Arpin v. R., [1975] C.T.C. 348, 75 D.T.C. 5259

Smith, DJ:

1 This is an appeal by way of trial de novo by the plaintiff from a decision of the Tax Review Board dismissing an appeal from a decision of the Minister disallowing a deduction of $22,789.15 claimed by the plaintiff from his income for the 1970 taxation year.

2 The facts are not in dispute. At the opening of the trial the parties filed an agreed statement of facts, reading as follows:

The parties hereto by their respective solicitors admit the following facts, provided that the admission is made for the purpose of this action only and may not be used against either party on any other occasion, and provided further that the parties may adduce further and other evidence relevant to the issues and not inconsistent wit this agreement.

1. At all material times the Plaintiff was a partner in a law firm, practising in Winnipeg, Manitoba.

2. During the 1970 taxation year the net income of the Plaintiff from his practice of law was $26,832.24.

3. At all material times the Plaintiff was the sole beneficial owner of all the issued shares of Acadian Investments Ltd., a private company.

4. During its 1970 taxation year, Acadian Investments Ltd was a personal corporation within the meaning of section 68 of the Income Tax Act.

5. During its 1970 taxation year, Acadian Investments Ltd engaged in no activities other than the rental of real property.

6. At all material times Acadian Investments Limited had only one rental asset, a leasehold interest in one parcel of real property consisting of land and the building erected thereon.

7. In its 1970 taxation year, Acadian Investments Ltd incurred a net loss of $22,789.15.

8. In filing his 1970 return of income, the Plaintiff claimed as a deduction from his income the said net loss of Acadian Investments Ltd in the amount of $22,789.15.

9. In assessing the Plaintiff for his 1970 taxation year, the Minister of National Revenue disallowed the deduction by the Plaintiff, of the net loss of Acadian Investments Ltd.

DATED at Winnipeg, this 25th day of March, 1975.

“D S Thorson”

PP J A Weinstein

D S Thorson

Deputy Attorney General of Canada

Ottawa, Ontario.

3 No other documents were filed and no witnesses were called to give viva voce evidence.

4 The plaintiff is a highly competent barrister and Queen's Counsel of long experience. He argued his own case with all his usual skill, force and logic, resulting in considerable persuasive effect. He did not cite any judicial decisions in support of his argument, but relied on his interpretation of certain sections of the Income Tax Act and on an attractive argument for fairness and justice in the application of the law.

5 The plaintiff pointed out that Acadian Investments Ltd was a private company, a personal corporation, of which he held all the capital shares except directors' qualifying shares, and that he alone planned and carried out everything that was done in the corporation's business, viz: the rental of real estate. He contended that if, instead of setting up the company, Acadian Investments Ltd, he had carried on the real estate rental business personally, on his own account, he would unquestionably have been entitled to set off the losses incurred in that business against the profits earned by him in the practice of law in the same taxation year, and that as he, being the only shareholder, was the only person who could gain or lose from the company's operations, there was no good reason why the interposition of the company should have an adverse effect upon his taxation rights. Further, to hold that it did entail such an adverse effect would be most unfair and unjust to him.

6 This argument has a good deal of appeal, but certain facts must be looked at. As the plaintiff himself stated, Acadian Investments Ltd was formed for the very common purpose, inter alia, of protecting the plaintiff against liability for debts that might be incurred by the rental business, beyond the amount of his investment in shares of the company. But as has been stated by judges in a number of cases, a step of this kind, designed to afford protection against excessive loss, may produce other results that are not beneficial to the incorporater.

7 The plaintiff's argument suggests some reliance on what has sometimes been called the alter ego theory, viz: that a corporation which has in reality only one shareholder who conducts all the corporation's business, is simply the alter ego of that shareholder. With that theory I do not agree. At least since the leading case of Salomon v. Salomon, [1897] 2 A.C. 22, it has been clearly established that a corporation once formed is a legal person separate and distinct from the person or persons who had it brought into existence. This is true whether the corporation has one shareholder or a thousand. The company's assets are owned by itself, not by the shareholders. Nor do the shareholders own the company, they merely own shares of stock that have been issued by the company.

8 Further, a corporation is not an agent for its shareholders, even if there is only one shareholder. However, the converse may be true. It must be remembered that a corporation being a notional thing, recognized by the law as a legal person, but without any human or physical existence, can act only through agents. Thus where one man holds all the shares of a company (except a couple of directors' qualifying shares) he may, as director, president, manager or by virtue of the company's by-laws, be the only person entitled to act as an agent for the company. But the company is not his agent.

