Dale v. R., 97 DTC 5252, [1997] 2 CTC 286 (FCA)

Robertson J A.:

This is yet another case in which the Court is called on to determine whether a taxpayer is to be denied a tax advantage on the basis of what the Minister of National Revenue characterizes as an ineffective or invalid transaction. Section 85 of the Income Tax Act (hereafter the “Act”) requires that the consideration on a rollover of property from an individual to a corporation must include at least one share of the capital stock of the transferee. In this instance preference shares were issued to the transferor, the appellant taxpayers, but at a time when the authorized capital of the corporate transferee did not permit such. To effect the necessary increase in capital, supplementary letters patent were required but never obtained. Eventually, the corporate transferee did obtain an order of the Supreme Court of Nova Scotia which deemed the preference shares to have been validly issued within the relevant taxation year. Both the appeal and cross-appeal can be disposed of in favour of the taxpayers if the Nova Scotia order is accepted according to its terms. I conclude that the law requires the Minister to give full legal effect to the order in question and, therefore, the taxpayers are entitled to the tax relief claimed.

Bernard Dale and his son Peter, the taxpayers, were the beneficial owners of an apartment building located in the city of Halifax. In 1985 they decided to sell the building. Rather than effecting a direct transfer to a third party the taxpayers proposed to convey the property to the Dale Corporation, incorporated under the laws of Prince Edward Island. The taxpayers owned 23 of the 26 issued shares of that corporation. The remaining shares were owned by Bernard’s wife and the two other Dale children. All the shareholders of Dale Corporation approved the purchase of the apartment building. The consideration for the transfer was the assumption of the existing mortgage indebtedness and the issuance to each taxpayer of a preference share having a redemption value of approximately $1.1 million. However, the Dale Corporation did not, at that time, have an authorized capital which would permit the issuance of preference shares. Accordingly, at a meeting held on December 28, 1985, the shareholders of Dale Corporation passed a by-law authorizing the increase in capital and the making of an application for supplementary letters patent as required by section 35 of the Companies Act of Prince Edward Island. In anticipation of the grant of supplementary letters patent, the Dale Corporation issued the two preference shares.

The obvious purpose of the transaction was to ensure that the taxpayers did not realize the recapture and capital gain on the disposition of a property to a non-arm’s-length party. In addition, the Dale Corporation had sufficient losses to offset any capital gain and recapture which it would have had to include in its income return upon disposition of the property to a third party. As described by Judge Bowman of the Tax Court the transaction was “a perfectly acceptable form of tax planning” ((1993), 94 D.T.C. 1100 (T.C.C.), at 110). I would simply add that this is one instance where the Act expressly provides for and encourages beneficial tax planning.

The sale by the taxpayers to the Dale Corporation was completed on December 30, 1985. On the following day the Dale Corporation transferred the property to a third party and declared and paid what was thought to be a tax-free capital dividend of $80,000 on each of the two preference shares. At the time of the transfer all the necessary corporate steps to give effect to the transactions were properly taken, except for the supplementary letters patent requirement. As well, the taxpayers and the Dale Corporation executed and filed the section 85 elections by March of 1986 as required by the Act. It was not until 1988 that it was discovered that supplementary letters patent had not been obtained. This may have been due to the fact that the records of the Dale Corporation were held by the Receiver-Manager appointed on February 13, 1985. Those records were not returned until after the discharge of the Receiver-Manager on September 1, 1988. As well the intervening death of Mrs. Dale, the corporate secretary, is advanced as another reason for the failure to apply for supplementary letters patent.

On December 6, 1988, the shareholders of Dale Corporation ratified the requisite increase in share capital and resolved that the Corporation would continue under the laws of Nova Scotia. A certificate of continuance was issued by the Registrar of Joint Stock Companies of that province on July 27, 1989. On May 22, 1991, the shareholders again ratified the increase in share capital. They also passed a resolution on the same day authorizing an application to the Supreme Court of Nova Scotia to permit the late filing under section 109 of the Nova Scotia Companies Act of the contract entered into by the taxpayers and the Dale Corporation in December of 1985 with respect to the issuance of the preference shares as partial consideration for the apartment building. Section 109 requires, when shares are issued for consideration other than cash, that a copy of the underlying contract be filed with the Registrar before the shares are issued. In instances where that requirement has not been met subsection 109(3) enables a corporation to obtain retroactive relief. On June 28, 1991, the Dale Corporation obtained from the Supreme Court of Nova Scotia an order under subsection 109(3) of the Companies Act of that province. The relevant portion of that order reads as follows:

IT IS ORDERED THAT the Contract appended as Schedule “A” to this Order bearing execution date December 30, 1985, be and is hereby declared to be a sufficient Contract executed in due compliance with the requirements of Section 109 of the Companies Act, R.S.N.S. 1989, c. 81;

AND IT IS FURTHER ORDERED THAT upon the filing of that Contract with the Registrar aforesaid within Thirty (30) days next following the date of this Order that such filing shall, in relation to such shares, operate as if it had been duly filed with the Registrar aforesaid before the issue of such shares, that being a filing as of Monday, December 30, 1985.

