216663 Ontario Ltd. v. R., [1998] 3 CTC 2425, 98 DTC 1628

Mogan T.C.J.:

At all relevant times, the Appellant owned all of the issued and outstanding shares of 434908 Ontario Inc. (herein referred to as “Co. 908”). On February 1, 1988, the Appellant sold all of its shareholdings in Co. 908 to an arm’s length purchaser for the nominal sum of $100. Upon that sale, the Appellant realized a capital loss exceeding $1,000,000. As a consequence of that capital loss, the Appellant claimed a “business investment loss” and an “allowable business investment loss” (“ABIL”) as those terms are used in paragraphs 39(1)(c) and 38(c) of the Income Tax Act. When computing income for its 1988 taxation year (fiscal period ending March 31), the Appellant deducted a portion of that ABIL. When computing taxable income for its 1989 taxation year, the Appellant deducted a further portion of that ABIL as part of its “non-capital loss”.

The Minister of National Revenue disallowed the Appellant’s deduction of any amount as an ABIL on the basis that, with respect to the loss realized on the sale of the shares in Co. 908, the Appellant may reasonably be considered to have artificially or unduly created such a loss within the meaning of subsection 55(1) of the Income Tax Act. The issue in these appeals is whether subsection 55(1) of the Act applies to “one or more transactions” which ended with the Appellant’s sale of its shares in Co. 908 on February 1, 1988. The Appellant’s taxation years under appeal are 1988 and 1989.

The Appellant and Co. 908 were part of a group of corporations which operated a number of nursing homes in Ontario. Each nursing home was operated by a separate corporation. The group of corporations was controlled by one family. As a result of significant family troubles in 1984, a decision was made to sell the nursing home business. After the usual reflections on whether to sell shares or assets, the group of corporations entered into an arm’s length agreement to sell all of the nursing home assets for aggregate proceeds of $18,930,000. The sale transaction closed on October 25, 1985. Each corporation which owned nursing home assets received a portion of the aggregate proceeds of sale. The proceeds were allocated among the various corporations based on nursing home licences, buildings, lands and other tangible assets. There is no dispute between the parties with respect to the allocation of the proceeds of sale among the group of corporations.

Each corporation reported its respective sale of assets in its income tax return for the fiscal year ending March 31, 1986 and paid the assessed tax. After the payment of tax, each corporation had a cash surplus. According to Exhibit A-2, the Appellant was at the top of the corporate chain like a parent company with the other companies as subsidiaries. After obtaining professional advice from accountants and lawyers, a plan was developed to move all of the cash surpluses up into the Appellant at the top of the corporate chain. Exhibit A-6 is a memorandum from the Appellant’s chartered accountants showing that the plan was carefully thought out. In this appeal, I am concerned with only that part of the plan which involved a transfer of funds from Co. 908 to the Appellant and a resulting loss realized by the Appellant when it sold its shares in Co. 908.

On October 28, 1986, Co. 908 obtained Articles of Amendment (Exhibit R-24) authorizing an unlimited number of Class B shares without par value but the redemption amount of each Class B share was one thousand dollars ($1,000). On February 26, 1987, the Appellant subscribed for 4,979 Class B shares of Co. 908 at a price of only one cent ($.01) per share making an aggregate consideration of $49.79. See Exhibit R-26. On the same day, the Appellant’s subscription was accepted by the directors of Co. 908 (Exhibit R-28) and 4,979 Class B shares of Co. 908 were allotted to the Appellant subject to the payment of $49.79.

Exhibits R-29, R-30 and R-31 are copies of three resolutions of the directors of Co. 908 signed and passed on February 26, 1987 redeeming respectively and in order 3,762 Class B shares, 50 Class B shares and 13 Class B shares. The resolutions specified that the redemptions were to occur on February 27, 1987. The redemption of these Class B shares caused the following amounts to be paid by Co. 908 to the Appellant:

Under subsection 84(3) of the Income Tax Act, when a corporation like Co. 908 redeems a share and pays to its shareholder a redemption amount exceeding the paid-up capital with respect to that share, the excess is deemed to be a dividend. The paid-up capital of each Class B share was only one cent. Therefore, on the above redemptions, the Appellant was deemed to receive aggregate dividends of $3,825,000. Co. 908 made an election under subsection 83(2) of the Act to designate the aggregate dividends of $3,825,000 as capital dividends, and they were so reported by the Appellant in its income tax return for the fiscal year ending March 31, 1987 (Exhibit R-2).

