Cullen
J.:-This
is
an
appeal
by
CPL
Holdings
Limited
("the
plaintiff"
or
"the
taxpayer")
from
a
decision
of
the
Minister
of
National
Revenue
("the
Minister")
in
respect
of
a
reassessment
of
its
income
tax
for
its
1987
taxation
year,
ending
June
30,
1987.
The
plaintiff
sought
to
deduct
the
entire
amount
of
a
dividend
received
by
it
from
Clem
Industrial,
pursuant
to
subsection
112(1)
of
the
Income
Tax
Act,
R.S.C.
1952,
c.
148
(am.
S.C.
1970-71-72,
c.
63)
(the
"Act").
The
Minister
disallowed
the
deduction,
claiming
the
dividend
to
be
proceeds
of
disposition
and
deeming
it
to
be
a
capital
gain.
Agreed
statement
of
facts
To
their
credit,
both
counsel
were
able
to
shorten
the
proceedings
substantially
by
agreeing
to
the
basic
chronology
of
events.
Counsel
for
the
plaintiff
emphasized
that
there
was
very
little
case
law
which
discussed
subsection
55(2)
of
the
Income
Tax
Act
and
none
which
was
specifically
on
point.
Rather,
this
case
turns
on
its
facts.
The
agreed
statement
of
facts
is
reproduced
in
its
entirety:
1.
Clem
Industrial
Machine
Ltd.
("Clem
Industrial")
has
operated
a
machine
shop
since
its
incorporation
on
August
8,
1972.
2.
Prior
to
March
18,
1986,
Clem
Industrial
was
directly
controlled
by
Mr.
Clem
Lamothe
who
owned
99
of
100
outstanding
shares
of
the
corporation.
The
other
outstanding
share
was
owned
by
Mr.
Lamothe’s
wife,
Pauline
Lamothe.
3.
In
February
1985,
Clem
Industrial
was
retained
by
Blocker
Drilling
Canada
Ltd.
to
repair
a
drilling
rig
owned
by
it,
and
Clem
Industrial
did
so.
The
drilling
rig
thereafter
overheated
and
malfunctioned
and
on
or
about
March
5,
1985
was
returned
to
Clem
Industrial
for
further
repair
which
was
completed
on
or
about
March
12,
1985.
4.
By
statement
of
claim
dated
December
9,
1985
and
issued
out
of
the
Court
of
Queen’s
Bench
of
Alberta,
Judicial
District
of
Edmonton,
Blocker
Drilling
Canada
Ltd.
commenced
an
action
against
Nor-West
Oilfield
Hauling
Ltd.
and
Timothy
Arthur
claiming
damages
with
respect
to
the
drilling
rig
described
in
the
preceding
paragraph,
consisting
of
damages
for
costs
of
repairs
in
the
amount
of
$108,018.67
and
damages
for
loss
of
income
in
the
amount
of
$126,197.68
and
interest
thereon.
5.
At
a
meeting
held
on
February
19,
1986
between
Messrs.
Robert
L.
Allan
and
John
H.
Askin
of
Messrs.
Askin
Sciur,
Mr.
Allan,
on
behalf
of
Mr.
Clem
Lamothe
instructed
Mr.
Askin
to
undertake
a
number
of
reorganization
transactions
including:
(a)
incorporation
of
a
new
holding
company;
(b)
the
transfer
of
all
shares
owned
by
Mr.
and
Mrs.
Lamothe
in
Clem
Industrial
to
the
new
holding
company
on
a
tax
deferred
basis
utilizing
the
provisions
of
section
85
of
the
Income
Tax
Act;
(c)
dividend
payment
from
Clem
Industrial
to
the
new
holding
company;
and
(d)
"loan-back"
from
the
new
holding
company
to
Clem
Industrial
in
an
amount
equal
to
the
amount
of
the
dividend
pursuant
to
subparagraph
(c)
above.
6.
In
his
budget
delivered
in
the
House
of
Commons
by
the
Honourable
Michael
H.
Wilson
on
February
26,
1986,
he
proposed
a
number
of
changes
with
respect
to
the
taxation
of
small
incorporated
businesses
and,
in
particular,
that
the
12-1/2
per
cent
dividend
distribution
tax
imposed
by
Part
II
of
the
Act
be
repealed
effective
January
1,
1987.
7.
In
a
letter
dated
February
27,
1986
written
by
John
H.
Askin
to
Robert
L.
Allan
confirming
the
instructions
given
at
the
February
19,
1986
meeting,
he
added
as
a
postscript
the
suggestion
that
in
light
of
the
recent
budget
“we
may
wish
to
defer
dividend
payment
until
after
December
31,
1986
Re:
Abolition
of
Part
II
tax”.
8.
Pursuant
to
the
instructions
given
by
Mr.
Allan,
Mr.
Askin
caused
the
plaintiff
to
be
incorporated
by
certificate
of
incorporation
dated
March
17,
1986.
9.
Clem
Lamothe
and
Pauline
Lamothe,
on
the
advice
of
Robert
L.
Allan
and
others,
determined
that
the
fair
market
value
of
the
assets
of
Clem
Industrial,
and
so
of
the
shares
held
by
them
in
Clem
Industrial,
was
$415,000
as
at
December
31,
1985.
10.
