Davis v. The Queen, 94 D.T.C 1934, [1994] 2 CTC 2033 (TCC)

McArthur, J.T.C.C.:— Joint Trawlers Inc. (the "company") paid cash dividends to its only two shareholders Marget Davis and Herbert Davis in 1985 and 1986. On November 11, 1986, the company was assessed a total tax liability of $36,543.88 for its 1985 taxation year. It subsequently filed its 1986 return reporting a non-capital loss of $94,806 resulting in a revised tax liability for the 1985 taxation year of $23,409.50. The Minister of National Revenue (the "Minister") assessed a total income tax liability on Herbert Davis and Marget Davis (the "appellants") pursuant to subsections 160(1) and (2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") in the amount of $34,585.93, to include interest dated August 1, 1991, on account of a transfer of property by way of dividends paid by a non-arm's length person. The appellants objected and the assessment was confirmed August 28, 1992 by the Minister. The company had ceased operations in late 1986.

The appeals were heard on common evidence.

Preliminary issue

Did the Minister assess the appellant’s returns within the time limits set out in the Act?

It was the contention of counsel for the appellants that the accountants and solicitors for the appellants were in constant touch with the respondent, her agents or servants, during the period of July 1988 to October 1988 yet the respondent, her agents and servants, did nothing until August 1991 for matters pertaining to the taxation years of 1985 and 1986 and because of the lapse of time the assessments should be vacated.

The relevant provision in the Income Tax Act is subsection 160(2) which reads:

The Minister may at any time assess a transferee in respect of any amount payable by virtue of this section and the provisions of this Division are applicable mutatis mutandis in respect of an assessment made under this section as though it had been made under section 152.

Section 160 is an anti-avoidance provision and is similar in this respect to paragraph 152(4)(a) which read in part for 1985 and 1986:

The Minister may at any time assess tax for a taxation year, interest or penalties, if any, payable under this Part by a taxpayer or notify in writing any person by whom a return of income for a taxation year has been filed that no tax is payable for the taxation year, and may

(a) at any time, if the taxpayer or person filing the return

(i) has made any misrepresentation that is attributable to neglect, carelessness or wilful default or has committed any fraud in filing the return or in supplying any information under this Act, or. . . .

In argument, the appellant’s counsel cited J. Stollar Construction Ltd. v. M.N.R.,

[1989] 1 C.T.C. 2171, 89 D.T.C. 134 (T.C.C.). That case dealt with subsection 152(1) of the Act which read in part at the relevant time:

The Minister shall, with all due dispatch, examine a taxpayer's return of income for a taxation year, assess the tax for the year, the interest and penalties, if any, payable and determine. . . .

J. Bonner, of this Court, held that an unexplained delay of 75 months was not acceptable.

In subsection 160(2) the scope of power given to the Minister by the Legislature is broad indicating a lack of limitation on when the Minister can assess. In Dupuis v. Canada, [1993] 2 C.T.C. 2032, 93 D.T.C. 723 (T.C.C.), the appellant taxpayer was assessed under section 160. The taxpayer argued that the assessment or reassessment was statute-barred under subsection 152(4). The Court held this argument was not tenable.

In Payette v. M.N.R., [1978] C.T.C. 3113, 78 D.T.C. 1801 (T.R.B.). The Court stated at page 3114 (D.T.C. 1802):

The fact that the Minister “may at any time assess a transferee in respect of any amount payable by virtue of this section” precludes any contention by the appellant that the Minister’s assessment is statute-barred. Since the appellant’s assessment under review is the original assessment, the four-year limitation period imposed by subsection 152(4) which relates to the reassessment or additional assessment has no application.

In conclusion, with respect to this first issue, I am satisfied that the words "at any time” provide a freedom to assess without the restrictions of "with all due dispatch" regardless of the lapse of time since the assessment at issue is an original assessment.

Substance of the appeal

The substance of the appeal raises the following issues:

(a) Can a corporate dividend be considered a transfer of property?

(b) Can corporate dividends be paid in exchange for consideration at law?

(c) If the first two questions are answered in the affirmative, was consideration paid in fact in the present instance?

Briefly, the facts include these.

In June 1984, the appellants commenced the business of selling fish, in quantities measured in metric tons, in the international market. In October 1984, the business was incorporated under the name Joint Trawlers Inc. (the "company"). The appellants were the only shareholders of the company—Herbert Davis holding 67 per cent and Marget Davis 33 per cent of the common shares. At the outset, the business flourished.

