7 April 1991 Income Tax Severed Letter - Redemption of Preferred Shares

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Subject: XXX Redemption of Preferred Shares

The purpose of this memorandum is to respond to your memorandum of March 25, 1991 in respect of the above matter. This memorandum is a supplement to our memorandum dated February 20, 1991 on file 7-903320, and is premised on the same recitation of facts as set forth in that earlier memorandum.

Issues

In this memorandum we propose to discuss two issues, as follows:

• 1. What is the scope of subsection of 16(3) of the Canada Business Corporations Act (the "CBCA") as it pertains to the facts of this situation?
• 2. What are the parameters within which a transaction may be documented after its purported effective date?

Issue 1: Scope of Subsection 16(3) of the CBCA

Subsection 16(3) of the CBCA reads as follows:

No act of a corporation, including any transfer of property to or by a corporation, is invalid by reason only that the act or transfer is contrary to its articles or this Act.

It is our view that this subsection may have either a narrow interpretation or a broad interpretation. We will analyze these two interpretations in the context of an example in which a corporation purports to pay a dividend in kind by transferring certain properties to its shareholder, but without the directors having passed the requisite resolution to approve the dividend, as impliedly required by subsection 102(1) of the CBCA.

Pursuant to the narrow interpretation, subsection 16(3) does nothing more than to ??? the intended effect ??? result of the impugned transaction, without having any impact on the procedural nature or character of the transaction. In the context of the example, subsection 16(3), narrowly construed, provides that the effect or result of the transaction is to convey ownership of the properties from the corporation to the shareholder, such that the shareholder, and not the corporation, is thereafter the legal and beneficial owner thereof. However, subsection 16(3), according to this interpretation, has no application in determining whether the properties have been transferred by means of a dividend or by some other means. Thus, insofar as the income tax consequences of the transaction are concerned, subsection 16(3) does not assist in determining whether the shareholder should be taxed under subsection 82(1) of the Income Tax Act (Canada) (the "Act") as having received a dividend or under subsection 15(1) of the ITA as having received a benefit.

Pursuant to the broad interpretation, not only does subsection 16(3) validate the intended effect or result of the impugned transaction, but it also validates the means or procedure whereby it was intended that such effect or result should be obtained. Thus, in the example, the subsection provides that title to the properties passes to the shareholder pursuant to a dividend, and not pursuant to some other form of transaction, such as the conferral of a benefit. Accordingly, subsection 16(3), if broadly construed, may have an impact on the characterization of the income tax consequences of the particular transaction.

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We have been unable to find any judicial or academic authority as to the scope of subsection 16(3) of the CBCA; therefore, we are not in a position to ??? a preference between the narrow and broad interpretations. Since the proper interpretation of subsection 16(3) is a question of law, you may wish to consult with Legal Services in respect of this issue.

Issue 2: Ex Post Facto Remedial Documentation

During our telephone conversations on March 21 and 22, 1991 you requested that we provide you with a few additional comments in respect of XXX

Concerning the ex post facto documentation of a transaction, David W. Ross states the following at page 1567 of "Retrospectivity: The Income Tax Act and the Time Machine," (1988) 36 CTJ 1567:

Agreements are commonly backdated to a time prior to their execution and delivery. Backdating is usually justified on the grounds that the document reflects an oral agreement or letter of intent that was reached earlier. Although this justification has some merit, caution must always be exercised.

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As stated in the Wood case, which was cited on page 8 or our memorandum of February 20, 1991, a corporation and its shareholder are not entitled, for income tax purposes, to rewrite history or to treat imaginary events as having happened.

In a similar vein, the following was stated in Herbacz v. MNR (1956) [14 Tax A.B.C. 241] 14 Tax ABC 241 at 243, a case in which a taxpayer was attempting to correct, after the fact, a mistake that had been made in recording a particular payment:

Unfortunately for the appellant, the matter became a fait accompli a considerable time age. It is not within the Board's power to treat a transaction as having been effected in a particular way when, actually, it was performed in an altogether different way.

The above statement was quoted with approval in ??? v. MNR [[1984] C.T.C. 2354] [1984] CTC 2354 at 2356 (TCC).

In Adam v. MNR [[1985] 2 C.T.C. 2383] [1985] 2 CTC 2383 (TCC) the court considered a situation in which a closely held corporation had, throughout most of a particular year, made weekly salary payments to its president, who was also the majority shareholder. Near the end of the year the corporation purported to reverse the salary payments and to treat such payments as dividends. At pages 2384 and 2385 the court stated:

The salary, once received, cannot for tax purposes become anything else. Mr Adam cannot by any "ex post facto" act alter the destination of the moneys, or the purpose for which they were paid to him and received by him. ... An adjustment to the books of account of a taxpayer cannot render null that which has transpired. Past events cannot be ignored. ...

... no taxpayer has the right to retroactively alter events when it best suits his purposes. ...