Co. 908 also redeemed the remaining 1,154 Class B shares at a redemption amount of $1,000 per share causing the Appellant to receive a further deemed dividend of $1,154,000. This was an ordinary taxable dividend and not a capital dividend. The remaining 1,154 Class B shares may not have been all redeemed on February 27, 1987 because the Appellant reported a taxable dividend of $1,087,486 in its 1987 income tax return (Exhibit R-2) indicating a redemption of only 1,087 Class B shares before March 31, 1987. Also, a letter dated November 21, 1991 from Revenue Canada to the Appellant (Exhibit R-53) states that the Appellant reported a taxable dividend of $66,464 in its 1988 taxation year as part of the redemption of the remaining 1,154 Class B shares indicating a redemption of 66 Class B shares after March 31, 1987. The total of $1,087,486 plus $66,464 equals $1,153,950; and that total is exactly $50 less than the full $1,154,000 amount for the redemption of the remaining 1,154 Class B shares. The $50 difference could be the paid-up capital ($49.79) for the 4,979 Class B shares originally issued.

The issue and redemption of the Class B shares caused Co. 908 to pay $4,979,000 to the Appellant by way of redemption amounts which were, in substance (i.e. except for $49.79), deemed to be dividends to the Appellant. The transfer of these funds from Co. 908 to the Appellant on the issue and redemption of the Class B shares reduced significantly the value of the remaining shares in Co. 908 (common and Class A) held by the Appellant. The adjusted cost base (“ACB”) of the common and Class A shares in Co. 908 held by the Appellant was approximately $1,900,000 (Transcript - pages 35 and 36). When the Appellant sold its common and Class A shares in Co. 908 for $100 on February 1, 1988 in an arm’s length sale, the Appellant realized a loss in excess of $1,000,000 and claimed a corresponding “business investment loss” and ABIL.

The parties agree that the computations of the ABIL in paragraphs 9(1) and 9(m) of the Respondent’s Reply are not accurate. According to a statement by counsel for the Appellant at page 40 of the transcript, the Appellant and Respondent have agreed that, if the Appellant is entitled to deduct an ABIL with respect to the sale of its shares in Co. 908, the amount of that ABIL would be $791,415. Counsel for the Respondent remained silent when this statement was made by Appellant’s counsel. In any event, I am not asked to determine the amount of any ABIL when deciding this appeal. The only issue is whether the Appellant may deduct in its 1988 and 1989 taxation years portions of an ABIL which it claims to have realized upon the sale of its shares in Co. 908 on February 1, 1988.

As an aside, an ABIL or any part thereof which is realized by a taxpayer in a particular taxation year but not absorbed by other income in that year under paragraph 3(d) of the Act becomes part of the taxpayer’s “non-capital loss” as defined in paragraph 111(8)(b) of the Act. That non-capital loss may, within certain time limits in paragraph 111(1)(a), be deducted in computing the taxable income of adjoining years.

When making the assessments under appeal, the Minister of National Revenue relied on subsections 55(1) and 112(3) of the Income Tax Act:

55(1)

For the purposes of this subdivision, where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatever is that a taxpayer has disposed of property under circumstances such that he may reasonably be considered to have artificially or unduly

(a) reduced the amount of his gain from the disposition,

(b) created a loss from the disposition, or

(c) increased the amount of his loss from the disposition,

the taxpayer’s gain or loss, as the case may be, from the disposition of the property shall be computed as if such reduction, creation or increase, as the case may be, had not occurred.

112(3)

Where a corporation owns a share that is a capital property and receives a taxable dividend, a capital dividend or a life insurance capital dividend in respect of that share, the amount of any loss of the corporation arising from transactions with reference to the share on which the dividend was received shall, unless it is established by the corporation that

(a) the corporation owned the share 365 days or longer before the loss was sustained, and

(b) the corporation and persons with whom the corporation was not dealing at arm’s length did not, at the time the dividend was received, own in the aggregate more than 5% of the issued shares of any class of the capital stock of the corporation from which the dividend was received,

be deemed to be the amount of that loss otherwise determined, minus the aggregate of all amounts each of which is an amount received by the corporation in respect of

(c) a taxable dividend on the share to the extent that the amount thereof was deductible from the corporation’s income for any taxation year by virtue of this section or subsection 138(6) and was not an amount on which the corporation was required to pay tax under Part VII of this Act as it read on March 31, 1977,

(d) a capital dividend on the share, or

(e) a life insurance capital dividend on the share.