The company was run out of a fully equipped office in the appellants’ home in Ottawa, Ontario. Both appellants directed their services full-time for the benefit of the company and no doubt worked very hard. Herbert and Marget Davis each received a nominal yearly salary from the company of approximately $2,000 and $7,500 respectively in both 1985 and 1986. On the advice of its accountant, the company paid Herbert Davis cash dividends of $45,000 and $43,000, and to Marget Davis $22,500 and $21,500 in 1985 and 1986 respectively. The dividends were declared in January of each year but paid by monthly "draws".

In January 1986 when the company declared a dividend in favour of its two shareholders, in the total amount of $64,500, there was in excess of $200,000 in the company bank account. The company's accountant testified that there was sufficient money to cover the company's tax liability for the 1985 taxation year. Its return for the 1985 taxation year was assessed in December 1986.

During the second quarter of 1986 a Swedish based trawling company declared bankruptcy, unexpectedly, leaving the company with a $196,000 bad debt. The company never recovered from this substantial loss. The appellant, Herbert Davis gave uncontradicted evidence that the appellants sold their home in St. John's during the summer of 1986 and invested $40,000 from the net proceeds in the company. This money was not reflected in the company statements. Despite those efforts, Joint Trawlers Inc. went out of business in late 1986. As referred to earlier, the company's non-capital loss of $94,806 for 1986 was carried back and applied to the 1985 year resulting in a total tax liability inclusive of interest as of August 1, 1991 of $34,585.93.

The appellant, Herbert Davis, testified that he and his wife worked "day in and day out”, full time, for the benefit of the company and were paid, receiving by monthly draws, an amount equivalent to the dividends declared in January 1985 and January 1986. He stated that he did not know the difference between a dividend receipt and salary. He relied in complete confidence, on the advice of his accountant. As far as he was concerned, they were paid a salary for services rendered to the company.

Mrs. Davis confirmed the evidence of her former husband Herbert. Both were credible witnesses. There was no evidence that the dividend arrangement was an attempt to avoid payment of corporate tax.

The appellants acknowledged in cross-examination that they had no accurate work schedules or time dockets. In the pleadings, the appellants’ Answer paragraph 5(g) states in part:

(g) the appellant should be entitled to compensation for taking the risks and initiative of starting and assisting the company. Based on this the dividends received by the shareholder represent consideration or compensation for the risks and initiative she has undertaken.

The appellants could not give a per cent portion paid for taking the risks and initiative of starting and assisting the company stating they relied on professional advice.

The appellants’ accountant testified that there were company tax advantages in compensating the shareholders for their work by paying dividends and not salary and it was the custom of his office to declare the dividend at the beginning of the fiscal year in anticipation of the services to be rendered. He further stated that when the dividend of $64,500 was declared in January of 1986, there were sufficient company funds on hand to cover any tax liability and the dividend debt. He added that there were no indications that the Swedish company would declare bankruptcy resulting in a company bad debt of approximately $196,000. He admitted that by declaring a dividend in January of 1986, the company incurred a legal liability to the appellants of $64,500, the dividend having been declared in anticipation of services to be rendered during the 1986 fiscal year.

The relevant subsection of the Act reads as follows:

160. Tax liability re property transferred not at arm's length.

(1) Where a person has, on or after May 1, 1951, transferred property, either directly or indirectly, by means of a trust or by any other means whatever, to

(a) his spouse or a person who has since become his spouse,

(b) a person who was under 18 years of age, or

(c) a person with whom he was not dealing at arm’s length,

the following rules apply:

(d) the transferee and transferor are jointly and severally liable to pay a part of the transferor’s tax under this Part for each taxation year equal to the amount by which the tax for the year is greater than it would have been if it were not for the operation of sections 74 to 75.1, in respect of any income from, or gain from the disposition of, the property so transferred or property substituted therefor, and

(e) the transferee and transferor are jointly and severally liable to pay under this Act an amount equal to the lesser of

(i) the amount, if any, by which the fair market value of the property at the time it was transferred exceeds the fair market value at that time of the consideration given for the property, and

(ii) the aggregate of all amounts each of which is an amount that the transferor is liable to pay under this Act in or in respect of the taxation year in which the property was transferred or any preceding taxation year,

but nothing in this subsection shall be deemed to limit the liability of the transferor under any other provision of this Act.

Section 160 is an anti-tax avoidance section. In general terms it provides that when a person (which includes a company by definition) owes tax, and transfers property to another non-arm’s length taxpayer, without consideration, then the transferor and transferee are both liable for the tax owing jointly and severally.

