[OFFICIAL ENGLISH TRANSLATION]
Date:
20020918
Dockets:
96-1458(IT)G
96-1459(IT)G
BETWEEN:
RALPH E. FARAGGI,
ROBERT LANGLOIS,
Appellants,
and
HER
MAJESTY THE QUEEN,
Respondent.
REASONS FOR ORDER
Garon,
C.J.T.C.C.
[1] This
is a motion by the Appellants under section 58 of the Tax Court of Canada
Rules (General Procedure) for the Court to rule on a question of law before
the hearing on the merits of appeals of assessments for the 1987 and 1988
taxation years. This application was made in a notice of motion dated
November 30, 2001.
[2] Through
those assessments, the Minister of National Revenue added to each Appellant's
reported income for the 1987 year as taxable dividends the amounts of
$8,114,350.07 in the case of Appellant Robert Langlois and
$8,034,165.93 in the case of Appellant Ralph E. Faraggi. For the 1988 taxation
year, the Minister of National Revenue added $155,912.00 to the earnings
reported by each of the two Appellants as taxable dividends. Through these
assessments, the Minister of National Revenue also assessed interest and
penalties for those same two years.
[3] It
is not in dispute that on different dates throughout the 1987 taxation year,
four private corporations paid dividends on their shares to both Appellants.
One of the four corporations also paid dividends in 1988 on its shares to
both Appellants.
[4] The
question of law is set out as follows:
[translation]
subsection 83(2) of the Income Tax Act,
S.C. 1970‑71‑72 c. 63 as amended (the "I.T.A."),
when read with subsection 184(2) of the I.T.A., is it consistent with
the reassessments made against the Appellants to the effect that the dividends
in respect of which private corporations of which they were shareholders made
an election under subsection 83(2) of the I.T.A. in the prescribed manners
and forms and in the time period were assessed as "taxable"
dividends.
[5] The
procedure regarding the motion under section 58 of the Rules, supra, is
twofold. During the first step, the applicant must establish the right to apply
to the Court for a ruling on a question of law prior to the hearing of the
appeals.
[6] In
this case, the Respondent agreed that the Court first rule on the question of
law. Accordingly, I issued an order dated December 12, 2001, setting
out certain matters relating to factums to be filed by the parties prior to the
motion hearing and setting the hearing date for this motion.
[7] I deem it appropriate to refer to the grounds
submitted by the Appellants in their Notice of Motion:
[TRANSLATION]
THE GROUNDS
FOR THIS MOTION ARE AS FOLLOWS:
(a) Parliament, under subsection 83(2) of the I.T.A.,
clearly and unambiguously, established that "no part of the dividend (at
issue in each case and in respect of which an election was made) shall
be included in computing the income of any shareholder of the
corporation", "aucune partie du dividende n'est incluse dans le
calcul du revenu de tout actionnaire de la corporation";
(b) the only
prerequisites to the application of subsection 83(2) relative to dividends
payable in every case at issue are restricted to the evidence of filing of
prescribed forms within the timeframe set out in the I.T.A., conditions
that are in no way contested by the Respondent in his pleadings:
(c) consequently,
the assessments are simply prohibited by subsection 83(2); and
(d) furthermore, the
determination of this question
(i) only
implies a question of law that does not depend on a determination of questions
of fact; and
(ii) shall
completely dispose of these appeals without a trial at relatively little cost
and in a relatively short time for both the parties, as well as for the Court.
Appellants' Arguments
[8] On behalf of the Appellants, it was argued that
the rule set forth in subsection 83(2) of the Income Tax Act is
simple, imperative and unqualified and does not vary from one shareholder to
another. They argued that the only elements required for the application of
subsection 83(2) of the Act relate to the fact that a dividend be
payable to shareholders and that the corporation made an election. The
Appellants pointed out that the Respondent admitted that the amounts received
were dividends and that the elections were made by the corporations involved
within the prescribed time and in accordance with the prescribed form.
Therefore, according to the Appellants, the dividends received by them under
these circumstances could not be included in computing their income.
[9] After
indicating that subsection 184(2) of the Act sets forth the
consequences of an election made in respect of a dividend that exceeds the part
of which is deemed to be a capital dividend, the Appellants' senior counsel
argues that nothing in that subsection sets forth the consequences of an
election in respect of the shareholder. A taxpayer or corporation is not
required to make a reasonable attempt to determine his or its capital dividend
account in order to be entitled to benefit from subsections 184(3) and 184(3.2)
of the Act.
[10] The same counsel for the Appellants mentioned that Parliament could
have, in formulating an anti‑avoidance rule relative to capital dividends
in subsection 83(2.1) of the Act, provided for its retroactive
application to the period covered under these appeals.
[11] With regard to the Respondent's argument that there is a
"sham", the Appellants argue that this concept cannot be applied to
the Applicants because they did not present the Minister of National Revenue
with facts that do not reflect reality. The Respondent does not deny that the
Appellants received dividends. The "sham" concept does not apply in
respect of the elections set out in subsection 83(2) of the Act.