On June 25, 1992, the Dale Corporation obtained a further order declaring its authorized share capital to have been amended effective December 28, 1985 and confirming that the preference shares were validly issued as of December 31, 1985. The pertinent portion of that order reads as follows:

IT IS ORDERED THAT the authorized share capital of the Dale Corporation be and is hereby declared to have been amended as per Schedule “A” to this Order, effective December 28, 1985.

IT IS FURTHER ORDERED THAT the two Preference Shares issued are hereby ratified and confirmed as having been validly issued and outstanding as at December 31, 1985.

The June 25, 1992 order was issued ex parte pursuant to section 44 of the Companies Act of Nova Scotia which states in relevant part:

44. (1) If

(a) the name of a person is, without sufficient cause, entered in or omitted from the register of members of a company; or

(b) ...

the person aggrieved, or any member of the company, or the company, may apply to the Court by motion for rectification of the register, and the court may either refuse the application or may order rectification of the register, and payment by the company of any damages sustained by any party aggrieved.

(2) On application under this Section the Court may decide any question relating to the title of any person who is a party to the application to have his name entered in or omitted from the register, whether the question arises between members or alleged members, or between members or alleged members on the one hand and the company of the other hand, and generally may decide any question necessary or expedient to be decided for rectification of the register.

The Minister took the position that the section 85 election was invalid because the preference shares had not been validly issued in 1985. He also argued that the capital dividend declared on December 31, 1985 was a taxable shareholder benefit under subsection 15(1) of the Act because all the steps necessary to perfect the issuance of the preference shares were not in fact and in law completed by December 31, 1985. With respect to the latter issue Judge Bowman agreed with the Minister and held that for dividends to be payable on a class of shares all necessary steps for the valid issuance of the shares must in fact and law have been completed at that time: “Dividends cannot become payable on embryonic shares” (at 1111). In reaching that conclusion Judge Bowman questioned whether an order of the Supreme Court of Nova Scotia could have retroactive effect to a time when the Dale Corporation was not subject to the law of Nova Scotia. After referring to Hillis v. R., (1983), 83 D.T.C. 5365 (Fed. C.A.) (F.C.A.) and Boger Estate v. Minister of National Revenue, (1993), 93 D.T.C. 5276 (Fed. C.A.) (F.C.A.), he concluded that “whatever might be the effect of a specific statutory provision, a court order purporting to have retroactive effect cannot create a state of affairs in an earlier year that did not in fact exist” (at 1112).

Judge Bowman went on to reject the Minister’s argument that the section 85 election was invalid because the preference shares were not issued simultaneously with the transfer of the property or within the same taxation year. He reasoned that the Minister’s interpretation of section 85 was unduly restrictive and would defeat the purpose underlying that provision. In the opinion of Judge Bowman, the words “consideration that includes shares” contained in subsections 85(1) and (2) do not imply that shares must necessarily be issued simultaneously with the transfer of property to a corporation or indeed within the same taxation year. In his opinion, it is sufficient for purposes of compliance with section 85 that there be a binding obligation to issue shares at the time the property is transferred and that the shares be issued within a period that, in all the circumstances, is reasonable. On the facts of the present case Judge Bowman held that both of those requirements were satisfied, at the very latest by June 25, 1992 and probably by May 22, 1991 if not July 27, 1989. Accordingly, the taxpayers were entitled to succeed on this issue.

The taxpayers appeal that part of Judge Bowman’s decision holding the capital dividend payment to be a taxable benefit under subsection 15(1) of the Act. The Minister cross-appeals the finding that the section 85 rollover was valid because of the promise to issue shares and their issuance within a reasonable period. My colleague Pratte J.A. has concluded that the taxpayers are not entitled to succeed on either issue. Respectfully, I am of the contrary opinion. Briefly stated, I am of the view that the order of the Supreme Court of Nova Scotia, dated June 25, 1992 is determinative of the issues at hand. As a matter of law both the Tax Court and this Court are required to give effect to orders issued by the superior courts of the provinces. Before turning to the legal effect of the order in question I propose to restate some basic propositions which serve as a useful background for my analysis.

There can be no doubt that the onus rests on the taxpayer or his or her advisors to ensure that a tax planning scheme meets both the requirements of the Act and the general requirements, imposed at law, for establishing a particular type of relationship or transaction. A transaction which fails to comply with those requirements in some fundamental or essential aspect will be deemed ineffectual for income tax purposes: see Atinco Paper Products Ltd. v. R. (1978), 22 N.R. 485 (Fed. C.A.), leave to appeal to S.C.C. refused (1979), 25 N.R. 603n (S.C.C.), where it was held that a valid trust was not created; see also Paxton v. R., (1996), 97 D.T.C. 5012 (Fed. C.A.), where there was a failure to properly document a sale of the family business to the owner’s children prior to its sale to a third party.

