McNichol v. R., 97 DTC 111, [1997] 2 CTC 2088 (TCC)

Bonner T.C J .:

The appellants appeal from assessments of income tax for the 1989 taxation year. The appeals were heard on common evidence. At issue in each case is the application to a transaction portrayed as a sale of shares of subsection 84(2) and sections 84.1 and 245 of the Income Tax Act (“Act”). The Minister of National Revenue (“Minister”) viewed the transactions as surplus strips. The assessments and a partial outline of the events giving rise to them are set out in an Agreed Statement of Facts as follows:

1. The four Appellants, Peter Blair, Jonathan Chase, Garry MacLean, and William McNichol, are practising lawyers and have been members of the New Brunswick Bar since the 19705.

2. For some years up to mid-1988, the Appellants were partners in a Moncton, New Brunswick, law firm (the “Firm”), which in early 1988 was known as MacLean, Chase, McNichol, Blair & Murphy.

3. Following disputes that had arisen among the partners of the Firm regarding, among other things, the manner of distribution of Firm profits, the Appellants Blair and McNichol withdrew from the Firm effective July 8, 1988. The name of the Firm was subsequently changed to MacLean, Chase & Murphy.

4. Bec Holding Corporation Limited (the “Corporation”) was formed in July 1975 under New Brunswick legislation, primarily for the purpose of constructing and owning the office building at 85 Bonaccord Street in Moncton (the “Building”) in which the Firm would carry on its practice. When the Building was completed, the Firm moved its offices there and paid rent to the Corporation. From time to time, another tenant of the Corporation occupied a portion of the Building.

5. From 1979 until the shares were sold in March 1989, all issued and outstanding shares of the Corporation were held equally by the four Appellants, being 125 shares each with a paid-up capital of $1.00 per share. As the Firm grew, other lawyers were admitted as partners who did not acquire shares in the Corporation. This came to be a source of contention among some of the partners.

6. By early 1988, most of the partners had decided that the Firm should move its offices to another location. Other partners opposed such a move.

7. The Building was listed for sale in early 1988. Shortly afterward, negotiations commenced to move the Firm’s premises to a new building (the “Blue Cross Centre”) being constructed in Moncton by Six-44 Main Inc. In conjunction with these negotiations, Six-44 Main Inc. agreed that it, or its nominee, would purchase the Building for $600,000 after the Firm moved to the Blue Cross Centre.

8. The firm moved to the Blue Cross Centre at the end of 1988, and the sale of the Building by the Corporation to Bluecorp Realty Inc. and Bruntel Estates Inc., the nominees of Six-44 Main Inc., was closed in late January 1989.

9. At this time, communication among the Appellants was difficult or non-existent. To the extent that decisions had to be made regarding the Corporation, they were made through the good offices of Freeman Dunnett, FCA, of KPMG Peat Marwick Thorne, who had been their accounting and tax adviser.

10. On Mr. Dunnett’s advice, the capital dividend account created in the Corporation by reason of the capital gain it had made on the sale of the Building was distributed equally to the four Appellants in the form of capital dividends, as provided for in subsection 83(2) of the Income Tax Act (the “Act”).

11. After the sale of the Building was closed, Mr. Malcolm Dunfield, a client of the Appellant Garry MacLean, expressed an interest in buying the shares of the Corporation for a price approximately $40,000 less than their book value.

12. Subsequently Michael Forestell, who had had some dealings with the Firm, indicated to the Appellant Jonathan Chase that he might be interested in buying the shares of the Corporation.

13. After further discussion between Mr. Chase and Mr. Forestell, and after receiving advice from Mr. Dunnett, the Appellants agreed to sell their shares of the Corporation for a total price of $300,000. The signed agreement, dated March 29, 1989, showed the purchaser as Beformac Holdings Limited and Mr. Forestell as the President of that company.

14. A few days later, the sale was closed at the purchaser’s bank, and each of the Appellants received a payment of $75,000 for his shares.

15. At the time of sale of the shares of the Corporation, its balance sheet indicated that the Corporation had a book value of $314,491. Except for $300 of subscriptions receivable, this amount was entirely represented by net cash assets. The Corporation also had refundable dividend tax on hand, as defined in subsection 129(3) of Act, in the amount of $34,232.

16. In filing their respective 1989 personal tax returns, each of the Appellants reported his sale of shares of the Corporation as a disposition of capital property, reported as a capital gain the excess of $75,000 over the adjusted cost base of his shares, and claimed their available “capital-gains exemption” under former subsection 110.6(3) of the Act. As a consequence, no net tax was calculated as payable by Messrs. MacLean and McNichol on these dispositions, and a relatively small amount of net tax was shown as payable by Messrs. Chase and Blair.

17. The Respondent reassessed the Appellants for 1989 on the basis that the anti-avoidance role (GAAR) in section 245 of the Act applied to the disposition of the shares of the Corporation, and the Respondent taxed the Appellants as if they had received taxable dividends of $75,000 each. These reassessments are the subject of the current appeal.

18. Subsequently, by amendment to the Reply filed in the present proceedings, the Respondent invoked subsection 84(2) of the Act as an additional reason for taxing the amounts received by the Appellants for their shares as taxable dividends.

19. By further amendment to the Reply filed in the present proceedings, the Respondent revoked section 84.1 of the Act as an additional reason for taxing the amounts received by the Appellants for their shares as taxable dividends.