On
March
18,
1986,
Clem
Lamothe
subscribed
for
and
was
issued
100
Class
B
voting
shares
in
the
capital
stock
of
the
plaintiff
at
a
price
of
$0.10
per
share.
11.
Further,
pursuant
to
the
instructions
of
Mr.
Allan,
Mr.
Askin
prepared
memoranda
of
agreements
made
effective
March
18,
1986
pursuant
to
which
Clem
Lamothe
and
Pauline
Lamothe
transferred
all
of
their
shares
in
Clem
Industrial
to
the
plaintiff
in
consideration
for
the
issuance
to
them
by
the
plaintiff
of
1
Class
A
share
for
each
share
owned
by
them
in
Clem
Industrial
with
each
such
Class
A
share
having
a
redemption
price
of
$4,150
and
having
a
stated
capital
of
$1
per
share.
12.
Each
of
Clem
Lamothe
and
Pauline
Lamothe
duly
executed
and
filed
with
the
Minister
elections
on
form
T2057
in
relation
to
the
deemed
proceeds
of
disposition
of
their
shares
in
Clem
Industrial
at
an
agreed
amount
of
$1
per
share
as
permitted
under
the
provisions
of
subsection
85(1)
of
the
Act.
13.
In
consequence
of
the
elections
on
form
T2057
filed
jointly
by
each
of
Clem
Lamothe
and
Pauline
Lamothe
and
the
plaintiff,
the
shares
of
Clem
Industrial
acquired
by
the
plaintiff
and
the
shares
issued
by
the
plaintiff
to
Clem
Lamothe
and
Pauline
Lamothe
for
their
shares
in
Clem
Industrial
all
had
the
same
adjusted
cost
base,
as
did
the
shares
in
Clem
Industrial
transferred
by
Clem
Lamothe
and
Pauline
Lamothe
to
the
plaintiff.
The
adjusted
cost
base
to
Clem
Lamothe
and
Pauline
Lamothe
of
their
shares
in
Clem
Industrial
was
$100,
and
that
was
the
adjusted
cost
base
of
these
shares
to
the
plaintiff
after
the
acquisition
thereof,
and
was
also
the
adjusted
cost
base
of
the
shares
received
by
Clem
Lamothe
and
Pauline
Lamothe
from
the
plaintiff.
Thus,
before
the
transfer
of
the
shares
of
Clem
Industrial
to
the
plaintiff
there
was
an
$414,900
unrealized
gain
inherent
in
the
shares
in
Clem
Industrial.
A
gain
of
equal
amount
was
inherent
in
the
shares
received
by
Clem
Lamothe
and
Pauline
Lamothe
from
the
plaintiff
in
consideration
for
their
shares
in
Clem
Industrial.
14.
Further,
pursuant
to
the
instructions
of
Mr.
Allan,
Mr.
Askin
prepared
a
resolution
of
the
directors
of
Clem
Industrial
pursuant
to
which
Clem
Industrial
declared
a
dividend
payable
to
the
plaintiff
on
January
1,
1987
of
$415,000
and
authorized
the
borrowing
of
the
proceeds
of
the
dividend,
a
resolution
of
the
plaintiff
lending
the
$415,000
to
Clem
Industrial,
a
demand
promissory
note
in
favour
of
the
plaintiff
by
Clem
Industrial
for
$415,000,
and
a
demand
debenture
by
Clem
Industrial
in
favour
of
the
plaintiff
securing
the
assets
of
Clem
Industrial
for
the
repayment
to
the
plaintiff
of
the
$415,000.
15.
The
dividend
and
borrowing
resolution,
the
lending
resolution,
the
promissory
note
and
the
demand
debenture
were
dated
January
1,
1987
and
were
fully
executed
on
April
2,
1986
and
the
note
and
debenture
were
held
by
Mr.
Askin
for
registration
and
delivery
on
or
after
January
1,
1987,
the
date
when
these
transactions
were
to
be
implemented.
16.
By
third
party
notice
dated
May
29,
1986
duly
filed
by
Nor-West
Oilfield
Hauling
Ltd.
and
Timothy
Arthur
and
served
upon
Clem
Industrial
promptly
thereafter,
Nor-West
Oilfield
Hauling
Ltd.
claimed
judgment
against
Clem
Industrial
in
the
sum
of
$234,216.35,
together
with
interest
and
costs
thereon,
being
the
entire
amount
claimed
by
Blocker
Drilling
Canada
Ltd.
against
Nor-West
Oilfield
hauling
Ltd.
in
the
statement
of
claim
described
in
paragraph
4
above.
17.
Clem
Industrial
duly
filed
a
defence
to
the
third
party
notice.
18.
Subsequent
to
the
filing
of
the
defence
to
the
third
party
notice,
extensive
correspondence
and
discussions
ensued
between
Mr.
Askin
Sciur
on
behalf
of
Clem
Industrial
and
Mr.
Brownlee
Fryett
on
behalf
of
Guardian
Insurance
Company
of
Canada,
Clem
Industrial’s
insurers,
on
the
question
of
whether
and,
if
so,
to
what
extent
the
claims
against
Clem
Industrial
pursuant
to
the
third
party
notice
were
covered
by
the
commercial
insurance
policy
issued
by
Guardian
Insurance
Company
of
Canada
to
Clem
Industrial.
19.