There is also little doubt that the courts have been diligent in requiring adherence to legal formalities imposed at law or by statute if certain tax advantages are to be accorded. I am not suggesting that the standard to be met by the taxpayer is best described as one of “perfection”. In Stubart Investments Ltd. v. R., [1984] 1 S.C.R. 536 (S.C.C.), the Supreme Court of Canada acknowledged that certain deficiencies may be found to be inconsequential. In that case there had been, among other things, a failure to ensure that the buyer of the appellant’s business held a licence under the Excise Act in conjunction with that business. Despite that omission, it was held that the contract of purchase and sale of the business was complete and the associated tax reduction scheme valid.

In determining whether a legal transaction will be recognized for tax purposes one must turn to the law as found in the jurisdiction in which the transaction is consummated. Often that determination will be made without the aid of guiding precedents which are on point and, hence, the effectiveness of a transaction may depend solely on the proper application of general common law and equitable principles. In some instances it will be necessary for the Tax Court to interpret the statutory law of a province. As for the Minister, he must accept the legal results which flow from the proper application of common law and equitable principles, as well as the interpretation of legislative provisions. This leads me to the question of whether the Minister is bound by an order issued by a superior court, which order has its origins in the interpretation and application of the provisions of a provincial statute.

In the court below, the Minister argued that the order of the Nova Scotia Supreme Court might be binding as between the taxpayers and the Dale Corporation but not on him. Judge Bowman rejected that argument, and in my opinion rightly so, but went on to reason that an order allegedly having retroactive effect “cannot create a state of affairs in an earlier year that did not in fact exist” (at 1112). As I understand his reasons, this is so even though the Nova Scotia court was acting under the provisions of the Companies Act of that province. Counsel for the taxpayers now relies on the decision of the Supreme Court of Canada in R. v. Wilson, [1983] 2 S.C.R. 594 (S.C.C.), to support the argument that the Minister and Tax Court are bound by the terms of the Nova Scotia order. That decision establishes the general rule that an order of a superior court cannot be attacked collaterally unless it is lawfully set aside. In Wilson the Supreme Court was called on to determine whether a provincial court judge could look behind the apparently valid search order of a superior court and rule inadmissible the evidence obtained thereunder. In the course of delivering its reasons for judgment the Supreme Court made some general statements of the law concerning the binding effect of orders issued by superior courts.

The first principle is that the record of a superior court is to be treated as “absolute verity so long as it stands unreversed” (per McIntyre J. at 599, quoting Monnin J.A. in the Manitoba Court of Appeal). Second, an order which has not been set aside must receive full effect according to its terms (at 604). Third, the order is binding on all the world (at 601, citing Bird J.A. in Canadian Transport Co. v. Alsbury, (1952), [1953] 1 D.L.R. 385 (B.C.

C. A.) (B.C.C.A.) at 418). Fourth, a collateral attack is deemed to include proceedings other than those whose specific object is to effect a reversal or nullification of the order. At page 599 McIntyre held as follows:

It has long been a fundamental rule that a court order, made by a court having jurisdiction to make it, stands and is binding and conclusive unless it is set aside on appeal or lawfully quashed. It is also well settled in the authorities that such an order may not be attacked collaterally--and a collateral attack may be described as an attack made in proceedings other than those whose specific object is the reversal, variation, or nullification of the order or judgment.

Rarely are guiding rules or principles expressed as absolutes and so it is proper to ask whether the prohibition against collateral attacks is subject to exceptions. The Supreme Court in Wilson expressly singled out instances where orders were issued in fraudulent circumstances but declined to offer an exhaustive list of exceptions to the rule (at 599-600). For purposes of deciding this appeal it is unnecessary to circumscribe the precise boundaries of the exceptional category relating to the rule against collateral attacks. I need only address the Minister’s “jurisdictional” attack. As I understand it, the Minister’s position is that a court order which has the effect of rewriting fiscal history is not binding on him. Based on the existing authorities, he posits that a court order cannot create a state of affairs in an earlier year that did not in fact exist.

It seems only logical that a court would decline the invitation to grant a retroactive order which has the clear legal effect of rewriting fiscal history. Assuming that such an order were granted then it would be proper to ask whether the Minister is entitled to ignore it for taxation purposes. One might be tempted to permit an attack on the ground of fiscal revisionism where it could be shown that the order was obtained by non-disclosure or misrepresentation. More likely than not revisionist orders will be obtained on consent, or in circumstances where it is likely that the tax ramifications of the order were not placed squarely before the judge, or where the judge was obviously sympathetic to the taxpayer’s situation. There are two reported tax cases decided prior to Wilson which aptly illustrate the judicial sympathy scenario: see Bentley v. Minister of National Revenue, (1954), 54 D.T.C. 510 (T.A.B.) and Hobbs v. Minister of National Revenue), (1970), 70 D.T.C. 1744 (T.A.B.). In both cases it is obvious that there was no legal foundation, statutory or otherwise, for making the retroactive orders requested. Assuming without deciding that those decisions come within the exceptional category recognized in Wilson, they are readily distinguishable from the case under appeal.