At the hearing of the appeal evidence was given by each of the appellants and by:

(a) Freeman Dunnett C.A., the appellants’ source of tax advice; advice which included an analysis of the advantages to the appellants of sale of the Bec shares;

(b) Charles R. Smith, the official of the Canadian Imperial Bank of Commerce (“CIBC”) with whom arrangements were made for a loan to Beformac Holdings Limited (“Beformac”) of $300,000 used to pay the appellants for their Bec shares;

(c) Philip Haylock, C.A., a chartered accountant from whom Mr. Forestell sought advice with respect to a plan to fund the repayment of the bank loan by the use of money which was formerly the property of Bec but which became the property of the corporation formed by the amalgamation of Bec and Beformac;

(d) Gavin Ross, an auditor with Revenue Canada who confirmed that section 245 of the Act was the basis on which the assessments in issue were made; and

(e) Hillary D. McGraw, an auditor with Revenue Canada who found that the minute book and other corporate records of Bec were still located in the offices of the appellant Garry MacLean on November 6, 1991, some 31 months after the sale of the shares to Beformac. The evidence indicated that the completion in January of 1989 of the sale of Bee’s building marked the end of its rental business. By then relationships among the appellants had deteriorated to such an extent that there was no prospect whatever that Bec would commence any new business. Bee’s property then consisted only of cash. All subsequent activities of the appellants and their accounting and tax adviser Mr. Dunnett were focused on the payment of Bee’s tax liability, the payment to the appellants of a capital dividend and the realization by the appellants of their interests in Bec. That realization could be accomplished very simply by dividend distribution. Its economic equivalent could be accomplished, with some effort, by share sale. At this point one or more of the appellants or someone acting for them mounted a campaign to find a buyer for the Bec shares. The shares in a company of this sort are not normally the subject of unsolicited offers. There was inconsistent testimony as to the identity of the person who took the initiative in finding a buyer but in light of the passage of time such inconsistencies are not surprising.

It is worth reflecting for a moment on the nature of the property which the appellants were attempting to sell. It consisted of shares of a corporation with nothing whatever to offer save for cash in the bank. Its business had ended and provision had been made for payment of its only liability, the tax on the capital gain realized on the sale of the building. Direct extraction of Bee’s cash balance by dividend on winding-up would result in taxation under subsection 84(2) of the Act, a result which the appellants evidently regarded as unattractive. A memorandum dated February 17, 1989 from the appellant Chase to the appellant MacLean makes it clear that the appellants sought to attract the purchaser of Bee’s shares by offering to share with the purchaser the tax savings which would accrue to them as a result of a sale of shares. The memo reads:

Freeman [Dunnett] also asked what sum of money we would propose to pay or make available to a purchaser of the shares; and was going to do some calculations based on figures of $25,000.00 and $40,000.00.

I told Freeman that, subject to the feelings of yourself and the other two owners of BEC, I would think that the tax savings divided five ways might not be an unreasonable method of approaching the question. You had earlier mentioned the figure $40,000.00, and that is why I have asked Freeman to do a calculation based on that number.

By March 16, 1989 plans had been made, at least tentatively, for a sale of the shares on March 31st. On March 16th Mr. Dunnett wrote the following to the appellants:

We are enclosing the following:

• Draft copy of the unaudited financial statements of BEC Holding Corporation Ltd. for the period to January 31, 1989. If the transaction on the sale of the shares takes place on Match 31, 1989, these financial statements will have to be updated to March 31, 1989 and ultimately income tax returns filed as of that date since there will be a deemed year end for tax purposes on the change of control of the company.

• 3 copies of Form T2054 - Election In Respect of a Capital Dividend and Certified Resolution to be signed by the secretary of the company. As soon as this resolution has been signed, we will arrange to courier a copy to Revenue Canada District Taxation office, Saint John. The election claims that the capital dividend becomes payable on or after March 23, 1989. These dividends are tax free to the shareholder.

• Schedule on computation of capital gain, taxable capital gain and income taxes payable arising from the transaction. You will note that all of these computation are before any consideration by the shareholders as to the discount which they are prepared to accept on the disposition of the shares of the company. Any discount on the disposition of the shares will reduce the proceeds to the shareholder and the capital gain accordingly.

In addition to the payment of the tax free capital dividend to the shareholders prior to the sale of the shares of the company, the other consideration was as to whether it was more advantageous to pay taxable dividends to the shareholders to trigger a dividend refund to the camp of 20% of the dividends paid or not pay the dividend thus increasing the eligible capital gain to the shareholders in the disposition of the shares. Basically, since the taxable capital gain is considered non active business income to the company, the gain is taxed at the high rate of taxes. However, if the company pays dividends to the shareholders, it is eligible for a dividend refund of 20% of such dividends.

However, as indicated on the attached schedules, there is a combined tax saving to the company and the shareholders of $8,482.00 by not paying taxable dividends to the shareholders. The schedule also shows that before any consideration of a discount on the sale of the shares, there is available an amount of approximately $100,275.00 for distribution tax free to each shareholder, including the capital dividends.

As previously discussed with you, our initial concern on the proposed sale of the shares was whether there might be a potential for application of the new general anti-avoidance rules in the Income Tax Act where the shareholders are selling the shares at a discount and realizing a capital gain and thus taking advantage of the capital gains tax exemptions versus paying out all of the cash as dividends and winding up the company. ...

Beformac did not have sufficient funds to buy the Bec shares. It had only $62 in its bank account It was obliged to borrow the $300,000 to be paid to the appellants. The money was borrowed from CIBC. A colorful, if somewhat inaccurate, description of the transaction was prepared by Mr. Smith, the CIBC official who authorized a loan of $300,000 to Beformac. In the loan documentation he stated:

BEC Holding Corporation Ltd. is being disolved [sic] by its owners and they have the opportunity, under present income tax legislation, to merge the Company with another, selling the shares to that Company. This allows the shareholders to avoid in the vicinity of $25M income taxes each and provides our customer a payday in the $20M vicinity. The deal is somewhat unusual but our position is fully secured and we accordingly recommend.

Mr. Smith’s understanding of the transaction could only have come from the bank’s client, Mr. Forestell.