Subsection 112(1) of the Act permits a corporation receiving a taxable dividend from a taxable Canadian corporation to deduct the amount of the dividend in computing the taxable income of the receiving corporation. This subsection is important because it permits the tax-free flow of dividends among Canadian corporations. Subsection 112(3) imposes a limitation on the amount of any loss resulting from the disposition of a share. As I understand subsection 112(3), where Corporation X owns a share in Corporation Y as capital property and sells that share realizing a loss, the amount of that loss to Corporation X is reduced by any taxable dividend or capital dividend received by Corporation X from Corporation Y with respect to that share.

The Appellant is candid in acknowledging that the Class B shares of Co. 908 were created, issued and redeemed to avoid the consequences of subsection 112(3). If Co. 908 had declared, elected and paid on its common and Class A shares a capital dividend of $3,825,000 (see paragraphs 6 and 7 above), and if it had declared and paid on its common and Class A shares a taxable dividend of $1,154,000 (see paragraph 8 above), and if the Appellant had sold those common and Class A shares after such dividends, any loss resulting from such sale would have been reduced (in accordance with subsection 112(3)) by the amounts of the capital dividend and taxable dividend. The ACB of the common and Class A shares of Co. 908 to the Appellant was $1.9 million. Therefore, if the above two dividends had been paid to the Appellant on the common and Class A shares of Co. 908, those two dividends are so large that subsection 112(3) would have prevented the Appellant from realizing any loss at all on the disposition of its common and Class A shares in Co. 908.

The Appellant knew that it had to extract about $4.9 million from Co. 908 if it were to realize the maximum loss on the disposition of its common and Class A shares in Co. 908. The Appellant decided that the new Class B shares in Co. 908 would be the vehicle for extracting $4.9 million from Co. 908 without affecting the Appellant’s ACB of the common and Class A shares of Co. 908 and without causing subsection 112(3) to reduce the amount of any loss “otherwise determined” which the Appellant might realize on the disposition of such common and Class A shares. As described in paragraphs 7 and 8 above, the redemption of the Class B shares caused Co. 908 to pay and the Appellant to receive a deemed capital dividend of $3,825,000 and a deemed taxable dividend of $1,153,950.

I find as a fact that the Class B shares of Co. 908 were created, issued to the Appellant, and then redeemed for the following purposes:

(i) to permit the removal of $4.9 million from Co. 908 without paying any dividends on the common or Class A shares of Co. 908;

(ii) to reduce the fair market value of the common and Class A shares of Co. 908 by such removal of $4.9 million;

(iii) to avoid any reduction in the ACB of the common and Class A shares of Co. 908 held by the Appellant;

(iv) to permit the realization of a loss by the Appellant upon the disposition of the common and Class A shares of Co. 908; and

(v) to avoid any reduction of such loss for income tax purposes by the operation of subsection 112(3) of the Income Tax Act.

There is no doubt that the use of the Class B shares of Co. 908 has permitted the Appellant to receive $4.9 million from Co. 908 on a tax-free basis (through the application of subsections 83(2) and 112(1)), and has avoided the application of subsection 112(3) to reduce any loss “otherwise determined” upon the Appellant’s disposition of the common and Class A shares in Co. 908. Does the use of the Class B shares of Co. 908 together with the subsequent disposition of the common and Class A shares of Co. 908 bring the Appellant within the ambit of subsection 55(1)? I will repeat what I regard as the most relevant words of subsection 55(1):

55(1)

...where the result of one or more sales, ... or other transactions of any kind whatever is that a taxpayer has disposed of property under circumstances such that he may reasonably be considered to have artificially or unduly

(a)

(b) created a loss from the disposition

(c) ...

the taxpayer’s ... loss ... from the disposition of the property shall be computed as if such ... creation ... had not occurred.

