Scandia Plate LTD v. Minister of National Revenue, [1981] CTC 2852, 81 DTC 643

The Chairman:—The appeal of Scandia Plate Ltd is from an assessment whereby the Minister of National Revenue disallowed a small business deduction under subsection 125(1) of the Income Tax Act on the ground that the appellant was not a Canadian-controlled private corporation throughout its 1979 taxation year running from May 1, 1978 to April 30, 1979.

The assumptions on which the Minister based his assessment are as follows:

2. (a) prior to 1979 the Appellant was a wholly owned subsidiary of Ssab Svenskt Stal Atkiebolas, a company incorporated in Sweden at at all material times, not resident in Canada;

(b) by an agreement dated the first day of May, 1978, between Gerald J. Lo- zinski and Ssab Svensket Stal Atkiebolas, Lozinski, a resident of Canada, at all material times agreed to purchase all the issued and outstanding shares of the Appellant;

(c) the transaction contemplated by the said agreement of the first day of May, 1978, closed on the 8th day of December, 1978, at which time Lozinski acquired legal title to the shares of the Appellant;

(d) at all material times the fiscal year of the Appellant was May 1 to April 30.

3. The Respondent submits that control of the Appellant was not acquired by Lozinski until the transaction contemplated by the said Agreement of the first day of May, 1978 was closed on December 8, 1978 and until December 8, 1978, control of the Appellant remained with Ssab Svenskt Stal Atkiebolas, a corporation not resident in Canada.

The facts of this appeal are not disputed and can briefly be summarized as follows:

T Granges, a Swedish Steel Company, decided to expand its business in Canada and Scandia Plate Ltd (Scandia), the appellant, a wholly-owned subsidiary of Granges, was incorporated in August 1977 under The Company Laws of Ontario to carry on business in Canada. For that purpose, Mr Gerald J Lozinski was hired as manager.

Since Scandia was owned by non-residents, Granges tried unsuccessfully to obtain approval of its operations under the Canadian Foreign Investment Review Act (Exhibits A-1 to A-4). Its application having been refused, Granges had to either discontinue its Canadian business or sell the shares of Scandia to a Canadian resident.

After negotiations between principals of Granges and Mr Lozinski, it was agreed that all the Scandia shares would be purchased by Mr Lozinski, the company’s president, a Canadian citizen, for the amount of $10 at the end of its 1978 fiscal year (ie April 30, 1978) in order to coincide with the amalgamation of Granges and two other Swedish corporations. The said agreement of purchase and sale, to be found as the first document in the brief submitted by the appellant, was executed on May 1, 1978.

According to the terms of the agreement, it is alleged that the relationship between Mr Lozinski and Granges changed officially in that his employment contract with Granges was terminated and the distribution agreement with respect to Scandia’s operations (Summarized in Exhibit A-6) came into effect on May 1, 1978. The appellant further stated that the financial adjustments between SSAB Svenskt Stal Atkiebolas (SSAB) and Scandia were made as of April 30, 1978, and all profits and losses of Scandia after that date accrued to Mr Lozinski as the new owner of Scandia. In other words, the appellant submits that, according to the terms of the agreements, Mr Lozinski effectively became the owner of 100% of the shares of Scandia as of May 1, 1978.

There is no disagreement between the parties that the transaction was closed on December 8, 1978 and indeed, because of the geographical distance between SSAB and Mr Lozinski, and the voluminous legal work necessary for the amalgamation of Granges and other Swedish companies which took place at that time, the agreement provides that the date of closing would be December 8, 1978.

It is the appellant’s submission that from May 1, 1978 to April 30, 1979, its 1979 fiscal year, it was a Canadian-controlled private corporation and entitled to the small business deduction provided under subsection 125(1) of the Income Tax Act.

The respondent submits that the appellant was properly disallowed a deduction under subsection 125(1) of the Income Tax Act, RSC 1952, c 148 as amended in respect of its active business income as throughout its 1979 taxation year running from May 1, 1978 to April 30, 1979 it was not a Canadian-controlled private corporation within the meaning of paragraph 125(6)(c) of the Income Tax Act in that for the period from May 1, 1978 to December 8, 1978, it was controlled by a non-resident.