Mr. Forestell was appointed sole director and officer of Bec and was furnished with the corporate seal immediately before the dosing of the transaction. Thus he became able to cause Bec to pledge its bank balance of $318,666 to CIBC in support of the $300,000 loan. Without that security, CIBC was not prepared to advance the funds. The sale of the Bec shares took place on March 31, 1989. The amalgamation of Bec and Beformac took place on April 5, 1989. The $300,000 loan was repaid on April 21, 1989.

Before making a commitment to purchase the Bec shares Mr. Forestell consulted Philip Haylock, his accounting and tax advisor. When Mr. Forestell did so he was in possession of the letter dated March 16, 1989 from Mr. Dunnett to the shareholders of Bec. Mr. Haylock testified that:

... From Mr. Forestell’s point of view, he was to make some commission — some income from the transaction, there was to be some income tax savings. ... Beformac was a vehicle to be used to purchase the shares of Bec Holding Corporation.

Mr. Haylock did not recall discussing with Mr. Forestell how Beformac planned to finance the purchase. However, it was agreed by the appellants and the respondent that the amalgamation device was not suggested to Mr. Forestell by the appellants or their advisors. Indeed, Mr. Forestell received no communication or advice from them with regard to the acquisition of the shares or the financing of the transaction.

The respondent argued first that the $300,000 payment made by Beformac, ostensibly as consideration for the appellants’ shares of Bec, was within the meaning of subsection 84(2) of the Act, a distribution of the funds of Bee on the winding-up of its business with the consequence that a dividend was deemed by the subsection 84(2) to have been paid. Subsection 84(2) reads:

(2) Where funds or property of a corporation resident in Canada have at any time after March 31, 1977 been distributed or otherwise appropriated in any manner whatever to or for the benefit of the shareholders of any class of shares in its capital stock, on the winding-up, discontinuance or reorganization of its business, the corporation shall be deemed to have paid at that time a dividend on the shares of that class equal to the amount, if any, by which,

(a) the amount or value of the funds or property distributed or appropriated, as the case may be,

exceeds

(b) the amount, if any, by which the paid-up capital in respect of the shares of that class is reduced on the distribution or appropriation, as the case may be,

and a dividend shall be deemed to have been received at that time by each person who held any of the issued shares at that time equal to that proportion of the amount of the excess that the number of the shares of that class held by him immediately before that time is of the number of the issued shares of that class outstanding immediately before that time.

Counsel for the respondent argued that the evidence supports a conclusion that the purchaser was someone who, for consideration, provided services to the appellants in the form of a transformation of corporate funds into cash in the hands of the appellants, which cash had the appearance of capital. Counsel noted that immediately before the sale, Bec had no goodwill and no business; in fact it had but one asset, the sum of $318,666 in its treasury. There was no conceivable commercial reason for Beformac’s purchase of the shares. She noted that Beformac, prior to the purchase, had only $63 in its bank account and was obliged not only to borrow the $300,000 to be paid to the appellants, but also to use Bee’s cash as collateral. She reasoned that the source of the payments made by Beformac to the appellants had to be Bec’s cash.

I have concluded that subsection 84(2) does not apply. The respondent’s argument involves the conversion of the transaction which in fact took place into something else which is regarded as its equivalent and the application of the subsection to the latter. I know of no authority for such a process. Subsection 84(2) is not ambiguous. It applies only “where funds or property of a corporation ... have ... been distributed or otherwise appropriated in any manner whatever to or for the benefit of the shareholders ...”. It is impossible to conclude that the money which found its way into the pockets of the appellants was Bec’s money in the face of evidence which demonstrates clearly that

(a) Beformac used money borrowed from CIBC to fund the payment of the sale price to the appellants and

(b) Bee’s money remained in its bank account until the amalgamation of Bec and Beformac on April 5, 1989 and continued to sit in that same bank account as an asset of the amalgamated company until April 21, 1989 when a portion of the money was used to retire the $300,000 debt to CIBC which had been incurred by Beformac.

This branch of the respondent’s argument seems to involve a delicate process in which the concept of sham is invoked while, at the same time, the use of the word is avoided. In my view, it cannot be said that the sale of the Bec shares was a distribution or appropriation to the appellants of funds or property of Bec on the basis that the transactions were infected with sham. The classic definition of the term is found in Lord Diplock’s reasons in Snook v. London & West Riding Investments Ltd}'. [1]

I apprehend that, it if has any meaning in law, it means acts done or documents executed by the parties to the “sham” which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. One thing I think, however, is clear in legal principle, morality and the authorities ..., that for acts or documents to be a “sham”, with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating.

This definition was adopted by the Supreme Court of Canada in Stubart Investments Ltd. v. R. [2] There was no element of sham here. The transactions were exactly what they purported to be. They were not deceptive. The legal results of the sale of the Bec shares were intended to govern and were allowed to govern. The appellants ceased to own the shares on March 31, 1989 and thereafter Beformac, as owner of the shares, exercised dominion over them. After March 31st the appellants had nothing to do either with the Bec shares or with Bee’s money. The fact that the appellant MacLean, acting on the instructions of Forestell, caused Bec and Beformac to amalgamate is irrelevant, because the work was done by MacLean qua Forestell’s lawyer and not qua owner or former owner of the shares of Bec.

Counsel for the respondent relied on the decision of the Supreme Court of Canada in Minister of National Revenue v. Merritt, [1942] S.C.R. 269, [1942] C.T.C. 80, 2 D.T.C. 561. In that case the taxpayer held shares in Security Company. It sold its assets and undertaking to a purchaser, Premier Company. The contract called for Premier to pay the consideration which consisted of 11/2 fully paid shares of Premier for each Security Company share to the shareholders and not, as might have been expected, to Security itself. The assessment of tax rested on the premise that the appellant thereby received a pro rata share of the undistributed income on hand of Security. Subsection 19(1) of the Income War Tax Act provided that:

(1) On the winding-up, discontinuance or reorganization of the business of any incorporated company, the distribution in any form of the property of the company shall be deemed to be the payment of a dividend to the extent that the company has on hand undistributed income.