The use of the Class B shares alone did not provide the Appellant with a loss of any kind. The Appellant had to make the actual arm’s length sale of the common and Class A shares of Co. 908 on February 1, 1988 for the nominal sum of $100 in order to realize a loss. Having realized a capital loss exceeding $1,000,000, the Appellant claimed an ABIL; and the parties appear to agree that, if the Appellant is entitled to deduct any amount as part of an ABIL, the quantum of that ABIL is $791,415.

If the Class B shares had never been created, the Appellant could have sold the common and Class A shares of Co. 908 in February 1987 for approximately $4.9 million. After deducting the Appellant’s ACB of $1.9 million, the Appellant would have realized a capital gain of approximately $3.0 million. That did not happen. The transactions described above reduced the fair market value of the common and Class A shares of Co. 908 to approximately $100; and they were sold for that sum on February 1, 1988. The Appellant’s ACB of $1.9 million caused the Appellant to realize a capital loss exceeding $1,000,000.

Having regard to the words of subsection 55(1), I am satisfied that the actions of the Appellant and Co. 908 in creating, subscribing for, issuing and redeeming the Class B shares were “transactions of any kind whatever”. Also, the Appellant’s arm’s length sale for $100 on February 1, 1988 was a transaction. Therefore, the Appellant is brought within the opening words of paragraph 55(1 )(Z?) in the sense that:

the result of one or more transactions is that the Appellant has disposed of the common and Class A shares of Co. 908 under circumstances such that the Appellant may reasonably be considered to have created a loss from the disposition.

The critical question is whether the Appellant may reasonably be considered to have “artificially or unduly” created the loss. In Nova Corp. of Alberta v. R. (1997), 97 D.T.C. 5229 (Fed. C.A.), the Federal Court of Appeal decided that subsection 55(1) did not apply to certain capital losses of the corporate taxpayer. Delivering the judgment for the majority, McDonald J.A. stated at page 5236:

Subsection 55(1) is not a broad anti-avoidance provision. It’s scope cannot be expanded beyond its plain meaning where there is no ambiguity. A plain reading of the provision indicates that it required some action on the part of the taxpayer in order for it to apply. That is, the taxpayer must actually do something to affect his loss on disposition of the property. As I have explained, this entails affecting either the ACB or the proceeds of disposition. In this case, the taxpayer did nothing to affect those figures. The ACB’s of the shares were inherited by the taxpayer, and the shares were disposed of for their market value, which was nothing. The losses claimed by the taxpayer came about through the inheritance of ACB’s and this inheritance came about through operation of the Act. The taxpayer did nothing but avail himself of the provisions as they then existed.

If the taxpayer “must actually do something to affect his loss”, then I would conclude without any doubt that the Appellant herein did something to affect its loss. It removed $4.9 million from Co. 908 for the sole purpose of reducing the fair market value of the common and Class A shares of Co. 908 (all held by the Appellant) from $4.9 million to the nominal sum of $100. In terms of realizing a loss on the disposition of the common and Class A shares, the Appellant did nothing to change its ACB of those shares but it did something truly significant to change the fair market value and the resulting proceeds of disposition on the sale of those shares.

In Nova, the corporate taxpayer paid $1,237,500 in an arm’s length transaction to purchase the sole share of Co. 842 whose only asset was a block of shares in Co. A having an ACB of $16,500,000 to Co. 842 and a fair market value of almost nil. Upon the dissolution of Co. 842, Nova acquired the block of shares in Co. A and “inherited” from Co. 842 the ACB of $16,500,000. The high ACB of the block of shares in Co. A was inherited by Nova through the operation of secrion 88 of the Act. Upon the sale of the block of shares in Co. A, Nova realized a big loss. Nova did not “actually do something” to affect its loss because the ACB and the fair market value of the block of shares in Co. A did not change after Nova came on the scene.

When Nova was decided in this Court ((1995), 95 D.T.C. 599 (T.C.C.)), Rip J. allowed the appeal and also concluded that Nova did not actually do something to affect its loss. Rip J. stated at page 608:

The transfer of adjusted cost base from one tier subsidiary to another tier subsidiary, complained of by respondent’s counsel, took place at the time Carma controlled these subsidiaries. Carma served up the Allarco Preferred Shares to Nova on a fiscally advantaged plate.