Subsection 125(1) of the Act reads as follows:

Small business deduction

(1) There may be deducted from the tax otherwise payable under this Part for a taxation year by a corporation that was, throughout the year, a Canadian- controlled private corporation, an amount equal to 25% of the least of

(a) the amount, if any, by which

(i) the aggregate of all amounts each of which is the income of the corporation

for the year from an active business carried on in Canada,

exceeds

(ii) the aggregate of all amounts each of which is a loss of the corporation for the year from an active business carried on in Canada,

(b) the amount, if any, by which the corporation’s taxable income for the year exceeds the aggregate of

(i) 10/4 of the aggregate of amounts deducted under subsection 126(1)

from the tax for the year otherwise payable by it under this Part, and

(ii) 2 times the aggregate of amounts deducted under subsection 126(2)

from the tax for the year otherwise payable by it under this Part,

(c) the corporation’s business limit ior the year, and

(d) the amount, if any, by which the corporation’s total business limit for the year exceeds its cumulative deduction account at the end of the immediately preceding taxation year,

except that in applying this section for a taxation year after the 1972 taxation year, the reference in this subsection to “25%” shall be read as a reference to “24%” for the 1973 taxation year, “23%” for the 1974 taxation year, “22%” for the 1975 taxation year, and “21%” for the 1976 and subsequent taxation years.

A Canadian-controlled private corporation is defined as follows:

Paragraph 125(6)(a)

“Canadian-controlled private corporation”.—“Canadian-controlled private corporation” means a private corporation that is a Canadian corporation other than a corporation controlled, directly or indirectly in any manner whatever, by one or more non-resident persons, by one or more public corporations or by any combination thereof.

There can be no doubt that a valid contract existed and was binding on the parties as of May 1, 1978. The effect of the agreement was that Mr Lo- Zinski acquired the right to purchase all of the Scandia shares and SSAB assumed the obligation to sell them to Mr Lozinski at the date of closing if and when all the conditions of the agreement were f ullf i I led or waived by the contracting parties. During the period of May 1, 1978 to December 8, 1978, although both parties to the agreement (once the conditions of the agreement had been met) may have been legally bound to give effect to the purchase and sale of the Scandia shares, the agreement was not binding on independent third parties, including Scandia, the appellant and the Minister of National Revenue.

In my opinion, Scandia or any other independent third party was not affected by the agreement until it was finally closed and the shares of Scandia were unquestionably and unconditionally owned by Mr Lozinski which, I understand, occurred after December 8, 1978. I do not believe that the right given to Mr Lozinski by the agreement to purchase the Scandia shares within a limited period of time conferred upon him any right of ownership in the shares or control over Scandia until the transaction was finally closed. Nor, as I read the preamble of the May 1st agreement, had the vendor any intention of relinquishing ownership of the shares prior to the closing of the contract.

The second paragraph of the preamble of the agreement reads as follows: (Document #1 — appellant’s brief)

AND WHEREAS it is contemplated that at the time of closing (as hereinafter defined) the issued capital of the Company will consist of 10,001 common shares (the “Purchased Shares”) all of which shall be beneficially owned by the Vendor.

In my opinion, SSAB did not intend nor did it transfer ownership of Scandia’s shares to Mr Lozinski on May 1, 1978.

The contracting parties also provided for the termination of the agreement by either the purchaser or vendor if any of the stipulated conditions were not fulfilled (Clause 7, Document #1 — appellant’s brief). The right of Mr Lozinski to purchase the shares as of May 1, 1978, as a result of the agreement, was contingent upon the realization of certain conditions not yet fulfilled, not the least of which was the issuance of 10,001 common shares of Scandia (the subject shares).

3. The Vendor hereby represents and warrants to the Purchaser that:

(e) following March 31, 1978 and prior to the Closing there shall not have been any change in the authorized or issued capital of the Company except for the issue of ten thousand (10,000) common shares of the Company to the Vendor for a consideration of One hundred, thirty-three thousand, five hundred and fifty-four dollars ($133,554).

I can accept, on the evidence that some of the provisions of the agreement became effective as of May 1, 1978, Mr Lozinski may have been named president of Scandia; he may have received full authority and responsibility for the operations of Scandia, independently of SSAB and the company books may have been adjusted so that receivables, liabilities and earnings of Scandia would henceforth be reflected in Scandia’s operational accounts. These aspects of the agreement, which may well have taken effect on May 1, 1978, have really to do with the administration of Scandia’s operations by its newly appointed president, with the concurrence of and under the authority of SSAB.

There is no dispute as to the fact that Mr Lozinski was given the day-to- day management of Scandia and, in that sense, he did have the effective control of the company’s operations on May 1, 1978. That however, in my opinion, has nothing to do with the transfer of ownership of the shares or the control of the corporation within the meaning of paragraph 125(6)(a) of the Act .

