|
Citation: 2004TCC719
|
|
Date: 20041029
|
|
Docket: 2001-2716(IT)G
|
|
BETWEEN:
|
|
DENIS HOWE,
|
|
Appellant,
|
|
and
|
|
|
|
HER MAJESTY THE QUEEN,
|
|
Respondent,
|
AND BETWEEN:
|
Docket: 2001-3707(IT)G
|
|
|
|
TIMOTHY GAMBLE,
|
|
Appellant,
|
|
and
|
|
|
|
HER MAJESTY THE QUEEN,
|
|
Respondent,
|
AND BETWEEN:
|
Docket: 2001-3715(IT)G
|
|
|
|
CAMERON W.D. WHITE,
|
|
Appellant,
|
|
and
|
|
|
|
HER MAJESTY THE QUEEN,
|
|
Respondent,
|
AND BETWEEN:
|
Docket: 2001-3712(IT)G
|
|
|
|
KENNETH M. HAWLEY,
|
|
Appellant,
|
|
and
|
|
|
|
HER MAJESTY THE QUEEN,
|
|
Respondent,
|
AND BETWEEN:
|
Docket: 2001-2718(IT)G
|
|
|
|
CRAIG LODGE,
|
|
Appellant,
|
|
and
|
|
|
|
HER MAJESTY THE QUEEN,
|
|
Respondent.
|
|
|
REASONS FOR JUDGMENT
Bell, J.
[1] The issues are defined by the
parties as set forth in paragraphs 85 and 86 of the Partial
Agreed Statement of Fact, but are restated here as:
1. Whether entitlement to
the amount that the respective unitholders of two partnerships
were to receive, pursuant to the offers that Vidatron was
required to make to effect the exchange of its shares for units,
being interests in those partnerships, was granted or to be
granted for the purpose of reducing the impact "... of
any loss that the unitholders may sustain" within the
meaning of paragraph 96(2.2)(d), thereby reducing the
"at-risk" amount and the consequent amount of
partnership losses deductible by the partners.
2. Whether, in the
alternative, the transactions between each of the two
partnerships, NM I and NM II and Vidatron were avoidance
transactions which resulted directly or indirectly in tax
benefits to the Appellants within the meaning of subsection
245(2) and paragraph 245(3)(b) of the Act.
[2] Although it is for the Court to
determine, with respect to the first issue, the parties agreed
that as stated in paragraph 87:
Except for the issue described above with respect to paragraph
96(2.2)(d) and the general anti-avoidance rule, the
parties are agreed that the Appellants' would be entitled to
deduct their share of the NM I and NM II business losses in
accordance with the provisions of the Act.
[3] The parties filed a Partial Agreed
Statement of Facts and Issues which reads as follows. This was
supplemented by oral evidence and portions of examinations for
discovery.
PARTIAL AGREED STATEMENT OF FACTS AND ISSUES
For the purposes of the proceedings in Timothy Gamble v. HMTQ
TCC 2001-3707(IT)G, Cameron W.D. White v. HMTQ TCC
2001-3715(IT)G, Denis Howe v. HMTQ TCC 2001-2716(IT)G, Kenneth M.
Hawley v. HMTQ TCC 2001-3712(IT)G, and Craig Lodge v. HMTQ
TCC 2001-2718(IT)G and any appeal therefrom, the following facts
are agreed to by the Appellants and the Respondent:
1. Vidatron
Entertainment Group Inc. ("Vidatron") is a company
incorporated under the laws of the Province of British Columbia.
The common shares of Vidatron were at all material times publicly
listed on the Vancouver Stock Exchange.
2.
Vidatron's business at all material times included producing
and distributing film, video and interactive programming for the
corporate, education, and entertainment market sectors.
New Media Marketing Limited Partnership
3. The New
Media Marketing Limited Partnership ("NM I") was
established as a limited partnership under the laws of the
Province of British Columbia on March 15, 1995.
4. The general
partner of NM I was New Media Finance Ltd. (Vidatron Marketing
Ltd. was the original general partner of NM I and was replaced by
its successor in interest, New Media Finance Ltd.). Kathleen
Martin and Shelley Kirk were the directors of the general
partner. Kathleen Martin was the president and sole shareholder.
Cameron White was the secretary.
5. NM I is one
of a series of marketing limited partnerships in which Vidatron
was involved: the others are Georgia Marketing Limited
Partnership (1990), Georgia II Marketing Limited Partnership
(1991), Vidatron Marketing (1993) Limited Partnership and New
Media Marketing II Limited Partnership (1996).
6. On March
15, 1995 Vidatron and several related companies entered into a
joint venture agreement (the "First JV Agreement") with
NM I whereby NM I agreed to undertake an advertising and
marketing program to promote Vidatron's products and
services. The First JV Agreement was amended by an agreement
dated October 15, 1995.
7. The
management committee referenced in the First JV Agreement was
comprised of Shelley Kirk, Kathleen Martin, Tim Gamble and
Cameron White.
8. Under the
terms of the First JV Agreement as amended, NM I was required to
expend a minimum of $485,000 and a maximum of $1,275,000 during
the period from March 15, 1995 to December 31, 1995. Vidatron
agreed to match NM I's initial expenditures during the period
from January 1, 1996 until the end of the term of the
First JV Agreement on December 31, 2005.
9. In return
for its initial expenditures under the First JV Agreement, and
subject to further adjustments, Vidatron was required to pay NM I
a share equal to 8% of "Net Revenues" as that term is
defined in the First JV Agreement, commencing on January 1,
1996.
10. NM I's
proportionate share of revenues was subject to a further annual
adjustment based on the cumulative expenditures made by NM I and
Vidatron in connection with the marketing program. The net
revenues to be shared with the partnership are arrived at by
first reducing the gross revenue by a base revenue adjustment of
$7,000,000. The base revenue adjustment is an estimate of the
revenue that would be achieved over the term of the marketing
program in the absence of such program (both the initial phase
and the remainder of the program).
11. Under the terms of the
First JV Marketing Agreement, Vidatron agreed to make an offer to
acquire the outstanding units of NM I after April 1, 1996 and
before August 31, 1996. Vidatron agreed to make the offer at a
price equal to the lesser of:
(a) $1,080 per unit;
and
(b) the fair market
value of the unit,
which was to be fully payable in common shares of Vidatron at
their weighted average price for the 20 trading days preceding
the fifth business day before the offer was made.
12. The First JV Agreement
further provided that if 65% or more of the units issued,
excluding any units owned by Vidatron, were tendered in
acceptance of the exchange offer, the remaining limited partners
were required to sell their units in NM I and the general partner
was required to sell its interest to Vidatron in accordance
with the terms in the First JV Agreement.
13. NM I offered its units
for sale by way of offering memorandum dated October 15, 1995. NM
I sold a total of 934 units at a price of $1,000 per unit for
gross offering proceeds of $934,000.
14. NM I's 1995 fiscal
period ended on December 31, 1995. For its 1995 fiscal period NM
I had no revenues and expenses of $858,949 for an aggregate net
business loss of $858,949.
15. The expenditures
giving rise to NM I's net business loss were incurred mainly
as follows: consulting fees paid to Vidatron management and
officers, producing of demo and promotional videos, direct mail
out of promotional material including brochures, pamphlets and
proposals incorporating graphic design and printing, general
promotion including trade shows, travel, clothing, meals,
entertainment and advertising.
16. In accordance with the
limited partnership agreement, $857,326 of the 1995 net loss for
NM I was allocated to the limited partners. Each NM I limited
partnership unit was allocated a loss of $917.90.
17. On July 31, 1996
Vidatron made an offer (the "NM I Offer" to acquire the
limited partners' NM I units for $1,080 per unit (being the
lesser of $1080 per unit and the fair market value of $1627 per
unit) as required under the First JV Agreement. At that time unit
holders were provided with the following documents: Offer to
Purchase, Offering Circular, Valuation Report prepared by I.S.
Grant & Associates dated June 7, 1996, Vidatron's
financial statements for the nine months ended May 31, 1996,
Director's Circular and a Letter of Acceptance and
Transmittal. Subscribers had until August 23, 1996 to transmit
their letters of acceptance to Vidatron.
