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Citation: 2004TCC239
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Date: 20040323
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Docket: 2003-2107(IT)I
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BETWEEN:
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ALINE MORASSE,
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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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REASONS FOR JUDGMENT
Miller J.
[1] The Minister of National Revenue
assessed Ms. Morasse's 2001 taxation year to include $12,342
of additional investment income, based on the value of a stock
distribution of 400 units of Series L ADR of América
Móvil S.A. de C.V. (the "America Movil
securities"). Ms. Morasse appeals by way of the informal
procedure claiming, firstly, that the receipt of the Movil
securities constituted an eligible distribution governed by
section 86.1 of the Income Tax Act and consequently not
taxable; and, secondly, if section 86.1 is not applicable, the
receipt of the Movil securities was not a stock dividend on
income account but a non-taxable capital receipt. I find the
distribution of the Movil securities does not qualify under
section 86.1, but I also find that the receipt of the Movil
securities by Ms. Morasse was not income.
[2] In 2001, Ms. Morasse owned 400
Class L ADR of Teléfonos de México, S.A. de C.V.
ADR stands for American Depository Receipts. These securities
were traded on the New York Stock Exchange (NYSE), while the
underlying shares of the Mexican company, which they represent,
were traded on the Mexican Stock Exchange. I will refer to this
Mexican Company simply as Telmex.
[3] In an Information Statement dated
September 15, 2000,[1] Telmex described a spin-off anticipated to be approved
by September 25, 2000, the approval date. The statement indicated
that on the approval date, each holder of Telmex shares would
become the owner of an equal number of América
Móvil, S.A. de C.V. ("America Movil") shares
and, from that point until a distribution date, the shares of
both companies could only be owned and transferred together. The
Information Statement went on to state:[2]
Description of the Spin-off
The Spin-off will be implemented using a procedure under Mexican
corporate law called escisión or
"split-up". In an escisión, an existing
company is divided, creating a new company to which specified
assets and liabilities are allocated. This procedure differs from
the procedure by which a spin-off is typically conducted in the
United States, where a parent company distributes to its
shareholders shares of a subsidiary. The escisión
will be approved on the Approval Date by a single
action of the shareholders at the extraordinary meeting
establishing América Móvil and allocating certain
assets and liabilities of Telmex to América Móvil.
Prior to the Approval Date, Telmex will reorganize certain of the
intermediate holding companies through which it holds various
assets and subsidiaries, so as to facilitate the implementation
of the Spin-off.
Effective immediately on the Approval Date:
·
América Móvil will be established as a separate
company, with a fully independent legal existence and full
capacity to own and dispose of its assets. Its initial board of
directors will be elected at the same extraordinary meeting that
approves the Spin-off.
· Specified
assets of Telmex, including the shares of specified subsidiaries,
will be transferred to América Móvil. All the
businesses to be conveyed to América Móvil are
conducted by separate corporations, and the continuity of
existence of those corporations will be undisturbed by the
Spin-off.
· All the
shares of América Móvil will be owned by the
shareholders that own Telmex shares as of the Approval Date.
· Certain
agreements between Telmex and América Móvil will
take effect.
Promptly following the Approval Date, the shareholders'
resolution from the extraordinary meeting will be notarized,
registered in the Mexican Public Registry of Commerce and
published in the Diario Offical (Official Gazette).
Following the registration and publication of the resolution,
Mexican law provides for a period of 45 days during which the
Spin-off may be challenged by certain parties, as described
below. América Móvil shares will not be delivered
or held separately from Telmex shares before the end of this
statutory period.
On the Approval Date, the Spin-off will affect Telmex
shareholders as follows:
· Each owner
of Telmex L Shares will become the owner of the same number of
América Móvil L Shares.
· Each owner
of Telmex A Shares will become the owner of the same number of
América Móvil A Shares.
· Each owner
of Telmex AA Shares will become the owner of the same number of
América Móvil AA Shares
· Each Telmex
shareholder will continue to own the same number of Telmex
shares.
Prior to the Share Distribution Date, however, there will be
no separate certificates for América Móvil shares,
and the right to receive América Móvil shares will
be transferred together with Telmex shares. Investors will not be
able to buy or otherwise acquire, or sell or otherwise transfer
or deliver, Telmex shares or América Móvil shares
separately.