This election was made within the time and in the prescribed form.
[12] According to the Appellants, it is important to note that for the
purposes of applying subsection 83(2) of the Act, there simply
needs to be a dividend and not a capital dividend and that the election be made
in respect of a dividend. According to the Appellants' senior counsel, a
dividend may be a "sham" but the Respondent is not claiming that the
dividends received by the Appellants were a "sham". The same counsel
continues by arguing that the application of paragraph 83(2)(b) of
the Act depends on the existence of the dividend, not on the existence
of the capital dividend account.
[13] The Appellants' senior counsel adds that the Court's jurisdiction
issue is res judicata in order to rule on the question of law given the
Court Order dated December 12, 2001.
Respondent's Arguments
[14] Counsel for the Respondent argues that on the
basis of the assessment, the Minister of National Revenue recognizes it as a
dividend. According to the Minister, this is the only way to process amounts
received by Appellants. He argues that there was "fabrication of a
dividend", or of a capital dividend account, a "sham" set up to
generate business income and that the election was only part of that
fabrication. According to the Minister, to rule otherwise would be to allow a
taxpayer who is both responsible for a "sham" to also take advantage
of an election in a "sham" to avoid personal tax assessment.
[15] According to the Respondent, "the election made pursuant to
subsection 83(2) is one of the steps or is the final step leading up to
the 'sham'". Counsel for the Respondent advances that the election may not
be set up against the Minister because the Court must assume that everything
flows from an operation that is a "sham". In the Minister's opinion,
a "sham" corrupts everything.
[16] The Respondent argues that all of the circumstances leading up to the
election must be taken into account. As everything flows from a
"sham", the Minister of National Revenue was justified in considering
the election as non‑existent. In the absence of an election, there is no
non-taxable dividend. In his view, election has no legal value. Furthermore,
according to the Respondent, the fact that the Minister of National Revenue
assessed the dividends does not result in the validation of an election which
he deems non‑existent.
[17] In reference to the extent of
subsection 83(2) of the Act, counsel for the Respondent said the
following at paragraphs 24 and 25 of the document entitled [TRANSLATION] "Outline of the
Respondent's Argument…":
[translation]
24. With respect for the contrary opinion, absolute rules are rare
in tax law and we believe that this is not the extent of subsection 83(2)
of the I.T.A. even when read in combination with subsections 89(1)(j),
184(2) and 185 of the I.T.A.
25. The absolute
extent of the principle appears to us as highly doubtful in the following
example:
A
corporation that, in bad faith and without a shadow of a doubt, received no
capital dividends from other corporations, realized no disposition of property
even possibly giving the appearance of a capital gain (basically, absolutely
nothing in the "cda") and that despite those facts and circumstances
decided to pay a dividend and call it a capital dividend, hence believing to
put the dividend (and the shareholder receiving it) in a total personal tax
shelter because the election may not, in any case, in its entirety, be set up
against the Minister.
We believe
that election could not be set up against the Minister given the absence of any
apparent substance that may justify the election.
[18] As regards the facts that must be assumed to reply to the question of
law, counsel for the Respondent is of the opinion that the judge will have to
determine whether or not this is a "sham". The Respondent, agreeing
to move on to the second phase of the procedure set out in section 58 of the Rules
is not dropping as such the "sham" argument. The Court, according to
the Respondent, in ruling on the question of law, cannot presume that the
election is valid. It must consider the existence or non‑existence of a
"sham" in order to resolve this question.
Analysis
[19] Prior to discussing the application of
subsection 83(2) of the Act respecting capital dividends, I find it
useful to broach the general treatment of dividends set out by the Income
Tax Act. This act provides for two types of dividends: the taxable dividend
and the tax‑free dividend. The taxable dividend is defined in
paragraph 89(1)(j) as follows:
(1) In
this subdivision,
. . .
(j) "taxable dividend" means a dividend other than
(i) a dividend in respect of which the corporation paying
the dividend has elected in accordance with subsection 83(1) as it read
prior to 1979 or in accordance with subsection 83(2), and
(ii) a
qualifying dividend paid by a public corporation to shareholders of a
prescribed class of tax‑deferred preferred shares of the corporation
within the meaning of subsection 83(1).
This definition clearly establishes that dividends are generally taxable
but exceptions apply, including the type of dividend set out in
subsection 83(2) of the Act, namely capital dividends.
[20] If the dividend is taxable, it is included in the income under
paragraphs 12(1)(j) and 82(1)(a) of the Act.
Paragraph 82(1)(b) of the Act sets out that the sum included in
income as taxable dividends must be raised by one quarter or one third,
depending on the taxation year at hand, if the taxpayer is an individual. The
individual is entitled to a tax credit under section 121 of the Act
set out in accordance with the increase and set at two thirds of the
increase during the relevant period.