18. The valuation required
pursuant to section 2.16 of the First JV Agreement was prepared
by I.S. Grant & Company for Vidatron.
19. Pursuant to the NM I Offer,
more than 65% of all of the limited partnership units were
tendered in acceptance of the exchange offer. Consequently, all
of the NM I units were tendered to Vidatron, in exchange for an
aggregate of 473,538 shares in Vidatron, at a deemed price of
$2.13 a share (being the weighted average price for the shares as
traded on the Vancouver Stock Exchange for the 20 trading days
ending five days prior to the announcement of the NM I
Offer).
20. The NM I Offers were
accepted as described above and the interest of the general
partner was sold to Vidatron before the base revenue of
$7,000,000 was achieved.
21. NM I was dissolved
once Vidatron acquired all the units of NM I.
New Media Marketing II Limited
Partnership
22. The New Media
Marketing II Limited Partnership ("NM II") was
established as a limited partnership under the laws of the
Province of British Columbia on March 6, 1996.
23. The general partner of
NM II was New Media Finance II Ltd. Kathleen Martin and Shelley
Kirk were the directors of the general partner. Kathleen Martin
was the president, Shelley Kirk was the secretary and
collectively they owned 100% of the shares of the general
partner.
24. NM II is one of a
series of marketing limited partnerships in which Vidatron was
involved: the others are Georgia Marking Limited Partnership
(1990), Georgia II Marketing Limited Partnership (1991), Vidatron
Marketing (1993) Limited Partnership and New Media Marketing
Limited Partnership (1995).
25. On March 6, 1996
Vidatron and several related companies entered into a joint
venture agreement (the "Second JV Agreement")
with NM II whereby NM II agreed to undertake an advertising and
marketing program to promote Vidatron's products and
services.
26. The management
committee referenced in the Second JV Agreement was comprised of
Shelley Kirk, Kathleen Martin, Tim Gamble and Cameron White.
27. Under the terms of the
Second JV Agreement, NM II was required to expend a minimum of
$835,000 and a maximum of $1,700,000 during the period from March
6, 1996 to December 31, 1996. Vidatron agreed to match NM
II's initial expenditures during the period from January 1,
1997 until the end of the term of the Second JV Agreement on
December 31, 2006.
28. In return for its
initial expenditures under the Second JV Agreement, and subject
to further adjustments, Vidatron was required to pay NM II a
share equal to 8% of "Net Revenues" as that term is
defined in the Second JV agreement, commencing on January 1,
1997.
29. NM II's
proportionate share of revenues was subject to a further annual
adjustment based on the cumulative expenditures made by NM II and
Vidatron in connection with the marketing program. The net
revenues to be shared with NM II are arrived at by first reducing
the gross revenue by a base revenue adjustment of $11,000,000.
The base revenue adjustment is an estimate of the revenue that
would be achieved over the term of the marketing program in the
absence of such program (both the initial phase and the remainder
of the program).
30. Under the terms of the
Second JV Agreement, Vidatron agreed to make an offer to acquire
the outstanding units of NM II after April 1, 1997 and before
August 31, 1997. Vidatron agreed to make the offer at a price
equal to the lesser of:
(a) $1,080 per unit;
and
(b) the fair market value of
the unit,
which was to be fully payable in common shares of Vidatron at
their weighted average price for the 20 trading days preceding
the fifth business day before the offer was made.
31. The Second JV
Agreement further provided that if 65% or more of the units
issued, excluding any units owned by Vidatron, were tendered in
acceptance of the exchange offer, the remaining limited partners
were required to sell their units in NM II and the general
partner was required to sell its interest to Vidatron in
accordance with the terms in the Second JV Agreement.
32. NM II offered its
units for sale by way of offering memorandum dated June 15, 1996.
NM II sold a total of 1,999 units at a price of $950 per unit for
gross offering proceeds of $1,899,050.
33. NM II's 1996
fiscal period ended on December 31, 1996. For its 1996 fiscal
period NM II had gross revenues of $1,471 and an aggregate net
business loss of $1,796,405. Each NM I limited partnership unit
was allocated a loss of $894.32.
34. The expenditures
giving rise to NM II's net business loss were incurred mainly
as follows: consulting fees paid to Vidatron management and
officers, production of demo and promotional videos, direct mail
out of promotional material including brochures, pamphlets and
proposals incorporating graphic design and printing, general
promotion including trade shows, travel, clothing, meals,
entertainment and advertising.
35. On or about June 11,
1997 Vidatron made an offer (the "NM II Offer") to
acquire the limited partners' NM II units for $1,080 per unit
(being the lesser of $1080 per unit and the fair market value of
$1886 per unit) as required under the Second JV Agreement. At
that time unit holders were provided with the following
documents: Offer to Purchase, Offering Circular, Director's
Circular, Valuation Report of I.S. Grant & Company Ltd. dated
June 1, 1997, Vidatron's Financial Statements for the six
months ended February 28, 1997 and Letter of Acceptance and
Transmittal. Subscribers had until July 4, 1997 to transmit their
letters of acceptance.
36. The valuation report
required pursuant to section 2.16 of the Second JV Agreement was
prepared by I.S. Grant & Company for Vidatron.
37. Pursuant to the NM II
Offer, on July 4, 1997 a majority in excess of 65% of the limited
partners tendered their acceptance of the exchange offer.
Consequently, all of the limited partnership units were tendered
in exchange for an aggregate of 423,042 shares in Vidatron, at a
deemed price of $5.25 a share (being the weighted average price
for the shares as traded on the Vancouver Stock Exchange for the
20 trading days ending five days prior to the announcement of the
exchange offer).
38. The NM II Offers were
accepted as described above and the interest of the general
partner was sold to Vidatron.
39. NM II was dissolved
once Vidatron acquired all the units of NM II.
Timothy Gamble ("Gamble")
40. At all material times
Gamble was the president, and director or officer of Vidatron and
a member of the management committee of the General partner.
41. Gamble acquired 25
units of NM I at $1,000 per unit for a total of $25,000. He
subscribed for the NM I units on December 28, 1995 and paid for
the units by cheque dated December 31, 1995. The general partner
accepted his subscription on December 29, 1995.
42. Gamble's share of
NM I's business loss for the 1995 taxation year was $917.90
per unit or $22,947.45 in total.
43. Gamble deducted his
share of NM I's business loss in computing his income for the
1995 taxation year on the basis that the loss was deductible
pursuant to paragraph 96(1)(g) of the Act.
44. Further to
Vidatron's offer under the First JV Agreement, Gamble sold
his units of NM I to Vidatron in consideration for 12,676 common
shares of Vidatron.
45. Vidatron and Gamble
filed a joint election under subsection 85(1) of the Income
Tax Act (Canada)(the "Act") in respect of the
transfer of Gamble's NM I units at an "agreed
amount" of $82.102 per unit or $2,052.55 in aggregate.
46. By Notice of
Reassessment dated April 15, 1999, the Minister of National
Revenue (the "Minister") reassessed Gamble's 1995
taxation year to deny Gamble's share of NM I's business
loss ("Gamble's 1995 Notice of Reassessment").
47. In confirming the
reassessment of Gamble's 1995 taxation year the Minister
relied on the GAAR as an alternate basis to disallow the
deduction of Gamble's share of NM I's business loss for
1995.
48. Gamble acquired 25
units of NM II at $950 per unit for a total of $23,750. Gamble
paid the full purchase price for his units by cheque on
closing.
49. Gamble's share of
NM II's business loss for the 1996 taxation year was $894.32
per unit of $22,358.02 in total.
50. Gamble deducted his
share of NM II's business loss in computing his income for
the 1996 taxation year on the basis that the loss was deductible
pursuant to paragraph 96(1)(g) of the Act.
51. Further to
Vidatron's offer to acquire the Gamble's New Media II
Partnership units under the Second JV Agreement, Gamble sold his
units of NM II to Vidatron in consideration for 5,150 common
shares of Vidatron.
52. Vidatron and Gamble
filed a joint election under subsection 85(1) of the Act in
respect of the transfer of Gamble's NM II units at an
"agreed amount" of $55.67 per unit or $1,391.75 in
aggregate.