It is perhaps not surprising that it was held that the diversion, into the hands of the shareholders of Security, of consideration for the sale of Security’s assets was regarded as a “distribution in any form of the property of the company” within the meaning of section 19. Merritt is not of assistance in analyzing the question whether funds or property of Bec were distributed or appropriated to the appellants within the meaning of subsection 84(2) because, as already indicated, the funds paid to the appellants were the proceeds of a loan made to Beformac and because Bec retained its property for some time after the purchase price was paid to the appellants. The Merritt case does shed light on the meaning of the phrase “... upon the winding-up, discontinuance or reorganization of the business ...” of a corporation. However, no question of timing arises in the present case because the evidence shows that the event which subsection 84(2) requires to be timed, a distribution to the appellants of funds or property of Bec, cannot, by reason of the form of the transaction, be said to have occurred either directly or indirectly or at all.

Counsel argued as well that the decision of the Supreme Court of Canada in Smythe v. Minister of National Revenue, [1970] S.C.R. 64, [1969] C.T.C. 558, 69 D.T.C. 5361 has application. She asserted that in Smythe, as here, the shareholders’ intent leading to the transactions was the same, that is to say, a desire to distribute surplus in the most advantageous way. It is not necessary to delve into the complexities of the transaction in Smythe. There the shareholders started with a company which carried on an active business. As a consequence of intricate paper transactions and fancy footwork the shareholders ended up with a different company possessing the same business assets and cash or securities equal to the undistributed income of the old company. The court described the steps taken as “artificial transactions” and stated that their purpose was to distribute or appropriate to the shareholders the undistributed income of the old company. The Court appears to have regarded the dividend stripping companies as agents of the taxpayers. It described the consideration received by those companies as a fee. In my opinion Smythe is not analogous to the present case. I am unable to discover any basis on which the sale by the appellants of the Bec shares can be described as artificial. By reason of the form of the transaction the appellants did not, in the end, receive any property which at any time belonged to Bec. Bec retained its property and carried it forward into the amalgamated company. I reiterate that it cannot be said that Bee’s property was distributed or otherwise appropriated to the appellants “in any manner whatever”.

The respondent’s characterization of the transaction as something other than a sale of shares rests in part on the premise that the appellants participated in or in some way were responsible for the events which followed the Share sale. I gather from the comment of Mr. Smith, the CIBC official, that it was assumed by all concerned that Beformac would, after completing the purchase, do exactly what it did but that is not a basis for finding that either it or Mr. Forestell was under any obligation to the appellants to adopt that or any other course of action. I reject the respondent’s submission that Forestell acted in an “agent-like” way. So far as the appellants were concerned the completion of the sale of the shares was the end of the matter. They had their money and anything that Mr. Forestell did or caused Beformac to do was of no concern to them. The appellants cannot be linked to events that occurred after the closing of the sale of the shares.

I turn next to the respondent’s alternative argument that section 84.1 of the Act has application. That provision is intended to prevent the stripping of corporate surplus in cases where shares of a Canadian corporation have been transferred in a non-arm’s length transaction. It was common ground that paragraph 84.1(1)(b) would apply to deem a dividend to have been paid to any of the appellants who did not deal at arm’s length with Beformac at the time of the sale of the Bec shares. So far as relevant it read in 1989:

84.1: Non-arm’s length sale of shares.

(1) Where after May 22, 1985 a taxpayer resident in Canada (other than a corporation) disposes of shares that are capital property of the taxpayer (in this section referred to as the “subject shares”) of any class of the capital stock of a corporation resident in Canada (in this section referred to as the “subject corporation”) to another corporation (in this section referred to as the “purchaser corporation”) with which the taxpayer does not deal at arm’s length and, immediately after the disposition, the subject corporation would be connected (within the meaning assigned by subsection 186(4) if the references therein to “payer corporation” and to “particular corporation” were read as “subject corporation” and “purchaser corporation” respectively) with the purchaser corporation,

(a) where shares (in this section referred to as the “new shares”) of the purchaser corporation have been issued as consideration for the subject shares, in computing the paid-up capital, at any particular time after the issue of the new shares, in respect of any particular class of shares of the capital stock of the purchaser corporation, there shall be deducted an amount determined by the formula

A

(A - B) x -

where ... and

(b) for the purposes of this Act, a dividend shall be deemed to have been paid to the taxpayer by the purchaser corporation at the time of the disposition in an amount determined by the formula

(A + D) - (E + F)

where ...

The question is one of factual arm’s length under paragraph 251(1)(b) of the Act because Beformac and the appellants were not related persons under section 251. The respondent has the onus on this issue because the Minister did not base his assessments on section 84.1 or on any finding or assumption of fact with respect to arm’s length.

Three criteria or tests are commonly used to determine whether the parties to a transaction are dealing at arm’s length. [3] They are:

(a) the existence of a common mind which directs the bargaining for both parties to the transaction,

(b) parties to a transaction acting in concert without separate interests, and

(c) “de facto” control.

The common mind test emerges from two cases. The Supreme Court of Canada dealt first with the matter in Minister of National Revenue v. Sheldon's Engineering Ltd.* [4] At page 180 (D.T.C. 1113-14) Locke J., speaking for the Court, said the following:

Where corporations are controlled directly or indirectly by the same person, whether that person be an individual or a corporation, they are not by virtue of that section deemed to be dealing with each other at arm’s length. Apart altogether from the provisions of that section, it could not, in my opinion, be fairly contended that, where depreciable assets were sold by a taxpayer to an entity wholly controlled by him or by a corporation controlled by the taxpayer to another corporation controlled by him, the taxpayer as the controlling shareholder dictating the terms of the bargain, the parties were dealing with each other at arm’s length and that s. 20(2) was inapplicable.