The
proposal
to
abolish
the
Part
II
tax
effective
January
1,
1987
was
brought
forward
in
section
65
of
a
Notice
of
Ways
and
Means
Motion
tabled
in
the
House
of
Commons
on
June
11,
1986,
and
again
in
section
69
of
a
superseding
Notice
of
Ways
and
Means
Motion
tabled
in
the
House
of
Commons
on
October
31,
1986,
and
was
passed
by
S.C.
1986,
c.
55,
s.
68
which
received
Royal
Assent
on
December
19,
1986.
20.
At
a
meeting
held
on
January
12,
1987
between
Messrs.
Robert
L.
Allan
and
John
H.
Askin,
Mr.
Allan
instructed
Mr.
Askin
to
prepare
a
written
agreement
pursuant
to
which
the
plaintiff
transferred
49
of
its
100
shares
in
Clem
Industrial
to
Mr.
Larry
Sych
effective
January
30,
1987
at
a
consideration
of
$1
per
share,
and
Mr.
Askin
did
so.
21.
On
January
13,
1987
the
plaintiff
secured
$415,000
from
Alberta
Treasury
Branches,
which
sum
was
deposited
into
its
account,
and
on
January
14,
1987
the
sum
of
$415,000
was
withdrawn
from
the
plaintiff’s
account
and
deposited
into
the
account
of
Clem
Industrial,
whereupon
Mr.
Askin
caused
the
debenture
executed
by
Clem
Industrial
on
April
2,
1986
to
be
registered
with
Corporate
Registry
of
the
Department
of
Consumer
Affairs,
Province
of
Alberta.
22.
Pursuant
to
an
Order
granted
by
the
Court
of
Queen’s
Bench
of
Alberta
on
February
13,
1987,
Blocker
Drilling
Canada
Ltd.
was
permitted
to
amend
its
statement
of
claim
to
elevate
the
claim
against
Clem
Industrial
from
a
liability
under
the
third
party
notice
to
include
it
as
one
of
the
defendants,
and
the
statement
of
claim
was
accordingly
amended
by
an
amended
statement
of
claim
filed
on
February
16,
1987.
23.
By
statement
of
defence
dated
March
4,
1987,
Clem
Industrial
filed
a
defence
to
the
amended
statement
of
claim.
24.
Both
Clem
Industrial
and
the
plaintiff
had
taxation
years
ending
June
30.
25.
In
filing
its
return
of
income
for
its
taxation
year
ending
June
30,
1987,
the
plaintiff
included
the
$415,000
dividend
in
computing
its
net
income
as
required
by
section
82
of
the
Act
and
deducted
the
said
amount
of
$415,000
in
computing
its
taxable
income
as
permitted
by
paragraph
112(l)(a)
of
the
Act,
resulting
in
the
plaintiff
having
no.
taxable
income
in
the
year
in
which
the
dividend
was
received.
No
part
of
the
dividend
was
subject
to
the
tax
imposed
under
Part
IV
of
the
Act.
26.
Neither
Clem
Industrial
nor
the
plaintiff
made
any
calculation
of
the
"safe
income"
of
Clem
Industrial
and
no
designation
with
respect
to
a
portion
of
the
$415,000
dividend
in
relation
to
"safe
income"
was
made
as
permitted
by
paragraph
55(5)(f)
of
the
Act.
The
Minister
determined
that
the
"safe
income"
of
Clem
Industrial
for
purposes
of
that
paragraph
was
$215,000.
27.
Mr.
Larry
Sych
was
not
related
to
the
plaintiff
or
Clem
Lamothe
or
Pauline
Lamothe
but
was
at
all
material
times
employed
by
Clem
Industrial
as
its
shop
foreman.
28.
The
action
commenced
by
Blocker
Drilling
Canada
Ltd.
was
finally
resolved
in
September
1989
for
a
total
sum
of
$115,000,
of
which
Clem
Industrial
paid
$13,870.
29.
By
a
reassessment,
a
notice
of
which
is
dated
March
1,
1990
for
the
taxation
year
ended
June
30,
1987,
the
Minister
reassessed
the
plaintiff
to
increase
its
taxable
income
from
nil
to
$107,475.50
by
including
a
capital
gain
of
$414,951
resulting
from
the
application
of
subsection
55(2)
of
the
Act
to
the
$415,000
dividend,
resulting
in
a
taxable
capital
gain
of
$207,475.50,
giving
rise
to
federal
tax
of
$76,913.14,
together
with
arrears
interest
of
$24,244.67,
for
a
total
"balance
unpaid"
of
$101,157.81.
The
Minister
further,
in
his
reassessment,
deleted
the
$415,000
dividend
previously
included
by
the
plaintiff
in
computing
net
income
under
section
82
of
the
Act
and
deducted
by
it
under
subsection
112(1)
thereof
in
computing
its
taxable
income.
30.
In
his
reassessment,
the
Minister
assumed
that
the
dividend
was
received
by
the
plaintiff
as
part
of
a
series
of
transactions
or
events,
within
the
meaning
of
subsection
55(2)
of
the
Act,
commencing
with
the
disposition
by
Clem
Lamothe
and
Pauline
Lamothe
of
their
shares
in
Clem
Industrial
to
the
plaintiff
and
ending
with
the
disposition
of
49
of
those
shares
by
the
plaintiff
to
Larry
Sych.
31.