[4] The transaction proceeded, as just
described, as is evidenced by the following excerpts from the
Annual Report of Telmex filed with the US Securities and Exchange
Commission on August 23, 2001.[3]
The Spin-Off
General
At an extraordinary shareholders' meeting held on September
25, 2000, our shareholders approved the spin-off of our Mexican
wireless business and most of our international operations into
América Móvil, a sociedad anónima de
capital variable organized under the laws of Mexico. The
spin-off was conducted by means of the procedure under Mexican
corporate law called escisión or
"split-up", in which an existing company is
divided, creating a new company to which specified assets and
liabilities are allocated. This procedure differs from the
procedure by which a spin-off is typically conducted in the
United States, where a parent company distributes to its
shareholders shares of a subsidiary.
The purpose of the spin-off was to improve our ability and that
of América Móvil to address the distinct challenges
and opportunities we each face. The Mexican wireless business and
the related investments outside Mexico, which were transferred to
América Móvil, face very different business and
regulatory environments from the Mexican fixed-line
telecommunications business, including Internet and data
businesses. The differences were reflected in the separate
corporate and management structures, fixed assets, operations,
marketing and billing that existed prior to the spin-off. We
expect that establishing two separate, publicly-traded companies
through the spin-off will provide benefits both to us and to
América Móvil. In particular, the spin-off will
permit us to pursue objectives tailored to the fixed-wire
business and to access financing more efficiently.
Prior to the spin-off, we conducted an internal reorganization.
Following the reorganization, one of our subsidiaries called
Sercotel, S.A. de C.V. directly or indirectly owned the shares of
Radio Móvil Dipsa, S.A. de C.V. (or Telcel, our wireless
subsidiary prior to the spin-off) and the subsidiaries that
conduct América Móvil' international businesses
and hold América Móvil's international
investments. Also as a result of the reorganization, subsidiaries
of Telcel held Ps.17.6 billion of our commercial paper and
Ps.11.9 billion of other liquid assets in order to help
América Móvil meet its capital requirements.
In the spin-off, América Móvil was established as a
separate company with a separate board of directors; the shares
of Sercotel were transferred to América Móvil; and
each holder of Telmex received an equal number of América
Móvil shares of the corresponding class. The spin-off was
completed on February 7, 2001, when shares and ADSs of
América Móvil began trading separately from our
shares and ADSs on the Mexican Stock Exchange, the New York Stock
Exchange and NASDAQ.
[5] This notice referred to a
completion date of February 7, 2001, and it was on that date that
Ms. Morasse's account with TD Waterhouse was credited with
what TD Waterhouse referred to as a "stock dividend" of
$12,342. TD Waterhouse also provided a T5 form to Ms.
Morasse indicating foreign investment income which included the
$12,342. The amount of $12,342 represents the value of the
America Movil securities.
[6] Ms. Morasse filed a return for
2001 bringing that amount into income, but later filed an amended
return electing to take advantage of section 86.1 and deferring
the tax on the distribution of the Movil securities in accordance
with that section.
[7] The distribution of shares of
America Movil has not been prescribed by the Government of
Canada.
[8] In addressing the first issue of
the applicability of section 86.1, it is useful to set out some
relevant portions of that provision:
86.1(1) Notwithstanding any other provision of this Part,
(a) the
amount of an eligible distribution received by a taxpayer shall
not be included in computing the income of the taxpayer; and
(b)
subsection 52(2) does not apply to the eligible distribution
received by the taxpayer.