Cameron White ("White")
53. In 1995 and 1996 White
was the CEO and director of Vidatron. At all material times White
was a member of the management committee of the general partners
involved in NMI and NM II. In 1995 he was also secretary of the
general partner.
54. White acquired 30
units of NM I at $1,000 per unit for a total of $30,000.
55. White's share of
NM I's business loss for the 1995 taxation year was $917.90
per unit of $27,536.94 in total.
56. White deducted his
share of NM I's business loss in computing his income for the
1995 taxation year on the basis that the loss was deductible
pursuant to paragraph 96(1)(g) of the Act.
57. Further to
Vidatron's offer under the First JV Agreement, White sold his
units of NM I to Vidatron in consideration for 15,210 common
shares of Vidatron.
58. Vidatron and White
filed a joint election under subsection 85(1) of the Act in
respect of the transfer of White's NM I units at an
"agreed amount" of $82.102 per unit or $2,463.26 in
aggregate.
59. By Notice of
Reassessment dated May 20, 1999, the Minister reassessed
White's 1995 taxation year to deny White's share of NM
I's business loss ("White's 1995 Notice of
Reassessment").
60. In confirming the
reassessment of White's 1995 taxation year the Minister
relied on the GAAR as an alternate basis to disallow the
deduction of White's share of NM I's business loss for
1995.
61. White acquired 27
units of NM II at $950 per unit for a total of $25,650. White
paid the full purchase price for his units by cheque on closing.
He subscribed for the NM II units on August 30, 1996 and the
general partner accepted his subscription on that same date.
62. White's share of
NM II's business loss for the 1996 taxation year was $894.32
per unit or $24,146.66 in total.
63. White deducted his
share of NM II's business loss in computing his income for
the 1996 taxation year on the basis that the loss was deductible
pursuant to paragraph 96(1)(g) of the Act.
64. Further to
Vidatron's offer to acquire the White's NM II units under
the Second JV Agreement, White sold his units of NM II to
Vidatron in consideration for 5,562 common shares of
Vidatron.
65. Vidatron and White
filed a joint election under subsection 85(1) of the Act in
respect of the transfer of White's NM II units at an agreed
amount of $55.67 per unit or $1,503.34 in aggregate.
Denis Howe ("Howe")
66. Howe acquired 13 units
of NM I at $1,000 per unit for a total of $13,000., He
subscribed for the NM I units on December 19, 1995. The
general partner accepted his subscription on December 20,
1995.
67. Howe's share of NM
I's business loss for the 1995 taxation year was $917.898 per
unit or $11,932.67 in total.
68. Howe deducted his
share of NM I's business loss in computing his income for the
1995 taxation year on the basis that the loss was
deductible pursuant to paragraph 96(1)(g) of the Act.
69. Further to
Vidatron's offer under the First JV Agreement, Howe sold his
units of NM I to Vidatron in consideration for 6,591 common
shares of Vidatron.
70. Vidatron and Howe
filed a joint election under subsection 85(1) of the Act in
respect of the transfer of Howe's NM I units at an
"agreed amount" of $82.102 per unit or $1,067.33 in
aggregate.
71. By Notice of
Reassessment dated March 11, the Minister reassessed Howe's
1995 taxation year to deny Howe's share of NM I's
business loss ("Howe's 1995 Notice of
Reassessment").
72. In confirming the
reassessment of Howe's 1995 taxation year the Minister relied
on the GAAR as an alternate basis to disallow the deduction of
Howe's share of NM I's business loss for 1995.
Kenneth M. Hawley ("Hawley")
73. Hawley acquired 27
units of NM II at $950 per unit for a total of $25,650. He
subscribed for the NM II units on August 30, 1996. The
general partner accepted his subscription on September 6, 1996.
Hawley paid the full purchase price for his units by cheque on
closing.
74. Hawley's share of
NM II's business loss for the 1996 taxation year was $894.32
per unit or $24,146.66 in total.
75. Hawley deducted
$23,830 of his share of NM II's business loss in computing
his income for the 1996 taxation year on the basis that the
loss was deductible pursuant to paragraph 96(1)(g) of the
Act.
76. Further to
Vidatron's offer to acquire the Hawley's NM II units
under the Second JV Agreement, Hawley sold his units of NM II to
Vidatron in consideration for 5,562 common shares of
Vidatron.
77. Vidatron and Hawley
filed a joint election under subsection 85(1) of the Act in
respect of the transfer of Hawley's NM II units at an
"agreed amount" of $55.67 per unit or $1,503.34 in
aggregate.
Craig Lodge ("Lodge")
78. Lodge acquired 25 units of
NM I at $1,000 per unit for a total of $25,000. He
subscribed for the NM I units on December 29, 1995. The
general partner accepted the subscription on December 29,
1995.
79. Lodge's share of
NM I's business loss for the 1995 taxation year was $917.90
per unit or $22,947 in total.
80. Lodge deducted his
share of NM I's business loss in computing his income for the
1995 taxation year on the basis that the loss was
deductible pursuant to paragraph 96(1)(g) of the Act.
81. Further to
Vidatron's offer under the First JV Agreement, Lodge sold his
units of NM I to Vidatron in consideration for 12,676 common
shares of Vidatron.
82. Vidatron and Lodge
filed a joint election under subsection 85(1) of the Act in
respect of the transfer of Lodge's NM I units at an
"agreed amount" of $82.102 per unit or $2,052.55 in
aggregate.
83. By Notice of
Reassessment dated April 1, 1999, the Minister reassessed
Lodge's 1995 taxation year to deny Lodge's share of NM
I's business loss ("Lodge's 1995 Notice of
Reassessment").
84. In confirming the
reassessment of Lodge's 1995 taxation year the Minister
relied on the GAAR as an alternate basis to disallow the
deduction of Lodge's share of NM I's business loss for
1995.
Issues:
85. The first issue is
whether the amount that the respective unitholders were
contingently entitled to receive pursuant to the exchange offers
that Vidatron was required to make was granted for a purpose
outlined in paragraph 96(2.2)(d).
86. A further issue is
whether, in the alternative:
(a) the transactions
between NM I, NM II and Vidatron were avoidance transactions,
which resulted directly or indirectly in tax benefits to the
Appellants within the meaning of subsection 245(2) and paragraph
245(3)(b) of the Act; and
(b) whether
subsection 245(2) of the Act does not apply because of subsection
245(4) of the Act.
87. Except for the issue
described above with respect to paragraph 96(2.2)(d) and the
general anti-avoidance rule, the parties are agreed that the
Appellants would be entitled to deduct their share of the NM I
and NM II business losses in accordance with the provisions of
the Act.
The Parties agree that they shall be entitled to adduce other
evidence (in addition to this Partial Agreed Statement of Facts
or the Joint Book of Documents) or to ask the Tax Court of Canada
to draw inferences from the evidence presented, provided that
such additional evidence or inferences are not inconsistent with
this Partial Agreed Statement of Facts.
The Appellants and Respondent agree to file copies of the
following documents with the Court as exhibits for the purposes
of this proceeding. The Parties agree that filing the following
documents with the Court as exhibits pursuant to this agreement
does not constitute compliance with Rule 145 of the Rules of
General Procedure respecting expert witnesses.
A1. This Partial Agreed
Statement of Facts
A2. Joint Book of Documents.
[4] SUMMARY OF BUSINESS LOSSES
CLAIMED BY THE FIVE APPELLANTS:
Gamble
1995
$22,947.45
1996
$22,358.02
White
1995
$27,536.94
1996
$24,146.66
Howe
1995
$11,932.67
Hawley
1996
$24,146.66
Lodge
1995
$22,947.00
FACTS FROM EVIDENCE GIVEN AT HEARING:
[5] When White was asked, on
cross-examination, whether there was an expectation on the part
of the company that unitholders would exercise their rights to
exchange units for shares when Vidatron made the offer, his
response was:
Well, I don't know how to answer that. Was there an
expectation? Yeah, there was -- there was a chance that it would
happen, a good chance it would happen, but one never knows.
[6] The cross-examination continued as
follows:
Q. Vidatron
certainly wanted that to happen, is that not correct?
A. Well, I think I
said yesterday I didn't -- I was somewhat indifferent once we
had raised the money. That was the principal objective I had. And
so -- and so as the company continued to grow it was good to have
an opportunity to buy those revenue streams back but in 1994 and
1995 -- or 1995 and 1996 when we did these, the main objective
was to attract investment capital.