On the facts of this appeal, the Nova Scotia court granted the June 25, 1992 order on the basis of section 44 of the Nova Scotia Companies Act. In my view, any objection that the court lacked jurisdiction to issue that order is without foundation. If the legislature of a province authorizes its courts to deem something to have occurred on a date already past, then it is not for the Minister to undermine the legislation by refusing to recognize the clear effect of the deemed event. In any case I am not prepared to concede that section 44 has the revisionist effect advanced by the Minister. This is not a case where a court order deems shares to have been issued when in fact they were not. This is a case where shares were issued, but not validly so until such time as either supplementary letters patent were obtained in Prince Edward Island or the Nova Scotia court granted the June 25, 1992 order. After all, no one has argued that the share issuance constituted a nullity, nor could it be so argued.

I digress here for a moment to point out that while the common law may treat the share issuance as being ineffective a different result could be reached in equity, vis-à-vis the validity of the share issuance as between the taxpayers and the Dale Corporation. In other words, it may well be that in equity the share issuance would be viewed as effective. The maxim that “equity looks on that as done which ought to be done” is of some import. Its impact is revealed in the seminal decision of Walsh v. Lonsdale (1882) 21 Ch. D. 9 (Eng. C.A.). Since that decision imperfect agreements for value have often been treated as if they had been performed at the time they ought to have been, thus yielding the same consequences as if they had been completely performed: see P.V. Baker and P. St.J. Langan, Snell’s Principles of Equity (London: Sweet & Maxwell, 1982) at 41. I say no more on this point as it was not raised in argument.

In the court below it was observed that the Nova Scotia Supreme Court may have lacked the jurisdiction to issue an order having the retroactive effect of amending the share register of a company to a date when the company was not subject to the law of Nova Scotia or the jurisdiction of its Supreme Court. I do not deny that the problem identified raises an interesting question of law, but in my view it is not a sufficient basis to ground a collateral attack on the June 25, 1992 order. First, I would point out that subsection 44(2) of the Companies Act of Nova Scotia authorizes its Supreme Court to decide “any question necessary or expedient to be decided for rectification of the register”. Second, I revert to the reasoning in Wilson to the effect that however wrong or irregular an order of a court may be, that order still binds until reversed. If the law is to recognize exceptions to the rule against collateral attacks then the jurisdictional error complained of must be, at the very least, self-evident and not a matter of further debate: compare with Bently, supra and Hobbs, supra.

In concluding that retroactive orders made on the basis of statutory authority are generally immune from jurisdictional collateral attack, it remains to be decided whether the jurisprudence of this Court holds otherwise. In my view, neither the Hillis nor Boger Estate decisions, supra, are of assistance to the Minister. In Hillis, this Court was dealing with Saskatchewan legislation expressly conferring retroactive effect on an order of the court. The decision is a fragmented one which, respectfully, reveals no discernible ratio. Each of the three Justices on appeal disagreed with the other two on each of the issues raised. More importantly no consideration was given to the rule against collateral attacks. In this regard I note that Wilson, supra, was decided subsequent to Hillis. With respect to the Boger decision, it did not involve giving effect to a retroactive order of a court.

In summary, the June 25, 1992 order of the Nova Scotia Supreme Court is binding on the Minister and constitutes proof of the fact that as of the end of the taxation year (December 31, 1985) the preference shares in the Dale Corporation were validly issued and outstanding. It follows that the appeal must be allowed and the cross-appeal dismissed.

My colleague Justice Pratte is also of the view that the Nova Scotia order is not subject to collateral attacks. Nonetheless he concludes that the Minister is not bound by that order for the reason that it is not permissible to take into consideration orders based on facts that occur after the end of the taxation year. This logically follows from Justice Pratte’s earlier premise that if there is an appeal from the Minister’s assessment then the correctness and validity of that assessment must be decided on the basis of the facts that existed at the end of the taxation year. Thus, if the Minister may not take into account facts which arise outside the taxation year for assessment purposes then neither can he take into consideration orders based on such facts. In the present case Justice Pratte notes that the Dale Corporation had become a Nova Scotia company with an increased capital stock and that its shareholders had ratified the issuance of the preference shares before and after the continuation of the company in that province. Some of these events clearly took place outside the relevant taxation year. Thus, Justice Pratte reasons that the June 25, 1992 order was based on evidence of facts that may not properly be taken into account for taxation purposes.

My initial difficulty with the above analysis is that the likelihood of finding an order being issued without the applicant relying on subsequent facts is remote. For example, it would not have been unreasonable for the Nova Scotia Court to insist in 1992 that existing shareholders ratify the issuance of the preference shares, as in fact they did, given the nature of the order sought. Presumably, the purpose of the ratification was twofold: to ensure both that the state of affairs that existed on December 31, 1985 continued to exist as of June 25, 1992 and that no shareholder at that latter time would be adversely effected by the ex parte order being sought. Had it been necessary for the taxpayers to seek specific performance surely they would have had to establish that no existing shareholder would be prejudiced by an award of that remedy. In my opinion, to impose the requirement that retroactive orders not be based on facts arising after the end of the taxation year, if such orders are to have any force in tax proceedings, is to unduly restrict the effectiveness of such orders and provide the Minister with a more effective means of avoiding the rule against collateral attacks. Finally, I have serious reservations about adopting an inflexible rule requiring that facts be established as of the end of the taxation year. I prefer to leave that issue for another day.

