REASONS
FOR JUDGMENT
Justice Favreau
[1]
This is an appeal against a new assessment made
under the Income Tax Act, R.S.C. (1985), c. 1 (5th Suppl.), as amended (the
Act), by the Minister of National Revenue (the Minister)
dated May 23, 2008 pertaining to the Appellant’s 2004 taxation year.
[2]
Under the new assessment of May 23, 2008,
the Minister rejected the deduction of a capital loss of $7,319,100, which was
deemed void in accordance with the provisions of the anti-avoidance rule set
out in section 245 of the Act.
[3]
The point at issue does not involve the application
of the anti-avoidance rule to the reported capital loss, but instead the determination
of the proceeds of disposition of shares that the Appellant held in the
corporations "Les Investissements Claude Deragon
Inc." and "Les Gestions Claude Deragon
Inc.". The transactions took place on May 1, 2004, and were part
of a transfer of interests that the Appellant held in the Groupe Transpel
NJN 1994 to a group known and referred to as "Transforce".
[4]
The dispute involves the application of a price
adjustment clause set out in two share purchase agreements. The appellant
claims that the sellers were unable to earn an amount of $1,500,000 from the
agreed-upon sale price.
[5]
At the start of hearing, the Respondent conceded
that an amount of $500,000 from the agreed-upon sale price had not been earned
by the sellers, including the Appellant, up to an amount of $350,000 in the
latter’s case.
[6]
Under an initial share purchase agreement
taking effect on May 1, 2004 (hereinafter the "first
agreement"), the Appellant, Fiducie Ronald Doutre and
Fiducie M.A. Labelle (hereinafter the "sellers") agreed to sell to Gestion TFI Inc. (hereinafter "TFI") all of the issued
and outstanding shares of Les Gestions Claude Deragon Inc. (hereinafter "Gestions"), of Transport
N.J.N. Inc. (hereinafter "N.J.N."), of Transport F. Audet Inc. (hereinafter "Audet") and of Transport
Serge Durivage Inc. (hereinafter "Durivage"). The shares of Audet and Durivage were held directly by
Gestions, whereas the N.J.N. shares were held by Gestions and Durivage.
[7]
Subject to any
adjustment provided for in said agreement, the purchase price of the shares
sold was $12,781,475.72, minus the total long-term debts of Gestions, N.J.N.,
Audet and Durivage on April 30, 2004, but excluding inter-company
debts in the amount of $3,515,181.82. The net purchase price of the shares was
allocated as follows:
|
Fiducie Claude Deragon =
Fiducie Ronald Doutre =
Fiducie M.A. Labelle =
|
$6,486,405.73
$1,853,258.78
$ 926,629.39
|
[8]
The share
purchase price adjustment clause was in paragraph 4.3 of the first agreement
and read as follows:
[translation]
4.3 The Share Purchase Price shall be adjusted upwards or downwards by
an amount equal to the increase or decrease of the equity of the Companies'
Shareholders at the fiscal year end date compared to the equity of the
Companies’ Shareholders at January 31, 2004.
The adjustment set out above shall be made based on the data in the
Companies’ audited statements determined by the Companies’ auditors as set out
in section 5 herein, on the understanding that, on the Close-off Date, the
loans or advances of the shareholders, administrators, directors and employees
shall be eliminated and that the loans or advances to the shareholders, administrators,
officers and employees shall be discharged.
[9]
For the purpose
of the share purchase price adjustment clause, the fiscal year end date meant
the day preceding the actual sale date of the shares, and the equity of the
companies’ shareholders at January 31, 2004 was based on internal
financial statements, i.e. on the balance sheets and income statements of Gestions,
N.J.N., Durivage and Audet prepared internally for the period ending January 31, 2004.
[10]
Under a second
share purchase agreement taking effect on May 1, 2004 (hereinafter
the "second agreement"), the Appellant, Fiducie Ronald Doutre and Fiducie M.A.
Labelle (hereinafter the "sellers") agreed
to sell to Gestion TFI Inc. (hereinafter "TFI") all of the issued and outstanding shares of Les
Investissements Claude Deragon Inc. (hereinafter "Investissements"), of Transport
Transterm Montréal Inc. (hereinafter "Transterm"), of Groupe Frapar Transports Inc. (hereinafter "Frapar") and of P&W
Intermodal Inc. (hereinafter "P&W"). The shares of Frapar, Transterm and P&W were held
directly by Investissements.