Q. But it was good
for Vidatron to get the units and exchange them for shares?
A. Well, I don't
know. I don't know. You have to look in hindsight to see
whether that was good or bad.
[7] Upon re-examination the following
occurred:
Q. Did the company
have the resources in the absence of these partnerships to go out
and undertake these programs on its own?
A. Well, not -- you
know, generally not really. I mean, there wasn't -- and in
fact I don't think in earlier years there was a concerted
program. It was just largely up to the managers of each division
to try to do what they could within their resources to expand
their business.
[8] With respect to Gamble's
evidence, the following took place on direct examination:
Q. Did you ever
finance Vidatron in other ways, say through shareholder
loans?
A. Yes. You know,
right from day one I took a second mortgage on my house to
finance its -- you know, the beginning of the company. And then
all along I participated in every financing the company did. I
felt if it was good for investors it was good for me.
Q. Now I understand
Vidatron participated in a number of other limited -- or
marketing limited partnership arrangements in the early
1990s.
A. Yes.
Q. Why did it enter
into these limited marketing partnership arrangements?
A. Well, first and
foremost, the company was looking for marketing dollars to expand
the market for its products and services and it was a way in
which the company could attract investment dollars and marketing
money and it was difficult to raise money on any other basis. It
was a -- and so it seemed like it was a win-win for the investor.
It was good for the customer and so it was a -- seemed like a
good financial structure to raise new capital. ...
Q. Now in 1995
Vidatron entered into a joint venture agreement with the New
Media Marketing Limited Partnership and what was -- from
Vidatron's perspective, what was the reason for entering into
that joint venture agreement with the New Media Marketing Limited
Partnership?
A. Well, again it
was a business relationship which would provide the company with
marketing dollars. And so it was -- we felt it was an appropriate
time for the company to be raising -- having access to money for
the purpose of marketing its products and services.
Q. And why was it
important to the company to raise marketing dollars?
A. Well, ultimately
again, getting back to our original plan, we wanted to become
less client focused, more product driven, and we needed to expand
the markets for our products and so we needed to get exposure, we
needed to have marketing for attending trade shows, for
advertising, for doing direct mail so that we could really
exploit, you know, the money that was invested in our product
side of our business. So we then felt that it was extremely
important to have marketing money.
Q. And was it your
view that the joint venture agreement, the 1995 agreement between
Vidatron and the New Media Marketing Limited Partnership, that
that would be a good thing for the investors as well?
A. Yes,
absolutely.
Q. And what in your
view -- why in your view would it have been good for the
investors?
A. Well, first of
all because it was marketing money it allowed them to participate
in the growth of the business and it was money that was going in
as sort of last money in, but the investors were participating in
the first dollars out from marketing. And so it wasn't
R & D, it was marketing expenditures and then the investors got
to participate in the success, if there was success, in the sales
of the products and services. So we felt that it was a real
win-win for both the investors and the company. ...
Q. Okay let's
just speak about the potential to share in the revenue
stream.
A. Yes.
Q. What was your
understanding of how that worked?
A. Well, my
understanding was, is that for incurring the -- for putting up
the money to market its products and services the investors would
have the right to earn a percentage of the company's gross
revenue over a period of time.
Q. And you are aware
there was an exchange feature in the joint venture --
A. Yes.
Q. -- agreements?
And what was your understanding of that exchange feature and how
it would work?
A. Well, my
understanding was that the investors would have an option to
either elect to convert to equity or to stay in and keep a
royalty stream, keep a revenue stream.
Q. And what was your
understanding of the terms of the exchange offer?
A. Well, you know,
I'm a little foggy on the actual mechanics of it but the
exchange offer would be based on a number that was around 1,080
and it was the lesser of that number, and so it was a -- if the
valuation was greater than that number it would -- the investors
would receive $1,080, if it was less than that they would receive
less than that.
...
Q. ... at that
time what did you know about the method of valuation that would
be used to determine the fair market value of the units for the
purposes of the exchange offer?
A. I knew nothing
about the method of evaluation. It was --
Q. And with respect
to the 1996 joint venture agreement what did you know at the time
of entering into that agreement? What -- the method of valuation
that would be used?
A. I knew nothing
about the method of valuation.
Q. Now based on your
understanding of the joint venture agreements what then was the
minimum return that an investor would guarantee to receive by
virtue of subscribing for units in the New Media Marketing
Limited Partnership?
A. I mean, I
don't -- I mean, I don't think there was an amount that
was guaranteed.
Q. Why do you say
that?
A. Well, it's
interesting. There were three features to the investment, as I
see it. There was the write-offs, a potential revenue stream, and
equity. And the only thing I thought for sure that was guaranteed
was that they would get the write-off. Whether there was going to
be a revenue stream that was going to make sense I don't know
or whether there was going to be -- what the exchange offer was
going to be I didn't -- nobody knew at the time. So I
don't know what the guarantee would be.
Q. And what was your
view of the riskiness, if you will, of a subscription in the
partnership units in New Media I and New Media II?
A. Well again, I --
there was risk obviously associated with investing in this
business. We did try to -- we did believe that we were building a
successful business. We did believe that we were spending
marketing money. We were going to spend it wisely and therefore
we did think it would have a very positive effect on the
business. But there was no way of knowing to what extent the
marketing money was going to be effective or work. But we did
manage it properly and we did enter into -- you know, used the
money wisely and therefore we had good results with it. But at
the point in time we had no way of knowing what the results would
be. ....
Q. And how well did
you know Mr. Grant prior to him preparing the valuations for the
New Media Marketing I Limited Partnership?
A. I didn't know
him at all really. As it turned out, we had people -- it turned
out we knew we had -- we had people that we knew in common but
that was about it.
Q. Do you know when
Mr. Grant was actually hired to do the valuation for the New
Media Marketing I Limited Partnership?
A. I don't know
the specific date. ...
Q. What instructions
did you provide to Mr. Grant when he was hired to do the
valuation?
A. I didn't
provide any -- no instructions. ...
Q. When did you
first know what Mr. Grant's valuation would be in respect of
the New Media Marketing I units?
A. I don't think
I knew until he actually published something and wrote something.
...
Q. And what effect
did the marketing expenditures that were made by the New Media I
partnership and New Media II partnership, what effect did those
marketing expenditures have on Vidatron?
A. Well, I think
they -- they had a terrific impact on the growth of the company.
Some of the businesses really prospered. Not all the expenditures
paid off, there were certain things that didn't work as well
as others. But overall, it was money that was very well spent and
had a terrific impact on the growth of the business. ...
Q. And how did
Vidatron grow or change between 1995 and 1996?
A. Well, you know,
having access to marketing money definitely initiated growth in
our sales and revenues and as a result of that we were able to
also go into new areas. And so we expanded into the -- we had
money to expand into the area of television and film and that
area experienced terrific growth over the next few years and that
was a result of having access to money to attend trade shows and
to market these existing products and so on.
Q. And how did
Vidatron grow or change from 1996 to 1997?
A. Well, again it
was always becoming -- our revenue came from the product side of
our business. So the service side of the business stayed pretty
constant but we then were able -- we had more money to be
developing and marketing products and that area was really the
film and television area and so -- and that area experienced
terrific growth.
...
Q. ...
Could you please clarify how the revenue stream is related to the
riskiness of a subscription in units?
A. Well, first of
all, if the investor choose -- chose to keep his interest in the
revenue stream, there was no guarantee on what the future
revenues were going to be. As it turned out, because of a number
of factors, the company experienced a terrific growth. It would
have been a very good investment had the investors stayed in and
-- and managed to earn the revenues they had coming to them but
there was absolutely no way of knowing. One of the main reasons
for the growth in the business was because the Canadian dollar
went from 74 cents to 64 cents and, therefore, there was enormous
growth in the film and television business and there was no way
of predicting that that would happen at the time.
Q. And also in
answer to my question on the riskiness of the subscription in the
partnership agreement, you made a comment about there being
uncertainty in equity and could you please explain to the court
what you meant by that?
