of a private foundation. The
initial board is appointed by the founder or founders. Their successors are
named as specified in the founding deed or a supplementary deed. A beneficiary,
the spouse of a beneficiary, or a person related to a beneficiary within a
specified degree cannot be a member of the board, and neither can any
corporation. Two of the members of the board must have permanent residence in Austria.
[11]
A
private foundation, except one established for the benefit of the public at
large, must have at least one “Begünstigter”, a person to whom the property of
the private foundation may be distributed at the discretion of the board
subject to the terms of the founding deed of the private foundation or a
supplementary deed. The founding deed must either designate that person (or
persons), or stipulate how and by whom they will be designated. The word
“Begünstigter” is
translated as “beneficiary”, but
since the law of Austria does not recognize common law trusts, it should not be
inferred that a “Begünstigter”, as such, necessarily has all the legal rights
of the beneficiary of a common law trust.
[12]
The
founding deed may permit the designation of a beneficiary or beneficiaries in a
supplementary deed executed by the founder or founders, or it may permit the
designation of a beneficiary or beneficiaries by a “Stelle” (an organ of the
private foundation created by the founder or founders for that purpose),
failing which the board may designate the beneficiary or beneficiaries. A
supplementary deed is a separate notarized document that is not necessarily
required to be filed with the Austrian Register of Corporations. If a
supplementary deed is not required to be filed, its contents do not become
publicly available information.
[13]
The
founding deed or a supplementary deed may also name a “Letzbegünstigter”
(translated as “ultimate beneficiary”). An ultimate beneficiary is a person who
is entitled to receive the property of the private foundation upon its
revocation or dissolution, after the creditors of the private foundation have
been satisfied. There may be more than one ultimate beneficiary. If a private
foundation is dissolved and no ultimate beneficiary has been named, the assets
of the private foundation become the property of the Republic of Austria.
[14]
A
private foundation must have a “Stiftungsprüfer” (translated as “auditor”). It
may, and in some circumstances must, have an “Aufsichtsrat” (translated as
“supervisory board”). It may also
have other organs established for
specified purposes, including a “Beirat” (translated as “advisory board”) to
advise the board. However, an advisory board cannot replace the board or
exercise any of its functions. The existence of an advisory board does not
relieve the board of its legal obligation to manage the affairs of the private
foundation in accordance with its stated purposes, or affect the legal standard
of care imposed on members of the board.
[15]
The
dissolution of an Austrian private foundation may occur in a number of ways,
including upon a resolution of the board, but not by a resolution of any other
organ or the beneficiaries. There are circumstances in which the board must
pass a dissolution resolution. If the right of revocation has been reserved by
the founder or founders, the board must pass a dissolution resolution upon
receiving notice of the revocation. The board must pass a dissolution
resolution upon the achievement of the private foundation’s purposes, upon a
determination that its purposes are no longer achievable, upon the occurrence
of an event that is stipulated in the founding deed to require dissolution or,
in the case of a private foundation established for a fixed term, upon the
expiry of the term. In the case of a non-charitable private foundation whose
major purpose is for the benefit of individuals, a dissolution resolution must
be passed when the private foundation has lasted for 100 years, unless all
ultimate beneficiaries resolve unanimously that it should continue for another
period not exceeding 100 years at a time.
[16]
The
founding deed of a private foundation may be amended by the founder or founders
only if that right has been reserved. If an amendment is required but cannot be
made because no such
right has been reserved, or because
the founder or founders are unable to act, the board may make any amendments
necessary to achieve the purpose of the private foundation, subject to the
approval of the court. An amendment to the founding deed is made by a
supplementary deed, and becomes effective only when the supplementary deed is
accepted for filing in the Austrian Register of Corporations.
[17]
A
beneficiary or an ultimate beneficiary, as such, has no right to exercise any
authority vested in the board, or to manage or have a say in the management of
the private foundation’s affairs or in the exercise of any discretion as to the
distribution of property to the beneficiaries. The legal rights of a
beneficiary or ultimate beneficiary are limited to obtaining information about
the affairs of the private foundation, and asking the court to take steps to
ensure that the terms of the founding deed and any supplementary deeds are
respected. As well, each beneficiary and ultimate beneficiary has a specific
statutory right to apply to the court for dissolution of the private foundation
if an event has occurred that makes dissolution mandatory and the board has not
passed a dissolution resolution, or if the board has passed a dissolution
resolution when no event requiring dissolution has occurred.