(2) For the purposes of
this section and Part XI, a distribution by a particular
corporation that is received by a taxpayer is an eligible
distribution if
(a) the
distribution is with respect to all of the taxpayer's common
shares of the capital stock of the particular corporation (in
this section referred to as the "original shares");
(b) the
distribution consists solely of common shares of the capital
stock of another corporation that were owned by the particular
corporation immediately before their distribution to the taxpayer
(in this section referred to as the "spin-off shares");
(c) in the
case of a distribution that is not prescribed,
(i) at the
time of the distribution, both corporations are resident in the
United States and were never resident in Canada,
(ii) at the time of
the distribution, the shares of the class that includes the
original shares are widely held and actively traded on a
prescribed stock exchange in the United States, and
(iii) under the United
States Internal Revenue Code applicable to the distribution, the
shareholders of the particular corporation who are resident in
the United States are not taxable in respect of the
distribution;
(d) in the
case of a distribution that is prescribed,
(i) at the
time of the distribution, both corporations are resident in the
same country, other than the United States, with which Canada has
a tax treaty (in this section referred to as the "foreign
country") and were never resident in Canada,
(ii) at the time of
the distribution, the shares of the class that includes the
original shares are widely held and actively traded on a
prescribed stock exchange,
(iii) under the law of the
foreign country, those shareholders of the particular corporation
who are resident in that country are not taxable in respect of
the distribution, and
(iv) the distribution is
prescribed subject to such terms and conditions as are considered
appropriate in the circumstances;
(e) before
the end of the sixth month following the day on which the
particular corporation first distributes a spin-off share in
respect of the distribution, the particular corporation provides
to the Minister information satisfactory to the Minister ...
(f) except
where Part XI applies in respect of the taxpayer, the taxpayer
elects in writing filed with the taxpayer's return of income
for the taxation year in which the distribution occurs (or, in
the case of a distribution received before October 18, 2000,
filed with the Minister before July 2001) that this section apply
to the distribution and provides information satisfactory to the
Minister ...
(3) Where a spin-off
share is distributed by a corporation to a taxpayer pursuant to
an eligible distribution with respect to an original share of the
taxpayer,
(a) there
shall be deducted for the purpose of computing the cost amount to
the taxpayer of the original share at any time the amount
determined by the formula
A × (B/C)
where
A is the cost
amount, determined without reference to this section, to the
taxpayer of the original share at the time that is immediately
before the distribution or, if the original share is disposed of
by the taxpayer, before the distribution, at the time that is
immediately before its disposition,
B is the
fair market value of the spin-off share immediately after its
distribution to the taxpayer, and
C is the total
of
(i) the fair
market value of the original share immediately after the
distribution of the spin-off share to the taxpayer, and
(ii) the fair market
value of the spin-off share immediately after its distribution to
the taxpayer; and
(b) the cost
to the taxpayer of the spin-off share is the amount by which the
cost amount of the taxpayer's original share was reduced as a
result of paragraph (a).
[9] Clearly, there are two categories
of foreign spin-offs contemplated by section 86.1: those
involving American companies, and those involving all other
foreign companies. For the latter category to be subject to the
benefits of section 86.1, the distribution, according to
subparagraph 86.1(2)(d)(iv) must be prescribed. Prescribed
means prescribed by Regulation or determined in accordance
with Rules prescribed by Regulation. The evidence
was that the distribution of the shares of America Movil was not
prescribed in accordance with the requirements of the Act.
The Respondent indicated that such a transaction never would be
prescribed as the shares of the spin-off company were never owned
by the company undertaking the spin-off. It follows that
Ms. Morasse cannot look to paragraph 86.1(2)(d) as
applying to this Mexican distribution.
[10] Although it was not argued directly,
Ms. Morasse's agent alluded to the twist in this case in that
Ms. Morasse did not hold the shares of Telmex directly, nor did
she receive the shares of America Movil directly. This was all
done through her holding of ADRs, sometimes referred to as
American Depository Shares. Does then paragraph
86.1(2)(c), dealing with corporations resident in the US,
come into play? I do not believe it does. The section refers to
corporations, either resident in the US or elsewhere. The only
corporations involved in this particular spin-off were Mexican
corporations. The use of ADRs to allow for the trading of these
Mexican companies on a US exchange, does not in any way create a
US corporation. The only corporations at issue here are Mexican
corporations, and if the distribution of a Mexican company's
shares is not a prescribed distribution, subsection 86.1(2)
simply does not apply.
[11] I can certainly understand how Ms.