9 Next, it must be remembered that there is no legal obligation upon a sovereign legislature to act fairly in enacting laws. Whatever intention such a legislature has expressed in a statute is the law, though legislatures generally act in a manner intended to be fair to people in respect of their persons and property. Similarly courts, in applying a statutory provision, seek to find such an intention to be fair, if the rules of interpretation properly so admit, but always bearing in mind that plain clear words must be given their ordinary meaning, unless the statute contains a clear indication that something else is intended.

10 The question for determination is thus: what did the Parliament of Canada intend in the Income Tax Act, as it stood in the 1970 taxation year, concerning the income and taxation of personal corporations, with particular reference to the meaning of “income”, “profits” and “dividend”? The intention of Parliament is of course to be found in the words of the Act.

11 The word “income” appears many times in the Act, and apparently not always with precisely the same meaning. The plaintiff submits that the word means not only gain or profit but also includes what he calls “negative income” or loss. This is not an impossible conception of “income” but we have in section 4 of the Act the following definition:

4. Subject to the other provisions of this Part, income for a taxation year from a business or property is the profit therefrom for the year.

12 This definition clearly identifies income with profit, except where some other provision in Part I of the Act indicates that a different meaning is intended. The plaintiff did not argue that “profit” includes “loss”, with which it is normally contrasted, and in my view it would require very clear wording in a statute to indicate that in a particular expression “profit” was intended to include “loss”.

13 The Tax Review Board attached decisive weight to subsection 67(1) of the Income Tax Act, which at the relevant date read as follows:

67. (1) The income of a personal corporation whether actually distributed or not shall be deemed to have been distributed to, and received by, the shareholders as a dividend on the last day of each taxation year of the corporation.

14 The terms of this subsection point up important differences between a personal corporation and its shareholders on the one hand and an ordinary (public or private) corporation and its shareholders on the other. All of the income of a personal corporation is deemed to have been distributed to its shareholders, and the amounts so deemed to have been received form part of the incomes of those shareholders who are accordingly assessed for income tax thereon. By subsection 67(2) a personal corporation is not itself liable to pay income tax, and by subsection (3) the distribution of the corporation's income is not proportional simply to the proportion of the shares held by each shareholder, but is proportional to the portion of the total investment made by each shareholder, including, eg the amount of any loans made by a shareholder to the corporation.

15 In an ordinary public or private corporation dividends are declared by the directors and only then are they paid. Only then are the shareholders entitled to receive them. For common shares there is normally no requirement that dividends shall be paid, even though the company has earned substantial profits. The directors may decide that no dividend shall be paid in a particular year, or that a dividend equal to part or all of the profits shall be paid. The corporation is liable to pay income tax on its income and the shareholders are only taxable on the amount of the dividend received by each of them, as part of their income for the year. Dividends, when declared, are for an equal amount on each share of the same class.

16 Dividends can only be paid out of profits. If a company has not earned any profits in a particular year no dividends can be paid for that year unless the company has on hand profits from a previous period which have not been distributed to the shareholders. Where a company sustains a loss in a particular year and has no reserve of profits from previous years, there is no distribution of the loss among the shareholders. The situation is simply that the company has suffered a loss of capital.

17 It must be remembered that the profits earned by a company are its profits, not profits of the shareholders, and similarly the losses sustained by a company are its losses, not losses of the shareholders. What happens when income of a corporation is distributed to its shareholders by way of dividend is that part or all of the company's profits are transferred to the shareholders, proportionately to their respective shareholdings. This involves a reduction in the company's assets. Logically, if company losses were distributed to the shareholders there would be a transfer of these losses from the company to the shareholders, which in turn would involve a decrease in the company's liabilities or an increase in its assets. Logically again, such a decrease in the company's liabilities or increase in its assets, arising from the transfer of losses to the shareholders, would require that the shareholders become liable to pay to the company, proportionately to their respective shareholdings, the amount of the losses so transferred. Otherwise there would not be a transfer of the losses and the company would still be saddled with them.

18 A result of this kind would run completely contrary to a fundamental feature of a limited company, ie that shareholders are liable only for the amount of their subscription for shares and that once his shares have been paid for in full a shareholder has no further liability either to the company or its creditors. Any such radical change in fundamental company law and the rights of shareholders, if it were ever intended by Parliament, would, in my view, require very clear language expressing that intent.