In
his
reassessment,
the
Minister
further
assumed
that
one
of
the
purposes,
within
the
meaning
of
subsection
55(2)
of
the
Act,
of
the
payment
of
the
dividend
was
to
effect
a
significant
reduction
in
the
portion
of
the
capital
gain
that,
but
for
the
dividend,
would
have
been
realized
on
a
disposition
at
fair
market
value
of
the
shares
of
Clem
Industrial
immediately
before
the
dividend.
32.
In
his
reassessment,
the
Minister
further
assumed
that
the
dividend
was
received
by
the
plaintiff
as
part
of
a
series
of
transactions
or
events
that
resulted
in
a
disposition
of
shares
of
Clem
Industrial
to
a
person
with
whom
the
plaintiff
was
dealing
at
arm’s
length
or
in
a
significant
increase
in
the
interest
in
Clem
Industrial
by
Larry
Sych,
and
that
the
plaintiff
was
dealing
at
arm’s
length
with
Mr.
Larry
Sych
within
the
meaning
of
paragraph
55(3)(a)
of
the
Act.
33.
By
notice
of
objection
dated
April
2,
1990
and
duly
filed
with
the
Minister,
the
plaintiff
objected
to
the
adjustments
made
in
the
reassessment.
34.
By
notice
of
reassessment
dated
May
3,
1990,
the
Provincial
Treasurer
of
Alberta
without
making
an
independent
review
of
the
transactions
or
the
merits
of
the
federal
reassessment
also
reassessed
the
plaintiff
to
increase
its
taxable
income
from
nil
to
$207,475
to
reflect
the
adjustments
made
in
the
reassessment
issued
by
the
Minister,
resulting
in
an
increase
in
tax
payable
from
the
previous
assessment
of
nil
to
a
revised
assessment
of
$24,891.32
and
interest
of
$732.15,
for
a
total
of
$25,623.47.
The
plaintiff
duly
objected
to
that
reassessment
as
well
and
further
processing
thereof
has
been
held
in
abeyance
pending
the
outcome
of
the
dispute
respecting
the
validity
of
the
federal
assessment.
35.
By
notification
confirmation
by
the
Minister
dated
October
23,
1990,
the
Minister
confirmed
the
reassessment
for
the
following
reasons:
The
$415,000
is
claimed
to
be
proceeds
of
disposition
on
the
1987
disposition
of
the
Class
A
Common
Shares
of
Clem
Industrial
Machine
Ltd.
Pursuant
to
subsection
55(2)
of
the
Act,
the
taxable
capital
gain
realized
from
the
disposition
of
the
shares
has
been
determined
and
taken
into
account
in
computing
your
income
in
accordance
with
the
provisions
of
sections
3
and
54
and
paragraphs
38(a),
39(1
)(a)
and
40(1
)(a)
of
the
Act.
Relevant
statutory
provisions
For
ease
of
reference,
I
will
set
out
the
relevant
provisions
of
the
Income
Tax
Act:
55(2)
Where
a
corporation
resident
in
Canada
has
after
April
21,
1980
received
a
taxable
dividend
in
respect
of
which
it
is
entitled
to
a
deduction
under
subsection
112(1)
or
138(6)
as
part
of
a
transaction
or
event
or
a
series
of
transactions
or
events
(other
than
as
part
of
a
series
of
transactions
or
events
that
commenced
before
April
22,1980),
one
of
the
purposes
of
which
(or,
in
the
case
of
a
dividend
under
subsection
84(3),
one
of
the
results
of
which)
was
to
effect
a
significant
reduction
in
the
portion
of
the
capital
gain
that,
but
for
the
dividend,
would
have
been
realized
on
a
disposition
at
fair
market
value
of
any
share
of
capital
stock
immediately
before
the
dividend
and
that
could
reasonably
be
considered
to
be
attributable
to
anything
other
than
income
earned
or
realized
by
any
corporation
after
1971
and
before
the
transaction
or
event
or
the
commencement
of
the
series
of
transactions
or
events
referred
to
in
paragraph
3(a),
notwithstanding
any
other
section
of
this
Act,
the
amount
of
the
dividend
(other
than
the
portion
thereof,
if
any,
subject
to
tax
under
Part
IV
that
is
not
refunded
as
a
consequence
of
the
payment
of
a
dividend
to
a
corporation
where
the
payment
is
part
of
the
series
of
transactions
or
events)
(a)
shall
be
deemed
not
to
be
a
dividend
received
by
the
corporation;
(b)
where
a
corporation
has
disposed
of
the
share,
shall
be
deemed
to
be
proceeds
of
disposition
of
the
share
except
to
the
extent
that
it
is
otherwise
included
in
computing
such
proceeds;
and
(c)
where
a
corporation
has
not
disposed
of
the
share,
shall
be
deemed
to
be
a
gain
of
the
corporation
for
the
year
in
which
the
dividend
was
received
from
the
disposition
of
a
capital
property.
