Don Henderson Limited v. Minister of National Revenue, [1987] 1 CTC 2031, 86 DTC 1848

Taylor, T.C.J.:—This is an appeal heard in Belleville, Ontario, on September 30, 1986, against an income tax assessment for the year 1983, in which the Minister of National Revenue recalculated the “Capital Dividend Account” as filed by the appellant. In view of the unusual nature of this appeal I will provide a substantial portion of the background information given to the Court.

The notice of appeal, as prepared by Wilkinson & Company, Chartered Accountants of Trenton, Ontario stated:

Facts:

— On June 26, 1982, the company sold its inventory equipment and goodwill in an arms-length transaction.

— For the fiscal year ended May 31, 1983, the company reported a taxable capital gain of $91,823 on the sale of the equipment and an income inclusion of $85,955 the disposition of the eligible capital property (goodwill) referred to above and paid its income tax accordingly.

— The fiscal year end of the corporation was changed to December 31 effective December 31, 1983, with Revenue Canada’s permission.

— On December 22, 1983, at a duly authorized shareholders meeting, an election was made to pay a dividend of $181,278 out of the capital dividend account calculated to be at that particular time to have a balance of $181,278.

— On December 26, 1983, the company acquired inventory equipment and goodwill in an arms-length transaction and these assets are considered by the company and Revenue Canada as replacement properties.

— In early 1984, amended May 31, 1983 corporate tax returns were filed to reflect the elections being made under Section 44(1)(a) and 14(b) for the replacement properties acquired.

— In early 1984, the corporate tax returns for the fiscal year ended December 31, 1983 were filed reflecting the acquisition of the replacement properties at values as outlined under sections 44 and 14.

— Revenue Canada has assessed the calculation of the capital dividend account as defined by Section 89 of the Income Tax Act to be nil as follows.

Capital dividend account

as filed		$ 181,278.00
Less— application of
Subsection	44(5)	$91,823
	14(6)	89,455
		181,278.00
Balance of Capital Dividend Account per Revenue Canada Taxa
tion		NIL
— Revenue Canada has assessed Part III tax on the
excessive election under Section 184(2)
in the amount of A x 181,278		135,958.50
and charged interest of		24,312.35
		$160,270.85
Reasons:

— We disagree with Revenue Canada’s calculation of nil for the Capital Dividend account as Revenue Canada has taken events (the acquisition of the replacement properties) and elections (to have 44 and 14 apply to the replacement properties) to retroactively apply as reductions to the capital dividend account as calculated at December 2, 1983.

— Section 89(1)(b) clearly defines the calculation of the Capital Dividend account of a corporation at any particular time to mean (1) /2 of the amount by which . . . the capital gains for the period commencing on the first day of the year commencing after the time the corporation last became a private corporation ending after 1971 and ending immediately before the particular time exceeds the capital losses for that same period (i.e. the particular time) plus paragraph (iii) that contains similar wording to include the appropriate portion of the eligible capital amounts.

— We believe the particular time to be December 22, 1983, the date on which the election was made and only events up to the end of that particular time period should be considered in the calculations.

— Sections 44, 14, and 89 concerning the replacement property rules do not contain any clauses that inter-relate the calculations.

— On December 2, 1983, the company had not even acquired the replacement property so could not elect to have 44 and 14 apply to reduce the June, 1982 capital gains and income inclusions.

— There are also numerous other sections of the Income Tax Act that allow capital transactions of one year to effect previous years yet not affect the current calculation of the capital dividend; for example:

— December 1983 taxation year capital gain	$50,000
January 1984 — Capital Dividend Account
Election allowable	50,000
November 1984 Capital Loss	60,000

This entire November 1984 Capital Loss can be carried back to 1983 to recover income tax paid and reduce taxable income yet will have no affect on the valid January 1984 capital dividend account election.

— We believe that the capital dividend account was properly calculated on December 22, 1983 and a valid election was filed on the payment of the dividend, thus the assessment should be reversed.

— If for any particular reason the above appeal is not successful, the shareholders of the corporation and the corporation hereby elect under Section 184(3) to treat the excess as a separate taxable dividend. All the shareholders of the corporation are:

Donald Henderson

Diane Henderson

In response thereto the Minister of National Revenue asserted:

Statement of Facts

— He admits all the allegations of fact referred to under the heading ‘Facts:’ contained in the Notice of Appeal except for the reference to ‘Section 44(1)(a) and 14(b)’ at line 16.