[11]
Subject to any
adjustment provided for in said agreement, the purchase price of the shares
sold was $2,503,774.42, minus the total long-term debts of Investissements,
Transterm, Frapar and P&W at April 30, 2004, but excluding
inter-company debts in the amount of $746,489.35. The net purchase price of the
shares was allocated as follows:
|
Fiducie Claude Deragon =
Fiducie Ronald Doutre =
Fiducie M.A. Labelle =
|
$1,255,203.62
$ 338,904.98
$ 163,176.47
|
[12]
The share
purchase price adjustment clause was in paragraph 4.3 of the second agreement
and was identical to the one set out in the first agreement, which is reproduced
in paragraph 8 herein.
[13]
For the purpose of the share purchase price
adjustment clause, the fiscal year end date meant the day preceding the actual
sale date of the shares, and the net equity of the companies’ shareholders at
January 31, 2004 was based on internal financial statements, i.e. on
the balance sheets and income statements of Investissements, Frapar and P&W
prepared internally for the period ending April 30, 2004 and those of
Transterm for the period ending January 31, 2004.
[14]
Under a third share purchase agreement
taking effect on May 1, 2004 (hereinafter the "third
agreement"), Mr. Claude Deragon agreed to sell to Gestion
TFi II Inc. (hereinafter "TFi II") all of the issued and outstanding shares of A&D
Transport Inc. (hereinafter "A&D") that he personally held. A&D was a U.S. company
incorporated under section 402 of the Business Corporation Law of the State of
New York (USA).
[15]
Subject to any
adjustment provided for in said agreement, the purchase price of the shares
sold was $714,749.86, minus the total of the company’s long-term debts at
April 30, 2004, but excluding inter-company debts in the amount of $466,638.86.
Therefore, the net purchase price of the shares was $248,111.00.
[16]
The share
purchase price adjustment clause was in paragraph 4.3 of the third agreement
and was identical to the one set out in the first agreement, which is
reproduced in paragraph 8 herein.
[17]
To summarize, we
have here the sale of a company for a total sale price of $16,000,000 minus the
balance of long-term debts. Therefore, the net purchase price of the shares, after
deducting the debts, was $9,266,293.90 under the first agreement, $1,757,285.07
under the second agreement and $248,411.00 under the third agreement. Since the
net purchase price of A&D’s shares was not payable to the Appellant, that
amount is not at issue in this appeal.
[18]
The portion of
the total purchase price of the shares that was payable to the Appellant amounted
to $7,741,609.35, or $6,486,405.17 under the first agreement and $1,255,203.62 under
the second agreement.
[19]
Now, at the close
of the transactions, the Appellant received a total amount of $8,523,578.90, or
$6,766,293.90 under the first agreement and $1,757,285.07 under the second
agreement. An additional amount of $500,000 was paid at the close under the
first agreement, which was issued in escrow to the purchaser’s lawyer.
[20]
In addition to
those amounts, the Appellant was entitled to receive an amount of $2,000,000 over
three years (i.e. $666,666.67 on each anniversary date of the closing of the
first agreement) provided that the companies’ EBTID (earnings before taxes,
interest and depreciation) on the given anniversary date were not below 75% of
the EBTID of the 2003 financial statements of the companies sold.
[21]
In 2005, the parties
to the transactions realized that employee vacation pay and taxes payable had
not been discharged or provided for as of the closing date of the transactions,
which resulted in the application of the price adjustment clauses set out in paragraphs
4.3 of each share purchase agreement. According to the closing financial
statements, the equity of the purchased companies’ shareholders was lower by an
amount of roughly $2,428,233.00 than the equity of the purchased companies’
shareholders as of January 31, 2004.
[22]
After difficult negotiations,
the parties signed on or around July 4, 2005 a settlement declaration
regarding the establishment of the purchase price for the shares of Gestions,
Investissements and A&D, which provided, among other things, that the total
share purchase price be set at $15,500,000 minus long‑term debts, or a
net reduction of $500,000 (hereinafter the "adjustment"). The parties
further specified that the adjustment had been established as follows:
a)
that the amount
of the balance of the conditional sale price be increased by the amount of $1,000,000
up to $3,000,000 and be payable over five years instead of over three years, as
initially provided for in the agreements;
b)
that an amount of
$1,500,000 be reimbursed to TFI by the Appellant and by Fiducie Ronald Doutre from
the amounts held back on the amounts due to the Appellant and to Fiducie Ronald
Doutre by TFI ($500,000) and from the amounts of the balance of the conditional
sale price payable by TFI to the Appellant and to Fiducie Ronald Doutre ($600,000
per year for five years).