In
plain
language,
subsection
55(2)
of
the
Income
Tax
Act
deems
a
dividend
received
by
a
corporation
to
be
a
capital
gain
under
the
following
conditions:
1.
the
taxpayer
was
a
corporation
resident
in
Canada,
2.
the
taxpayer
received
after
April
21,
1980,
a
taxable
dividend
in
respect
of
which
it
was
entitled
to
a
deduction
under
subsection
112(1)
of
the
Income
Tax
Act,
3.
the
taxable
dividend
was
received
as
part
of
a
transaction
(or
event
or
series
of
transactions
or
events)
that
was
commenced
after
April
22,
1980,
4.
one
of
the
purposes
of
the
transaction
(or
event
or
series
of
transactions
or
events)
was
to
effect
a
significant
reduction
in
the
portion
of
the
capital
gain
that,
but
for
the
dividend,
would
have
been
realized
on
a
sale
of
the
capital
stock
immediately
before
the
dividend,
and
5.
the
capital
gain
must
not
be
attributable
to
income
earned
after
1971.
An
exception
to
the
deemed
capital
gains
rule
is
found
in
subparagraph
55(3)(a)(i)
of
the
Act:
55(3)
Subsection
(2)
does
not
apply
to
any
dividend
received
by
a
corporation,
(a)
unless
such
dividend
was
received
as
part
of
a
transaction
or
event
or
series
of
transactions
or
events
that
resulted
in
(i)
a
disposition
of
any
property
to
a
person
with
whom
that
person
was
dealing
at
arm’s
length....
Subsection
55(2)
will
not
apply
where
the
transaction
(or
event
or
series
of
transactions
or
events)
resulted
in
a
disposition
of
property
to
a
person
with
whom
the
taxpayer
was
not
dealing
at
arm’s
length.
In
other
words,
only
if
the
plaintiff
corporation
sells
its
shares
to
a
person
with
whom
it
is
dealing
at
arm’s
length
does
subsection
55(2)
apply.
Section
251
of
the
Act
sets
out
the
rules
for
establishing
whether
parties
are
dealing
at
arm’s
length.
Subsection
55(4)
is
a
general
anti-avoidance
provision:
where
the
principal
purpose
of
the
transactions
or
events
is
to
cause
two
or
more
persons
to
not
deal
with
each
other
at
arm’s
length
so
as
to
make
subsection
55(2)
inapplicable,
those
persons
are
deemed
to
be
dealing
with
each
other
at
arm’s
length.
A
good
explanation
of
the
rationale
behind
section
55
of
the
Income
Tax
Act
is
found
in
Trico
Industries
Ltd.
v.
Canada,
[1994]
2
C.T.C.
2053,
94
D.T.C.
1740
(T.C.C.).
Teskey
J.T.C.C.
states
at
page
2058
(D.T.C.
1744):
John
R.
Robertson
F.C.A.,
Director
General,
Corporate
Rulings
Directorate
in
1981,
said
at
the
Annual
Conference
of
the
Canadian
Tax
Foundation
that
in
regards
to
the
purpose
of
subsection
55(2):
The
amendments
are
designed
to
ensure
that
while
all
the
existing
corporate
rollovers
will
continue
to
apply,
the
realized
proceeds
on
a
variety
of
arm’s
length
intercorporate
share
sales
will
not
be
treated
as
tax-free
intercorporate
dividends,
but
will
instead
be
treated
as
capital
gains.
The
application
of
subsection
55(2)
is
intended
to
be
limited
to
cases
of
genuine
tax
avoidance
and
common
sense
should
prevail.
Issues
In
the
case
at
bar,
there
is
no
question
that
the
taxpayer
was
a
corporation
resident
in
Canada
and
that
it
received
a
taxable
dividend
in
respect
of
which
it
claimed
a
deduction
under
subsection
112(1)
of
the
Income
Tax
Act.
There
was
also
no
dispute
that
the
capital
gain
was
attributable
to
income
earned
after
1971.
Although
the
plaintiff
made
arguments
that
Larry
Sych
was
a
person
with
whom
the
plaintiff
was
not
dealing
at
arm’s
length,
I
do
not
accept
these
submissions.
I
find
that
Larry
Sych
was
a
person
with
whom
the
plaintiff
was
dealing
at
arm’s
length.
Accordingly,
it
is
for
this
Court
to
determine
whether
the
transaction
meets
the
remaining
requirements
of
subsection
55(2).
Specifically,
it
must
be
determined:
1.
whether
one
of
the
purposes
of
the
transaction
was
to
effect
a
significant
reduction
in
the
portion
of
the
capital
gain
that,
but
for
the
dividend,
would
have
been
realized
on
the
sale
of
the
shares,
and
2.
whether
the
disposition
of
49
per
cent
of
the
plaintiff’s
Clem
Industrial
shares
was
part
of
the
same
transaction
as
the
declaration
and
payment
of
the
dividend
to
the
plaintiff.
Analysis
Burden
of
proof
In
Québec
(Communauté
Urbaine)
v.
Corp.
Notre-Dame
de
Bon-Secours,
[1994]
3
S.C.R.
3,
[1995]
1
C.T.C.
241,
171
N.R.
161,
the
Supreme
Court
of
Canada
affirmed
that
the
party
claiming
the
benefit
of
a
legislative
provision
must
show
that
he
or
she
is
entitled
to
rely
on
it.
The
burden
of
proof
thus
rests
with
the
tax
department
in
the
case
of
a
provision
imposing
a
tax
obligation
and
with
the
taxpayer
in
the
case
of
a
provision
creating
a
tax
exemption.
In
the
case
at
bar,
the
burden
rests
on
the
plaintiff-the
party
seeking
to
rely
on
the
deductions
under
subsection
112(1)
of
the
Act-to
demonstrate
that
none
of
the
purposes
behind
the
payment
of
the
dividend
was
to
effect
a
significant
reduction
in
the
portion
of
the
capital
gain
or
that
the
transaction
was
not
related
to
the
subsequent
sale
of
the
shares.