[18]
In
this appeal, the Austrian tax treatment of a private foundation is not
relevant, but as it is mentioned by Justice Miller in his reasons, I will
summarize the evidence presented on that point. An Austrian private foundation
generally is subject to the same income tax law as other Austrian corporations,
but it may be exempted from Austrian income tax if it files certain information
with
the tax authorities, including a
supplementary deed naming the beneficiaries. However, a private foundation is
not exempt from Austrian income tax on “Spekulationsgeschäfte” (translated as
“speculative transactions”), including a gain on the sale of corporate
securities within one year of its acquisition, or a gain on the sale of real
property within ten years of its acquisition. Thus, a private foundation can
and is intended to provide limited shelter from Austrian income tax with
respect to income from the use or disposition of its property. Generally, a
distribution of the property of a private foundation is subject to Austrian
income tax in the hands of the beneficiary who receives it, unless the
beneficiary is entitled to an exemption (for example, under an international
income tax convention). The private foundation may be obliged to withhold tax
from the distribution and remit it to the tax authorities to be applied against
the tax liability of the beneficiary.
Facts
[19]
At
all times material to this appeal, Peter Sommerer was resident in Canada. It is not alleged that he was resident in Austria or in any other country during
the relevant period.
[20]
Herbert
Sommerer, the father of Peter Sommerer, executed the founding deed of the
Sommerer Private Foundation on October 3, 1996. On the same date, he endowed
the Sommerer Private Foundation with 1,000,000 Austrian shillings. The founding
deed was registered with the Austrian Register of Corporations. The founding
deed names three individuals unrelated to the Sommerer family as the initial
members of the board.
[21]
The
purpose of the Sommerer Private Foundation as set out in its founding deed is
as follows (translated from German):
|
The purpose of the foundation
is to promote the interests of those individuals indicated in the
supplementary deed from the income generated by the foundation funds.
Engaging
in investment activities, in particular the purchase of shares on credit, is
also in line with this purpose.
Beneficiaries and those who may
become beneficiaries based on the purpose of the foundation have no legal
claim to grants from the foundation.
|
[22]
On
October 4, 1996, Herbert Sommerer executed the supplementary deed referred to
in the first paragraph quoted above. The beneficiaries are named in section 2
of that supplementary deed. It reads as follows (translated from German):
|
The beneficiaries are Mr. Peter
Sommerer, his wife, Mrs. Dawn Elizabeth Sommerer, as well as the children
from their marriage, but only as of their eighteenth birthday and, in the
event of their death, their offspring, provided they are resident in Austria.
|
[23]
Dr.
Torggler interpreted this provision to mean that the named persons are only
potential beneficiaries unless and until they become resident in Austria. Dr. Plesser agreed. Justice Miller also agreed, and his conclusion on this point
is not challenged in this appeal. Thus, the fact that Peter Sommerer was
resident in Canada in October of 1996 means that he was not then eligible to
receive a distribution as beneficiary, but he could become eligible by becoming
resident in Austria.
[24]
Under
the October 4, 1996 supplementary deed, Peter Sommerer and his spouse are also
named as the ultimate beneficiaries of the Sommerer Private Foundation. The
provision naming them as ultimate beneficiaries contains no condition as to
their place of residence.
[25]
In
the founding deed, Herbert Sommerer reserved the right to revoke the private
foundation. He also reserved the right to amend the founding deed with the
consent of the advisory board. The October 4, 1996 supplementary deed
establishes an advisory board consisting of the founder (Herbert Sommerer) and
the two oldest beneficiaries. It apparently was intended that Peter Sommerer
and his spouse would be members of the advisory board, although technically
that would be impossible unless they became resident in Austria.
[26]
According
to the English translation of the October 4, 1996 supplementary deed, the
advisory board “shall advise the [board] in determining grants to beneficiaries
and has the right to supervise the activities of the [board].” The
supplementary deed also provides that it (that is, the supplementary deed) may
be “revoked by the [board] with unanimous approval by the advisory board, and
all items may be modified or supplemented.”