— A Notice of Assessment dated August 12, 1985 was issued to the Appellant with respect to an election made pursuant to section 83(2) of the Income Tax Act dated December 22, 1983 informing it that the capital dividend account was nil at the time the election was made and, therefore, the Appellant was liable to pay Part III tax as follows:

Election Date	— December 22, 1983
Amount Subject to Election	— $181,278.00
Excess Amount Subject to
Part III Tax	— $181,278.00
Amount of Part III Tax
Assessed	— $135,958.50

— In so assessing the Appellant with respect to Part III tax, the Respondent made, inter alia, the following assumptions of fact:

— During the Appellant’s taxation year ending May 31, 1983, it disposed of capital property for proceeds of disposition;

— In reporting its income for the taxation year ending May 31, 1983, the Appellant included in income the following amounts with respect to the disposition referred to in paragraph 3(a):

Taxable Capital Gain — $91,823.00

Negative Cumulative Eligible Capital — $89,455.00

— On December 22, 1983 the Appellant made an election pursuant to section 83(2) of the Income Tax Act to pay a dividend in the amount of $181,278.00;

— On December 26, 1983 the Appellant acquired a replacement property with respect to the disposed property referred to in paragraph 3(a) for which the Appellant made elections pursuant to sections 14(6) and 44(5) of the Income Tax Act;

— As a consequence of the elections referred to in paragraph 3(d), the Appellant’s capital gain and negative cumulative eligible capital for the taxation year ending May 31, 1983 were deemed to be nil;

— The capital dividend account during the taxation year ending December 31, 1983 was nil;

— The excessive dividend paid out of the capital dividend account with respect to the election referred to in paragraph 3(a) and tax thereon were in the following amounts:

Excessive Dividend	— $181,278.00
Part III Tax	— $135,958.50

B. Statutory Provisions Upon Which the Respondent Relies and the Reasons He Intends to Submit

— The Respondent relies, inter alia, upon sections 3, 4, 9, 14, 38, 39, 40, 44, 54, 83, 89, 184, 185 and 248(1) of the Income Tax Act, R.S.C. 1952, c. 148 as amended by S.C. 1970-71-72, C. 63, section 1.

— The Respondent submits that the Appellant’s capital dividend account was reduced to nil by operation of the law for the taxation year ending May 31, 1983 due to the elections it made pursuant to sections 14(6) and 44(5) of the Income Tax Act.

— The Respondent submits that the appellant was liable to pay Part III tax pursuant to section 184(2)(a) of the Income Tax Act as its capital dividend account at any particular time in the taxation year ending December 31, 1983 was nil; therefore the Appellant was properly assessed pursuant to section 185 of the Income Tax Act.

At the commencement of the hearing, the following agreed statement of fact was filed:

1. On August 12, 1985, the Appellant was reassessed for his 1983 taxation year under Part III of the Income Tax Act.

2. The Minister reassessed the Appellant in the manner described on form T7W-C attached to this Agreed Statement of Fact as Appendix 1.

3. On August 23, 1985, the Appellant filed a Notice of Objection to the reassessment referred to in paragraph 1 above.

4, On December 13, 1985, the Minister of National Revenue confirmed the reassessment referred to in paragraph 1 above.

5. On June 26, 1982, certain assets of the Appellant Company was sold in an arms length transaction to Rod Lyons and Oswald Kuenzig.

6. The Appellant’s corporate return for the May 31, 1983 fiscal period was received by Revenue Canada on August 23, 1983.

7. In the corporate return noted in paragraph 6 herein, the Appellant reported receiving, among others, the following amounts from the sale to Rod Lyons and Oswald Kuenzig:

91,823 — taxable capital gain — equipment

89,455 — negative cumulative eligible capital

— goodwill

8. On December 20, 1983, the Appellant requested a change in its fiscal year end which was agreed to by the Respondent on January 12, 1984, changing the Appellant’s year end from May 31, 1983 to December 31, 1983.

9. The Appellant filed an amended return for its May 31, 1983 taxation year, which was received by the Respondent on January 19, 1984.

10. On December 22, 1983, the Appellant made an election pursuant to s. 83(2) of the Income Tax Act to pay a dividend from its Capital Dividend Account in the amount of $181,278.00.

11. The Appellant was aware on December 22, 1983, that it would be acquiring replacement property within a few days.

12. On December 26, 1983, the Appellant reaquired the equipment and goodwill in an arms length transaction from Rod Lyons and Oswald Kuenzig.

13. In its amended corporate return for the 1983 taxation year, the Appellant filed elections pursuant to s. 14(6) and 44(1) of the Income Tax Act.

14. As a consequence of the elections referred to in paragraph 13 herein, the Minister calculated the Appellant's Capital Dividend Account to be nil for the Appellant's fiscal year ending May 31, 1983.