Moreover,
from
the
wording
of
the
statutory
provision
("one
of
the
purposes
of
which...was
to
effect
a
significant
reduction
in
the
portion
of
the
capital
gain"),
it
is
not
sufficient
for
the
taxpayer
to
show
that
only
the
main
purpose
of
the
transaction
was
business-related.
The
witnesses
The
plaintiff
called
four
witness
and
no
expert
witnesses.
The
Court
heard
evidence
from:
John
Askin,
the
lawyer
involved
in
the
transactions;
Bob
Allen,
the
plaintiff’s
accountant;
Clem
Lamothe,
the
plaintiff’s
president
and
principal
shareholder;
and
Larry
Sych,
the
transferee
of
the
shares.
The
defendant
called
William
Nakano,
a
tax
avoidance
officer
with
the
Department
of
National
Revenue
and
formerly
a
tax
auditor
with
D.N.R.
I
found
all
of
the
witnesses
to
be
credible.
The
testimony
of
the
plaintiff
witnesses
did
not
conflict
on
any
of
the
major
points,
however,
I
have
relied
a
great
deal
on
the
evidence
presented
by
Askin
because
I
found
his
statements
to
be
particularly
clear
and
persuasive.
He
is
an
unusual
person:
a
lawyer
who
is
also
an
excellent
witness.
Issue
no.
1
:
Purpose
of
the
transaction
The
plaintiff’s
witnesses
were
unanimously
agreed
that
the
purpose
behind
the
declaration
of
the
dividend
and
the
loan
of
the
proceeds
of
the
dividend
was
to
secure
the
position
of
Lamothe
as
a
creditor
to
Clem
Industrial
Machine.
There
was
no
intention
to
avoid
taxation.
Lamothe
testified
that
he
began
his
own
business
in
1972.
He
was
not
a
good
witness.
Despite
the
best
efforts
of
his
counsel
to
help
him
without
leading,
Lamothe
could
not
seem
to
grasp
the
issues.
His
testimony
about
his
motives
and
the
chronology
of
events,
however,
was
consistent
with
the
recollection
of
other
witnesses.
Lamothe
testified
that
in
the
summer
of
1985
or
1986-he
could
not
recall
which-he
learned
that
his
corporation
could
be
named
in
a
lawsuit.
This
lawsuit
was
the
impetus
for
speaking
to
Askin.
In
reply
to
counsel’s
question
about
his
motives,
Lamothe
stated,
’’Well,
I
had
talked
to
Mr.
Askin
about
this
[the
lawsuit],
and
I
wanted
to
know
if
there
is
a
way
I
could
protect
my
investment
there
[in
Clem
Industrial
Machine]
and
I
guess
that
is
where
it
all
started
from"
(transcript,
page
95).
Askin’s
evidence
about
the
purpose
behind
the
rollover
and
the
debenture
loan
supported
Lamothe’s
testimony.
Regarding
the
lawsuit,
Askin
testified
that
Lamothe
attended
at
his
office
in
1986
and
was
very
concerned
about
a
potential
lawsuit
and
wished
to
place
himself
in
a
preferred
position
(transcript,
page
26).
Askin
further
testified
about
the
purpose
behind
the
transactions
(transcript,
page
11):
A.
The
purpose
as
indicated
by
the
file
and
according
to
my
recollection
was
to
secure
Mr.
Lamothe’s
interest
in
Clem
Industrial
Machine
Ltd.
At
that
time
his
only
interest
was
a
shareholder.
He
had
certain
shareholder
loans
and
other
matters,
but
he
was
not
in
any
type
of
a
secured
position
in
the
company
vis-a-vis
unsecured
creditors.
Q.
So
he
had
a
concern
about
unsecured
creditors,
did
he?
A.
Yes,
that
was
brought
up
very
clearly
as
being
the
reason
why
he
wished
to
undergo
these
transactions
was
to
put
himself
in
a
position
of
security
vis-a-vis
the
company
such
that
he
would
ostensibly
rank
ahead
of
any
unsecured
creditors
that
may
arise
in
the
future.
Allen,
Lamothe’s
accountant,
further
emphasized
the
point
already
made
by
Lamothe
and
Askin:
the
purpose
behind
the
transaction
was
to
make
Lamothe
a
secured
creditor
of
the
corporation.
His
testimony
was
as
follows
(transcript,
page
89):
Q.
What
the
Ministry
of
National
Revenue
is
assuming,
Mr.
Allan,
is
at
least
one
of
the
purposes
of
the
dividend
that
was
declared
in
March
or
April
1986
and
paid
in
January
1987,
at
least
one
of
its
purposes
was
to
reduce
the
gain
otherwise
realizable
on
the
disposition
of
the
shares
of
Clem
Industrial
by
CPL
Holdings.
What
do
you
say
to
that?
A.
Well,
what
I
remember
of
the
transaction
that
the
section
85
rollover
was
done
to
secure
the
assets
of
Clem
Industrial
Machine
at
that
time.
He
was
due
to
have
a
considerable
size
suit
against
him.
Nakano,
who
testified
on
behalf
of
the
respondent,
maintained
that,
in
his
opinion,
one
of
the
purposes
of
the
transaction
was
to
reduce
the
fair
market
value
of
the
Clem
Industrial
shares.