[27]
Dr.
Torggler and Dr. Plesser did not agree on whether, as a matter of Austrian law,
the advisory board was validly created on October 4, 1996 as an organ of the Sommerer
Private Foundation. However, it seems to me that none of the issues in this
appeal turn on that point.
[28]
A
supplementary deed executed in January of 1999 changed the residence
requirement for beneficiaries and ultimate beneficiaries. The result of the
amendment is that the persons named in the October 4, 1996 supplementary deed
as beneficiaries or ultimate beneficiaries are entitled to receive
distributions of property of the private foundation or distributions on
dissolution, as the case may be, if they are resident in any country designated
by the advisory board except Canada. As Peter Sommerer was still resident in Canada at that time, he was not then eligible to receive any distributions, but that would change if
he ceased to be resident in Canada and became resident in another country
designated by the advisory board. Another supplementary deed executed in 1999
removed the supervisory role of the advisory board.
[29]
Despite
the residence requirement for beneficiaries as it existed between October of 1996
and January of 1999 that might have precluded Peter Sommerer from being a
member of the advisory board during that period, the record contains a
significant body of evidence indicating that Peter Sommerer was present at most
if not all meetings of the board of the Sommerer Private Foundation, and
offered his advice on the transactions that gave rise to this case. In my view,
the fact that Peter Sommerer offered advice to the board is not relevant to any
of the issues on appeal, whether or not he did so as a member of the advisory
board.
[30]
On
October 4, 1996, Peter Sommerer sold to the Sommerer Private Foundation
1,770,000 shares of Vienna Systems Corporation (the “Vienna shares”) for their
fair market value of $1,177,050 (66.5¢ per share). The Sommerer Private
Foundation paid $117,705 of the purchase
price on the date of the agreement
and was legally obliged to pay the remainder at a later date, with interest.
The sale was unconditional. The cash portion of the purchase price was paid
using part of the initial endowment from Herbert Sommerer (paragraphs 67 and 88
of Justice Miller’s reasons).
[31]
In
December of 1997, the Sommerer Private Foundation sold 216,666 of the Vienna shares for $4.50 per share to three individuals unrelated to the Sommerer family, realizing
a capital gain. In December of 1998, the Sommerer Private Foundation sold the
remaining Vienna shares to Nokia Corporation for $9.00 per share, realizing a
further capital gain.
[32]
In
April of 1998, Peter Sommerer sold to the Sommerer Private Foundation,
unconditionally, 57,143 shares of Cambrian Systems Corporation (the “Cambrian
shares”) for $100,000 (approximately $1.75 per share). In December of 1998, the
Sommerer Private Foundation sold the Cambrian shares to Northern Telecom
Limited for $14.97 (US) per share, plus a further $4.12 (US) per share conditional on certain milestones being met in 1999. That sale resulted in
another capital gain for the Sommerer Private Foundation.
[33]
The
Minister took the position that the capital gains realized by the Sommerer
Private Foundation on the sale of the Vienna shares and the Cambrian shares
were attributable to Peter Sommerer pursuant to subsection 75(2) of the Income
Tax Act. For reasons that are not relevant to any issues raised in this
appeal, putting that conclusion into effect required income tax reassessments
for the years 1996 to 2000. As mentioned above, those reassessments were
successfully appealed to the Tax Court of Canada, and the Crown now appeals to
this Court.
Analysis
(A) Introduction to subsection 75(2)
[34]
Broadly
speaking, subsection 75(2) is intended to ensure that a taxpayer cannot avoid
the income tax consequences of the use or disposition of property by
transferring it in trust to another person while retaining a right of reversion
in respect of the property or property for which it may be substituted, or
retaining the right to direct the disposition of the property or substituted
property. Subsection 75(2) operates by attributing any income or loss from the
use of trust property, and any gain or capital loss on the disposition of trust
property, to the person from whom the property, or property for which it was
substituted, was received by the trust.