The decision of Cattanach, J. in Minister of National Revenue v. Merritt [5] is also helpful. At page 217 (D.T.C. 5165-66) he said:

In my view, the basic premise on which this analysis is based is that, where the “mind” by which the bargaining is directed on behalf of one party to a contract is the same “mind” that directs the bargaining on behalf of the other party, it cannot be said that the parties were dealing at arm’s length. In other words where the evidence reveals that the same person was “dictating” the “terms of the bargain” on behalf of both parties, it cannot be said that the parties were dealing at arm’s length.

The acting in concert test illustrates the importance of bargaining between separate parties, each seeking to protect his own independent interest. It is described in the decision of the Exchequer Court in Swiss Bank Corp. v. Minister of National Revenue^ [6] At page 437-38 (D.T.C. 5241) Thurlow J. (as he then was) said:

To this I would add that where several parties — whether natural persons or corporations or a combination of the two — act in concert, and in the same interest, to direct or dictate the conduct of another, in my opinion the “mind” that directs may be that of the combination as a whole acting in concert or that of any of them in carrying out particular parts or functions of what the common object involves. Moreover as I see it no distinction is to be made for this purpose between persons who act for themselves in exercising control over another and those who, however numerous, act through a representative. On the other hand if one of several parties involved in a transaction acts in or represents a different interest from the others the fact that the common purpose may be to so direct the acts of another as to achieve a particular result will not by itself serve to disqualify the transaction as one between parties dealing at arm’s length. The Sheldon's Engineering case [supra], as I see it, is an instance of this.

Finally, it may be noted that the existence of an arm’s length relationship is excluded when one of the parties to the transaction under review has de facto control of the other. In this regard reference may be made to the decision of the Federal Court of Appeal in Robson Leather Co. v. Minister of National Revenue, [1977] C.T.C. 132, 77 D.T.C. 5106.

The evidence in the present case shows that arm’s length bargaining was present in the sale of the Bec shares. The interests of vendors and purchaser were divergent with regard to the purchase price. The appellants were clearly price sensitive for they terminated discussions with regard to the sale of the shares to a prospective purchaser, Malcolm Dunfield, upon learning that Forestell would pay a higher price. Conduct of overriding importance in establishing that the purchaser dealt with the appellants at arm’s length, is Mr. Forestell’s action in consulting Mr. Hay lock, his own accounting and tax adviser, before committing Beformac to the transaction. At Mr. Forestell’s request Mr. Hay lock reviewed the situation and gave his opinion on the transaction from the point of view of Mr. Forestell. The actions of the appellants and Mr. Forestell in negotiating the share sale transaction were clearly governed by their respective perceptions of their own self-interest and nothing else. The fact that the tax savings potentially accruing to the appellants as a consequence of sale formed not only the reason for the sale but also the boundaries within which sale price might be negotiated does not suggest that the appellants and Forestell acted in concert. Buyer and seller do not act in concert simply because the agreement which they seek to achieve can be expected to benefit both. Section 84.1 is therefore not applicable.

I turn next to section 245 of the Act. It was introduced in 1988 and has application to transactions entered into after September 13, 1988. It is the well known general anti-avoidance rule (GAAR). As previously noted the Minister relied on section 245 in making the assessments in issue. The provision reads:

245(1) Definitions.

In this section and in subsection 152(1.11),

“tax benefit’. — “tax benefit” means a reduction, avoidance or deferral of tax or other amount payable under this Act or an increase in a refund of tax or other amount under this Act;

“tax consequences”. — “tax consequences” to a person means the amount of income, taxable income, or taxable income earned in Canada of, tax or other amount payable by, or refundable to the person under this Act, or any other amount that is relevant for the purposes of computing that amount;

“transaction”. — “transaction” includes an arrangement or event.

(2) General anti-avoidance provision.

Where a transaction is an avoidance transaction, the tax consequences to a person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that, but for this section, would result, directly or indirectly, from that transaction or from a series of transactions that includes that transaction.

(3) Avoidance transaction.

An avoidance transaction means any transaction

(a) that, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit; or

(b) that is part of a series of transactions, which series, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.

(4) Provision not applicable.

For greater certainty, subsection (2) does not apply to a transaction where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of this Act or an abuse having regard to the provisions of this Act, other than this section, read as a whole.

(5) Determination of tax consequences.

Without restricting the generality of subsection (2),

(a) any deduction in computing income, taxable income, taxable income earned in Canada or tax payable or any part thereof may be allowed or disallowed in whole or in part,

(b) any such deduction, any income, loss or other amount or part thereof may be allocated to any person,

(c) the nature of any payment or other amount may be recharacterized,

and

(d) the tax effects that would otherwise result from the application of other provisions of this Act may be ignored,

in determining the tax consequences to a person as is reasonable in the circumstances in order to deny a tax benefit that would, but for this section, result, directly or indirectly, from an avoidance transaction.

(6) Request for adjustment.

Where with respect to a transaction

(a) a notice of assessment, reassessment or additional assessment involving the application of subsection (2) with respect to the transaction has been sent to a person, or

(b) a notice of determination pursuant to subsection 152(1.11) has been sent to a person with respect to the transaction,

any person (other than a person referred to in paragraph (a) or (b)) shall be entitled, within 180 days after the day of mailing of the notice, to request in writing that the Minister make an assessment, reassessment or additional assessment applying subsection (2) or make a determination applying subsection 152(1.11) with respect to that transaction.

(7) Exception.

Notwithstanding any other provision of this Act, the tax consequences to any person, following the application of this section, shall only be determined through a notice of assessment, reassessment, additional assessment or determination pursuant to subsection 152(1.11) involving the application of this section.

(8) Duties of Minister.