Carma took steps to facilitate the transfer of the capital loss in Allarco Preferred Shares to persons with whom it dealt with at arm’s length, including Nova. Nova was not an actor in any transaction leading to 842 acquiring an asset having a low market value and a high adjusted cost base, that is, the Allarco Preferred Shares....

In my opinion, the Appellant actually did something to affect its loss. It subscribed for the Class B shares and then caused Co. 908 (its wholly owned subsidiary) to redeem those shares. Before the Class B shares were issued and redeemed, the fair market value of the common and Class A shares was approximately $4.9 million. After the Class B shares were issued and redeemed, the fair market value of the common and Class A shares was only $100. The facts in this appeal are easily distinguished from the facts in Nova.

Returning to the decision of this Court in Nova, Rip J. stated at page 607:

It is not the transaction or the transactions themselves that are described as artificial in subsection 55(1). The transactions may be and often are real. However if, as a result of the transactions, a taxpayer’s gain from the disposition is reduced or a loss is created from the disposition or the amount of the loss from the disposition is increased, then the taxpayer may be caught by subsection 55(1). In other words it is the loss or increase in the loss that is artificial or undue for subsection 55(1) to apply.

In Spur Oil Ltd. v. R. (1981), 81 D.T.C. 5168 (Fed. C.A.), Heald J. A. delivered judgment for the Federal Court of Appeal allowing the appeal of the corporate taxpayer and declined to apply section 137 of the pre-1972 Income Tax Act. At page 5173, he commented on the words “undue” and “artificial” as follows:

My first comment with respect to this submission would be that the finding of artificiality in the transaction being examined, does not, per se, attract the prohibition set out in subsection 137(1) of the Income Tax Act supra. To be caught by that subsection, the expense or disbursement being impeached must result in an artificial or undue reduction of income. “Undue” when used in this context should be given its dictionary meaning of “excessive”... Turning now to “artificial”, the dictionary meaning when used in this context is, in my view, “simulated” or “fictitious”.

Adopting the view of Rip J. quoted above from Nova, in subsection 55(1) it is not the transactions which may be very real and not artificial but the result (in this appeal a significant loss) flowing from those transactions which must be measured to determine whether that result (loss) was “artificially or unduly” created. Also, adopting the synonyms from Spur Oil, was the loss in this appeal simulated or fictitious or excessive?

On February 1, 1987, the Appellant held common and Class A shares of Co. 908 which had a fair market value of approximately $4.9 million and an ACB to the Appellant of approximately $1.9 million. One year later, on February 1, 1988, the Appellant sold those same common and Class A shares of Co. 908 for $100 which was their fair market value at that time. Looking at those two facts in isolation from all other transactions, the Appellant appears to have suffered a significant loss because its ACB did not change in the intervening 12 months. Did the Appellant, however, really suffer a loss? In actual fact, the Appellant did not suffer any financial or economic loss because, between the above two dates (February 1, 1987 and February 1, 1988), the Appellant had taken $4.9 million from Co. 908 on a tax-free basis; and it was the removal of the $4.9 million which reduced the fair market value of the common and Class A shares to only $100.

I cannot resist the conclusion that the loss created by the Appellant on the disposition of the common and Class A shares of Co. 908 was both artificial and undue. It was artificial (i.e. simulated or fictitious) in the sense that the sale of the common and Class A shares of Co. 908 on February 1, 1988, when joined with the issue and redemption of the Class B shares, did not result in a loss at all but in a significant financial gain to the Appellant. It was undue (i.e. excessive) in the sense that the Appellant was permitted to report a big loss when the Appellant had in fact realized a big gain.

In Central Supply Co. (1972) Ltd. v. R. (1997), 97 D.T.C. 5295 (Fed. C.A.), the Federal Court of Appeal considered the application of subsection 245(1) to certain limited partnerships engaged in financing oil and gas explorations. Linden J.A. delivering the judgment for the majority stated at page 5301:

This Court has, however, reflected on the application of subsection 245(1), most recently in H.M.Q. v. Fording Coal. In applying subsection 245(1) to deductions taken by a taxpayer for cumulative CEE and cumulative Canadian development expense (CDE), Strayer J.A., writing for himself and Décary J.A., set out three factors relevant to the determination of whether a taxpayer has unduly or artificially reduced its income. These were, first, whether the deduction sought is contrary to the object and spirit of the provision in the Act, second, whether the deduction is based on a “transaction or arrangement which is not in accordance with normal business practice”, and third, whether there was a bona fide business purpose for the transaction. Strayer J.A., in conformity with Stubart, was careful to qualify the importance of a bona fide business purpose by stating that, although it "... is not determinative of the artificiality of the deduction”, it “is certainly relevant”.