[35]
Subsection
75(2) reads as follows:
|
75. (2) Where, by a
trust created in any manner whatever since 1934, property is held on
condition
(a) that
it or property substituted therefor may
(i) revert
to the person from whom the property or property for which it was substituted
was directly or indirectly received (in this subsection referred to as “the
person”), or
(ii) pass
to persons to be determined by the person at a time subsequent to the
creation of the trust, or
(b) that,
during the existence of the person, the property shall not be disposed of
except with the person’s consent or in accordance with the person’s
direction,
any income or loss from the property or from
property substituted for the property, and any taxable capital gain or
allowable capital loss from the disposition of the property or of property
substituted for the property, shall, during the existence of the person while
the person is resident in Canada, be deemed to be income or a loss, as
the
case may be, or a taxable capital gain or allowable capital loss, as the case
may be, of the person.
|
75. (2) Lorsque, en
vertu d’une fiducie créée de quelque façon que ce soit depuis 1934, des biens
sont détenus à condition :
a) soit que ces
derniers ou des biens qui leur sont substitués puissent :
(i) ou
bien revenir à la personne dont les biens ou les biens qui leur sont
substitués ont été reçus directement ou indirectement (appelée « la personne
» au présent paragraphe),
(ii) ou
bien être transportés à des personnes devant être désignées par la personne
après la création de la fiducie;
b) soit que,
pendant l’existence de la personne, il ne soit disposé des biens qu’avec son
consentement ou suivant ses instructions,
tout revenu ou toute perte
résultant des biens ou de biens y substitués, ou tout gain en capital
imposable ou toute perte en capital déductible provenant de la disposition
des biens ou de biens y substitués, est réputé, durant l’existence de la
personne et pendant qu’elle réside au Canada, être un revenu ou une perte,
selon le cas, ou un gain en capital imposable ou une perte en capital
déductible, selon le cas, de la personne.
|
(B)
The French version of subsection 75(2)
[36]
There
was some debate in this case as to whether the French version of subsection
75(2) of the Income Tax Act and the English version say the same thing,
whether the French version contains a drafting error (evidenced by some
obviously unintended effects), and whether the apparent differences between the
English and French versions have any bearing on the issues in this case. These
issues are discussed by Justice Miller in paragraphs 95 to 102 of his reasons.
He found the differences between the English and French versions to be of no
consequence to the issues in this case, and I agree. I mention this point only
to urge the Crown to consider whether there is a drafting error in the French
version of subsection 75(2), and if so to initiate corrective steps. If there
is an error in that provision, the same error or a similar error may be present
in a number of other provisions of the Income Tax Act mentioned in the
submissions made in this case.
[37]
The
Crown argued in the Tax Court that the Sommerer Private Foundation is a trust.
Peter Sommerer argued that it is a corporation. Justice Miller concluded that
it is a corporation that holds its property in trust for Peter Sommerer and the
other named beneficiaries. He went on to conclude that subsection 75(2) of the Income
Tax Act does not apply to attribute to Peter Sommerer the capital gains
realized by the Sommerer Private Foundation on the sale of the Vienna shares
and the Cambrian shares. He held in the alternative that Article XIII (5) of
the Canada-Austria Income Tax Convention precludes Canada from taxing Peter Sommerer on the capital gains realized by the Sommerer Private
Foundation.
[38]
The
Crown’s appeal assumes that Justice Miller was correct when he concluded that
the Sommerer Private Foundation holds its property in trust. The Crown
challenges only Justice Miller’s conclusions on the application of subsection
75(2) of the Income Tax Act and Article XIII (5) of the Canada-Austria
Income Tax Convention. Peter Sommerer does not agree that the Sommerer
Private Foundation holds its property in trust, but as respondent in this
appeal he has chosen not to argue that point. He has concentrated instead on
defending Justice Miller’s conclusions on the application of subsection 75(2)
of the Income Tax Act and Article XIII (5) of the Canada-Austria
Income Tax Convention. Because of the manner in which this appeal was
argued, the proposition that the Sommerer Private Foundation holds its property
in trust was not the subject of submissions, and I will express no final
opinion on whether it is correct. However, I will say that in my view, it is a
doubtful proposition.