The case of D'Astous et al. v. MNR [[1985] 2 C.T.C. 2086] [1985] 2 CTC 2086 (TCC) may have particular relevance to the present situation. In that case Pierre D'Astous, the president and principal shareholder of a corporation, desired and intended, in his personal capacity, to make a loan of $43,000 to his son, Bertrand D'Astous, who was a minority shareholder of the corporation; however, the cheque whereby the loan was advanced was drawn on the account of the corporation. Approximately six months after the loan had been advanced, Pierre and Bertrand executed a notarized document in which Bertrand acknowledged that he owed $43,000 to Pierre. The issue before the court was whether the loan should be included, under subsection 15(2), in the income of Pierre or Bertrand. In holding that the corporation had made a loan to Bertrand, and not to Pierre, the court stated at pages 2088 and 2089:

Whether Chateauneuf Construction Ltee made a $43,000 loan in 1976 to Bertrand D'Astous or to his father Pierre D'Astous should be determined, in my opinion, by bearing in mind the father's intentions and the agreement between Bertrand (the son) and him at the time the loan was made. ...

There is absolutely no doubt that Pierre D'Astous wanted to lend $43,000 to Bertrand in 1976. ...

Neither Pierre nor Bertrand D'Astous could change the names of the parties to the agreement six months after the transaction. ...

... even though in February 1976 Pierre D'Astous had intended to personally lend the $43,000 to his son, that is not what happened either in fact or in law, and the acknowledgement of debt signed subsequently cannot change anything.

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Summary

To summarize the foregoing, it is our view, subject to the comments made below under the heading "Transactions Involving Corporations," that a transaction may, for income tax purposes, properly be documented after the fact where the parties actually agreed, understood or resolved that the transaction would occur in a particular manner, but not where such agreement, understanding or resolution was only reached or passed after the hoped-for effective time of the transaction.

Transactions Involving Corporations

It is possible that the principle summarized above may not apply to a transaction (not documented in timely manner) to which a corporation is a party. Where a corporation is involved in a transaction, there is some authority to suggest that a greater degree of formality is required than where only individuals are parties to the transaction. In Abrahams v. MNR [[1966] C.T.C. 694] [1966] CTC 694 (Exch) the following was stated at pages 708-709:

While, as against third parties, the intent of a closely held company is to be judged by the acts of those who are in charge of its affairs and the Court is bound to assume that the owner of all the shares of a company who purports to act on its behalf has taken the necessary steps to give himself the authority he purports to have, when it is a question of establishing, as between such a person and third parties, that he has entered into a contract with a company all of whose shares belong to him, in my view, evidence is required to establish that there has in fact been a formulation and expression of the intent of the company, which is not, after all, a person of flesh and blood having a mind of its own, in one of the modes contemplated by the law, namely, a resolution of the board of directors or an act of an officer, servant or agent of the company acting in the course of employment or of the agency.

In Taylor v. MNR [[1987] 2 C.T.C. 2178] [1987] 2 CTC 2178 (TCC) the following was stated at page 2185:

In a small corporation, the absence of registration [i.e., documentation] of a decision is very often without consequence. If a registration of the decision is required, it is done retroactively.

Then, indeed, all the interested parties are shareholders who have common interests.

It is different, however, when a third party is involved in the transaction. ...

[Quoting from The Queen v. Neudorf [[1975] C.T.C. 192] [1975] CTC 192 at 196 (FCTD)):

... since one of the parties to the arrangement was a corporation, there is more formality required such as corporate resolutions, for example) than in the case of individuals and particularly where the details of a relationship are important as against third persons such as the Revenue.

In Cayer v. MNR [[1990] 1 C.T.C. 2562] [1990] 1 CTC 2562 (TCC) counsel for the taxpayer argued that where closely related companies are involved, the intention of the majority shareholder (who is also a director) should be sufficient to cause the companies to act. The court rejected this argument, stating the following at pages 2565-2566:

I have difficulty with the counsel's submission. In my view, even in, perhaps particularly in, closely related companies involving shareholders, transactions that may affect third parties should be authorized or confirmed in writing from the outset. ... [Quoting from Barnes v. MNR [[1986] 2 C.T.C. 2079] [1986] 2 CTC 2079 at 2082]:

The role of the Court is to base its judgment on the transaction as it occurred and not on what the taxpayer chose to report a few months after everything was completed. ... I would not like to leave the impression that the Court condones situations where documents relating to a transaction, especially in cases where a corporate entity is involved, are filled out much after the pertinent events. ...

[Quoting from Gannon v. MNR [[1988] 1 C.T.C. 2422] [1988] 1 CTC 2422 at 2424]:

An agreement between a company and its shareholder is not formed by a mere fleeting thought in the mind of the individual who controls it.

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Evidentiary Considerations

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If you have any questions in respect to this matter, we would be please to discuss them with you.