In conclusion, I would allow the appeal with costs, set aside that part of the judgment of the Tax Court, dated December 14, 1993, declaring the $80,000 dividend paid to each appellant to be a shareholder benefit and refer the matter back to the Minister for reconsideration in a manner consistent with these reasons. The appellants are entitled to their costs in the Tax Court on a party and party basis with only one counsel fee for both appellants. I would dismiss the cross-appeal with costs.

Pratte J A.:

The appellants appeal and the respondent cross-appeals from judgments of the Tax Court of Canada allowing in part the appellants’ appeals to that Court from the reassessments of their 1985 income taxes.

In 1985, the appellants, who are father and son, owned 23 of the 26 issued shares of the Dale Corporation. That company was incorporated by Letters Patent under the Companies Act of Prince Edward Island with an authorized capital of $5,000.00 divided into 50 shares of a par value of $100.00. The appellants also owned an apartment building in Halifax, Nova Scotia, that they wanted to sell to an arm’s length purchaser. They knew that, if the sale was made directly to that purchaser, they would have to pay substantial tax on the capital gain and recapture of capital cost allowance that they would realize. In order to avoid that unpleasant result, they proposed to take advantage of subsection 83(2) and section 85 of the Income Tax Act. [1] Their plan was to dispose of the apartment building to their com- pany (it had sufficient losses to offset the capital gain and recapture) which, in return, would assume the mortgage on the building and issue to each of them a fully paid redeemable preference share of $1,142,702.00 on which the company would, after having sold the building at a profit, declare a tax free capital dividend of $80,000.00 under subsection 83(2).

(a) the dividend shall be deemed to be a capital dividend to the extent of the corporation’s capital dividend account immediately before the particular time; and

(b) no part of the dividend shall be included in computing the income of any shareholder of the corporation.

85. (1) Where a taxpayer has, after May 6, 1974, disposed of any of his property that was a capital property (other than real property, an interest therein or an option in respect thereof, owned by a non-resident), a property referred to in subsection 59(2), an eligible capital property or an inventory (other than real property) to a taxable Canadian corporation for consideration that includes shares of the capital stock of the corporation, if the taxpayer and the corporation have jointly so elected in prescribed form and within the time referred to in subsection (6), the following rules apply:

(a) the amount that the taxpayer and the corporation have agreed upon in their election in respect of the property shall be deemed to be the taxpayer’s proceeds of disposition of the property and the corporation’s cost of the property;

(b) subject to paragraph (c), where the amount that the taxpayer and the corporation have agreed upon in their election in respect of the property is less than the fair market value, at the time of the disposition, of the consideration therefor (other than any shares of the capital stock of the corporation or a right to receive any such shares) received by the taxpayer, the amount so agreed upon shall, irrespective of the amount actually so agreed upon by them, be deemed to be an amount equal to that fair market value; ...

(2) Where, after May 6, 1974,

(a) a partnership has disposed of any partnership property that was a capital property (other than real property, an interest therein or an option in respect thereof, owned by a partnership that was not a Canadian partnership at the time of the disposition), a property referred to in subsection 59(2), an eligible capital property or an inventory (other than real property) to a taxable Canadian corporation for consideration that includes shares of the capital stock of the corporation, and

(b) the corporation and all the members of the partnership have jointly so elected, in prescribed form and within the time referred to in subsection (6),

paragraphs (1)(a) to (/) are applicable, with such modifications as the circumstances require, in respect of the disposition as if the partnership were a taxpayer resident in Canada who had disposed of the property to the corporation.

The appellants, by an agreement with their company dated December 30, 1985, disposed of their apartment building in consideration of the assumption of the mortgage by the company and the issuance to each of them of a fully paid preference share having a redemption value of $1,142,702.00. The signature of that contract, which also contained a clause whereby the parties agreed to “do and perform all such further acts ... as are necessary to implement this Agreement,” had been authorized by the shareholders and directors of the company who had also resolved, at the same time, that “the Company make application through its solicitors for amendment to the Letters Patent of the Company” to increase its capital stock from $5,000.00 to $6,000,000.00 so as to enable it to issue the two preference shares. Anticipating that the Supplementary Letters Patent would be obtained, the company then issued a fully paid preference share certificate to each of the appellants, sold the building at a profit and immediately declared “a dividend out of its Capital Dividend Account pursuant to subsection 83(2) of the income tax [act] in the amount of $80,000.00 per share on each of the two issued, outstanding and fully paid preference shares....” The appellants and their company subsequently filed the election required by section 85 and the company filed the election required by subsection 83(2).

In their income tax returns for 1985, the appellants, as one could expect, assumed the validity of the section 85 rollover and the tax free character of the dividends they had received on their preference shares. Nobody could have challenged that assumption with any chance of success had it not been for an omission which was apparently discovered three years later, at a time when the Dale Corporation was about to apply for a certificate of continuance under the Companies Act of Nova Scotia, a jurisdiction where companies are constituted by Memorandum of Association rather than by Letters Patent as in Prince Edward Island.