[39]
According
to the undisputed evidence of Dr. Torggler, the law of Austria does not recognize trusts as understood in Canadian law. However, it is evident
that as a practical matter (and putting aside for the moment any income tax
considerations), Herbert Sommerer may well have achieved many of the objectives
that could have been achieved in a common law jurisdiction by settling a trust
for Peter Sommerer, his spouse and their children. He did so by creating and
endowing the Sommerer Private Foundation under the Austrian Private
Foundations Act and naming Peter Sommerer, his spouse, and their children as
beneficiaries and ultimate beneficiaries. But that does not mean as a matter of
law that the creation and endowment of the Sommerer Private Foundation was the
settlement of a trust, or that a trust existed or came into existence when the
Sommerer Private Foundation bought the Vienna shares or the Cambrian shares
from Peter Sommerer.
[40]
As
mentioned above, an Austrian private foundation is a juridical person with the
legal capacity to own property in its own right and to deal with its property
on its own account. The legal right of an Austrian private foundation to deal
with its own property is the same as the legal right of a Canadian corporation
to deal with its own property. That is so despite the fact that the board of an
Austrian private foundation must manage its affairs in furtherance of the
purposes stipulated in its constating documents. The board of directors of a
corporation is similarly constrained, in the sense that it must manage the
affairs of the corporation in its best interests, subject to any terms and
conditions in its constating documents.
[41]
A
corporation does not hold its property in trust for its shareholders or
members, except to the extent that a trust deed or an analogous legal
instrument imposes the legal and equitable obligations of a trustee on the
corporation with respect to specific corporate property. Assuming it is
theoretically possible for an Austrian private foundation to hold its property
in trust (that is, subject to conditions that are analogous to the legal and
equitable obligations of a trustee in a common law jurisdiction), that
possibility cannot be realized unless those conditions are formally
established. Nothing in the constating documents of the Sommerer Private
Foundation or the law of Austria, as reflected in the record of this case,
supports the conclusion that the right of the Sommerer Private Foundation to
deal with its property is constrained by any legal or equitable obligations
analogous to those of a common law trustee.
[42]
Looking
at the situation from another point of view, a shareholder or member of a
corporation, as such, is not the beneficial owner of any property or the
corporation, and has no legal or equitable claim to the corporate property
(unless such a claim arises upon the declaration by the board of directors of a
dividend, or when the dissolution of the corporation is imminent). Unless and
until such an event occurs, a shareholder or member has only an inchoate right
to receive distributions of corporate property from time to time at the
discretion of the board of directors, and to share in the distribution of the
corporate property upon its dissolution. The same can be said of the interest
of a beneficiary or an ultimate beneficiary in the property of an Austrian
private foundation. Nothing in the Austrian Private Foundations Act or
the constating documents of the Sommerer Private Foundation gives Peter
Sommerer a legal or equitable claim to the corporate property that is different
from that of a shareholder or member of a corporation.
[43]
For
these reasons, I doubt that the Sommerer Private Foundation holds any of its
property in trust for Peter Sommerer. However, in the remainder of these
reasons I set aside my doubts about whether the Sommerer Private Foundation
holds its property in trust, and I assume without deciding that in October of
1996 when Herbert Sommerer created the Sommerer Private Foundation and endowed
it with the equivalent of $126,000, he settled a trust for the benefit of Peter
Sommerer, his spouse and their children, with the Sommerer Private Foundation
as trustee.
(D) Does
subsection 75(2) apply?
[44]
The
Sommerer Private Foundation used part of the money it received from Herbert
Sommerer as an endowment to pay Peter Sommerer part of the purchase price of
the Vienna shares. The Sommerer Private Foundation later sold the shares and
realized a capital gain. The position of the Crown is that subsection 75(2)
applies to attribute that capital gain to Peter Sommerer.
