Albert Kieboom v. Minister of National Revenue, [1990] 2 CTC 2090, 90 DTC 1612

Goetz, J.T.C.C.:—The appellant appeals his reassessments for his 1981 and 1982 taxation years. An agreed statement of facts was filed and synopsis of those facts is set out as follows:

On the 3rd day of May 1976, the appellant incorporated a company known as Carpet Colour Centre (Red Deer) Limited, which company carried on the business of the sale of carpets in Red Deer, Alberta and the surrounding area. At the time of incorporation, the appellant, Albert Kieboom, acquired nine common shares in the capital stock of the company, and Adriana Kieboom, his wife, acquired one common share.

By special resolution passed October 31, 1979, the authorized capital of the company was increased by the creation of 10,000 Class "A" shares. The principal difference between the original 10 common shares and the newly created Class "A" common shares is that the latter are non-voting.

1. On February 12, 1980, the appellant and Adriana being at that time the directors and shareholders of the company held a meeting to issue a portion of the newly created non-voting Class "A" common shares of the company. At this meeting, Adriana was issued eight Class "A" common shares and the appellant was issued none of the Class "A" common shares.

The original common shares and the Class "A" shares were equal in terms of equity in the assets of the company. The issuing of 8 Class "A" shares to Adriana caused the appellant, to decrease from 90 per cent ownership position in the company to a 50 per cent ownership position. Conversely, his wife, Adriana increased from a 10 per cent ownership position in the company to a 50 per cent ownership position.

After the meeting of February 12, 1980, shares were owned as follows:

2. On March 1, 1981, Sheila Ibbotson, Yost Kieboom and Alma Kieboom (children of the appellant and Adriana) each acquired 8 Class "A" shares for a consideration of $1 per share by way of share subscription authorized and approved by the appellant and Adriana as the only directors of the company at that time.

Immediately prior to the children’s acquisition of the 24 Class "A" shares, the "company" was valued at $285,600.

Therefore, the fair market value of the Class "A" shares of the capital of the company issued to Sheila, Yost and Alma on March 1,1981 was $6,800 per share.

As of March 1, 1981 the appellant decreased from a 50 per cent ownership position in the company to a 21.4 per cent ownership position. Adriana Kieboom also decreased from 50 per cent ownership to 21.4 per cent ownership. Each of the three children went from a nil ownership position to an ownership position of 19 per cent in the company.

A more graphic picture of these transactions is as follows:

It was agreed to by both parties in this action that the aforesaid transactions were planned and executed by the appellant who desired to increase first his wife's and then, together with his wife, their children’s shareholding in the company.

The Minister reassessed Mr. Kieboom in two respects:

1. (a) The issuance of shares by the company in 1981 to their children Sheila, Yost and Alma constituted a disposition by the appellant and Adriana of an economic interest in the company by way of gift pursuant to paragraph 245(2)(c) of the 1981 Act.

Therefore, the appellant and Adriana each received proceeds of disposition equal to one half of the fair market value of the economic interest deemed to have been disposed of by them on the issuance of shares to Sheila, Yost and Alma pursuant to the provisions of subparagraph 69(1)(b)(ii) and section 40 of the 1981 Act.

(b) Furthermore, the minister pleads that the 1980 transaction that allowed Adriana to acquire her eight Class 'A" common shares, although virtually identical to the 1981 transaction involving the children, was not a gift by way of paragraph 245(2)(c) but a subsection 73(1) spousal transfer. Therefore, a portion of the proceeds of disposition deemed to have been received by Adriana by virtue of her deemed disposition of her economic interest in the company on the issuance of shares to Sheila, Yost and Alma were attributed to the appellant and included in his income under the provisions of subsection 74(2) of the 1981 Act.

2. The Minister's second reassessment flows from the appellant's 1982 taxation year. In that year Adriana received a dividend in the amount of $4,000 on her one common share of the company and a dividend of $3,750 per share for each of her eight Class 'A" common shares of the company.

