Re the Estate of the Late Helen Gertrude Fleck, Deceased., [1952] CTC 196, [1952] DTC 1050

HOGG, J. A.:—Mrs. Helen Gertrude Fleck, late of the City of Ottawa, widow, died on the 19th June 1941, and probate of her last will and testament was granted by the Surrogate Court of the County of Carleton on the 26th December 1941, to Mr. John Gordon Fleck, of the said City of Ottawa, and Mr. Bryce Walker Fleck, of the City of Vancouver in the Province of British Columbia, as executors and trustees of her will.

Certain questions having arisen respecting the administration of the trust property in the hands of the executors and trustees, this application has been made by them for the advice and direction of the Court, pursuant to Section 59 of The Trustee Act and Rule 600 of the Rules of Court.

The question propounded is as follows:

“Does the Twenty Thousand Dollars ($20,000.00) representing the proceeds payable to the Executors and Trustees of the Estate of Holen Gertrude Fleck, deceased, on the redemption of two hundred (200) preferred shares, being part of the redemption of one thousand (1,000) preferred shares of Booth Lumber Limited issued by way of stock dividend out of the tax paid undistributed income of the company following an election by the company to exercise rights under Section 95A(1) of the Income Tax Act, S.C. 1948, Chapter 52, constitute income or capital in the hands of the Trustees?”

The Booth Lumber Company Limited, hereinafter called ‘‘the Company’’, is a private company incorporated under the laws of the Dominion of Canada, and having its head office in the Province of Quebec. The authorized capital of the company consists of 30,000 common shares without par value and 15,000 redeemable preferred shares of the value of $100.00 each. All of the common shares have been issued as fully paid-up. Following the incorporation and organization of the Company in 1943 and up to 31st December 1949, the Company accumulated as distributable surplus the sum of $606,488.60.

The directors of the Company, by resolution dated the 5th December 1950, determined to invoke the provisions of Section 95A(1) of the Income Tax Act, Dominion Statutes 1948, chapter 52, and amendments thereto. This resolution reads as follows :—

“IT WAS RESOLVED

“(a) Whereas the Company had on hand $606,488.60 undistributed income as at the end of the 1949 taxation year of the Company.

“(b) And whereas the only dividends that have been paid by the Company since commencement of business in 1943 amounted to $60,000.00 in 1950.

“(c) And whereas under the existing provisions of The Income Tax Act the Company may, by paying a special tax of 15% of the amount of its undistributed income as at the end of its 1949 taxation year (December 31, 1949) have the balance of such undistributed income rank as tax paid undistributed income, and may thereupon distribute the said tax paid undistributed income in the form of redeemable shares which will be tax free to the shareholders, and may thereafter redeem the said shares subject to the provisions of the Companies Act;

“(d) And whereas the Company may, after first paying the aforesaid special tax in respect of its undistributed income as at December 31, 1949, pay a like special tax on that portion of income earned in 1950 and subsequent years that is equivalent to the amount of ordinary dividends paid in such years and thereby have the balance of said portion of income rank as tax paid undistributed income which may thereupon be distributed in the form of redeemable shares tax free to the shareholders and be thereafter redeemed subject to the provisions of the Companies Act;

“(e) And whereas the Company’s liquid financial position is strong and it desires to distribute its income to the shareholders in the form that will cost them the least in income taxes.

that the directors of Booth Lumber Limited hereby elect to have the Company pay tax on its undistributed income on hand at December 31, 1949, in accordance with subsection 1 of Section 95A of the Income Tax Act".

The Company paid a tax on the above-mentioned undistributed income, of 15% of the total sum, leaving in the hands of the Company a balance in the amount of $515,386.84. Pursuant to By-law 6 of the Company which authorizes the issue of a stock dividend, a resolution of the 28th November, 1951, provided for the issue, and there was issued 1,000 non-cumulative redeemable preferred 5% shares of the Company of the par value of $100.00 each on the basis of 1 preferred share for each 30 common shares held by a shareholder of record 28th November 1951. This resolution is as follows:

“WHEREAS the company has on hand the amount of $515,386.84 as tax paid undistributed income; AND WHEREAS the company is authorized to issue non-cumulative, redeemable, five per cent preferred shares of the par value of $100 each as a stock dividend ; IT IS RESOLVED that a stock dividend out of said tax paid undistributed income be and the same is hereby declared to be payable to shareholders of the company as of this date in the amount of one preferred share for each 30 shares held by a shareholder’’.

Subsequently, on the same date, the directors of the Company resolved to redeem the 1,000 preferred shares at par. This resolution reads as follows:

“WHEREAS the company has issued, 1,000 non-cumula- tive redeemable, five per cent preferred shares of the par value of $100 each.

"AND WHEREAS the said issued non-cumulative, redeemable, five per cent preferred shares are redeemable at ar ;

“IT IS RESOLVED that the 1,000 issued non-cumulative, redeemable, five per cent preferred shares of the company, being all the issued preferred shares of the company, be redeemed and the Secretary is directed to take such steps as may be requisite to effect the redemption and to execute such documents as may be necessary to effectively redeem the said preferred shares’’.

The trustees of Mrs. Fleck’s estate were the holders of 6,000 common shares of the company, and they received the sum of $20,000.00 upon the redemption of 200 preferred shares issued pursuant to the first resolution of the 28th November 1951, above recited. The affidavit of Mr. George A. Welch, one of the directors of the company, sets out, inter alia, that,—

“14. It was the positive intention of the Directors of the Company that the tax paid undistributed income paid to the shareholders by way of dividend in the form of preferred shares should constitute a payment of income to shareholders rather than a creation of capital and the stock dividend and subsequent redemption of such stock were in fact in lieu of actual cash dividends to take advantage of advantageous tax legislation and representing the cash dividend which would have been declared in the ordinary course of events by the Directors of the Company’’.