15. The Minister of National Revenue determined that there was an excessive dividend paid out of the Appellant's Capital Dividend Account in the 1983 taxation year and assessed tax thereon in the following amounts:

Excessive Dividend	$181,278.00
Part III Tax	$135,958.50

16. The parties hereto by their respective solicitors have by their signatures, agreed to the facts recited above.

During the hearing, the parties agreed that the original income tax return including the financial statements and supporting schedules, as well as the amended income tax return also with its supporting schedules should be filed as Exhibit A-1.

The issue, as seen by the appellant, was summarized in the opening remarks of counsel:

The Appellant in this case has availed itself of two provisions of the Income Tax Act. The first, to declare a dividend out ot the capital dividend account, and that occurred in December, 1983.

And the second, which I submit is a totally distinct transaction — that was to file an election to apply the replacement property rules. And when I speak of the “replacement property rules” I’m referring to sections 14 and 44. In my submissions I’ll restrict myself to section 44, because it essentially mirrors the provisions of section 14; whereas section 44 deals with capital property, section 14 deals with goodwill, so I’m not going to refer to both of them, because if the case is decided for the Appellant, then it will do so in both instances. And I think my friend agrees about that.

There’s really only one issue, then, and that is whether an election to apply the replacement property rules can retrospectively undo what has been done when an election has been filed to have a dividend paid out of a capital dividend account at a particular point in time. In other words, once a transaction has occurred and has been crystallized and consummated, can it subsequently be undone by another step taken by a taxpayer under a separate provision of the Act? It is my submission that it cannot.

From counsel for the respondent, the introduction was:

In my research on this particular file I noted that there was no particular case on point; that this matter had never before been brought up before the Court.

The taxpayer is, in effect, arguing here that the definition in the Income Tax Act of the capital dividend account crystallizes any amount that may be in it. He points out that there’s no specific provision in the Act to allow the Minister to retroactively deem the capital dividend account to be nil. The Minister, on the other hand, wishes to point out that the taxpayer knew it would be re-acquiring “replacement property" and, knowing this made its declared dividend under section 83(2).

What, in a sense, the taxpayer is asking the Court to accept is that for the purposes of determining the capital dividend account of his corporate taxpayer for the 1983 taxation year, that there was a gain. And there was a gain in 1983 and this is the amount of the gain, and because this is the amount of the gain, one half of that amount will be put in the capital dividend account. On the other hand, for the purposes of filing an election to defer recognition of that same gain for that same year, he filed an election in his amended return — an election under 14(6) and 44(1), specifically electing to defer that gain.

The problem, as my friend has so aptly characterized it — what happens when a dividend is paid out of the capital dividend account, and how does the effect of 14(6) and 44(1) affect the transaction?

The Minister’s position is three-fold. Firstly, the capital dividend account is not crystallized . . .

The second major position of the Minister is that the amended corporate return, with the election under 14(6) and 44(1), has the effect of clearing out the capital dividend account and making any dividend paid out in excess of this account an excessive election pursuant to section 184(2) . . .

The third major position of the Minister is that if the taxpayer’s interpretation is correct, the object and spirit of the legislation would be defeated . . .

It was agreed between the parties that the “changed year end” from May 31, 1983 to December 31, 1983 had no bearing on the specific issue before the Court. I would also note that no copy of the election form (T2054) respecting the capital dividend declared on December 22, 1983 was filed with the Court, but I can presume that one was properly filed — at least the Minister did not take an objection on that point. Further, there was no specific indication at the hearing, whether an assessment of tax was struck by the Minister based on the taxable income indicated by the appellant in the original filing, before the amended return was filed, although I do note that the disputed income tax arises out of a reassessment dated April 16, 1984. And I would also note that I do not see merit in the one posture adopted by the Minister — that relied on the “intention” of the appellant to invoke the provisions of sections 44 and 14, before electing to declare the capital dividend involved.

Before turning to an analysis of this matter, I would quote from certain sections of the argument presented by counsel for the appellant, and responses to questions from the Court:

. in determining what is in the capital dividend account, section 89(1)(b) is very specific. It describes the capital dividend account of a corporation at any particular time — at any particular time — means the amounts, if any, by which the aggregate of (a) — one half of the amount, if any, by which the amount, if any, by which the aggregate of the capital gain of the corporation for a period commencing the first day of the first taxation year commencing after the time the corporation last became a private corporation and ending after 1971, and ending immediately before any particular time.

So what they’re saying, as I read it, is that when the corporation became a private corporation, that starts the period running, and then the period ends immediately before the particular time, which goes back to line two, which describes that moment in time when the amount in the capital dividend account is determined.