The Minister reassessed the appellant for his 1982 taxation year on the basis that the sum of $40,500 was includable in the income of the appellant pursuant to subsection 74(1) of the 1982 Act in respect of the dividends received by Adriana on her Class "A" common shares of the company which were transferred to her pursuant to subsection 73(1) of the 1982 Act.

Analysis

I will deal first with the issuance of shares by the company in 1981 to Sheila, Yost and Alma constituting a disposition by the appellant of an economic interest in the company by way of gift pursuant to paragraph 245(2)(c) of the 1981 Act.

Counsel for the appellant, Mr. McKenzie, concedes that this transaction clearly falls within the ambit of paragraph 245(2)(c) of the 1981 Act. The transaction therefore created a deemed payment and this payment is deemed to be a disposition by way of gift. However, counsel then tried to diffuse this concession by saying in effect “well so what, the Minister of National Revenue cannot tax it because there is no gift tax in Canada, and that has been [the] situation since 1971”.

It is true that the gift tax provisions in the Income Tax Act were repealed in 1971. However, this repeal was not a major event as counsel for the appellant makes out. Other provisions of the Income Tax Act have filled the void thereby maintaining the status quo. According to the publication “Analysis of the Canadian Tax Reform Bill 1971, CCH" (page 48):

The government has decided to vacate the estate and gift tax field after December 31, 1971, choosing instead to implement taxation of accrued gain on gifts and bequests. Any taxpayer making a gift of capital property in a year is deemed to have sold the property at that time for an amount to be computed in accordance with the provisions specified in the new Act. Having established the deemed selling price he will be required to bring any resulting capital gain or loss into his computation of income as he would have done if he had actually sold the property for that income. (NA s. 69(1)(b))

Therefore, gifts are no longer taxed under a specific gift tax provision of the Act. Gifts are now taxed under capital gains provisions. A gift may still result in tax implications if the fair market value of the gift at the relevant time exceeds the donor's adjusted cost base.

The case of M.N.R. v. Dufresne, [1967] C.T.C. 153; 67 D.T.C. 5105, factually on all fours with that at bar is of considerable assistance. The taxpayer therein held 164 shares of a company, his wife one and his five children held three each for a total of 15 shares. Twice the company offered to each of its shareholders the right to purchase five new shares for each share held at a purchase price of $100 a share. The original shares prior to the stock option each had a value of $1,421.47. Both times the children exercised the options and neither the taxpayer nor his spouse exercised their options. In the end, the taxpayer still had his original 164 common shares and the children’s shareholdings had gone from 15 to 360 common shares. Thus, the taxpayer's shares had fallen from a value of $243,044 to $78,560. The children’s shareholdings increased from a value of $21,315 to $199,400.

This case dealt with gift tax under the then section 137(2) of the Act. The old subsection 137(2) and subsection 245(2) of the 1981 Act are almost identical. As to whether there was a distinction in this factual situation between personal capacity and director's capacity, President Jackett said at page 162 (D.T.C. 5110):

. . . The sequence of events bears all the earmarks of a series of company transactions that had been arranged in advance by the major shareholder and father, after taking appropriate professional advice, with . . . view to achieving the result of increasing the children’s proportions in the ownership of the stock of the company. Moreover, the benefit, if it was one, was an increase in the proportions of the children almost entirely at the expense of a decrease in the respondent's.

There is no doubt in my mind that, if the result of the transaction was a benefit to the children, it was conferred on them by the respondent.

Another case that I have considered is the decision of The Queen v. Jim A. McClurg, [1988] 1 C.T.C. 75; 88 D.T.C. 6047 (now on appeal to the Supreme Court of Canada).