Upon receipt of a request by a person under subsection (6), the Minister shall, with all due dispatch, consider the request and notwithstanding subsection 152(4), assess, reassess or make an additional assessment or determination pursuant to subsection 152(1.11) with respect to that person, except that an assessment, reassessment, additional assessment or determination may be made under this subsection only to the extent that it may reasonably be regarded as relating to the transaction referred to in subsection (6).

245(1) Définitions.

Les définitions qui suivent s’appliquent au présent article et au paragraphe 152(1.11).

«avantage fiscal» — «avantage fiscal» Réduction, évitement ou report d’impôt ou d’un autre montant payable en application de la présente loi ou augmentation d’un remboursement d’impôt ou d’un autre montant visé par la présente loi.

«attribut fiscal» — «attribut fiscal» S’agissant des attributs fiscaux d’une personne, revenu, revenu imposable ou revenu imposable gagné au Canada de cette personne, impôt ou autre montant payable par cette personne, ou montant qui lui est remboursable, en application de la présente loi, ainsi que tout montant à prendre en compte pour calculer, en application de la présente loi, le revenu, le revenu imposable, le revenu imposable gagné au Canada de cette personne ou l’impôt ou l’autre montant payable par cette personne ou le montant qui lui est remboursable.

«opération» — «opération» Sont assimilés à une opération une convention, un mécanisme ou un événement.

(2) Disposition générale anti-évitement.

En cas d’opération d’évitement, les attributs fiscaux d’une personne doivent être déterminés de façon raisonnable dans les circonstances de façon à supprimer un avantage fiscal qui, sans le présent article, découlerait, directement ou indirectement, de cette opération ou d’une série d’opérations dont cette opération fait partie.

(3) Opération d’évitement.

L’opération d’évitement s’entend:

a) soit de l’opération dont, sans le présent article, découlerait, directement ou indirectement, un avantage fiscal, sauf s’il est raisonnable de considérer que l’opération est principalement effectuée pour des objets véritables — l’obtention de l’avantage fiscal n’étant pas considérée comme un objet véritable;

b) soit de l’opération qui fait partie d’une série d’opérations dont, sans le présent article, découlerait, directement ou indirectement, un avantage fiscal, sauf s’il est raisonnable de considérer que l’opération est principalement effectuée pour des objets véritables — l’obtention de l’avantage fiscal n’étant pas considérée comme un objet véritable.

(4) Non-application du par. (2).

Il est entendu que l’opération dont il est raisonnable de considérer qu’elle n’entraîne pas, directement ou indirectement, d’abus dans l’application des dispositions de la présente loi lue dans son ensemble — compte non tenu du présent article — n’est pas visée par le paragraphe (2).

(5) Attributs fiscaux à déterminer.

Sans préjudice de la portée générale du paragraphe (2), dans le cadre de la détermination des attributs fiscaux d’une personne de façon raisonnable dans les circonstances de façon à supprimer l’avantage fiscal qui, sans le présent article, découlerait, directement ou indirectement, d’une opération d’evitement:

a) toute déduction dans le calcul de tout ou partie du revenu, du revenu imposable, du revenu imposable gagné au Canada ou de l’impôt payable peut être en totalité ou en partie admise ou refusée;

b) tout ou partie de cette déduction ainsi que tout ou partie d’un revenu, d’une perte ou d’un autre montant peuvent être attribués à une personne;

c) la nature d’un paiement ou d’un autre montant peut être qualifiée autrement;

d) les effets fiscaux qui découleraient par ailleurs de l’application des autres dispositions de la présente loi peuvent ne pas être pris en compte.

(6) Demande en vue de déterminer les attributs fiscaux.

Dans les 180 jours suivant la mise à la poste d’un avis de cotisation, de nouvelle cotisation ou de cotisation supplémentaire, envoyé à une personne, qui tient compte du paragraphe (2) en ce qui concerne une opération, toute autre personne qu’une personne à laquelle un de ces avis a été envoyé a le droit demander par écrit au ministre d’établir à son égard une cotisation, une nouvelle cotisation ou une cotisation supplémentaire en application du paragraphe (2) ou de déterminer un montant on application du paragraphe 152(1.11) en ce qui concerne l’opération.

(7) Exception.

Malgré les autres dispositions de la présente loi, les attributs fiscaux d’une personne, par suite de l’application du présent article, ne peuvent être déterminés que par avis de cotisation, de nouvelle cotisation ou de cotisation supplémentaire Ou que par avis d’un montant déterminé en application du paragraphe 152(1.11), compte tenu du présént article.

(8) Obligations du ministre.

Sur réception d’une demande présentée par une personne conformément au paragraphe (6), le ministre doit, dès que possible, après avoir examiné la demande et malgré le paragraphe 152(4), établir une cotisation, une nouvelle cotisation ou une cotisation supplémentaire ou déterminer un montant en application du paragraphe 152(1.11), en se fondant sur la demande. Toutefois, une cotisation, une nouvelle cotisation ou une cotisation supplémentaire ne peut être établie, ni un montant déterminé, en application du présent paragraphe que s’il est raisonnable de considérer qu’ils concernent l’opération visée au paragraphe (6).

On the question whether a “tax benefit” as defined in subsection 245(1) arises here, counsel for the appellant characterized the position as one in which the appellants chose to follow from a group of one or more alternative means of achieving a legitimate business purpose, the one that gave rise to the least tax. Counsel referred to a paper, Surplus Stripping by H.H. Stikeman and R. Couzin, which questions whether, in circumstances such as the present, liquidation of the corporation might be regarded as a “tax detriment” compared to the alternative, sale. [7] In that article it is asserted that there is nothing unnatural in the choice of sale as a means of realizing the economic value of retained earnings by the sale of shares.