[45]
I
reproduce here the parts of subsection 75(2) upon which the Crown relies:
|
75. (2) Where,
by a trust created in any manner whatever since 1934, property is held on
condition
(a) that
it or property substituted therefor may
(i) revert
to the person from whom the property or property for which it was substituted
was … received (in this subsection referred to as “the person”), …
… any taxable capital gain … from the disposition
of the property … shall, during the existence of the person while the person
is resident in Canada, be deemed to be … a taxable capital gain … of the
person.
|
75. (2) Lorsque,
en vertu d’une fiducie créée de quelque façon que ce soit depuis 1934, des
biens sont détenus à condition :
a) soit que ces
derniers ou des biens qui leur sont substitués puissent :
(i) ou
bien revenir à la personne dont les biens ou les biens qui leur sont
substitués ont été reçus […] (appelée « la personne » au présent paragraphe),
[…]
[…] tout gain en capital imposable […] de la
disposition des biens […] est réputé, durant l’existence de la personne et
pendant qu’elle réside au Canada, être […] un gain en capital imposable […]
de la personne.
|
[46]
This
provision must be read together with paragraph 248(5)(a) of the Income
Tax Act, which provides, broadly speaking, that for the purposes of most
provisions of the Income Tax Act, the notion of the substitution of
property contemplates any number of substitutions. It reads in relevant part as
follows:
|
(5) For
the purposes of this Act …,
(a) where a person
has disposed of or exchanged a particular property and acquired other
property in substitution therefor and subsequently, by one or more further
transactions, has effected one or more further substitutions, the property
acquired by any such transaction shall be deemed to have been substituted for
the particular property….
|
5) Pour
l’application de la présente loi […]:
a) lorsqu’une personne
dispose d’un bien donné ou l’échange et acquiert un autre bien en
remplacement et que par la suite, par une ou plusieurs autres opérations,
elle effectue une ou plusieurs autres substitutions, le bien acquis par cette
opération est réputé substitué au bien donné […]
|
[47]
The
Crown argues that subsection 75(2) applies to this case because when Peter
Sommerer sold the Vienna shares to the Sommerer Private Foundation in October
of 1996, it was possible under the constating documents of the Sommerer Private
Foundation that the Vienna shares or property substituted for them (including
the proceeds of their sale, any property that might be acquired with the
proceeds of their sale, and so on), might one day be distributed to Peter
Sommerer as a beneficiary or an ultimate beneficiary. I agree that Peter
Sommerer may one day be entitled to a distribution from the Sommerer Private
Foundation of property that, by virtue of paragraph 248(5)(a), would be
property substituted for the Vienna shares. However, Justice Miller found that
to be an insufficient basis for the application of subsection 75(2). I agree.
[48]
Subsection
75(2) must be interpreted and applied to give effect to its language, read in
its proper context and with a view to giving effect to its intended purpose. As
mentioned above, subsection 75(2) generally is intended to ensure that a
taxpayer cannot avoid the income tax consequences of the use or disposition of
property by transferring it to another person in trust while retaining a right
of reversion or a right of disposition with respect to the property or property
for which it may be substituted. A common example of the application of
subsection 75(2) is the settlement of a trust where the settlor is also a beneficiary
with an immediate or contingent right to a distribution of the trust property.
In that situation, and in many other situations contemplated by paragraphs
75(2)(a) and (b), subsection 75(2) achieves its intended purpose.
[49]
In
this case, the Crown contends that the application of subsection 75(2) applies
also in respect of property that has been purchased by a trustee from a
beneficiary at fair market value and held subject to the terms of the trust. In
my view, to interpret subsection 75(2) so that it could apply to a beneficiary
in respect of property that the trust acquired from the beneficiary in a bona
fide sale transaction leads to outcomes that are absurd and could not have
been intended by Parliament.
[50]
A
series of examples will illustrate this point. (For the sake of simplicity,
assume that to the extent the trust in these examples earns any income from the
use of its property, the income is distributed to the beneficiaries on a
current basis, so that no property of the trust represents retained income or
property substituted for retained income.)
[51]
An
individual, Mary, settles a $10,000 trust for her children, naming them all as
beneficiaries who are to share equally in all distributions of property of the
trust, and naming herself as the sole beneficiary in the event that all of the
children predecease her. In this case, subsection 75(2) would apply to
attribute to Mary all of the income and losses of the trust from the use of its
property, and all of the capital gains and losses realized by the trust on the
disposition of its property (during her lifetime as long as she is resident in
Canada).