The facts in the McClurg case are that the appellant and his partner were owners of one class of common shares with voting rights and their wives held another class of shares without voting rights. The articles of incorporation provided that each class could receive dividends exclusive of the other classes. Dividends were declared on the class of shares held by the wives for three consecutive years while none were declared on the common shares held by the taxpayer and his partner. The Minister had reassessed the appellant on the basis that the dividends should have been attributed equally to all the shares no matter what class. The Minister relied on subsection 56(2). Mr. Justice Urie at pages 79-80 (D.T.C. 6050) said:

The language of the subsection creating the essential ingredients required in its application, viewed in light of its purpose, is simply not apt, in my opinion, to encompass the acts of a director when he participates in the declaration of a corporate dividend unless it is read in its most literal sense. To do so ignores the existence of the corporate entity. Only the most explicit language, which is not present in subsection 56(2), would justify the notion that a director acting as such could be seen as directing a corporation to divert a transfer or payment for his own benefit or the benefit of another person, absent bad faith, breach of fiduciary duty or acting beyond the powers conferred by the share structure of the corporation, none of which bases have been alleged here.

The Federal Court of Appeal in McClurg referred to two decisions of the Federal Court-Trial Division namely: Champ v. The Queen, [1983] C.T.C. 1; 83 D.T.C. 5029 and Murphy v. The Queen, [1980] C.T.C. 386; 80 D.T.C. 6314. None of McClurg, Champ or Murphy discussed or made reference to the Dufresne case.

McClurg, Champ and Murphy are 56(2) decisions and not 245(2) decisions.

56 (2) Indirect payments. A payment or transfer of property made pursuant to the direction of, or with the concurrence of a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer's income to the extent that it would be if the payment or transfer had been made to him.

245 (2) Indirect payments or transfers. Where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatever is that a person confers a benefit on a taxpayer, that person shall be deemed to have made a payment to the taxpayer equal to the amount of the benefit conferred notwithstanding the form or legal effect of the transactions or that one or more other persons were also parties thereto; and, whether or not there was an intention to avoid or evade taxes under this Act, the payment shall, depending upon the circumstances, be

(a) included in computing the taxpayer's income for the purpose of Part I,

(b) deemed to be a payment to a non-resident person to which Part XIII applies, or

(c) deemed to be a disposition by way of gift.

In my opinion McClurg is distinguishable on the facts. In that case the Minister was trying to attribute to the appellant something that the appellant never held personally: corporate dividends. In the case at bar the Minister is trying to attribute to the appellant something that the appellant once held personally: his value or economic interest in the company.

Counsel for the appellant raised the question as to whether paragraph 245(2)(c) is a charging section or merely a characterizing section. Paragraphs 245(2)(a) and 245(2)(b) may be charging sections, but 245(2)(c) is not.

The Exchequer Court of Canada in Craddock v. M.N.R., [1969] C.T.C. 566; 69 D.T.C. 5369; affg [1968] C.T.C. 379; 68 D.T.C. 5254 concluded that paragraph 137(2)(c) was not dependent upon or connected with any other section or sections of the Act. Paragraph 245(2)(c) is virtually identical to paragraph 137(2)(c). However, 245(2)(c) does not refer to "Part IV” as did 137(2)(c). Part IV contained the gift tax provisions of the old Act. Mr. Justice Gibson’s finding that 137(2)(c) stood on its own, or was a charging section, was predicated on the exact wording of 137(2)(c) which read: "(c) deemed to be a disposition by way of gift to which Part IV applies.” [Emphasis mine.]

At page 386 (D.T.C. 5259) of the judgment Mr. Justice Gibson says:

. . ., if the circumstances are such that it is correct that the "payment" be "deemed to be a disposition by way of gift to which Part IV applies", then for taxation purposes Section 137(2) of the Act should be considered in effect as being a separate section in Part IV of the Act.

In my opinion without the Part IV gift tax provisions, paragraph 137(2)(c) of the old Act would not have been found to stand on its own as a charging section. Since paragraph 245(2)(c) cannot make reference to gift tax provisions and does not refer to any other charging provisions, I find that it does not stand on its own and cannot be considered to be a charging section.

The Minister, at page 85 of the trial transcript, concedes that paragraph 245(2)(c) is a characterizing provision and not a charging provision when counsel says: "Therefore, sir, to continue, the Minister's tracking of this particular series of events is through section 245 to section 69(1 )(b)(ii)."