19 Is the situation just described different when the company is a personal corporation? In my opinion it is not. In the case of a personal corporation also, such a radical departure from the rules of company law, imposing a liability on shareholders to make up company losses, would require a very clear expression of an intention to that effect in the statute.

20 The fact that if, contrary to my view, subsection 67(1) were intended to direct the distribution and receipt, or transfer, of company losses to the shareholders, the transfer would not be actual but only deemed to have occurred; the situation would not be altered. The concept of transferring company losses to the shareholders would still be involved, with its radical change in fundamental company law.

21 This brings me to a brief examination of the effect of subsection 67(1) of the Income Tax Act. Even assuming for this purpose that the term “income”, in some sections of the Act, includes or may include negative as well as positive income, can it properly be interpreted in this double sense in subsection 67(1)? The critical words are: “The income ... shall be deemed to have been distributed to, and received by, the shareholders as a dividend ...”.

22 The plaintiff submits that the Income Tax Act ignores the existence of the personal corporation and treats it as if it was simply the alter ego of the shareholders, in this case himself as the sole shareholder. In so far as distribution of the company's income is concerned, there is some support for this submission in subsection 67(1), also in subsections (2) and (3) of that section and in section 68. But nowhere do I find any reference to a distribution of losses among the shareholders. Again, how is part of a personal corporation's “loss” received by a shareholder? When he receives part of a company's profits as a dividend he receives money or money's worth. Conversely, in my view, as indicated above, if he can be said to receive a part of the com pany's losses the effect would be that he would become liable to pay to the company the amount of the loss received by him. Nothing in the Act indicates that anything of this sort happens.

23 In my view the submission that Acadian Investments Ltd was only another name for the plaintiff, his alter ego, is not correct. The sections of the Act which suggest the possibility that it may be correct, particularly subsection 67(1), are limited in their effect. The separate legal personality of the corporation is not destroyed, though some of the rules affecting corporate income tax are altered.

24 The plaintiff submits that the words “as a dividend” in the phrase “distributed to, and received by, the shareholders as a dividend” do not refer to a true dividend, but mean only “in the same manner as a dividend”, or alternatively “as if it were a dividend”. In my opinion this interpretation involves a straining of language that in this instance is not permissible. In the first place the words “as a dividend” have a clear, simple grammatical meaning, which by the first rule of interpretation should be given their ordinary meaning, unless it is clear from the context or some other provision in the statute that something else is intended. I can find no indication of such an intention.

25 Secondly, the wording of several of the subsections of section 67 clearly indicate that an actual or true dividend is meant. For example, (1) subsection (10) begins:

(10) Where a dividend is deemed by this section to have been received from a personal corporation ..., the person by whom the dividend is so deemed to have been received ... that portion of the dividend that he is so deemed to have received ...

(a) the income of the personal corporation (from which the dividend is so deemed to have been received) ...

26 In neither of subsections (10) and (11) is there any suggestion that the words “a dividend deemed to have been received” intend by the word “dividend” anything other than the ordinary meaning of that word, viz a distribution to shareholders or to a shareholder out of the profits.

27 Another subsection, subsection (12) should be referred to. It reads:

(12) The shareholder by whom a personal corporation is controlled shall file with the return of his income for each taxation year a statement of the assets, liabilities and income of the personal corporation for the year and if he fails to file such a statement for a year there may be included in his income for that year double the amount of the part of the income of the corporation for the year that under this section is deemed to have been received by him.

28 The latter part of this subsection is obviously a penalty provision. It is clear that in it the word “income” means “positive” not “negative income”. If it included “negative income”, it would mean that a con trolling shareholder of a personal corporation who failed in any taxation year to file with his income return, a statement showing the negative income or loss for that year of the personal corporation might receive a deduction in his income for that year of double the amount of the part of the negative income or loss of the corporation for the year that he “was deemed to have received”. I cannot imagine a penalty section being designed to confer a taxation benefit of this sort.

29 In the result, after giving this matter the fullest and most careful consideration, the only conclusion I can come to is that the appeal must be dismissed. This result may seem unfair to the plaintiff, but in my view the relevant provisions of the Income Tax Act leave me no reasonable ground on which to base a contrary conclusion. The remedy, if one is desired, lies in the hands of Parliament, not of the courts.

30 No costs are allowed to either party.