Morasse, through her agent, believes this provision was aimed at
her type of situation, and from a policy perspective, it might
seem inequitable to her that she cannot avail herself of the
benefits of section 86.1. The Crown's response is that
because this type of spin-off did not involve stock of a
subsidiary being spun-off by a parent, it would never be
prescribed. Spin-offs in foreign jurisdictions may take many
different forms. Canadian tax legislation has identified the form
which it finds acceptable for purposes of affording some tax
deferral. Unfortunately for Ms. Morasse, the Mexican
escisión is not contemplated by the structures
outlined in section 86.1.
[12] Ms. Morasse's fall-back argument is
that the classification of the distribution of the America Movil
shares as a stock dividend is incorrect; the shares do not
represent investment income.
[13] This is an intriguing issue. As this is
an informal procedure matter, with an Appellant unrepresented by
a lawyer, involving foreign corporate reorganization laws, a deep
delving into the meaning of income, which has not been
extensively argued, is not warranted. However, how does a company
(Telmex), which does not own shares in America Movil distribute
such shares as a stock dividend? Certainly there was a stock
distribution, but it was as a result of an overall restructuring
of Telmex, a restructuring in which America Movil shares were
never actually owned by Telmex. TD Waterhouse referred to the
distribution as a stock dividend and recorded the value of the
stock as investment income, but that is certainly not
determinative. But is it truly investment income in the form of a
stock dividend?
[14] The answer lies in the starting point
of the Act - the general rules for the determination of
income found in section 3, part of which reads:
3 The
income of a taxpayer for a taxation year for the purposes of this
Part is the taxpayer's income for the year determined by the
following rules:
(a) determine
the total of all amounts each of which is the taxpayer's
income for the year (other than a taxable capital gain from the
disposition of a property) from a source inside or outside
Canada, including, without restricting the generality of the
foregoing, the taxpayer's income for the year from each
office, employment, business and property,
[15] Is the America Movil distribution
income from a source outside Canada, or a taxable
capital gain from the disposition of property or is it an
amount that simply does not fall under either category and
consequently ought not to be brought into income?
[16] To constitute a capital gain from the
disposition of property, Ms. Morasse must have disposed of some
property. She did not. The Mexican restructuring shifted value
from the Telmex shares to the America Movil shares, but
Ms. Morasse did not dispose of the Telmex shares. Nothing in
the description of the deal, in the documents provided to me,
suggest Ms. Morasse disposed of her Telmex shares and received in
return an equal number of Telmex and America Movil shares. This
would be stretching the legal substance of the restructuring
beyond what actually transpired. Telmex's equity would have
been reduced at the time of the spin-off, with a corresponding
increase in America Movil's equity. Ms. Morasse may not have
been economically advantaged by such a transaction, but as has
been made clear in several recent cases, it is not the economic
substance, but the legal relationship which governs a transaction
for purposes of the determination of the tax liability. Ms.
Morasse did not dispose of her Telmex shares notwithstanding
their reduced value: no disposition, no capital gain or loss.
[17] What then is the nature of the
distribution? I disagree with the Respondent's contention
that it is a stock dividend. It is not a stock dividend as
defined in the Act, since stock dividend must be a share
of the corporation which paid the dividend. Telmex did not issue
its own shares to the shareholders. America Movil did, but how
can a share issued to someone who is not a shareholder until the
issuance of the share be considered a dividend? The difficulty is
that the America Movil shares were issued as part of the
escisión, a concept which does not allow for a neat
categorization of the distribution as a dividend.
[18] If it is not a dividend, is it still
income from a source outside Canada? The America Movil shares
were issued as part of a reorganization: they would not have been
issued but for Telmex's decision to undertake the spin-off.
In other words, Telmex directed the issuance of shares by America
Movil to the shareholders. This is not, however, a shareholder
benefit, as paragraph 15(1)(a) specifically precludes
any benefit arising as a result of the reorganization. This is
the receipt of shares of one company solely as a result of owning
shares of another company, all in the course of a
reorganization.