[23]
The performances of
Gestions, Audet, Durivage and N.J.N. proved disastrous for the taxation years
ending April 30, 2008 and April 30, 2009, with the result
that the expected reimbursements to TFI could not be made by the Appellant and
by Fiducie Ronald Doutre for the last two years of the five-year period. The purchasers
TFI and TFiII demanded $300,000 from the sellers for the period ending on the date
of the fourth anniversary of the transaction and $1,000,000 for the period
ending on the date of the fifth anniversary of the transaction. An out-of-court
settlement was reached in April 2014 without reimbursement of the amounts demanded.
[24]
In its income tax
return for the 2004 taxation year, the Appellant reported a capital gain of $7,830,854.00
based on proceeds of disposition of $8,831,414.00 and an adjusted cost base of
$1,000,560.00. The capital gain was assessed as reported by the Appellant.
The parties’ position
[25]
The Appellant
maintains that the proceeds of disposition of its shares should have been $6,840,183,
calculated on the total purchase price of $16,000,000 reduced by the amount of
the purchase price adjustment of $1,500,000, or $14,500,000 minus long-term
debts, for total proceeds of disposition of $9,771,690, 70% of which belongs to
the Appellant.
[26]
The Respondent
maintains that the proceeds of disposition of the shares was $15,500,000 after
the $500,000 reduction in the purchase price. According to the Respondent, the
proceeds of disposition of the shares included the portion of the share
purchase price payable in instalments over five years, provided that the
companies’ EBTID at each anniversary of the close-off date was not below 75% of
the EBTID in the 2003 financial statements. The adjustment clause did not
increase the share purchase price to an amount exceeding $15,500,000. The
Respondent indicated that the Appellant had not claimed the five-year reserve and
that the Appellant was able to claim a capital loss for its 2014 taxation year
following the out-of-court settlement reached with the purchasers of the shares.
Analysis
[27]
The expression "proceeds of disposition" is defined in section 54 of the Act and includes such things
as the sale price of property.
[28]
In this case, the
sales of the shares took place on May 1, 2004, and the total
compensation from the sales was $16,000,000, which was brought down to $15,500,000
under the settlement declaration signed on or around July 14, 2005. Moreover,
under the settlement declaration, the conditional portion of the sale price of
the shares was increased by $1,000,000 and went from $2,000,000 to $3,000,000, which
was divided over five years instead of three years, as initially planned. Lastly,
the sellers undertook to reimburse $1,500,000 to the purchaser from the amount
held in escrow and the amounts of the conditional sale price, all divided over
the five-year period. The reimbursement amount was not paid in full because the
agreed-upon amounts for the last two years of the agreement were not paid.
[29]
Therefore, under
the circumstances, the issue is whether the conditional portion of the sale
price should have been considered when determining the proceeds of disposition of
the shares.
[30]
Under the three
share purchase agreements taking effect on May 1, 2004, the purchase
price of the shares is clearly stated in paragraph 4.1 of each of those
agreements, subject to any adjustment provided for in the agreements. In
paragraph 4.2 of the first and second agreements, the net purchase price of the
shares is allocated to each seller, whereas in paragraph 4.4 of those same
agreements, the terms for payment of the purchase price of the shares are
specified with an amount of $500,000 being placed in escrow and the added condition
involving the companies’ EBTID.
[31]
Under these
conditions, it appears obvious to me that the conditional portion of the sale
price of the shares was part of the proceeds of disposition of the shares.
[32]
As written, the
adjustment clause provided that the share purchase price could be adjusted
upwards or downwards by an amount equal to the increase or decrease of the
equity of the companies’ shareholders on the end date of the given fiscal year compared
to the equity of the companies’ shareholders at January 31, 2004. However,
the settlement declaration specified that, notwithstanding the adjustment clause,
the total purchase price of the shares was $15,500,000 rather than $16,000,000.
Therefore, after the adjustment, the total share purchase price of $15,500,000
became the maximum amount obtainable by the sellers following the sale of their
shares.
[33]
The increase in the
balance of the conditional sale price from $2,000,000 to $3,000,000 and the spreading
of the balance of the conditional sale price over five years instead of three years
had no impact on the total purchase price of the shares since the conditional sale
price was part of the total purchase price of the shares, as shown above by the
very terms of the share purchase agreements.
[34]
The $1,500,000 amount
that the Appellant and Fiducie Ronald Doutre had to reimburse under the
settlement declaration could not be deducted from the total purchase price of
the shares because it was contingent on and dependent on the condition involving
the companies’ EBTID. Moreover, under the out-of-court transaction between the parties,
the expected reimbursements in the last two years of the five-year period were
not made.