So whatever is in that account during that timeframe, from the time that the corporation became a private corporation to immediately before the time that the calculation was done, that’s the relevant timeframe. And that calculation was made December 22nd, 1982.

Now let’s look at the timeframe for section 44. It talks about the gain with respect to the “exchange of property” rules, and then somewhere, under subparagraph (d) it goes on to say that — it talks about the “replacement property” as replacement of its former property and replacement property has not been disposed of by him prior to the time of disposal of the property, notwithstanding section 40(1), if he so elects under this subsection in his return of income under this part for the year in which he acquired the replacement property.

So we have to look at the year in which the property was acquired, and that was following the year in which the gain arose and, it was following the termination of the period which is used to describe the capital dividend account.

So when the Minister says that there is deemed zero balance, there is perhaps a deemed zero balance for a particular purpose; for the purpose of establishing what the gain, if any, is in the year in which the property was acquired, but not for the purpose of establishing what the balance is in the capital dividend account.

HIS HONOUR: After the filing of the amended tax returns, which were filed some time in January, ’84, but dealt with the fiscal period ending May 31, '83 — after that point in time was there anything thereon which would have been interpretable by yourself, or by the Appellants or by the Minister or by anyone, as a capital dividend account available for the payment or dividends? Is there anything in the amended statements? Is there a capital dividend account which remains in the amended statements?

MR. MENNINGA: No, no. The amended statement makes no reference to any capital dividend account or any amount that is sought to be aside in that, in the statement.

HIS HONOUR: And I take it it’s the desire of the Appellant to substitute the amended set of financial statements and tax returns for the original ones, that’s the purpose of filing them.

If there is no capital dividend account thereon as of May 31, ’83, as per the amended set of statements, how does one pay a capital dividend, which is what one did?

MR. MENNINGA: Well, because he paid the capital dividend before he filed the amended return.

Analysis

As I see it, the appellant is saying that once the capital dividend was declared, (December 22, 1983) that completed the series of transactions which produced the “Capital Dividend Account”, and closed that part of the matter. In effect it was no longer open to the Minister to revive and review it, in fact reverse it. Barring anything very unusual I would agree. However it was not the Minister that revived it — it was done at the instigation of the appellant.

Originally, in declaring its taxable income for the year, the appellant characterized the gain as a “capital gain” using paragraph 89(1)(b) of the Act. In order to so do, the taxpayer included with the T-2 Corporation Tax Return for the year ended May 31, 1983, the financial statements thereof, showing “net earnings for the year” of $375,772. Starting with this amount, the taxpayer then prepared Form T2S(1) as follows:

Reconciliation of net income (loss) per financial statements with net income (loss) for income tax purposes

Net Income (loss) per financial statements $375,772

Add:

Income tax provision incume tax p $ 6,003

Taxable capital gains — TZS(6) 91,823

Life Insurance premiums 23

Gain on sale of goodwill T2S(1A) 85,955

183,804

Sub-total $559,576

Deduct:

Gain on disposal of assets per

financial statements statements $359,033

Capital cost allowance — T2S(8) (16,820)

3% Inventory allowance 6,002

248,215

Net income (loss) for income tax purposes —

carry forward to page 1 of T2, Item 1 $311,361

AMOUNT $311,361

The significant amounts thereon (for purposes of this review) are taxable capital gain — T2S(6) — $91,823 and Gain on sale of goodwill — T2S(1A) — $85,955. The other amounts can be reconciled from the information provided and do not affect the point at issue. The $91,823 (above) comes from the T2S(6) form as follows:

Summary of Disposition of Capital Property in the 1983 Taxation Year

Particulars of Current Year Dispositions

	(3)	(4)	(5) Outlays	(6) Gain
Types of	Proceeds	Adjusted	and	(col. 3
Capital	of	cost	expenses (re	less 4
Property	disposition	base	dispositions)	and 5)
Other Properties — Do not include losses on depreciable property.
Description				Gain
Equipment				(or loss)
and sign	400,000	213,932	2,422	183,646
Total			ê
Proceeds	400,000		(or loss)	183,646
Total Capital Gain (or loss)				183,646

Taxable Capital Gain (Allowable Capital Loss) — One-half of the above ‘Total

Capital Gain (or loss)’ 91,823.

The $85,955 is supported on T2S(1A) in this way:

Deduction in respect of cumulative eligible capital (a separate schedule must be filed for each business for which a deduction is claimed).