If those three factors are relevant to determine whether a loss has been artificially or unduly created within the meaning of subsection 55(1), then I am reinforced in my conclusion. The transactions in the Class B shares are contrary to the object and spirit of subsection 55(1) because, in Nova, both McDonald J.A. (for the majority) and Desjardins J.A. (in dissent) stated that subsection 55(1) was an anti-avoidance provision: McDonald J.A. referring to it as “not a broad anti-avoidance provision”. See page 5236. Also, the transactions in the Class B shares were not in accordance with normal business practice. And lastly, there was no bona fide business purpose for the issue and redemption of the Class B shares.

The Respondent pleaded the application of subsection 55(2) of the Act but, in argument, counsel for the Respondent abandoned any attempt to apply that subsection. There is no evidence that the assessments under appeal for 1988 and 1989 were in any way based on the application of subsection 55(2). I will not consider any possible application of that subsection.

In the Respondent’s pleading, it is alleged in paragraph 9 that the Minister of National Revenue assumed certain facts when assessing the taxation years under appeal, including the following facts:

9(e) on February 26, 1987, 434908 consented to the subscription of 4,979

Class B shares by the Appellant contingent on receiving consideration of $.01 per share for a total of $49.79;

9(f) on that same day, the Appellant purported to subscribe for 4,979 Class B shares of 434908;

9(g) no payment was made by the Appellant for the shares in issue;

9(h) on February 26, 1987, 434908 redeemed the 4,979 shares allegedly is-

sued to the Appellant for $4,979,000.00 resulting in deemed dividends pursuant to subsection 84(3) of the Income Tax Act in that same amount;

Because the Minister assumed that the Appellant did not pay the subscription price ($49.79) for the 4,979 Class B shares, the onus was on the Appellant to prove that it had paid. To discharge that onus, the Appellant called as a witness Joan Phillips, a professional accountant who carried on a public practice during the 1980s. Commencing in May 1986, she took over all the bookkeeping and accounting for the Appellant’s group of companies none of which were operating at that time because the business and its assets had been sold in October 1985. She was aware of the plan which had been developed by lawyers and a national accounting firm for the Appellant and its companies to minimize the taxes to be paid following the sale of the business, but she was not responsible for the execution of that plan.

On the simple question of whether the Appellant paid $49.79 for the Class B shares, there is no easy answer. Specifically, there was no cheque issued by the Appellant to Co. 908 on or about February 26, 1987 in the amount of $49.79 (or any similar amount) which can be identified as payment for the Class B shares. Nor was there any cash deposit of $49.79 in the bank account of Co. 908 on or about February 26, 1987 with a corresponding receipt to the Appellant. In my view, this was a serious oversight. When a taxpayer acting on sophisticated advice embarks upon a series of commercial or corporate transactions to achieve a beneficial tax result, it is important that all transactions be well documented and that essential transactions be verified with appropriate documentation. In Friedberg v. R. (1991), 92 D.T.C. 6031 (Fed. C.A.), Linden J.A. stated at page 6032: “In tax law, form matters”. I should have thought that the Appellant would be anxious to be able to prove its payment for the Class B shares when those shares were the cornerstone for removing $4.9 million from Co. 908.

The evidence of Joan Phillips with respect to payment for the Class B shares was certainly not conclusive. In a document headed “General Ledger Listing” (part of Exhibit R-46), she identified cheque no. 2000 issued by the Appellant to Co. 908 on February 25, 1987 in the amount of $830,727.63. That cheque was deposited in the bank account of Co. 908 on March 2, 1987. Ms. Phillips stated that there were many inter-corporate loans between and among the Appellant and the other six or seven companies in the group (including Co. 908) and, from time to time, some of the loans would be “cleared” by issuing one big cheque. Cheque no. 2000 was such a clearing event. She thinks that the amount of $49.79 was one of the many components making up the global amount of $830,727.63 but she did not have any working papers or other documents which would permit her to identify the components of that global amount.