The appellants submitted that their labour was consideration and employees of a company who have received dividends instead of wages and who declared and paid tax on such dividends should not be cast into some deemed relationship of paying another person's tax because of subsequent unfortunate circumstances where neither the company nor its employees were at fault. (The Swedish company went bankrupt which precipitated the downfall of the company.) The company declared and paid the dividends at a time when it was quite solvent and thriving.

The respondent's position was that at law no consideration can be given for dividends and from the facts of the case, no consideration had been given at the time of the declaration of the dividends.

The purpose of subsection 160(1) is to ensure that taxpayers do not avoid the payment of taxes by means of a transfer of property to a third party without consideration.

Rip, J.T.C.C., in Algoa Trust v. Canada, [1993] 1 C.T.C. 2294, 93 D.T.C. 405 (T.C.C.), made this comment at page 2302 (D.T.C. 411):

The purpose of section 160 is to foil an attempt by a taxpayer who is liable to pay any amount under the Act to avoid the fisc by transferring property otherwise available to satisfy the liability to one of three groups of persons, including a person with whom he or she was not dealing at arm's length.

(a) Can a corporate dividend be considered a transfer of property?

The appellant submitted that a payment of a cash dividend by the corporation cannot constitute a transfer of property. In the Algoa, supra, case, Rip, J.T.C.C. stated at page 2304 (D.T.C. 412):

The payment of a dividend in money or other property is a transfer of property within the meaning of subsection 160(1) of the Act. The corporation is impoverished and its shareholders are enriched. I fail to see the reason why a dividend is not a transfer of property.

I find in the case at bar that the payment of the cash dividends is a transfer of property.

(b) Can a corporate dividend be paid in exchange for consideration?

Counsel for the respondent's position was that shareholders receive dividends as of right so that no consideration can be given. One of the cases cited as authority was Algoa, supra, which included the following statement by Judge Rip at page 2302 (D.T.C. 410):

When a person subscribes for shares of a corporation he or she is paying theoretically for the acquisition of a share of the corporation and receives shares of a class in the capital stock of the corporation. The shareholder gives consideration for the shares and not for what the shares may bring. . . . When the shareholder receives a dividend it is not as a result of any consideration he or she gave the corporation and which the corporation is obliged to pay for investing. When a shareholder purchases shares he is not purchasing an income right. A shareholder receives a dividend solely because the right to a dividend is an attribute of owning shares.

The respondent's counsel also submitted that when the January 1986 dividend was declared in favour of the appellants, they had a valid right of action against the company for an amount equal to the dividend $64,500. At that time no services had been rendered and therefore no consideration given. The consideration was an anticipatory one until employment services had been rendered.

The appellant submitted that it is possible for parties to organize their affairs in such a way that dividends are paid in exchange for consideration in some form. In the case at bar the appellant argued that the consideration given for the dividend took the form of wages. In support of this proposition, the appellant relied upon the case of McClurg v. M.N.R., [1990] 3 S.C.R. 1020, [1991] 1 C.T.C. 169, 91 D.T.C. 5001. In McClurg, the taxpayer and his partner were the only directors of a company each holding class A and class C preferred shares. Their wives held class B shares. The company paid a dividend of $10,000 to each wife on the class B shares. The Minister of National Revenue added $8,000 to the respondent's (taxpayer's) income purporting to effect such reallocation under subsection 56(2) of the Act onthe basis that no distinction should have been made between class B shares and the dividend should have been paid proportionally on all common shares be they class A or class B it being an indirect payment to the husbands who were the majority shareholders. At the relevant time subsection 56(2) provided:

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

The Minister’s appeal was dismissed concluding inter alia that the wording of subsection 56(2) was not intended to apply to the declaration of dividends generally. After this conclusion Dickson, C.J. stated at page 1054 (C.T.C. 185, D.T.C. 5012):

I find this conclusion to be completely supported by the evidence. Wilma McClurg played a vital role in the financing of the formation of the company. Although I agree with Desjardins, J. that, with respect to a shareholder, "dividends come as a return on his or her investment" ([1988] 1 C.T.C. 75, 88 D.T.C. 6047 (F.C.A.), at page 83 (D.T.C. 6053)), in my view there is no question that the payments to Wilma MCC urg represented a legitimate quid pro quo and were not simply an attempt to avoid the payment of taxes. In my opinion, Goetz, J.T.C.C. erred when he found that the dividends were a blatant attempt at tax avoidance. Indeed, his dismissal of the relevance of Wilma McClurg’s contribution to the company and his description of her and Suzanne Ellis as "puppets" pay no regard to the very real contributions, financial and operational, made by Wilma McClurg. Furthermore, the efforts expended by Wilma McClurg in the operation of Northland Trucks, while not dispositive of the issue raised in this appeal, do provide further evidence that the dividend payment was the product of a bona fide business relationship.