[35]
The Minister’s
new assessment aligns with the position of the Canada Revenue Agency (the "CRA"), as set out in its interpretation bulletin IT-462 of
October 27, 1980, entitled "Payments
based on production or use" referring to
paragraph 12(1)(g) of the Act. Paragraph 9 of that bulletin states
the following:
Paragraph 12(1)(g) does not apply where the sale price of property
is originally set at a maximum which is equivalent to the fair market value of
the property at the time of the sale and which can be subsequently decreased if
certain conditions related to production or use are not met in the future. In
such a situation the proceeds will be on account of capital and if there is a
reasonable expectation at the time of disposition of the property that the
conditions will be met, then the disposition is treated in the ordinary manner,
and the original maximum amount is considered to be the sale price of the
property. If, subsequently, the conditions are not met then an appropriate
adjustment will be made in the year in which the amount of the reduction in the
sale price is known with certainty and will not vary in the future. Whether
there is a reasonable expectation that conditions will be met is a question
that is determined on the facts of the particular situation.
[36]
The CRA’s position
has been reproduced in many academic articles, including one by André Paquette entitled
"Clause
d’ajustement basée sur la performance (Earn-out)”
[performance-based adjustment clause], which he delivered at the 2006
convention of the Association de
planification fiscale et financière. The
following excerpt from that article is especially relevant for the current
issue, since the author explains the concept of a "reverse earn-out
clause":
[translation]
4.2 – The reverse earn-out clause
What about the tax considerations for earn-out clauses that are excluded
from the operation of paragraph 12(1)(g) of the ITA? This is
particularly the case when the share purchase price is determined at the closing
of the transaction and is a maximum price that may be revised downwards. This
is a reverse earn-out clause. In such a case, the entire sale price is treated
as proceeds of disposition. If the fiscal projections materialize, it follows
that the disposition of the property will be treated in the usual way, and the
original amount will be considered as the sale price of the property.
In the event that the seller does not reach its fiscal projections, the
adjustment in the income tax will be treated as a capital loss, in the year
when the amount of the compensation is known for certain and when there will be
no further fluctuations.
A purchaser who receives amounts from the seller, as adjustment and
compensation, will have to reduce the indicated purchase costs of the shares, using
a method for allocating the amounts on the assets acquired.
[37]
Paragraph 12(1)(g)
of the Act states the following:
There shall be included in computing the
income of a taxpayer for a taxation year as income from a business or property
such of the following amounts as are applicable:
(g) any amount received by the
taxpayer in the year that was dependent on the use of or production from
property whether or not that amount was an instalment of the sale price of the
property, except that an instalment of the sale price of agricultural land is
not included by virtue of this paragraph;
[38]
When paragraph 12(1)(g)
applies, the seller must include the initial payment, which corresponds to the
minimum purchase price of the company, as proceeds of disposition of the
property sold. The payments subsequently received based on the use of the
property or the production arising from it are fully included in the income.
[39]
In this case, the
Appellant clearly wanted to avoid the operation of paragraph 12(1)(g) of
the Act to avoid having to include in the calculation of its income the entire
conditional portion of the sale price of the shares. The Appellant sought to earn
a capital gain, which it then attempted to offset with an artificial capital loss.
[40]
Counsel for the
Appellant made reference to the Supreme Court of Canada decision in Daishowa-Marubeni
International Ltd. v. R., [2013] 2 S.C.R. 336 to justify reducing the
proceeds of disposition by the amount of $1,500,000 due to the increase in the
conditional sale price and to the obligation to reimburse that same amount from
the conditional sale price. Unfortunately for the Appellant’s counsel, I have
difficulty seeing how that decision can support the Appellant’s position. In
this case, we are clearly not in the presence of an obligation attributable to
the nature of the property sold. The Supreme Court of Canada decision involved reforestation
obligations taken on by the purchasers. In the current case, the obligation to
reimburse a portion of the conditional sale price simply depends on a condition
involving EBTID. If the EBTID were not at the anticipated level, no
reimbursement was due.
[41]
In my opinion, there
is no basis for excluding from the proceeds of disposition of the shares, amounts
for which reimbursement was conditional and which were not reimbursed for the
last two years of the five-year period.
[42]
For these reasons,
the appeal is allowed with costs in favour of the Appellant. The assessment is
referred back to the Minister for reconsideration and reassessment in order to
give effect to the Respondent’s concession to reduce
from $16,000,000 to $15,500,000 the total proceeds of disposition of the shares
sold by the Appellant and certain other shareholders under the three agreements
taking effect on May 1, 2004, for the purpose of calculating the capital
gain earned by the Appellant.
Signed at Ottawa, Canada, this 25th day of November 2015.
"Réal Favreau"
Translation certified true
On this 11th day of October 2016
François Brunet, Revisor
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