In the fall of 1988, the appellants found that the Supplementary Letters Patent authorizing the increase of the capital stock of their company had never been obtained. Realizing the serious fiscal consequences that this omission might have, they did everything in their power, short of obtaining Letters Patent under the Companies Act of Prince Edward Island, to remedy it. The increase in the capital stock of the company that had been decided by the shareholders in 1985 was thus ratified not only by further resolutions of the shareholders before and after the company had obtained its certificate of continuance under the Companies Act of Nova Scotia, but also by the increase of its capital stock under the Companies Act of Nova Scotia and by an order of the Supreme Court of that province. That order, made on June 25, 1992, declared “the authorized capital of the Dale Corporation ... to have been amended ... effective December 28, 1985,” and ratified the two preference shares “as having been validly issued and outstanding as at December 31, 1985.” [2]

That order had not yet been pronounced when the appellants’ income taxes for 1985 were reassessed on the basis that the two preference shares had not been validly issued in 1985. [3] It followed, in the Minister’s view, that the apartment building had not been transferred to the Dale Corporation, as required by section 85, for a “consideration that include[d] shares of the capital stock of the corporation” and that, as a consequence, the appellants were deemed to have disposed of their building at fair market value. It also followed, as dividends cannot be declared on shares that do not exist, that the capital dividends of $80,000.00 received by the appellants were not tax free dividends but appropriations to shareholders under subsection 15(1) of the Act.

The appellants’ appeals from those reassessments were allowed only in part. The Tax Court judge was of the view that, as long as the Dale Corporation had been governed by the Companies Act of Prince Edward Island, the preference shares could not be validly issued since the initial authorized capital stock had not been increased by Supplementary Letters Patent. He was also of opinion that, from the moment when the company had ceased to be a Letters Patent Prince Edward Island company to become a Memorandum of Association Nova Scotia company with an increased authorized share capital, the irregularity in the issuance of the preference shares had been cured. Accordingly, he held that the $80,000.00 dividends were not dividends since they had been declared at a time when the shares did not exist. On that point, he upheld the reassessments. However, on the question of the validity of the section 85 rollover, he ruled in favour of the appellants. He was of the view that the requirement of section 85 that the taxpayers shall dispose of their property to a corporation “for consideration that includes shares of the capital stock of the corporation does not imply that the shares must necessarily be issued simultaneously with the transfer of property to the company or indeed within the same taxation year.” According to him, “what is essential is that there be either an actual issuance of shares or a binding obligation to do so at the time of transfer and that the shares be issued within a period of time that, in all the circumstances, is reasonable.” He considered that, in the unusual circumstances of this case, the shares had been issued within a reasonable time. He therefore concluded that the section 85 rollover was valid.

The appellants appeal from the part of the judgment that relates to the $80,000.00 dividends; the respondent, by Her cross-appeal, challenges the conclusion that the section 85 rollover was valid.

The first question to be considered is the correctness of the judge’s decision that the two preference shares had not been validly issued in 1985. If he was wrong on that point and if, contrary to what he decided, the shares were really issued in 1985, there would be no reason to doubt either the validity of the section 85 rollover or the reality of the declaration of dividends; such a finding would dispose of the appeal, which would succeed, and the cross-appeal, which would be dismissed.

If, however, the judge was right on that point, the appeal would have to be dismissed and, in order to dispose of the cross-appeal, it would be necessary to determine the correctness of the judge’s finding that the requirements of section 85 had been met even though the two preference shares had not been validly issued in 1985.

The Validity of the Issuance of the Preferred Shares

According to the appellants, the failure of the Dale Corporation to obtain Supplementary Letters Patent increasing its capital stock did not invalidate the issuance of the two preference shares. Of the many arguments that they put forward in support of that contention, only three deserve consideration.

First, they say that, under the Companies Act of Prince Edward Island, [4] the two preference shares could be legally issued without any amendment to the Letters Patent of the company.

The Dale Corporation had been created by Letters Patent on December 9, 1969, pursuant to the Companies Act of Prince Edward Island. The Letters Patent described the capital stock of the company in the following terms:

The Capital Stock of the said Company shall be Five Thousand Dollars divided into Fifty Common Shares of One Hundred Dollars each subject to the increase of such Capital Stock under the provisions of the said Act.

The appellants’ contention that the issuance of the two preferred shares did not require an amendment to the Letters Patent of the company is based on two premises: first, they say that, under subsection 85(1) of the Companies Act of Prince Edward Island, the issuance of preferred shares did not need to be authorized by the Letters Patent of the company and, second, that, as the preferred shares here in question had no par value, they could be issued without increasing the capital stock of the company.

Both these propositions are wrong.

Under subsection 85(1) of the Prince Edward Island Companies Act, the directors and shareholders of a company may decide to issue part of the authorized capital stock of the company as preferred stock. They may not, however, create preferred stock in addition to the authorized capital stock of the company.

As to the assertion that the issuance of the two preferred shares did not increase the amount of the capital stock of the company, all that I can say is that I disagree: it is obvious that the issuance, for consideration exceeding two million dollars, of two shares without par value but with a redemption and retraction value of more than a million dollars each, had the effect of increasing the capital of the company.