Counsel for the appellant's position is that these comments constitute legal precedent and are to be followed being part of the ratio decidendi.

The respondent's counsel submitted that the statement was obiter dicta and not binding on this Court.

Sarchuk, J.T.C.C., in Neuman v. M.N.R., [1992] 2 C.T.C. 2074, 92 D.T.C. 1652 (T.C.C.), dealt at length with the law regarding obiter dictum and ratio decidendi. He was concerned with comments made by Dickson, C.J. in McClurg although not the specific statement quoted above.

Sarchuk, J.T.C.C. made these observations at page 2084 (D.T.C. 1660) in Neuman:

In order for the Supreme Court's comments to be taken as judicial dicta the intention to give guidance of a binding nature to the lower courts should be unambiguously expressed.

Nonetheless the opinion expressed, while not judicial dicta, are those of the Supreme Court and cannot be simply ignored.

While Dickson, C.J.'s statement may not be the ratio of his decision, he emphasized the fact that Mrs. McClurg made a very real contribution in consideration for the dividends paid her, it clearly supported his primary reasoning. I accept it for the position that consideration can be given for dividends.

This point has also been made in the unreported Tax Court of Canada case of B.E. Manchur v. M.N.R., 1991 (unreported), T.C.C. (Hamlyn, J.T.C.C.). In Manchur the facts were similar to the one at bar. The taxpayer was a shareholder in a company who received payments by way of dividends from a company, allegedly in exchange for services rendered. Hamlyn, J.T.C.C. stated at page 7:

By virtue of his relationship with the company, the company had transferred to the appellant dividends, that is the transfer of property at a time when the company owed taxes under the Act, and as such he, the appellant, is jointly and severally liable, along with the company, to pay amounts of tax that the company was liable to pay for the taxation year in which the transfer was made, if the transfer exceeded the consideration given for such transfer. The amount to be paid would be only that in excess of the consideration given.

[Emphasis added.]

He continued to find that the alleged consideration was a hindsight solution to a tax problem and not genuine. The inference to be taken from this is that consideration can be given for dividends. The Court concluded that no ascertainable consideration was given and stated at page 7:

. . the dividends were paid to shareholders in proportion to a shareholding arrangement agreed between the shareholders, and were paid from the income of the company. There was no accounting for the services rendered or the funds expended on behalf of the company by the appellant.

I find that consideration can be given in exchange for dividends.

(c) Was there consideration given in exchange for the dividends in fact in the case at bar?

Respondent's counsel argues that there was no consideration given in exchange for the dividends. In particular, counsel emphasized that there was no consideration given when the dividends were declared during the first week of the company's fiscal year. The services were not to be rendered until later in the year.

I do not accept the contentions of the respondent. The Ontario Business Corporations Act, R.S.O. 1990, c. B. 16, which is applicable to the company, gives directors discretion to pay dividends so long as the company is solvent. The company was solvent at the time of declaration of the dividend in January of 1985 and January of 1986.

It is within the discretion of the directors to declare dividends in exchange for consideration. I find that at the time of the declaration of the dividends, the appellants had committed their future services to the benefit of the business and in fact the dividends were not paid until the services were rendered.

Both had given up previous attractive employment situations and had set up a fully equipped office in their home for the benefit of the corporation.

I conclude from the facts, that good and sufficient consideration was [given] by the appellants to the company to justify the payment of $67,500 to them in 1985 and $64,500 in 1986. Had it been paid by way of salary, it is very doubtful that the respondent would have applied subsection 160(1) of the Act.

Conclusion

The purpose of subsection 160(1) is to prevent a person (company) with income tax liability, from avoiding the Minister's claim by transferring property, including cash dividends, to a non-arm's length person for no consideration. This is not the situation at bar. The appellants devoted their full-time services to the company and paid themselves by way of dividends rather than salary. At the time the dividends were declared the company was solvent and there is no question that the declaration and subsequent payment of dividend was not made to circumvent taxes. The taxes had not been assessed at the time the dividend was declared as paid.

The appeals are allowed, with costs, and the matter is referred to the Minister for reconsideration and reassessment.

These appeals having been heard on common evidence, only one counsel fee is allowed.

Appeals allowed.