[52]
Now
a complication is added. One of Mary’s children, Jack, donates a painting to
the trust, stipulating that it is to be held subject to the existing terms of
the trust except that if the painting is still held by the trust in ten years
time, the painting would revert to Jack. The trust sells the painting five
years later, realizing a capital gain on the sale. The capital gain is
attributed to Jack pursuant to subsection 75(2) because it was realized on the
disposition of property that the trust acquired from Jack subject to the terms
of the existing trust, and also subject to the condition that the property
could revert to him. It is important to observe that, because the painting was
donated to the trust by Jack and the trust gave nothing to Jack in return, it
cannot be said that the painting is property substituted for any property that
the trust received from Mary, so there could be no attribution to Mary of any
gain on the sale of the painting, or any income or gains associated with
property substituted for the painting.
[53]
Now
suppose that Jack, instead of donating the painting to the trust, sells it to
the trust for its fair market value with no conditions attached. The painting
is sold by the trust at a time when Jack is the only child of Mary still alive.
The trust realizes a capital gain on the sale. At that point, either Mary or
Jack could become entitled to receive all of the property of the trust, depending
upon which of them dies first.
[54]
Under
the conventional understanding of subsection 75(2), the painting would be
considered property substituted for money that the trust received from Mary.
That is because all of the property of the trust can be traced, through the
substituted property rule, to whatever property Mary donated to the trust when
it was settled. Because the painting and any property substituted for the
painting could revert to Mary, subsection 75(2) would apply to attribute to
Mary the capital gain on the sale of the painting. However, if the Crown’s
interpretation is correct, it would be equally valid to say that because the
trust received the painting from Jack when the terms of the trust were such
that the painting could revert to him, subsection 75(2) attributes to Jack the
capital gain on the sale of the painting.
[55]
Thus,
under the Crown’s interpretation of subsection 75(2), the same capital gain is
attributed simultaneously to Mary and Jack. That cannot be. Nothing in
subsection 75(2) contemplates an outcome involving the attribution of the same
gain to more than one person. This double application of subsection 75(2)
cannot be avoided by a discretionary use of subsection 75(2), because it is not
a discretionary provision. It applies automatically to every situation it
describes.
[56]
For
the same reason, it is no answer to say that in this particular case,
subsection 75(2) could never apply to Herbert Sommerer, the “settlor” of the
trust, because he is not a resident of Canada. Again, because subsection 75(2)
applies automatically to every situation it describes, it is not acceptable to
adopt one interpretation for transactions involving only residents of Canada,
and a different interpretation for transactions involving residents of other countries.
[57]
I
conclude that the Crown’s proposed interpretation is wrong because it is based
on the incorrect premise that subsection 75(2) can apply to a beneficiary of a
trust who transfers property to the trust by means of a genuine sale. Justice
Miller reached the same conclusion through a comprehensive application of the
principles of statutory interpretation to specific words and phrases in
subsection 75(2). His main conclusion is stated succinctly at paragraph 91 of
his reasons:
|
… once properly unravelled and
viewed grammatically and logically, the only interpretation is that only a
settlor, or a subsequent contributor who could be seen as a settlor, can be
the "the person" for purposes of subsection 75(2) of the Act.
|
[58]
It
remains only to apply this conclusion to the present case. The Sommerer Private
Foundation purchased the Vienna shares from Peter Sommerer using money from the
original endowment from Herbert Sommerer. Peter Sommerer has not endowed the
Sommerer Private Foundation with any other money or property. Therefore,
subsection 75(2) cannot apply to attribute any income or gains of the Sommerer
Private Foundation to Peter Sommerer.
[59]
That
is a sufficient basis for dismissing this appeal. However, since Justice Miller
dealt with Article XIII (5) of the Canada-Austria Income Tax Convention,
I will comment on that issue as well.
(E) Does the Canada-Austria
Income Tax Convention apply?
[60]
Justice
Miller concluded that if subsection 75(2) were to apply to attribute to Peter
Sommerer the capital gain realized by the Sommerer Private Foundation on the
sale of the shares it purchased from Peter Sommerer, Canada nevertheless is
precluded by Article XIII (5) of the Canada-Austria Income Tax Convention
from taxing the gain in his hands.
[61]
Article
XIII (5) of the Canada-Austria Income Tax Convention reads as follows:
|
5.