A. Well --
there's two factors -- one is there was no way of knowing how
many units -- how many units -- what the units would convert
into, what the value was going to be at the time of the
investment, and secondly, you didn't know what the value of
the equity was going to be. So there were two -- two aspects of
that that made it risky. ...
Q. And you were
aware of the tax aspect --
A. Yes.
...
Q. What was your
main reason for subscribing to units in both the New Media I and
New Media II limited partnerships?
A. Well, first and
foremost, I always participated in any investment with new
investors. I felt it was very important for me to put, you know,
my money where my mouth was and so to participate in the
investment with the investors. But ultimately it was a -- I felt
it was a terrific investment in the growth of the company. It was
a way to participate in the growth of the business and at the
same time have some -- some tax benefits for it. But it was
driven by the fact that I wanted to have an investment in the
business as I did from day one.
Q. Did you accept
the exchange offer when it was tendered to convert your units
--
A. Yes.
Q. To shares? And
why did you choose to exchange your units for shares?
A. Well, you know,
that's a good question and in hindsight I -- I wish I
hadn't have exchanged for shares but at the time it was a
climate where equity was more popular than income streams. You
know, had it been the year 2000 after the stock market crash or
1998 after the stock market crash, investors -- and I would have
been more interested in a -- revenue stream than I would be in
stock in -- in a liquid company and so it just happened to be the
economic climate. Also, the stock was going up at that time and
so it looked like it was a good -- you know, it was a good
opportunity.
[9] Kathleen Martin
("Martin"), who had been President and a director of
New Media Finance Limited, the general partner of the New Media
Marketing I Limited Partnership, a witness for the Appellant, had
the following exchanges with Appellants' counsel:
Q. .... Did the
general partner for New Media Marketing I select the valuator
under the provisions of this agreement?
A. Yes.
Q. And who did the
general partner select?
A. We had a choice
of three. Two were unavailable and we -- we selected Ian S. Grant
of Ian S. Grant & Associates.
...
Q. Did you know if
there were any regulatory requirements that would apply to the
valuation that was completed by a valuator?
A. The valuation had
to pass muster with the -- with the Vancouver Stock Exchange at
the time because the -- the exchange offer involved the issuance
of shares from treasury so the Exchange would have to -- the
Exchange would have to vet the valuation to see that it was fair
in the circumstances.
Q. And what
instructions did you provide to Mr. Grant in preparing his
valuation?
A. None. I
didn't instruct him on how to prepare a valuation. I
instructed him that there was a valuation needed. His process was
his process. It was -- it had nothing to do with me. I mean
certainly he probably wanted information from me but I didn't
instruct him on how to do his job.
...
Q. And when did the
general partner first determine that it would recommend the
acceptance of the offer?
A. After reviewing
the valuation report, having discussions with management of the
company and looking at comparable companies and looking at the --
at the stock performance would be when we would make that
recommendation.
Q. And to the best
of your knowledge were there any partners that did not accept the
offer to exchange units for shares with respect to the 1996
partnership?
A. Yes there were.
Q. Do you know how
many?
A. I don't. I do
know that in each partnership there were people who did not
accept. Obviously, the majority did accept because there was a
conversion but I do know that in each instance -- there were
limited partnership unitholders who did not accept the offer.
[10] Hawley, a financial advisor gave
evidence on behalf of the Appellant. Extracts of the direct
examination follow:
Q. And what were
your impressions about the business as a result of your meeting
people there?
A. Well, I had done
a little bit of research and it looked like it had been around
for about nine or ten years at that point and had gone through
various ups and downs and it looked like it was finally starting
to -- to do well and so I -- I was impressed with the people and
-- and the opportunity and it was an area personally that I
hadn't had any investment exposure in my portfolio in at that
time so I thought I would consider it.
...
Q. What was your
understanding of what the partnership was going to do, what the
relationship was between the partnership and Vidatron?
A. It was my
understanding that the partnership was raising capital in order
to help the business expand and grow. It was at a new stage in
its entrepreneurship and that they were going to be using the
money to promote their various products and services and enhance
the revenues of the firm.
...
Q. Did you
understand there was an exchange offer that was required to be
made by Vidatron?
A. I did.
Q. And what did you
understand about that offer?
A. That the offer
was going to take place about a year after the partnership came
into being and that as an investor you would be given an
opportunity to exchange your units in the limited partnership for
shares in the company based on a formula that said you would get
the lesser of $1,080 for each unit or the fair market value of
those units and those -- the fair market value of those units
were to be determined by an independent valuator.
...
Q. And at the time
you subscribed for your units did you have any concern that 65
percent of the unitholders would not choose to convert?
A. Yes, certainly,
because I had no idea who the other unitholders were and there
was a lot of uncertainties that were going to occur in the next
twelve months so as far as how the business was going to do and
-- and so there was -- yeah, always a great amount of uncertainty
whether or not it would -- it would happen or not.
Q. Did you view your
subscription for partnership units in the New Media Marketing
Limited Partnership II to be a speculative investment?
A. Yes,
certainly.
Q. And why was
that?
A. Well, for a lot
of reasons. One was that it was still a young kind of
entrepreneurial business in a -- in a type of area that was --
had lots of uncertainties to do with it but in -- after having
gone through the process of doing some investigation and
research, in my experience and in valuating these kind of
circumstances it -- you place a lot of credence on the management
and the players involved and I was impressed with the people in
the firm and so for those reasons, even though it was
speculative, I decided that it was worthwhile and it represented
a very tiny part of my investment portfolio so it wasn't a
significant portion of my investment.
Q. When you invested
-- subscribed for the units in the -- in the partnership what did
you think the fair market value of the units would be at the time
the exchange offer was to be made down the road?
A. I really had no
idea and I don't -- I think it was impossible to know because
it depended whatever the valuation report was going to determine
the fair market value at that particular time, so you knew it was
the less of the $1,080 or the fair market value but that fair
market value could have been greater or lesser and so -- so it
was an unknown.
Q. Were you aware
there was a tax aspect to your investment in the partnership?
A. Yes,
certainly.
Q. And what aspect
-- what impact did this tax aspect have on your decision to
invest in the partnership?
A. I considered it a nice
extra benefit but I didn't consider it material to my
investing. I would not have invested any money in the -- in this
partnership if I didn't feel that the business was a viable
business with a good potential and because I had witnessed too
many situations in dealing with clients over the years, where
they would have been much better off to have kept at least half
the money and paid their tax instead of losing all of it in poor
investments just because they were in a tax shelter.
[11] Lodge also testified. He spoke of a
limited partnership investment in Fossil Hills, involving real
estate in the U.S.A. He said that it had done very well and that
he has been able to share in the revenue stream from that
investment for some 14 years to the date of his testimony. He
stated that he had participated in a number of different
investments with Ken Stroud, who was in senior management with
the Plan Vest investment firm and had learned of the present
opportunity. He stated that the potential investment in
partnership units had an attraction for him because he wanted to
diversify his holdings and had not considered up until that time
a venture that would get involved in marketing and media and
ultimately, the movie business. He said:
At that time Hollywood North was being expressed as a
depiction of Vancouver and I thought that this is something that
I should get involved with if for no other reason of simply
diversifying my portfolio.
[12] He also stated:
A. I subscribed to
those units because it was my entry into this new sector that I
had not been involved with before so it was for reasons of
diversification and because of my positive experience with the
Fossil Hills investment three years prior to that. I anticipated
that there would be an investment opportunity, growth of the
company, a share in a revenue stream, all of which has come to
pass with Fossil Hills so I felt comfortable with it.
[13] This exchange then followed with
Appellants' counsel:
Q. You were -- were you
aware of a tax aspect that was involved with the investment?
A. Yes. That was
also a feature that was talked about and it goes without saying
that, in addition to the sharing in the growth opportunity of a
company, there was the added feature of reducing my exposure to
taxation.
Q. What impact did
the tax aspect have on your decision to invest in the
partnership?
A. Well, that was
the predominant feature in my mind. There was no way I would
invest in something that was going to go into the tank. The first
thing that I would have to consider is does this investment have
a reasonable chance of positive returns and can I stay in it for
some long term duration. Like I say, my time horizons on Fossil
Hills was five years so I looked firstly upon it as an investment
opportunity and share in the growth and naturally, the added
benefit of taxation exposure came along with that.