In
an
initial
examination
of
the
file,
Nakano
noted
that
Allen
had
made
an
affirmative
response
to
the
question,
"Was
the
purpose
of
the
$415,000
dividend
paid
by
Clem
to
CPL
to
reduce
the
fair
market
value
of
the
shares?"
However,
he
also
stated
that
Allen
later
clarified
his
response
as
meaning
that
the
effect
of
the
dividend
was
to
reduce
the
fair
market
value;
it
was
not
the
purpose
of
the
transaction.
According
to
Nakano,
he
examined
the
file
from
both
perspectives.
He
considered
the
taxpayer’s
submissions
that
the
rollover
was
not
intended
to
avoid
taxation;
he
also
considered
the
fact
that
30
days
after
the
rollover
took
effect,
the
taxpayer
was
able
to
sell
49
per
cent
of
the
shares
to
Larry
Sych
for
$1.
In
Nakano’s
opinion,
the
purpose
of
the
rollover
was
to
reduced
the
value
of
the
shares
by
the
payment
of
the
dividend
and,
accordingly,
he
recommended
that
the
deduction
be
disallowed.
Although
Nakano
had
reasonable
grounds
to
act
as
he
did,
I
do
not
agree
with
his
conclusion.
The
taxpayer
has
provided
convincing
evidence
that
the
purpose
of
the
rollover
was
to
make
Lamothe
a
secured
creditor
of
the
corporation.
I
do
not
find
that
the
purpose
of
the
transaction
was
to
reduce
the
fair
market
value
of
the
shares,
although
I
agree
that
it
was
one
of
the
effects
of
the
transaction.
Issue
no.
2:
Disposition
of
the
Clem
Industrial
shares
My
finding
that
the
purpose
behind
the
sale
of
the
shares
was
not
to
reduce
their
fair
market
value
is
supported
by
my
finding
that
the
sale
of
the
shares
to
Larry
Sych
is
unrelated
to
the
corporate
rollover
and
issuance
of
the
debenture.
The
timing
of
the
rollover
and
the
disposition
are
particularly
important.
In
the
February
1986
budget,
the
Minister
of
Finance
announced
that
the
Part
II
tax
would
be
repealed.
On
March
18,
1986,
the
plaintiff
acquired
all
of
the
shares
of
Clem
Industrial
and
soon
thereafter,
the
board
of
directors
of
Clem
Industrial
authorized
the
payment
of
a
dividend
of
$415,000
on
its
shares.
However,
the
payment
of
the
dividend
was
delayed
until
January
1,
1987
to
avoid
the
Part
II
tax.
The
proceeds
of
the
dividend
were
immediately
loaned
back
to
Clem
Industrial
by
the
plaintiff.
On
January
30,
1987,
the
plaintiff
sold
a
49
per
cent
interest
in
Clem
Industrial
to
Sych.
Larry
Sych
was
the
foreman
in
Lamothe’s
business.
Lamothe
testified
that,
late
in
1986,
he
made
the
decision
to
bring
in
Sych
as
a
shareholder
of
the
corporation.
Lamothe
stated
that
he
"couldn’t
handle
the
shop
any
more.
It
was
impossible.
Some
days
I
couldn’t
get
out
of
bed".
Although
Sych
was
an
employee,
Lamothe
was
afraid
that
he
might
leave.
There
were
no
negotiations
between
Lamothe
and
Sych
as
to
the
percentage
of
shares
that
Sych
would
receive.
Lamothe,
Sych,
and
Allen
met
for
lunch,
the
arrangement
was
explained
to
Sych,
and
the
parties
signed
the
documents
which
the
lawyers
and
accountants
had
drawn
up.
Allen
reiterated
the
points
made
by
Lamothe
and
his
dealings
with
Sych,
adding
that
it
was
at
his
suggestion
that
Lamothe
offer
the
shares
to
Sych
as
a
means
of
keeping
him
with
the
company.
Askin
provided
the
most
persuasive
and
clearest
testimony
with
respect
to
the
transfer
of
sales
to
Sych.
Askin
indicated
that,
in
his
mind,
the
registration
of
the
debenture
was
the
final
step
of
the
transaction
which
had
commenced
with
the
corporate
rollover
and,
again,
emphasized
that
the
only
reason
for
delaying
the
transaction
was
to
take
advantage
of
the
abolition
of
the
Part
II
tax.
Askin
conceded
that
if
one
was
to
look
only
at
the
date
for
the
rollover
and
the
date
for
the
disposition
of
the
shares,
it
was
understandable
how
one
could
come
to
the
conclusion
that
the
purpose
of
the
transaction
was
to
reduce
the
fair
market
value
of
the
shares.
However,
if
the
situation
is
considered
in
its
totality,
a
very
different
purpose
emerges.
His
testimony
on
this
point
is
particularly
illustrative
(transcript,
pages
28-30):
Q.
Now
the
fact
is,
and
this
is
what
raises
the
minister’s
suspicions
about
the
motivates
behind
all
this,
Mr.
Askin,
is
that
shares
were,
in
fact,
transferred
by
the
plaintiff.
It
received
100
shares
from
Mr.
and
Mrs.
Lamothe
on
March
18,
1986,
and
lo
and
behold
on
January
30,
1987,
49
of
these
shares
were
transferred
to
Mr.