Gains from the alienation of any property, other than those mentioned in
paragraphs (1), (2), (3) and (4) shall be taxable only in the Contracting State of which the alienator is a resident.
|
5. Les gains provenant de
l’aliénation de tous biens autres que ceux qui sont mentionnés aux
paragraphes 1, 2, 3 et 4 ne sont imposables que dans l’État contractant dont
le cédant est un résident.
|
[62]
Justice
Miller reasoned that the gain in issue falls squarely within the language of
Article XIII (5). After considering the relevant principles of the
interpretation of income tax conventions and the commentaries of the
Organization for Economic Cooperation and Development (the “OECD”), he found
nothing in the context of the Canada-Austria Income Tax Convention to
suggest that Article XIII (5) was not intended to apply literally.
[63]
The
Crown argues that even though the gains attributed to Peter Sommerer pursuant
to subsection 75(2) are gains from the alienation of property by a person who
is resident in Austria, and are thus within the scope of Article XIII (5), the
only consequence is that Canada cannot tax the alienator – the Sommerer Private
Foundation – on the gain. According to the Crown, Peter Sommerer can obtain no
relief from Canadian tax under Article XIII (5) because he is not resident in
Austria, and also because the tax in issue is not imposed on the basis that
Peter Sommerer is the alienator of the shares, but by the operation of the
attribution rule in subsection 75(2).
[64]
Justice
Miller rejected that argument because he considered it inconsistent with the
language of Article XIII (5), and the apparent premise for another provision of
the Canada-Austria Income Tax Convention, Article XXXVIII (2). In that
provision, Canada reserves the right to tax residents of Canada on income and gains attributed to them pursuant to section 91 of the Income Tax
Act (the foreign accrual property rules). The existence of that reservation
suggests that an underlying premise of the Canada-Austria Income Tax
Convention is that tax on attributed income generally is within its scope.
There is no similar reservation relating to the attribution of income and gains
under subsection 75(2), which means that Canada has not reserved the right to
tax residents of Canada on income and gains attributed to them under subsection
75(2).
[65]
The
Crown argues that the reservation clause in relation to the attribution of
income and gains under the foreign accrual property rules is not necessary but
was included only for greater certainty, and that foreign jurisprudence
establishes that domestic attribution rules do not conflict with international
tax conventions based on the OECD model. However, having reviewed all of the
foreign cases and learned commentary to which the parties referred, I am unable
to accept the Crown’s argument.
[66]
The
OECD model conventions, including the Canada-Austria Income Tax Convention,
generally have two purposes – the avoidance of double taxation and the
prevention of fiscal evasion. Article XIII (5) of the Canada-Austria Income
Tax Convention speaks only to the avoidance of double taxation. “Double
taxation” may mean either juridical double taxation (for example, imposing on a
person Canadian and foreign tax on the same income) or economic double taxation
(for example, imposing Canadian tax on a Canadian taxpayer for the attributed
income of a foreign taxpayer, where the economic burden of foreign tax on that
income is also borne indirectly by the Canadian taxpayer). By definition, an
attribution rule may be expected to result only in economic double taxation.
[67]
The
Crown’s argument requires the interpretation of a specific income tax
convention to be approached on the basis of a premise that excludes, from the
outset, the notion that the convention is not intended to avoid economic double
taxation. That approach was rejected by Justice Miller, correctly in my view.
There is considerable merit in the opinion of Klaus Vogel, who says that the
meaning of “double taxation” in a particular income tax convention is a matter
that must be determined on the basis of an interpretation of that convention (Klaus
Vogel on Double Taxation Conventions: A Commentary to the OECD –, UN –, and US
Model Conventions for the Avoidance of Double Taxation on Income and Capital,
3rd ed. (The Hague: Kluweer Law International, 1997)).
[68]
I
see no error of law or principle in the conclusion of Justice Miller that
Article XIII (5) applies to preclude Canada from taxing Peter Sommerer on the
capital gains realized by the Sommerer Private Foundation.
Conclusion
[69]
For
these reasons, I would dismiss the appeal with costs.
“K.
Sharlow”
“I
agree
Pierre Blais, Chief Justice”
“I
agree
Gilles Létourneau J.A.”
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