There is nothing mysterious about the subsection 245(1) concept of tax benefit. Clearly a reduction or avoidance of tax does require the identification in any given set of circumstances of a norm or standard against which reduction is to be measured. Difficulties may exist in other cases in identifying the standard but in this case there is no such difficulty. The benefit sought by the appellants is clearly identified in the March 16, 1989 letter of Mr. Dunnett. It is the difference between tax payable by the appellants upon receipt of taxable dividends and that payable upon realization of capital gains from the disposition of shares. It is beside the point that such benefit may also be described as the absence of a detriment. It cannot be said that the standard against which reduction is to be measured is nil on the basis that, absent a sale of shares, no tax would have been payable. For the appellants doing nothing was never in the realm of the possible, for their goal, present throughout, was the realization of the economic value of their shares, which value was derived from the accumulated surplus of Bec and nothing else. Their choice was between distribution of that accumulated surplus by way of liquidating dividend and sale of the shares and in choosing the latter they chose a transaction that resulted in a tax benefit within the subsection 245(1) definition.

The next question is whether the sale of the shares was a transaction that may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit within the meaning of subsection 245(3). The onus was on the appellants to establish that it could be so considered and they have failed to do so. Counsel for the appellants argued that the main purpose of the sale of the appellants’ shares was to terminate their association with each other in the common ownership of Bec. I do not agree. It is important to be clear on the nature of their “association” during the winter of 1989. What the appellants had in common was their interest as shareholders of Bec in its only asset, the undistributed surplus. The position as described by the appellants in a letter to the Department of National Revenue dated February 10, 1993 was:

Following the sale of the building, BEC was left with an asset — cash of approximately $315,000 after provision for income tax liabilities arising from the sale of $120,500 and tax-paid retained earnings of $314,000. Again, there was no agreement among the shareholders as to whether to wind up the Company and distribute the proceeds to shareholders or have BEC carry on business in some form. It became abundantly clear that none of the shareholders wanted to carry on business together.

The termination of the appellants’ association required only one decision: how to deal with the accumulated surplus. To disassociate the appellants had only to choose between payment of a liquidating dividend and sale of the shares. The transaction that resulted in the tax benefit, namely, the sale of shares was selected not for bona fide reasons, which as the French language version of section 245 makes clear, do not include tax avoidance, but rather because it gave rise to an apparent capital gain and consequent eligibility for a deduction under former subsection 110.6(3)of the Act.

Counsel for the appellants argued that even if the sale of shares was an avoidance transaction within subsection 245(3), subsection 245(2) would nevertheless not apply by reason of subsection 245(4). He suggested that the French language version of subsection 245(4) indicates that the abuse and misuse tests in the English version are substantially the same. [8] Further, he submitted that the words abuse or misuse refer to an “extreme undermining of statutory purpose” and not “ordinary tax planning”. The test in his submission requires that the object and spirit of relevant provisions of the Act be circumvented. That did not occur here, he said, because the capital gains exemption in subsection 110.6(3) on which the appellants relied had application to capital gains of all kinds without regard to the nature of the asset disposed of in the transaction giving rise to the gain. Counsel suggested that the rules with respect to the capital gains exemption are specific provisions which ought to be regarded as overriding more general provisions relating to corporate distributions. The specific provisions relating to capital gains are not, he said, generally speaking intended to vary in application depending on the nature of the property held by the corporation whose shares are in question.

Subsection 245(4) provides that subsection (2) does not apply to a transaction where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of the Act or in an abuse having regard to the provisions of the Act read as a whole. It operates by way of exception to the general rule laid down in subsection (3) and, I take it, must have been intended to make allowance for transactions which the legislature sought to encourage by the creation of tax benefit or incentive provisions or which, for other reasons, do no violence to the Act, read as a whole. Section 245 itself must not be read in a disjointed way. It is not to be assumed that the legislature enacted subsection (4) based on some sort of consciousness that the scope of subsection (3) was far greater than is evident from its language. Tests suggested by counsel such as “extreme undermining of statutory purpose” and “ordinary tax planning” are of little assistance and are not justified by the language of section 245 read as a whole. To accept such tests would undermine the object and spirit of section 245 and run counter to the teleological approach mandated by the Supreme Court of Canada: Québec (Communauté urbaine) v. Corp. Notre- Dame de Bonsecours? [9] The telos of section 245 is the thwarting of abusive tax avoidance transactions.

Section 13 of the Official Languages Act, ® [10] provides that both language versions of any act of Parliament are “equally authoritative”. It is not necessary or helpful to attempt to restate the subsection 245(4) test in language consistent with each word of both the French and English language versions. It is sufficient to note that on any view of subsection 245(4), the transaction now in question, which was, or was part of, a classic example of surplus stripping, cannot be excluded from the operation of subsection (2). After all, Bee’s surplus was, at the very least, indirectly used to fund the price paid to the appellants for their shares. The appellants have sought to realize the economic value of Bec’s accumulated surplus by means of a transaction characterized as a sale of shares giving rise to a capital gain in preference to a distribution of a liquidating dividend taxable under section 84. The scheme of the Act calls for the treatment of distributions to shareholders of corporate property as income. The form of such distributions is generally speaking irrelevant. On the one hand a distribution formally made by a corporation to its shareholders as a dividend to which the shareholders are entitled by virtue of the contractual rights inherent in their shares is income under paragraph 12(1)(/) of the Act. On the other hand, the legislature by section 15 of the Act, which expands the former section 8, demonstrates the existence of a legislative scheme to tax as income all distributions by a corporation to a shareholder, even those of a less orthodox nature than an ordinary dividend. In Minister of National Revenue v. Pillsbury Holdings Lid., [1964] C.T.C. 294, 64 D.T.C. 5184, Cattanach J. said at page 299 (D.T.C. 5186-87):

Provisions in the Income Tax Act, other than section 8, govern the taxability of such payments and distributions when made in the orthodox way. In the remainder of this judgment, when referring to dividends, I intend to refer to any of these payments or distributions referred to in this paragraph.