...
Q. And what was your
understanding of the price at which that exchange offer
would be made?
A. I understood that
there was going to be an evaluation process of the units and that
it was not a sure bet there was -- it remained to be seen what
those units were going to be evaluated at, but it was -- it was
something that could fluctuate wildly. ...
Q. Why did you
accept the offer to exchange units for shares?
A. Well, first of
all, there was a choice involved and that was clearly articulated
to me as to whether or not I go ahead and make that election for
-- for the exchange but I think it's fair to say that I
elected to go that way on the recommendation of Mr. Ken Stroud.
Like I say, it was -- it was -- it also had the added feature of
liquidity and that was the one thing that in my Fossil Hills
investment that I did not enjoy. Now as to whether or not at that
point in time I gave much prominence to the liquidity factor I
can't really say at this time if it -- if it factored in, but
it very -- it may have, it very well may have.
Q. Who was -- what
was your view on the nature, and by that I mean the risk, of your
investment in the partnership?
A. Well, just as a
general comment, I viewed it as very risky. First of all, we were
dealing with a junior start-up company which inherently has a lot
of risks. In fact, many start-up companies fail in their
formative years so I knew that there was a high degree of risk
and I didn't know for a certainty if I would be able to get
my money out of the partnership. That whole situation could have
gone sideways so the -- the revenue stream was certainly
indeterminate. ...
Q. Mr. Lodge, you --
you stated in cross-examination that you understood from Mr.
Stroud that you would get a reasonable return on your investment
in the partnership?
A. Yes.
Q. What guarantee
was provided to you by Mr. Stroud that you would get a reasonable
rate of return?
A. There was no
guarantee. Ken was very clear that things that have inherent risk
to it he -- he makes sure that he doesn't minimize that
so this wasn't presented to me as any kind of a
guarantee.
[14] One Kenneth Stroud
("Stroud"), a senior investment advisor with Assante
Capital, gave evidence on behalf of the Appellants. He had been a
financial advisor for 22 years. Lodge was one of his clients. He
said that he had 450 to 500 clients and that he identified about
30 people to whom he presented the possibility of the partnership
unit purchase. When asked why he didn't speak to all of his
clients he said:
A combination of things, but primarily just from a risk
tolerance point of view, the ability to -- the skill sets to look
at a product like that, having the financial wherewithal to
absorb the risk of a product like that, so it narrows down the
field pretty quickly.
[15] He described the risk as
"couple-fold". He said that because of the limited
partnership there was no immediate sale of units available in the
initial set-up. He said also that there was a junior company
involved and that there was accompanying uncertainty as to
whether it could achieve what it said it could do. He said that
22 people in total, 6 in 1995 and 16 in 1996 became involved with
this investment. He said that his clients liked the idea of the
film business and the idea of the tax break. He said that he was
aware of the exchange offer but could not make any assessment of
that until the exchange actually took place. He stated that one
would have to wait until the business actually materialized, that
one could check the value of a stock on the exchange and that the
share price was moving but that an investor would have to wait
for the third party evaluator to assess the units. He said that
he left up to his clients the decision as to whether to exchange
the shares or retain the units. He said that in 1995 when he
first looked at this investment product he was not aware of what
the valuation was going to be in the following year. In his
description of why he accepted the offer he said:
...
I was kind of torn between the two decisions. I thought that
the revenue streams -- they hadn't quite hit their mark yet,
but you know, the stock price was moving up. Maybe it was
suggesting that the revenues were on their way and away they
went. I guess ultimately I figured the liquidity that I could
create from taking the offer would allow me to, you know, make a
faster decision one way or the other.
[16] In cross-examination, in answer to a
query as to what persuaded him to buy the units instead of shares
of Vidatron he said:
Well, I think it just afforded the opportunity in two
situations. We could watch how the company could grow. We had the
potential to participate in revenue, which was an attraction. We
did get a tax break which was obviously an attraction and we had
choices at the end of the day that we could make and we were
involved in a company that was -- what seemed to be a moving
industry at the time.
[17] Ian Stuart Grant ("Grant"), a
witness for the Appellant, was the valuator referred to above. He
was involved in the following exchanges on direct
examination:
Q. And do you recall
who commissioned you to prepare this report?
A. I would have been
-- technically been commissioned by the general partner,
technically, but from a practical standpoint all of my
conversations of any -- of any major regard and ongoing
conversations would have been with the key management of
Vidatron.
Q. Okay. And do you
recall whether you were ever -- there was any indication as to a
target that you had to arrive at in preparing this valuation?
A. No. There was
never any discussion on that and there never would have been one
entertained.
Q. Now, were you
aware that this report might be subject to review by the
Vancouver Stock Exchange?
A. I was very aware
of that.
...
Q. Had you prepared
valuations in the past that were reviewed by the Vancouver Stock
Exchange?
A. Yes I did.
Q. And was this
valuation reviewed by the Vancouver Stock Exchange?
A. No it was not.
[18] Appellants' counsel advised the
Court that Mr. Grant had not been qualified as an expert witness
and that his evidence had not been tendered as an expert's
report.
[19] The Appellants' final witness,
Juliette Jones ("Jones") was an accountant who had been
employed by Vidatron since 1991. She stated that Vidatron's
operations themselves were not financing the overhead costs of
the business. The following exchange took place during direct
examination:
Q. What was
Vidatron's motivation in agreeing to enter into this
agreement?
A. Well, we wanted
to raise marketing money because we believed that by spending
money on marketing we could take the company to the next level
and grow a bigger, stronger company that was more capable of
catching the attention of the investment community, raise
additional capital and just overall grow our business.
Q. And why was it
that you targeted the marketing area as the focus for this
money?
A. Well,
specifically, we believed that by spending money on marketing we
could increase our revenues and by increasing our revenues we
would then -- am I answering your question?
Q. Yes, go on.
A. So by then
increasing our revenues we would then get the attention of the
investment community. At the time that we did the -- I think in
1994 we did about one and a half million in revenues and those
revenues grew, I believe, due to the fact that we were able to
get in front of people and to get our story told, get marketing
revenues in. We were able to become a bigger company, a stronger
company, and raise interest in the public markets as well as
raise interest in getting new contracts and new business in.
Jones said that she provided no instructions to Grant in
connection with his evaluation preparation and that Grant had
come to her telling her what he needed in order to do so. She
said she had no indication as to the value he was going to
"come up with" prior to him producing his report. She
also said that she never had any discussions with him as to a
target value that he should "arrive at". An extensive
cross-examination of Jones in an air of tension and hostility,
did not affect the evidence above described. On re-examination
the following exchange took place:
Q. You were referred
to the revenue projections that Vidatron made in 1995 in respect
to the 1995 partnership and for 96 in respect to the 96
partnership. Did you have any knowledge as to how Ian Grant
utilized those figures in coming up with his valuation?
A. No.
Q. Were you involved
in any way with his deliberations in how to plug those into his
formula?
A. No.
[20] Appellants' counsel then read into
evidence portions of the examination for discovery of T. Cillo,
an auditor at the Canada Customs and Revenue Agency. The
following portions are reproduced:
Q. I think that you
say later on in this document that one of the reasons that you
reassessed the partnership is because the transactions that
involved the acquisition of the partnership units followed by
their subsequent disposition by the partners was pre-ordained to
occur?
A. Yes.
Q. That it was
certain to occur?
A. That is
correct.
Cillo said that the value of the units had declined to about
ten percent of the initial subscription price. He said that when
the exchange of partnership units for shares of Vidatron took
place it was a "rollover" under section 85 of the
Income Tax Act. He said that the fair market value
from the valuation report was much higher than $1,080 and that on
the section 85 transaction the elected amount was the adjusted
cost base of approximately ten percent as above described. The
following exchange occurred:
Q. And you stated
earlier that in your view that was put there as a reference to an
economic loss that somebody might suffer?
A. Right.
Q. And so you have
also said that the adjusted cost base figure that was contained
in the section 85 election forms, namely around 10 percent of the
initial subscription price, was indicative of value?
A. Yes.
Q. Maybe not the
only indicator but indicative?
A. Exactly,
that's right.
Q. So when it comes
time to applying this test, in your mind at least, under
96(2.2)(d) you saw $1,080 being offered, right?