As an alternative to his submission that the effective date of the transfer of ownership of the shares to Mr Lozinski was May 1, 1978, it is the appellant’s position that, as of that date, SSAB was only a nominee or a bare trustee for Mr Lozinski and, as such, it had no rights over the Scandia shares.

It is very difficult for me to accept under any conditional purchase and sale agreement that a vendor would lose all rights of ownership before the transaction was actually closed. In this instance, it is impossible to conclude that SSAB no longer had any rights in the Scandia shares when it specified in the agreement its intention of retaining beneficial ownership of the shares until the date of closing.

The answer to the question as to who owned the Scandia shares and who controlled the corporation from May to December 1978, in my view, lies in the nature of the rights Mr Lozinski had during that period of time under the agreement. Considerable jurisprudence was cited and arguments made rela- tive to the de jure as opposed to the de facto control of the shares of a corporation. As suggested earlier, I doubt whether that distinction is really pertinent to issue in the instant appeal. It is my opinion that, under the agreement, Mr Lozinski’s rights from May to December 1978 included neither the de jure nor the de facto control of Scandia but gave him the legal right under specified conditions to acquire the shares of Scandia.

In this respect, Mr Arthur R A Scace, in his book The Income Tax Law of Canada at 634, which was cited by both parties, states in dealing with the definition of “Controlled Foreign Affiliate”:

Future jurisprudence may show that the phrase “controlled, directly or indirectly in any manner whatever” has expanded the meaning of “control” to encompass de facto control. Traditionally, however, courts which have had to pass upon the meaning of “control” of a corporation in taxing statutes have construed it strictly to refer to de jure control resulting from ownership of or direct influence over, sufficient voting shares to enable the holders to elect a majority of a corporation’s board of directors.

Mr Scace foresees the possibility at some future date of expanding the meaning of “control” to include “de facto" control but he points out that, according to the present state of the law, control is interpreted as being ‘de jure’ control resulting from ownership. In my opinion, Mr Scace was not including in his concept of “de facto" control of a corporation the managerial authority and responsibilities assigned to a person or group of persons for the implementation of decision taken by the corporation’s elected board of directors and/or shareholders.

The “de facto" control to which Mr Scace, in my view, referred is that of a group of shareholders of a corporation controlling, not necessarily owning a majority of the voting shares which gives it the legal right and the unfettered power to establish and decide the fundamental policies to be followed in the administration of the operations, the capital structure and, indeed, the very existence of a corporation. Mr Lozinski did not possess that power or control over Scandia under the agreement until December 8, 1978.

The decision to sell all of the Scandia shares to Mr Lozinski for $10 could only have been made by SSAB which had both the de jure and the de facto control of Scandia. In the purchase and sale agreement, SSAB specifically retained the ownership of the Scandia shares until the closing date. In my opinion, prior to closing, although Mr Lozinski may under the agreement have been given wide administrative authority in the corporation’s operations, he had neither the de jure nor the de facto control of Scandia as I understand those terms. He could not vary the capital structure of Scandia; he could not before closing have sold the assets or the shares of Scandia; SSAB alone, in my opinion, had the voting power and the necessary control of Scandia to make such decisions.

As useful and as interesting as case law on the distinction to be made between de jure and de facto control of corporations may be, it does not apply to the issue in this appeal which, in my opinion, must be determined strictly on the basis of the legal rights and legal limitations to which Mr Lozinski became subject on the signing of the purchase and sale agreement under the principles of the law of contracts. I cananot see on what ground Mr Lozinski can be said to have acquired either the de jure or the de facto control of Scandia prior to the closing date of the transaction since the May 1st agreement did not bind Scandia and Mr Lozinski had no control over the company as a corporate entity.

The appellant suggested that a decision unfavourable to his position would be a serious blow to the accepted business practice followed by many businessmen in concluding an oral agreement and considering it binding on the basis of a mere handshake. Such a contract may well be binding on the contracting parties but, for very valid reasons, under the law of contracts independent third parties, it seems to me, are not bound by the “substance” of the agreement until the day the transaction is formally closed and ratified.

In my opinion, Mr Lozinski did not acquire the shares nor the de jure and de facto control of Scandia until the date of closing, as provided for in the agreement.

I conclude therefore that the appellant Scandia Plate Ltd was a corporation controlled directly or indirectly by a non-resident corporation, within the meaning of subsection 125(6) of the Act until on or after December 8, 1978 and was not a Canadian-controlled private corporation throughout its 1979 taxation year commencing on May 1, 1978 to April 30, 1979. The Minister therefore did not err in disallowing a deduction under subsection 125(1) of the Income Tax Act.

For these reasons, the appeal is dismissed.

Appeal dismissed.