[21] These general remarks lead me to the special regime of capital
dividends.
[22] First of all, only a private corporation may pay tax‑freed
capital dividends for the shareholder.
[23] In order to pay a capital dividend, a private corporation must make an
election under subsection 83(2) of the Act by submitting a
prescribed form within the given time.
[24] The question asked in the Appellants' motion, reduced to its simplest
form, is to determine whether or not the assessments under appeal are
consistent with subsection 83(2) of the Act.
[25] To determine this question, one must first refer to
subsections 83(2) and 184(2) of the Act, which read as follows at
the relevant time:
83(2) Where at any particular time
after 1971 a dividend becomes payable by a private corporation to
shareholders of any class of shares of its capital stock and the corporation so
elects in respect of the full amount of the dividend, in prescribed manner and
prescribed form and at or before the particular time or the first day on which
any part of the dividend was paid if that day is earlier than the particular
time, the following rules apply:
(a)
the dividend shall be deemed to be a capital dividend to the extent of the
corporation's capital dividend account immediately before the particular time;
and
(b)
no part of the dividend shall be included in computing the income of any
shareholder of the corporation.
184(2) Where a corporation has
elected in accordance with subsection 83(2), 130.1(4) or 131(1) in
respect of the full amount of any dividend payable by it on shares of any class
of its capital stock and the full amount of the dividend exceeds the portion
thereof deemed by that subsection to be a capital dividend or capital gains
dividend, as the case may be, the corporation shall, at the time of the
election, pay a tax under this Part equal to ¾ of the excess.
[26] The conditions for application of subsection 83(2) of the Act
are simple. They may be summarized into three proposals:
1. A dividend must be payable by a private corporation to the
shareholders.
2. The corporation makes an election relative to the total dividend
amount.
3. The election is made according to terms and conditions set out by
regulations within the time set out in that subsection.
[27] There is no doubt that the corporations in question seemingly met the
three aforementioned conditions. However, the Respondent believes that the
elections made by the corporations under subsection 83(2) of the Act
cannot be set up against the Minister of National Revenue by both the
corporations having paid out dividends or by the Appellants. In this respect,
the Respondent refers to the Replies to the Notices of Appeal, particularly
paragraph 2 of each of those Replies. Paragraph 2 reads in part as
follows:
[TRANSLATION]
2. . . . and adds to the surplus:
(a) that
companies "2528", "1915", "1276"
and "1292" did not, in good faith, establish a capital dividend
account;
(b) these
companies had no capital dividend to pay their shareholders, including the
Appellant:
(c) the
election set out in paragraph 83(2) of the Income Tax Act made by
companies "2528", "1915", "1276"
and "1292" cannot be set up against the Minister of National
Revenue since these elections are an integral part of a scheme
("sham") set up by Robert Langlois and
Ralph E. Faraggi, who used a chain of corporations to fabricate
capital gains, thereby fictitiously creating a capital dividend account for the
purpose of reselling said capital dividend account to third parties for a
profit.
[28] The Respondent raises yet another fundamental question in his Replies
to the Notices of Appeal concerning the application of subsection 83(2) of
the Act, that is, whether the elections made by the private corporations
involved are an integral part of the "sham". At the hearing of that
question, under section 58 of the Tax Court of Canada Rules (General
Procedure), the Respondent put forward, in the same vein, the argument that
elections made by the corporations in question constituted, as part of a
certain number of operations, the final step of a "sham" and that
accordingly, they could not be set up against the Minister of National Revenue.
[29] I add that the determination on the "sham" issue in respect
of elections, for the purposes of applying subsection 83(2) of the Act,
appears to me to be perfectly relevant because if the elections were part of a
smokescreen or constituted a "sham", they would likely not be valid.
[30] I will note that the Court was not asked to determine whether or not
the elections made by private corporations pursuant to subsection 83(2) of the Act
constituted a "sham" and could not be set up against the Minister of
National Revenue, which would involve a question of mixed fact or law. The
question of law that is before me at this stage rests rather on the consistency
of assessments with the provisions of subsection 83(2)
of the Act.
[31] While at first glance it flows from my analysis that there is an
inconsistency between the assessments under appeal and subsection 83(2) of the Act, when read with subsection 184(2) of
the Act, it is essential to determiner whether or not the elections by
private corporations under subsection 83(2) of the Act constituted a
"sham" or are an integral part of a series of operations leading up
to a "sham". The response to the question on which the Appellants
applied to the Court for a ruling pursuant to section 58 of the Tax
Court of Canada Rules (General Procedure) cannot, therefore, put an end to
the case. Accordingly, a hearing on the merits of these appeals will be
necessary.
[32] Costs will be in the appeals.
Signed at
Ottawa, Canada, this 18th day of September 2002.
C.J.T.C.C.
on this 16th day
of March 2004.
Maria Fernandes, Translator
Email this Content