A. Correct.
Q. And you compared
it to the adjusted cost base of the units which was about ten
percent of the initial subscription price?
A. That's
correct.
Q. And in your mind,
that was the loss that was being enumerated or reduced by virtue
of this exchange offer?
A. Yes.
[21] Cillo also said that the tax benefit
was the ability to write-off what "in essence was a capital
investment in shares":
A. The partner or
the investor, whichever term you want to use, would eventually be
holding shares in the company.
Q. So you, in
essence, looked at the investors who began with cash in their
pockets and ended up a year later with shares in their
pockets?
A. Yes.
Q. And concluded
that these transactions ought to all be collapsed down
effectively into the space of a nanosecond such that it could be
viewed as an acquisition of shares?
A. Well, that's
not totally true. Of course we analyze the transaction from point
one to point -- to the end point. So we looked at the various
transactions that had taken place and we arrived at the
conclusion that -- I don't want to use the word again but
that's what the intention was.
[22] Cillo then said that if one is making a
capital investment he is not entitled to a complete write-off. He
said, accordingly, that section 18(1)(b) of the Income
Tax Act applied, that section having been circumvented by the
transactions that had taken place. These questions and answers
followed:
Q. Well, the general
anti-avoidance rule, for example, allows one to recharacterize
transactions and so you thought that these ought to be
recharacterized given the way the circumstances came about?
A. That's
correct.
Q. I don't see
any reference in these position papers to the transactions being
a sham for example?
A. No.
Q. Or that they were
legally ineffective? There's no reference to that?
A. No, there
isn't.
Q. So when you say
that it was in substance a purchase of shares you are really
relying on a recharacterization provisions of the anti-avoidance
rule?
A. I believe so,
yeah.
...
Q. All right. Can I
refer you back to that position paper ... There is a heading
part way down ... it states:
Vidatron however was, and continues to be, a commercially
viable public company with the ability to raise equity
financing.
Did you undertake any investigations to determine the extent
to which Vidatron was able to raise equity financing or did you
have any experience in that regard?
A. No I
didn't.
Q. And what did you
base this statement on then? Simply the fact that it was a public
company?
A. I believe so,
yes.
[23] Then, Respondent's counsel read in
portions of the examination for discovery of the Appellant Howe.
The following portions are reproduced:
Q. And did he tell
you during the course of that conversation that as a consequence
of making your initial investment you would then get a tax
write-off for your 1995 taxation year of about half of your
initial investment?
A. He told me it was
a tax write-off. He didn't really specify exactly what it
was.
Howe, in the examination, then advised that he had gone to the
premises and wanted to know exactly what they were doing and what
they planned to do. He said that he had talked to Kathleen Martin
or with Shelley Kirk by telephone. He then said:
And so they gave me the tour and explained things to me, and
it was after that that I went back and thought about it for a
while because I was interested in, in exactly -- you know,
it's all right to have a tax write-off but sometimes you
never see your money again, so I was interested in what that
business was going to do.
Other quotations follow:
Q. I take it that
this is what you understood would happen once you bought your
units. You would have a deductible expense, and this is
calculated per $10,000 investment and based on that $10,000
investment, according to this sheet there would be a deductible
expense right up front in 1995 of $9,375. And if you walk through
the various steps it showed the tax savings and a net investment
of about $4,900, is that correct?
A. That's what
it showed. ... Like they might have handed me the stuff but
like a lot of other things I don't read everything.
...
Q. Did you have any
understanding of how your units in the partnership would be
valued for the purposes of the exchange option which was to occur
before August, 1996?
A. Yeah. I
understood that for every $1,000 I would get a minimum of $1,080
back. That's what I understood. ...
Q. Did you have any
understanding that an appraisal would be done in respect to the
value, like a formal appraisal would be done in respect to the
value of the units?
A. I don't know
-- I don't understand what you mean, appraisal by who?
Q. An appraisal by
someone other than by the companies of Vidatron or the
partnership's choosing. Did you know that?
A. Not at the time I
bought. ...
Q. Well, what did
you understand gave rise to your deduction in 1995?
A. That I
contributed $13,000 into this partnership and for some reason it
was a tax deduction and they were using my money and I was going
to get the tax deduction for it.
ANALYSIS AND CONCLUSION:
[24] The first issue involves paragraph
96(2.2)(d) as it relates to Vidatron's obligation to
make an offer to all partners of the two partnerships at the
lesser of $1,080 per unit and the fair market value of each unit
at the time of the offer.
[25] For the purposes of this case, that
subparagraph describes the "at-risk amount" as the
total of the amount of the adjusted cost base of the
taxpayer's partnership interest plus the taxpayer's share
of income for the fiscal period minus certain amounts,
including that described in paragraph 96(2.2)(d), the
pertinent portions of which read as follows:
(d) Where the
taxpayer ... is entitled, either immediately or in the
future and either absolutely or contingently, to receive or
obtain any amount or benefit, whether by way of reimbursement,
compensation, revenue guarantee or proceeds of disposition or in
any other form or manner whatever, granted or to be granted
for the purpose of reducing the impact, in whole or in
part, of any loss that the taxpayer may sustain because the
taxpayer is a member of the partnership, or holds or disposes of
an interest in the partnership ...
(emphasis added)
[26] The Federal Court of Appeal in Peter
Brown v. The Queen, 2003 DTC 5298 at 5303 said:
[37] Broadly speaking, the
At-Risk Rules of the Income Tax Act restrict
limited partners' losses from a limited partnership, for
income tax purposes, to their capital at risk. ...
Under subsection 96(2.1) of the Act limited partners
can only deduct their proportionate share of business losses from
a partnership up to their "at-risk amount".
[27] The only "entitlement" at
issue in this case is the Vidatron exchange offer. It was
obligated to make an offer to acquire the partnership units at
the lesser of the fair market value and $1,080 per unit. Under
this formula, the price offered by Vidatron could never exceed a
unit's fair market value at the time of the offer. The
partners' risks fluctuated directly with the fortunes of the
partnership's business. As noted above, the auditor confused
the "elected amount" under the section 85 election - an
amount equal to the adjusted cost base of the partnership units -
with the units' fair market value. This led to his erroneous
conclusion that Vidatron had overpaid for the units. Counsel for
both parties made submissions with respect to whether the:
"purpose of reducing the impact ... of any
loss"[1]
required a subjective or objective analysis with respect to
the purpose. I see no value in presenting and analyzing those
submissions because it is clear, given the requirement that
Vidatron make an offer at the lesser of $1,080 and
the fair market value of a unit, that it was impossible for the
Appellants to receive any amount or benefit reducing the loss
sustained on the disposition of a partnership interest. Indeed,
if the lesser of the two figures was an amount lower than $1,080,
each partner would have suffered an economic loss. There is
nothing in the formula or in the evidence before me to suggest
any other conclusion. Respondent's counsel conducted lengthy
cross-examinations and referred to provisions of the relevant
documents and to the history of prior partnerships, obviously
attempting, through insinuation, to persuade the Court that the
amount to be offered in exchange for a unit would always be at
least $1,080. That is simply not in accord with the facts.
Respondent's counsel said, in her submissions:
I submit that where the amount of the benefit is ascertained
or ascertainable, the words in paragraph 96(2.2)(d) are
broadly worded enough to catch that benefit.
The weakness with that submission is that there is no proof
from the time of the creation of the exchange offer amount, that
the fair market value would be greater than $1,080.
Respondent's counsel also said:
...
The principals of Vidatron knew that the fair market value
would come out to a number greater than $1,080. They knew that.
And they knew that because of the history, they knew that because
of the fact that the values of the units were predicated on the
future revenue stream
...
There is no evidence to the effect that the principals knew
that the fair market value would be greater than $1,080. The same
comment can be made with respect to another submission by
Respondent's counsel, namely:
And once you look at the ensemble of the circumstances in the
evidence and if you find that yes, $1,080 was a floor and it
wasn't a ceiling, because everybody knew, or everybody could
have known, if they had looked at the documents and crunched the
numbers, that the fair market value in these two years, as in
previous years, would always come out to a number higher than
1,080.