Therefore, at this point in time, I have concluded that the transaction in question is within 245(2)(c), deeming there to be a “disposition by way of gift”. As the Minister suggests the next step is 69(1)(b)(ii).

69. (1) Except as expressly otherwise provided in this Act,

(b) where a taxpayer has disposed of anything

(ii) to any person by way of gift inter vivos,

he shall be deemed to have received proceeds of disposition therefor equal to that fair market value;

Subparagraph 69(1)(b)(ii) deals with the situation where a taxpayer sells anything at a price less than the fair market value to a person with whom he is not dealing at arm's length or to a person by way of gift inter vivos. It provides that in these circumstances, for the purpose of determining the taxpayer's income, the fair market value of the things sold shall be deemed to have been received therefor.

Counsel for the appellant raised concerns over the interpretation of the word “anything”. Dailley Recreational Services Ltd. and Virginia M. Dailley v. M.N.R., [1985] 1 C.T.C. 2148; 85 D.T.C. 134 is case authority for the proposition that the word "anything" is very wide and unrestricted. At page 2149 (D.T.C. 135) Taylor, T.C.J. says: "Subsection 69(1) does not restrict itself to 'real property' any 'property', it deals with 'anything'."

Counsel for the appellant also asserts at page 34 of the trial transcript "that there is no such thing in law as an economic interest in a corporation. There are only shares . . .”. I disagree with counsel.

Counsel provides us with a definition of share as found in Borland's Trustee v. Steel Brothers & Co. (1901), 1 Ch. 279 at 288:

A share is the interest of a shareholder in the company . . . A share is not a sum of money settled in a way suggested, but an interest measured by a sum of money.

From the “Proposals for a New Alberta Business Coloration Act", also provided by appellant's counsel, a further definition of "share" is provided: "A share is simply a proportionate interest in the net worth of a business".

The taxpayer's "economic interest" is his interest in the total of all the rights and privileges that are inherent in the shares that he owns. By diluting his shareholdings he disposes of a part of those rights and privileges.

In the case at bar, the appellant disposed of part of the value of his shares in the company without disposing of any of his shares in that company. Should this make the transaction any less of a disposition? It must be remembered that the appellant went from holding nine shares and a 50 per cent ownership position in the company to holding nine shares and a 21.4 per cent ownership position in the company. He may not have disposed of shares in the company but he certainly disposed of part of the value or economic interest of his shares.

I believe that an "economic interest" in a company is a concept acceptable in law and this is supported by Dufresne, supra. Furthermore, "economic interest" fits within the broad and unrestricted definition of "anything" given by Judge Taylor in Dailley, supra. Therefore the appellant's transaction falls within subparagraph 69(1)(b)(ii): Mr. Kieboom has disposed of his economic interest in the company to his children by way of gift inter vivos and he is deemed to have received proceeds of disposition therefor equal to that fair market value ($6,800). An "economic interest" in a corporation falls within the definition of property provided by subsection 248(1) of the Act. Mr. Kieboom will then have had a "disposition of property" from this transaction so as to meet the wording of section 40 of the Act, the capital gains provision. The Minister succeeds on Part A of the first issue in this appeal: the issuance of shares by the company in 1981 to Sheila, Yost and Alma constituted a disposition by the appellant and his wife of an economic interest in the company by way of gift to which paragraph 245(2)(c), subparagraph 69(1)(b)(ii) and section 40 of the 1981 Act apply.

Part B of the first issue and the second issue deal with the “spousal transfer" and “attribution” rules: see subsections 73(1), 74(1) and 74(2). The Minister contends, although the 1980 and 1981 transactions were virtually identical, that when Adriana Kieboom received her 8 Class "A" common shares that this was not a deemed gift like the children’s transaction in 1981, but a subsection 73(1) spousal transfer. If this transaction was a "transfer" of Mr. Kieboom's "economic interest" in the company to Adriana Kieboom and if the dividends received by Adriana flowed from her acquisition of that "economic interest" then the dividends Adriana Kieboom received on her Class "A" commons are attributed back to Mr. Kieboom (74(1)) and the proceeds of disposition flowing to Adrian Kieboom from the "Children's transaction" also flow to Mr. Kieboom (74(2)).