Sych
for
$1
a
share?
A.
Okay.
Q.
Could
you
tell
the
Court
the
circumstances
of
when
this
came
about?
A.
In
all
honesty,
you
know,
you
just
look
at
those
two
dates
and
you
ignore
everything
else
that
has
happened
in
all
of
these
transactions,
I
can
see
how
that
might
raise
a
question.
However,
you
can’t
just
look
at
those
discrete
events
without
looking
at
the
totality
of
the
circumstances.
First
of
all,
if
he
wanted
to
transfer
the
49
shares
to
Mr.
Sych,
he
could
have
done
so
immediately
after
we
did
the
reorganization
in
March
and
April
of
the
prior
year
without
any
tax
consequences.
The
payment
of
the
dividend
was
irrelevant.
We
had
already
done
the
section
85
rollover.
We
had
already
substituted,
if
you
will,
all
the
inherent
capital
gains
tax
liability
from
the
shares
of
Clem
Industrial
to
the
shares
of
CPL,
and
Mr.
Sych
could
have
been
brought
in
at
any
point
in
time
before
or
after
the
dividend.
It
wouldn’t
have
made
any
difference.
Q.
The
same
way
for
$49?
A.
Exactly.
The
dividend
was
totally
unrelated.
It
was
irrelevant.
Q.
And
as
you
mentioned
earlier,
Mr.
Askin,
you
and
I
probably
would
have
just
done
an
86
reorganization?
A.
That
would
have
probably
been
my
preference...my
personal
preference
is
a
section
86.
Despite
the
overwhelming
amount
of
evidence
which
indicated
that
the
sale
of
shares
to
Sych
was
unrelated
to
the
corporate
rollover,
there
was
one
conflicting
statement
by
Allen
to
Askin
which
I
will
address.
The
evidence
indicated
that
Askin
and
Allen
had
spoken
on
the
telephone
on
April
30,
1986,
although
neither
person
could
recall
the
conversation.
Askin’s
notes
from
the
conversation
indicated
that
Allen
had
asked
him
about
the
sale
of
shares
to
Sych.
This
conversation
took
place
only
about
a
month
after
the
corporate
rollover
plans
were
initiated
and
seems
to
contradict
the
evidence
that
the
sale
to
Sych
was
not
contemplated
until
January
1987.
However,
in
my
opinion,
Allen
was
simply
"testing
the
waters".
In
his
own
words,
Allen
stated
that
he
and
Askin
"had
many
different
conversations
about
many
different
things
and
I
would
slide
in
a
few
questions
if
I
wanted
some
information".
Allen
may
well
have
asked
Askin
about
bringing
in
Sych,
however,
I
do
not
accept
that
the
sale
was
seriously
contemplated
prior
to
December
1986
or
January
1987.
The
plaintiff
has
satisfied
me
that
the
disposition
of
the
shares
to
Sych
was
not
part
of
the
same
transaction
as
the
declaration
and
payment
of
the
dividend
to
the
plaintiff.
The
phrase
"series
of
transactions
or
events"
is
now
defined
in
subsection
248(10)
of
the
Act.
However,
the
explanation
given
by
Sarchuk
J.T.C.C.
is
in
454538
Ontario
Ltd.
v.
M.N.R.,
[1993]
1
C.T.C.
2746,
93
D.T.C.
427
(T.C.C.),
is
equally
applicable
to
the
case
at
bar.
At
page
2753
(D.T.C.
431-32),
His
lordship
stated:
The
phrase
"series
of
transactions
or
events"
must
be
read
in
its
grammatical
and
ordinary
sense
reflecting
the
context
in
which
it
is
found,
the
scheme
and
object
of
the
Act
and
the
intention
of
Parliament.
Bearing
this
stricture
in
mind
it
seems
reasonable
to
conclude
that
in
order
for
the
events
to
form
part
of
a
series
they
must
follow
each
other
in
time
and
must
somehow
be
logically
or
reasonably
connected
to
one
another.
Furthermore
the
appellant
and
539
themselves
must
intend
that
the
series
of
transactions
be
linked
together
to
achieve
the
specific
result
in
this
case
being
the
disposition
of
the
shares
of
Tri-M
to
461
in
the
circumstances
and
in
the
manner
previously
described.
This
approach
is
consistent
with
the
dictionary
definitions
of
the
words,
"series",
"transaction"
and
"event".
The
plaintiff
has
met
the
burden
of
proof
imposed
upon
it
and
proved
to
my
satisfaction
that
the
sale
of
shares
to
Sych
was
not
intended
to
be
linked
to
the
corporate
rollover
and,
in
fact,
was
not
linked
in
any
way.
Disposition
The
plaintiff
has
proved
to
the
Court’s
satisfaction
that
none
of
the
purposes
of
the
transaction
was
to
effect
a
significant
reduction
in
the
portion
of
the
capital
gain
that,
but
for
the
dividend,
would
have
been
realized
on
the
sale
of
the
shares
and,
further,
the
disposition
of
49
per
cent
of
the
plaintiff’s
Clem
Industrial
shares
was
not
part
of
the
same
transaction
as
the
declaration
and
payment
of
the
dividend
to
the
plaintiff.
Accordingly,
the
appeal
from
the
assessment
of
the
Minister
is
allowed.
Appeal
allowed.
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