The appellants’ second argument regarding the validity of the issuance of the preference shares is based on section 18 of the Companies Act of Prince Edward Island which, they say, makes it clear that the failure to obtain Letters Patent increasing the capital stock of the company was of no consequence. Section 18 reads, in part, as follows:

18. This Part as it relates to matters preliminary to the issue of the letters patent and supplementary letters patent are directory only; and no letters patent, or supplementary letters patent, issued under this Part shall be held void for any irreg- ularity, insufficiency or want of compliance herewith as respects such preliminary matter, …

This section does not help the appellants. It does not apply when, as in this case, no Letters Patent have been issued.

The appellants’ third argument is based on the order of the Supreme Court of Nova Scotia of June 25, 1992, which declared that the “authorized share capital of the Dale Corporation ... [had] been amended ... effective December 28, 1985,” and confirmed “the two Preference Shares issued ... as having been validly issued and outstanding as at December 31, 1985.”

As that order was made by a Superior Court, the appellants argue that it cannot be attacked collaterally until it is lawfully set aside or quashed (see R. v. Wilson, [1983] 2 S.C.R. 594 (S.C.C.)) and that the Tax Court erred in ignoring it.

I do not agree.

We are dealing here with the validity of an income tax assessment for the 1985 taxation year. Under our law, income tax is an annual affair. Taxpayers must file an income tax return for each taxation year and the Minister of Revenue must thereafter assess the tax for that year. It follows, in my view, that, save when the law prescribes otherwise, [5] the Minister, when he assesses the tax for a given year, must take into consideration the facts as they existed during that year. It also follows that, if there is an appeal from the Minister’s assessment, the correctness and validity of the assessment must be decided on the basis of the facts that existed at the end of the taxation year. An assessment which was correct when it was made cannot, with the passage of time, degenerate into an incorrect assessment. On an appeal from an income tax assessment, the question to be decided is whether the assessment was valid when it was made.

This is not to say that the Minister, in assessing or reassessing, must ignore all judgments concerning the taxpayer that are rendered after the end of the taxation year. In performing his assessment function, the Minister must first determine what were the relevant facts during the taxation year and, in making that determination, he must consider all pertinent evidence, whether it came to light before or after the end of the taxation year. If a judgment pronounced against or in favour of the taxpayer determines what was his situation during the taxation year, the Minister may not ignore it for the sole reason that it was rendered after the end of the taxation year. The situation is different, however, when a judgment, on the basis of facts which occurred after the end of the taxation year, declares the situation that existed during that year to be different from what it really was. Then, the judgment must be ignored by the Minister because it is irrelevant to the question that he has to address, namely the assessment of the taxpayer’s liability on the basis of the facts existing at the end of the taxation year. In other words, if the Minister may not, in the performance of his assessment function, take into consideration facts that occur after the end of the taxation year, he may not, either, take into consideration judgments based on such facts.

In this instance, the order of the Nova Scotia Supreme Court was made ex parte on an application by the Dale Corporation Limited under section 44 of the Companies Act of Nova Scotia upon reading the affidavit of Peter Dale who swore that, after issuing the two preferred shares, the company had become a Nova Scotia company with an increased capital stock and that the shareholders of the company, before and after the continuation of the company as a Nova Scotia company, had ratified the issuance of the two preferred shares. That judgment was clearly based on evidence of facts that occurred long after the end of the taxation year and long after the date on which the appellants and their company made their election (May 5, 1986). It could not affect the validity of the assessment made by the Minister. [6]

The judge of the Tax Court was therefore right when he held that the two preferred shares had been irregularly issued in 1985 and that this irregularity had not been corrected before 1989. Was he also right in his interpretation of section 85 and his conclusion that the invalidity of the issuance of the two preferred shares in 1985 did not affect the validity of the section 85 rollover?

The Section 85 Rollover

In order for the provisions of subsections 85(1) and (2) to apply, the taxpayers and the partnership concerned must have disposed of property to a taxable Canadian corporation “for consideration that includes shares of the capital stock of the corporation.” As the Dale Corporation, when it acquired the appellants’ apartment building, could not issue the two preferred shares, the Minister of National Revenue reassessed the appellants on the basis that the requirements of subsections 85(1) and (2) were not met because the consideration for which the appellants had disposed of their property did not, in fact, “include shares.” The trial judge disagreed. He conceded that, in fact, the appellants had disposed of their property in consideration of the mere promise of the company to obtain Supplementary Letters Patent and issue the two preferred shares. In his view, however, it did not follow that the consideration for which the appellants had disposed of their property did not include shares. As it is trite law that consideration may be of two kinds, executed and executory, and as he saw no reason to restrict the meaning of the word “consideration” in section 85 to executed consideration, he concluded that the requirement of subsections 85(1) and (2) concerning consideration is met not only when, at the time of the transfer of the property to the corporation, there is an actual issue of shares but also when, as here, there is at that time a binding obligation to do so provided, in such a case, that the shares be issued within a reasonable time.

I am not convinced by the reasoning of the judge.