Has there been a "transfer" in the case at bar? What is the definition of "transfer"? A very good definition is provided by President Thorson from the Exchequer Court of Canada in Estate of David Fasken v. M.N.R., [1948] C.T.C. 265; 49 D.T.C. 491 at 279 (D.T.C. 497):

In Gathercole v. Smith, (1880-81) 17 Ch. D. 1 at 7, James, L.J. spoke of the word "transfer" as "one of the widest terms that can be used,” and Lush L.J. said, at page 9:

The word “transferable,” I agree with Lord Justice James, is a word of the widest import and includes every means by which the property may be passed from one person to another.

The word "transfer" is not a term of art and has not a technical meaning. It is not necessary to a transfer of property from a husband to his wife that it should be made in any particular form or that it should be made directly. All that is required is that the husband should so deal with the property as to divest himself of it and vest it in his wife, that is to say, pass the property from himself to her. The means by which he accomplishes this result, whether direct or circuitous, may properly be called a transfer.

The definition of "transfer" is very broad and I must concede that the appellant's "transaction" with his wife could fall within the ambit of subsection 73(1) as stated above, however, the property transferred was not Class "A" shares but a portion of the appellant's "value" or "economic interest” of his nine common shares.

With virtually identical transactions in 1980 and 1981 the Minister seeks to treat the 1981 transaction as a deemed gift and the 1980 transaction as a spousal transfer.

The Minister's two-pronged attack against virtually identical transactions seeks to maximize the appellant's taxable income. However the Minister does not succeed in attributing the dividend income paid on Adriana's Class "A" common [shares] back to the appellant. Throughout this case the Minister has held fast to the proposition that what the appellant disposed of/transferred was an economic interest in the company. The Minister could not and has not claimed that the appellant in any way disposed of/transferred shares.

If shares have not been transferred by the appellant to his wife Adriana then attribution of income (74(1)) cannot happen. It is a principle of corporate law that dividends attach and flow to shares. According to D. Horsley and H. Sutherland, Fraser's Handbook on Canadian Company Law 335 (6th Ed. 1975) dividends are:

. . . a distribution of the profits of the company among the shareholders in respect of their shares. Such distributions are usually made by resolution of the directors declaring a dividend of a certain sum per share or at a rate percentage upon their shares to be payable on a certain date to shareholders of record as of a specified date subsequent to the date when the resolution is passed.

[Emphasis added.]

Dividends attach to shares, not to economic interests in a corporation. In McClurg, supra, the taxing provision was limited by the principles of corporate law and I propose it should be the same in this case. The simple answer to the Minister's argument under subsection 73(1) is that the dividends received by Adriana from her Class "A" shares did not flow from property transferred to her by the appellant and so subsection 74(1) does not apply.

The two transactions (1980 and 1981) are preferably characterized as gifts from the appellant rather than a transfer. A true transfer transaction is such as found in Alexander Orr v. M.N.R., [1989] 2 C.T.C. 2348; 89 D.T.C. 557 where the appellant increased his personal holdings of the capital stock and then transferred those shares to his sons. Relying on the Dufresne judgment, I find that these two virtually identical transactions are characterized as gifts.

The appellant's attempt to have the 1981 transaction come within the ambit of 73(5) must fail for the same reasons that the 74(1) attribution failed: at no time was there a transfer to the children of "a share of the capital stock of a small business corporation".

The appellant's appeal with respect to his 1981 taxation year is dismissed as regards Issue 1.(a), and allowed as regards Issue 1.(b). Therefore, the appellant shall have a capital gain of $81,600 included in his 1981 income. The appellant's appeal with respect to his 1982 taxation year (Issue 2) is allowed. The assessments shall be varied in accordance with the terms of these reasons for judgment. No costs are awarded.

Appeal allowed in part.