In addition, Respondent's counsel did not even refer to or
acknowledge the fact that any number of facts could have arisen
which could have affected the company's business adversely,
seriously affecting the fair market value used in the
formula.
Counsel for the Respondent, with respect to the
"purpose" as that word was used in paragraph
96(2.2)(d), said:
... that the purpose does not have to be exclusively,
within the words of the provision, for the purpose of reducing
the impact in whole or in part of any loss that the taxpayer may
sustain.
She referred to Ludco Enterprises Ltd. v. H.M.Q., 2001
DTC 505, a decision of the Supreme Court of Canada. Her
submission was, in part:
And the Ludco decision tells us that when the phrase "the
purpose" is used, it doesn't have to be the only
purpose. So it wouldn't be fatal to the Respondent's case
on purpose if you were to find on the facts that the purpose of
reducing any loss that these taxpayers may have sustained
otherwise isn't the only purpose. There can be more than one
purpose. That is all I am saying.
I read aloud the pertinent portion of the above subsection
with respect to a taxpayer being entitled to receive or obtain
any amount or benefit
granted or to be granted for the purpose of reducing the
impact, in whole or in part, of any loss that the taxpayer may
sustain.
When I asked counsel what purpose other than to reduce
"the impact ... of any loss" would be relevant to
an examination of that portion, she replied:
I am not suggesting that a consideration of other purposes
might be relevant. What I am suggesting is that in my learned
friend's submission, I understood him to say that the purpose
was to raise capital in Vidatron to expand on marketing
activities.
It is abundantly clear that any benefit must be "granted
for the purpose of reducing the impact" in order for the
assessment to stand. Any other discussion of purpose is
irrelevant and unnecessary.
ALTERNATE POSITION:
[28] At the hearing, Respondent's second
counsel, after some discussion of the "misuse" of
paragraph 18(1)(b) of the Act responded to a
question by the Court as follows:
Justice: Well, are you withdrawing that argument?
Ms.
Meneguzzi:
Yes, we are withdrawing it.
That ends the Respondent's "misuse"
position.
[29] With respect to whether the
transactions in this case resulted in "an abuse having
regard to the provisions of" the Income Tax Act,
read as a whole, counsel for the Appellant referred to the
Respondent's submission that the purchase of partnership
units was in effect, the purchase of Vidatron shares, i.e.
capital assets, and that paragraph 18(1)(b) of the
Act prohibited the deduction of capital outlays. Counsel
submitted in his written submission, referring to The Queen v.
Canadian Pacific Limited, 2002 DTC 6742:
54. However, the
transactions at issue cannot first be collapsed into a share
purchase either on an economic substance analysis or on the basis
of subsection 245(5) of the Act, as a prelude to applying the
GAAR. The decision of the Federal Court of Appeal in Canadian
Pacific is directly on point in these circumstances. In that
case, the taxpayer borrowed funds in Australian and New Zealand
dollars at a relatively high interest rate, converted the
borrowed funds immediately into Canadian dollars, and hedged the
required repayments under the debentures. As a result, the
taxpayer had to pay a high interest rate under the debentures but
by reason of the forward sale was assured of realizing a capital
gain at the end of debentures' term. The Minister sought to
recharacterize a portion of the interest payments under the
debentures as principal, asserting that a portion of the interest
was the economic equivalent of principal, since the rate far
exceeded comparable rates on Canadian dollar borrowings. The
Court held:
"The Minister's argument as to the abuse of the Act
as a whole must fail because it depends upon recharacterizing the
interest payment as capital payments. It is therefore unnecessary
to comment on his argument as to the policy of the Act."
The immediately preceding paragraph in that judgment
reads:
This does not mean a recharacterization cannot occur. A
recharacterization of a transaction is specifically permitted
under section 245, but only after it has been established that
there has been an avoidance transaction and that there would
otherwise be a misuse or abuse. A transaction cannot be portrayed
as something which it is not, nor can it be recharacterized in
order to make it an avoidance transaction.
Counsel continued as follows:
55. The Minister's
argument in this case is completely answered by the Federal Court
of Appeal's decision in Canadian Pacific. Without the
ability to first recharacterize the transactions in issue, the
respondent's asserted relevant policy of the Act - to
preclude the deduction of a capital outlay - has no application
to the unaltered transactions undertaken by the appellants in
this case. It is irrelevant.
56. The transactions that
were actually undertaken were in complete harmony with the
provisions of the Act. The appellants first acquired partnership
interests in one or the other, or both, of the New Media
partnerships. The partnerships were valid and subsisting
partnerships and each carried on a business. There is no dispute
that the NMI partnership carried on business and from those
business activities incurred a business loss in 1995 of $858,949
(paragraph 14 ASF). There is no dispute that the NMII partnership
carried on business and from its business activities incurred a
business loss in 1996 of $1,796,405(paragraph 33 ASFI).
[30] The facts in paragraph 56 were
established by the evidence, both in the agreed facts and as
presented in oral evidence by witnesses that I find to have been
credible. Nothing in the Act prevents the creation of
partnerships and joint venture agreements depending on whether
they did or did not incur business losses.
[31] Appellant's counsel in paragraphs
60, 61 and 62 of his written submission states:
60. Once it is determined
that the NMI and NMII partnerships incurred business losses,
paragraph 96(1)(g) of the Act deems each member of the
partnership to have incurred business losses from that same
source, to the extent of their respective share thereof. As a
corollary to the flow-through of the business losses from the
partnerships to the appellants, the appellants' adjusted cost
base of their partnership interests was reduced under
subparagraph 53(2)(c)(i) of the Act by the amount of the losses
allocated to each appellant. This provision has the effect of
recapturing, in capital gains form, any tax losses flowed through
to partnership members that are not reflected in underlying
economic losses to partnership assets.
61. The flow through of
business losses incurred by a partnership to its partners is not
the deduction of a capital outlay. A partnership is nothing more
than a conduit through which business income and losses are
flowed to the partners. Subsection 96(1) acknowledges this
conduit nature of a partnership by first treating a partnership
as a person for the limited purpose of income computation
(paragraph 96(1)(a)), and by then attributing the partnership
income or loss to the partners to the extent of their share
thereof (paragraphs 96(1)(f) and (g)).
62. With regard to the
exchange offer, incorporating a partnership on a tax-deferred
basis is in complete harmony with the policy of the Act. The Act
specifically contemplates two means by which members of a
partnership can transform a business carried on in partnership
form into one carried on in corporate form, on a tax-deferred
basis. One is by having all the partners transfer their
partnership interests into the corporation and file joint
elections under subsection 85(1) of the Act. The partnership then
ceases to exist as a matter of law, since it has only one partner
following the transfers. This is the means by which the
incorporation occurred in this case. The other means of
incorporation a partnership is under subsections 85(2) and (3) of
the Act whereby the partnership first transfers all its assets to
the corporation in return for shares of the corporation, and the
partnership then dissolves and distributes the corporate shares
out to its partners.
I am satisfied from the evidence that the partnerships were
established in the 1995 and 1996 taxation years for the purpose
of raising funds for specified purposes, including, in the words
of Gamble:
... expand the market for its products and services and
it was a way in which the company could attract investment
dollars and marketing money and it was difficult to raise money
on any other basis.
[32] The evidence shows clearly that the
Appellants were not involved in a transaction or series of
transactions within the meaning of subsection 245(3) since the
transaction in question may:
reasonably be considered to have been undertaken or arranged
primarily for bona fide purposes other than to
obtain the tax benefit.
(emphasis added)
[33] Accordingly, I conclude that:
(a) the Appellants were not,
within the meaning of subsection 96(2.2)(d) of the
Act, entitled to receive or obtain any amount or benefit
granted or to be granted for the purpose of reducing the impact
of any loss that they may have sustained by holding or disposing
of an interest in the partnership and that, therefore, the amount
of their partnership losses were not reduced by virtue of
subsection 96(2.1). That subsection provides that a
taxpayer's partnership loss will be reduced by any amount
determined not to be an "at-risk amount" under
subsection 96(2.2), and
(b) the general anti-avoidance
provisions of section 245 do not apply to the appeals.
[34] Therefore, the appeals are allowed with
one set of costs for the five Appellants.
Signed at Ottawa, Canada this 29th day of October, 2004.
Bell, J.
Email this Content