First, I am of opinion that the phrase “consideration that includes shares, ” in its plain and ordinary meaning, cannot refer to consideration that consists of a simple promise to issue shares.

Second, the interpretation adopted by the judge of first instance is difficult to reconcile with the intention of Parliament which, I assume, did not enact section 85 simply to allow taxpayers to gain tax advantages by disposing of property through the intermediary of a corporation. Parliament clearly intended that the taxpayer disposing of the property should acquire shares of the corporation. This, the judge clearly acknowledged by requiring, when the consideration consists of a mere promise to issue shares, that the shares be issued within a reasonable time. He failed to recognize, however, that the Minister of National Revenue must be in a position, as soon as an election is made under section 85, to assess the amount of tax owed by the taxpayer who chose to take advantage of that section. The Minister must, at that time, be able to determine whether the conditions prescribed by the section are met and, as he is not endowed with a gift of divination, he must make that determination on the basis of the facts as they exist at that time. Now, it is clear that the appellants had not acquired the preferred shares when they made their election on May 5, 1986; they acquired them more than three years later.

I am therefore of opinion that the judge of first instance was wrong when he concluded that the conditions prescribed by subsections 85(1) and (2) had been met in this case.

Contrary to what was argued by counsel for the appellants, I think that this conclusion is consistent with paragraph 85(l)(b) which refers to the “non share” portion of the consideration received by the taxpayer from the corporation as being the total consideration for the disposition “other than any share of the capital stock of the corporation or a right to receive any such shares.” That phrase certainly shows that the author of subsections 85(1) and (2) was very conscious of the difference between shares and a right to receive shares and of the possibility that the consideration received by the taxpayer could include both shares and a right to receive shares. I cannot draw any other inference from the use of those words in that paragraph.

I would, therefore, dismiss the appeal, allow the cross-appeal, set aside the judgement of the Tax Court as it relates to the appellants’ 1985 taxation year, and restore the Minister’s assessments for that year. I would, in addition, order the appellants to pay the respondent’s costs both here and below. Appeal allowed and cross-appeal dismissed.

Annex

Provisions of the Companies Act of Prince Edward Island relating to the capital stock of companies:

11.2 (1) Any or all of the shares of any company may be issued without any nominal or par value, but there must be included in its letters patent, the following statements:

a) the total number of shares that may be issued by the company;

b) the number of shares, if any, which are to have a par value and the par value of each;

c) the number of shares which are to be without par value; and

d) either one of the following clauses:

(i) the capital of the company shall be at least equal to the sum of the aggregate par value of all issued shares having par value, plus ... dollars (the blank space being filled in with some number representing one dollar or more) in respect to every issued share without par value, plus such amounts as, from time to time, by bylaw of the company, may be transferred thereto, or

(ii) the capital of the company shall be at least equal to the sum of the aggregate par value of all issued shares having par value, plus the aggregate amount of consideration received by the company for the issuance of shares without par value plus such amounts as, from time to time, by bylaw of the company, may be transferred thereto.

(2) There may also be included in the letters patent an additional statement that the capital shall not be less than ... dollars (the blank space being filled in with a number); such statements in the letters patent shall be in lieu of any statements prescribed by this Part, as to the amount of its capital stock or the number of shares into which the same shall be divided, or of which it shall consist.

32. (1) The directors of the company may make a bylaw for increasing the capital stock of the company to any amount which they may consider requisite for the due carrying out of the objects of the company.

34. (1) No bylaw for increasing ... the capital stock of the company, or subdividing the shares or consolidating or dividing share capital into shares of larger amounts than its existing shares has any force or effect whatever until after it has been sanctioned by a vote of not less than two-thirds in value of the shareholders at a general meeting of the company, duly called for considering the same, and afterwards confirmed by supplementary letters patent.

35. (1) At any time within six months from the sanction of a bylaw under section 34, the directors may apply to the Minister through the Provincial Secretary, for the issue of supplementary letters patent to confirm the same.

(2) With the application they must produce the bylaw, and establish to the satisfaction of the Provincial Secretary, or of such other officer as may be charged by order of the Lieutenant Governor in Council to report thereon, the due passage and sanction of the bylaw, and the bona fide character and expediency of the increase or decrease of capital thereby provided for.

36. (1) The Minister may thereupon grant supplementary letters patent and give notice in the Gazette of the granting thereof in the form prescribed by regulations.

(2) From the date of supplementary letters patent granted under subsection (1) the shares shall be subdivided, or the capital stock of the company shall be increased or decreased, as the case may be, to the amount, in the manner and subject to the conditions, set forth by the bylaw.

85. (1) The directors of every company incorporated under this Part may make bylaws for creating and issuing any part of the capital stock as preference stock, giving the same such preference and priority as respect principal and dividends or both, and in any other respect over ordinary stock as is by the bylaws declared.

(3) No bylaw referred to in subsection (1) has any force or effect until after it has been sanctioned by a vote of three-fourths of the shareholders present in person or by proxy at a general meeting of the company, or at a special general meeting duly called for considering the same and representing two-thirds of the stock of the company...