The Respondent called as a witness John Bradley, an auditor employed by Revenue Canada. He was asked by the Tax Avoidance Section in the London District Office of Revenue Canada to do a special audit of the Appellant and Co. 908 only with respect to payment for the Class B shares. He interviewed Joan Phillips and prepared a questionnaire (Exhibit R-46) asking for documentation to prove that the Appellant had paid $49.79 for the Class B shares. Joan Phillips signed Exhibit R-46 on or about August 1, 1989 stating:

In February of 1987 - 216663 Ontario Ltd. issued a cheque to 434908 Ontario Inc. for $830,727.63. Included in this cheque was the $49.79 for the purchase of 4979 class B shares. The assets of 434908 Ontario Inc. were subsequently transferred to 216663 Ontario Ltd. when these shares were redeemed.

I have no specific cheque or entry showing this amount.

If she did not have a “specified cheque or entry” in August 1989 when she was much closer in time to the actual transaction of February 26, 1987, I conclude that she was hypothesizing that the amount $49.79 must have been part of the cheque no. 2000. Also, if 66 of the Class B shares were redeemed after March 31, 1987 (see paragraph 8 above), then the financial statements of Co. 908 at March 31, 1987 should have shown some paid-up capital with resepct to the Class B shares. Ms. Phillips stated that payment for the Class B shares may have been effected only by a journal entry because she thought they were all issued and redeemed within two days.

Mr. Bradley’s own audit is more damaging to the Appellant’s claim that it paid for the Class B shares. On page six of Exhibit R-46, he performed an analysis of the inter-corporate account for the Appellant’s group of companies. He said that the inter-corporate account was like a separate entity - something like a bank for the corporate group. On January 31, 1987, Co. 908 was owed $5,105,922 by the inter-corporate account. On page three of Exhibit R-46, he attempts to reconcile the amount ($5,105,922) receivable by Co. 908. He adds four amounts from page six to make a total of $4,118,304 (including cheque no. 2000 for $830,727). When that total is subtracted from the Co. 908 receivable of $5,105,922, the balance on page three of $987,618 is close to the entry of $987,355 shown on page six as the net Co. 908 receivable at February 28, 1987. The difference of only $262 ($987,618 minus $987,355) could be the item in brackets on page six which Mr. Bradley did not carry over to page three. In any event, Mr. Bradley concluded that the big payment of $830,727 (which the Appellant claims contained the critical amount of $49.79 for shares purchased on February 26, 1987) dated back to the Co. 908 receivable of $5,105,922 from the inter-corporate account as at January 31, 1987 and was not connected in any way with the Class B shares. I find that Mr. Bradley’s audit was thorough, and that his analysis and evidence are compelling.

I strongly favour the evidence of Mr. Bradley over the evidence of Ms. Phillips. If it were necessary, I would find that the Appellant did not pay for the Class B shares. Counsel for the Respondent was not able to explain how such a finding would assist his client even though his pleading had challenged the Appellant to prove that it had paid for the Class B shares.

The Minister does not appear to have assessed on the basis that the Class B shares were not validly issued. For example, there is no evidence that the Minister used subsection 15(1) of the Act (an appropriation by a shareholder) to add an amount to the Appellant’s reported income for any year with respect to the purported redemption of the Class B shares if those shares were not validly issued. Indeed, the Appellant reported the deemed dividends which it thought it received on the redemption of the Class B shares; and the Minister’s only response in the assessments under appeal was to deny the deduction of any ABIL resulting from the disposition of the common and Class A shares of Co. 908.

It is clear from the evidence that the Appellant caused Co. 908 to pay $4.9 million to the Appellant either by redeeming Class B shares validly issued or by some other route, and that such payment reduced the fair market value of the common and Class A shares of Co. 908. I have applied subsection 55(1) to support the assessments under appeal. In the absence of any reason to pursue the question of whether the Appellant paid for the Class B shares, I do not propose to consider the consequences of the Appellant’s failure to pay for the Class B shares or whether such failure could be remedied by the corporate jurisprudence cited by counsel for the Appellant. The appeals for the 1988 and 1989 taxation years are dismissed, with costs.

Appeal dismissed.