Cumulative eligible capital—

beginning of year	$ 3,500
Sub-Total	$ 3,500
Less: Eligible capital amounts
Proceeds received during the year or
receivable at end of year	$198,789 (A)
(A) — (B)	$198,789 (C)

Lesser of (D) or (H)
.90% of (C)	178,910 (J)
(I) + (J)	$178,910	x 1/2	89,455
Cumulative eligible capital prior to cur
rent year’s
deduction — if negative carry forward to
TZS(1)
and include in income	Sub-Total		$(85,955)

The result was that the corporation declared a “net income for income tax purposes'" of $311,361 as indicated on Schedule TZS(1) above which included the capital gains of $91,823 and $85,955 (adjusted per TZS(1A) from $89,455) at issue in this appeal. In filing an amended income tax return an entirely different “net income for income tax purposes”, of $58,356 was determined by the appellant. To arrive at this amount — (upon which the corporation was prepared to pay tax by filing the amended tax return) — a new 12S(1) was filed:

Reconciliation of net income (loss) per financial statements with net income (loss) for income tax purposes

Net income (loss) per financial statements

— as filed	$375,772
Add:
Income tax provision	$ 6,003
Life insurance premiums	23
Employee bonus accrued	44,000
	50,026
Sub-Total	$425,798
Deduct:
Gain on disposal of assets per financial
statements	$359,033
Capital cost allowance — T2S(8)	2,407
3% Inventory allowance	6,002
	367 ,442
Net income (loss) for income tax purposes
— carry forward to page 1 of T2, Item 1	$ 58,356

The result was that the Minister reassessed and thereby eliminated from taxable income the amount of $91,823 and $89,455 included in the original filing as detailed on Schedules T2S(1) and TZS(1A). New supporting schedules — T2S(1), T2S(1A), etc., were prepared which disregarded the information earlier provided, and dealt with the gain in such a manner as to take advantage of the provisions of sections 44 and 14 of the Act.

Leaving aside for the moment, the secondary development which is the main issue in this appeal, — the elimination by the Minister in the reassessment of the alleged available “Capital Dividend Account”, — the immediate result of the filing of the amended tax return was the demand for a refund of taxes already paid as a result of filing the original tax return. To that degree at least, the act of filing the amended tax return by the appellant, must be taken as a retraction of the original tax return. “A return of the income for each taxation year . . .” is required by section 150 of the Act. That is one return, and as I see it one income, not two or more. That such a return may be “amended”, or adjustments made to it by the taxpayer would seem possible, at least under certain circumstances, although I am not aware the Minister is mandated to agree. But that such “amendments” can be made to the reported taxable income, without thereby disrupting the basis upon which that taxable income was determined, is certainly not as obvious to me. Clearly it is left to the taxpayer how, to his greatest advantage, he may reduce to the minimum the amount of “taxable income” he reports, but I am unaware of any provision which leaves open the prospect of reporting one “income” (taxable income) calculated in one way, and another income (taxable income) calculated another way, paying income tax on the calculation which produces the greatest advantage, but retaining the advantages on benefits derived from both sets of calculations. The appellant's proposition, in this appeal, would treat the original corporation's tax return and the schedules attached thereto, as merely mathematical exercises, to be discarded when a particular number (the Capital Dividend Account) has been calculated, rather than using them for the purpose of determining taxable income — for which precise purpose they are designed.

The Minister's assertion (supra) is fundamentally correct:

The Respondent submits that the Appellant’s capital dividend account was reduced to nil by operation of the law for the taxation year ending May 31, 1983 due to the elections it made pursuant to sections 14(6) and 44(5) of the Income Tax Act.

It might have been just as simple for the Minister to state that the taxpayer had changed the basis upon which it had reported its taxable income. To report two amounts of taxable income is, in my view, a contradiction in terms.

Counsel for the Minister did not make an issue of it, but it should be noted for the record that there may be some very real question whether a taxpayer can withdraw or amend an election filed, a point which could be even more disruptive to this appellant’s arguments — see Jack A. Miller v. M.N.R., [1985] 1 C.T.C. 2390; 85 D.T.C. 318 (now under appeal) and James Stephenson v. M.N.R., [1986] 2 C.T.C. 2073; 86 D.T.C. 1520.

In summary, therefore filing the amended return by the taxpayer left the Minister with possibly two alternatives — refuse to accept the amended return, leaving the original filing intact, thereby continuing the existence of the Capital Dividend Account; or accept the amended return, thereby automatically negating the original filing. In filing the amended return, the second course of action was that implicitly requested by the appellant, and the Minister simply accommodated the corporation. I fail to see wherein the appellant has any complaint.

The appeal is dismissed.

Appeal dismissed.