[19] There is no question Ms. Morasse
held her interest in Telmex as an investment: there was a source
of income outside Canada. That source yielded shares in America
Movil. But do the America Movil securities represent underlying
profits of Telmex? What does the $12,432 reflect? Was there a
corresponding decline in the value of the Telmex shares which
offset the "value" received by Ms. Morasse in the form
of the America Movil shares? In an annual report that Telmex
filed with US Securities and Exchange Commission on
August 23, 2001,[4] the trading history of Telmex ADS for the months of
February and March 2001 showed a decline from a high of $54 to
approximately $34 a share. Recall that the spin-off took place in
February 2001. Ms. Morasse held 400 Telmex ADRs and therefore
suffered a drop in the value at that time of approximately
US$8,000. Presuming an exchange rate of approximately one and
one-half to one, this amounts to roughly $12,000 or just shy of
the value the Respondent has attributed as income of Ms. Morasse
on receipt of the America Movil shares.
[20] In the Reply, the Respondent refers to
the distribution of 400 ADR shares as a stock distribution, quite
properly avoiding the term "stock dividend", although
section 90 is relied upon in conjunction with paragraph
12(1)(k) of the Act. Section 90 reads:
90(1) In computing the income for a taxation
year of a taxpayer resident in Canada, there shall be included
any amounts received by the taxpayer in the year as, on account
or in lieu of payment of, or in satisfaction of, dividends on a
share owned by the taxpayer of the capital stock of a corporation
not resident in Canada.
[21] As I have already indicated, the
America Movil securities received by Ms. Morasse were not
received as dividends as such, nor were they received in lieu of
payment of dividends on the Telmex shares. As part of the
reorganization, Telmex arranged that its shareholders receive the
America Movil shares, not as part of any distribution of profits,
but as recognition of a shift of capital from Telmex to America
Movil. T he documents produced at trial confirm this move from
one company to the other.
[22] The Respondent argued that the only
avenue available to Ms. Morasse to prove the stock distribution
was not a source of income would be to prove that it was either a
return of capital or a loan. I agree with Respondent's
counsel that there is no suggestion of a loan. However, I
disagree with him that the coincidental drop in the share price
of Telmex on balance is more probative of a dividend than any
return of capital. The Respondent argues that there is no
evidence that the stock distribution is not a distribution of a
share of corporate profits. Again, I disagree. The whole concept
of the escisión is that a separate, identifiable
business of one company is spun-off into another company, in this
case Telmex's wireless business. This is accomplished,
according to the Information Statement dated February 15, 2000,
by specified assets, including shares of subsidiaries, of Telmex
being transferred to America Movil. It is not accomplished by a
movement of undistributed corporate profits to the shareholder.
This is confirmed by the following statement in Note 2 to
Telmex's December 31, 2000 financial statements, attached to
Form 20-F/A filed with the Securities and Exchange Commission on
August 23, 2001:[5]
Assets and liabilities of the discontinued operations were
transferred to America Movil at their book value. The amount of
stockholders' equity transferred to America Movil in the
spin-off was determined as the difference between the assets and
liabilities transferred and will be accounted for as a reduction
in Telmex's equity at the time of the spin-off.
It appears that between Telmex and America Movil the
shareholders' equity has remained the same; in effect, there
has been no distribution of profits to shareholders in this
Mexican reorganization.
[23] The Respondent offered only two
possibilities for the distribution to be found to be non-taxable
- a loan or return of capital. Yet, what has transpired is
neither. What occurred is more akin to a stock split than a stock
dividend, and in the absence of any expert evidence on Mexican
law to the contrary, I am prepared to regard it in such
light.
[24] In summary, the distribution in this
reorganization was not a stock dividend. I am satisfied the
underlying equity in Telmex and America Movil after the
escisión reflected the equity of Telmex prior to
the escisión. The shareholder, Ms. Morasse, has
simply not received income from a source outside Canada subject
to section 3 of the Act: at best she has been the
recipient of shares in the course of a reorganization that is
most analogous to a form of stock split. Tax authors have written
realms on the subject of what is income. In this informal
procedure with an unrepresented Appellant, I am not inclined to
offer any further weighty tome on the subject. The exhibits
presented at trial have persuaded me this distribution is not
income. The appeal is allowed and the matter is referred back to
the Minister for reassessment and reconsideration on the basis
that the $12,342 is not income subject to section 3 of the
Act.
Signed at Ottawa, Ontario, this 23rd day of March, 2004.
Miller J.
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