Subsection (1) of section 8 is aimed at payments, distributions, benefits and advantages flowing from a corporation to a shareholder other than those referred to in the immediately preceding paragraph. While the subsection does not say so explicitly, it is fair to infer that Parliament intended, by section 8, to sweep in payments, distributions, benefits and advantages that flow from a corporation to a Shareholder by some route other than the dividend route and that might be expected to reach the shareholder by the more orthodox dividend route if the corporation and the shareholder were dealing at arm’s length. This is true of paragraph (a) of subsection (1). A corporation normally makes payments to its shareholders as dividends unless the payment is pursuant to a bona fide business transaction in which event it is not a payment accruing to the shareholder qua shareholder. If a payment is made to a shareholder qua shareholder, paragraph (a) requires that it be brought into the shareholder’s income whether or not it is made as a dividend. Similarly, as far as paragraph (b) of subsection (1) is concerned, the normal method whereby a corporation appropriates funds or property to, or for the benefit of, its shareholders is by a declaration of dividend payable in cash or in kind. If funds or property are appropriated to or for the benefit of a shareholder qua shareholder in any other way, paragraph (b) requires that they be brought into his income.

[Application of paragraph (c)]

Paragraph (c) of subsection (1) of section 8 may be expected, therefore, to apply to cases where benefits or advantages have been conferred on a shareholder in such circumstances that the effect is, in substance, equivalent to the payment of a dividend to the shareholder.

The scheme is also evident in section 84 of the Act. That provision was enacted to counteract the effect of Commissioner of Inland Revenue v. Burrell, [11] in which it was held that distributions to shareholders made on the winding-up of a limited company are capital and not in the nature of dividends. Clearly the legislature in Canada was not content to be governed by the statement made by Sargant L.J. at page 73 to the effect that:

the character in which any distribution by the company amongst its shareholders reaches their hands depends entirely on the circumstances in which the distribution is made. In the liquidation of a limited company the distribution of the surplus assets of the company is almost necessarily of a final and non-recurrent character, and reaches the hands of the shareholders quite irrespective of the sources from which the assets have accrued to the company.

Where the legislature intends that distributions of corporate property to shareholders be excluded from income express provision is made as in subsection 83(2).

Sections 12, 15 and 84 are not the only legislative measures designed to ensure that corporate distributions to shareholders are taxed as income. As noted by Stikeman and Couzin: [12]

One of the most longstanding and persistent sources of conflict between taxpayers and tax collectors is the practice commonly known as surplus stripping or dividend stripping. This subject is as topical as it is perennial. Taxpayers seem ever prepared to engage in complex and costly transactions to extract surplus from corporations. Surplus stripping is a natural and, we will suggest, not necessarily an unhealthy response to distortions in the tax system.

Accumulated corporate earnings can be “stripped” only if the law differentiates between the consequences of realizing such income as dividends and the consequences of realizing it in some other way. Stripping is, then, no different from other tax-avoidance or tax-mitigation behaviour....

The meaning attributed by the learned authors to the term surplus stripping is to be found in the following passage at page 1846:

Surplus stripping is considered to occur when a shareholder takes a shortcut in accessing accumulated surplus of a corporation. This has generally meant choosing to realize the economic value of such surplus through a transaction characterized as a sale of shares that gives rise to a capital gain rather than a distribution from the corporation that is taxed as a dividend.

The former subsection 247(1) of the Act was, prior to the enactment of section 245, one of the legislative responses to the practice of surplus stripping. It was repealed simultaneously with the coming into force of section 245 and I therefore do not suggest that it applies to the present case. However, I do suggest that the repeal cannot be regarded as a basis for a conclusion that the legislature intended to relax the strictures against surplus stripping. In light of the foregoing, subsection 245(4) cannot be invoked by the appellants. The transaction in issue which was designed to effect, in everything but form, a distribution of Bee’s surplus results in a misuse of sections 38 and 110.6 and an abuse of the provisions of the Act, read as a whole, which contemplate that distributions of corporate property to shareholders are to be treated as income in the hands of the shareholders. It is evident from section 245 as a whole and paragraph 245(5)(c) in particular that the section is intended inter alia to counteract transactions which do violence to the Act by taking advantage of a divergence between the effect of the transaction, viewed realistically, and what, having regard only to the legal form appears to be the effect. For purposes of section 245, the characterization of a transaction cannot be taken to rest on form alone. I must therefore conclude that section 245 of the Act applies to this transaction.

Having decided that section 245 applies to this transaction, I must next consider whether the Minister’s assessments of the appellants under subsection 245(5) are correct. The appellants submit that if they had liquidated their investments by way of dividend or deemed dividend instead of selling their shares, the distribution from Bec would have been augmented by a “dividend refund”. Had this dividend refund accrued under section 129 as a consequence of the payment of a taxable dividend it would have accrued to Bec and, indirectly, to its shareholder. The assessor, Mr. Ross, indicated in evidence that he did not overlook section 129. He said, when asked whether he had considered “... doing the reassessments in such a way as to put the taxpayers back in the same position they would have been in if they had done a liquidation”:

I did give consideration to it. And one of the reasons that we didn’t go that route is that a portion of that difference, whether it’s half or whatever, relates to the refundable dividend tax on hand, which is still available in — which flowed through on this share sale to, I guess — well, through the amalgamation, it flows through to the amalgam of the company. Still available to be withdrawn. And that was, I guess, basically the Department’s position as to why they didn’t choose that route.

In my view the Minister did not misapply subsection 245(5). By the assessments in issue he sought to “deny a tax benefit” that, but for section 245, would have resulted from a distribution to the appellants of a total of $300,000 which, after all, was the amount actually received by them. In any event, by virtue of paragraph 245(5)(d) “... the tax effects that would otherwise result from the application of other provisions of [the] Act may be ignored ...” Accordingly, I confirm the assessments.

For the foregoing reasons the appeals will be dismissed with costs.

Appeals dismissed.