The problem presented to the Court upon this application is one of very considerable interest and one which may frequently arise when investments representing a settled trust fund include shares of capital stock of a limited company.

By the terms of the will in question, the residuary estate of the testatrix is placed in the hands of the trustees and after the payment of debts and succession duties and a legacy to charity, is to be divided into three equal shares, the income of which is to be paid to certain of the beneficiaries for life and upon the termination of the life interests, the corpus is to be divided among the persons mentioned, some of such persons being infants or unborn infants. All of the beneficiaries who are sui juris have consented in writing that the $20,000.00 the subject of the resolutions with respect to dividends, passed by the Company, shall be treated as income payable to the life tenants.

Where property is held in trust for successive beneficiaries, the general rule of equity is that the tenant for life is entitled to receive the income. If the trust property consists of shares of capital stock of an incorporated company, the shares themselves will form part of the capital or corpus of the trust. A division of the profits or surplus of a company may be made in the form of a dividend paid in money to the shareholders and is income for purposes of any trust on which the shares are held subject to the terms of the trust instrument. A division of such profits may also be made by giving to each shareholder additional paid-up or partly paid-up shares equivalent to the dividend he would otherwise have got in cash. Such a distribution of profits or surplus is known as a stock dividend and would ordinarily form part of the capital of the Company and augment the corpus of the trust.

A leading case on the subject as to whether a company has distributed its accumulated profits as dividends to be regarded as income in the hands of trustees, or has converted them into capital, thereby increasing the corpus of the trust, is Bouch v. Sproule, [1887], 12 App. Cas. 385, in the House of Lords. The facts, in brief, are that the trustee of the residuary personal estate of a testator held certain shares of a company in trust for the widow of the testator for life, and after her death the shares vested in another beneficiary. The directors of the company, after the testator’s death resolved to distribute certain accumulated profits as a bonus dividend, to allot new shares to each shareholder, and to apply the bonus dividend in part payment of the new shares. It was held that, looking at all the circumstances, the real nature of the transaction was that the company did not pay, or intend to pay, any sum as a dividend, but intended to, and did, appropriate the undivided profits as an increase of the capital stock of the company. The bonus dividend was therefore held to be capital of the testator’s estate, and the life entitled was held not entitled to the bonus or to the new shares. Lord Herschell said at page 398, in discussing the question whether the company had distributed the accumulated profits as a dividend or whether such profits were converted into capital:

“I think we must look both at the substance and form of the transaction. . . . It was obviously contemplated, and was, I think, certain that no money would, in fact, pass from the company to the shareholders, but that the entire sum would remain in their hands as paid-up capital . . . I cannot, therefore, avoid the conclusion that the substance of the whole transaction was, and was intended to be, to convert the undivided profits into paid-up capital upon newly-created shares. ’ ’

Lord Watson, at page 401, said:

“But in a case like the present, where the company has power to determine whether profits reserved, and temporarily devoted to capital purposes, shall be distributed as a dividend or permanently added to its capital, the interest of the life tenant depends, in my opinion, upon the decision of the company. ’ ’

The conclusive test is whether or not the company has increased its capital in the distribution of the surplus profits. This is a question of fact. The real character of the arrangements made by the company in connection with the distribution of profits, that is to say, the substance and not only the form of the transaction, must be taken into account.

A later outstanding case on this subject is that of Hill v. Permanent Trustee Company of New South Wales, Limited, [1930] A.C. 720, the judgment of the Judicial Committee of the Privy Council being delivered by Lord Russell of Killowen. He considered and discussed the case when a limited company, possessing a fund of undivided profits, applied the whole in paying up new shares which are issued and allotted proportionately to the shareholders who would have been entitled to receive the fund if it had been in fact divided and paid away as a dividend. He said that under the circumstances which existed in the case then under consideration:

I A . . . moneys which had been capable of division by the company as profits among its shareholders have ceased for all time to be so divisible, and can never be paid to the shareholders except upon a reduction of capital or in a winding up. The fully paid shares representing them and received by the trustees are therefore received by them as corpus and not as income.”’

Referring to Bouch v. Sproule, supra, Lord Russell said that there it was held that what the shareholders received from the company was an interest in moneys, which had been converted from divisible profits into moneys capitalized and rendered incapable of being divided as profits. The shares, therefore, which were issued to a trustee shareholder and which represented moneys so capitalized, were corpus and not income which would go to the cestui que trust because the company had determined that the profits in question should be permanently added to the company’s capital. He adopted the statement of Eve, J., in In re Bates, [1928] Ch. 682, where that learned Judge said, in speaking of payments made by a company out of distributable profits :

“Unless and until the fund was in fact capitalized it retained its characteristics of distributable profit.”

The principle to be deduced from these judgments is that there must be, in fact, a conversion by the company of its profits or surplus into share capital in order that they shall be regarded as corpus and not income in the hands of a trustee, or as between a life tenant and a remainderman. Furthermore, that where a company has the power to deal with profits by converting them into capital of the company such exercise of its power is binding upon the person interested under a trust of the original shares set up by the testator’s will.

The question here under consideration came before Mr. Justice Middleton in Re Bicknell [1919], 46 O.L.R. 416. He expressed the following opinion:

“If the company has power to declare that its earnings shall be retained and form part of the capital, and does so, then the tenant-for-life is bound and cannot complain; but here the stock was issued in lieu of a dividend on preference shares, and the principle of Zn re Malawi, [1894] 3 Ch. 578 and Re Colville (1918), 144 L.T.J. 327, applies. The new shares in truth represent a dividend declared upon the old, and are therefore income.’’

The subject is also discussed by Hugh Kelly, J., in Re Walker (1931), 40 O.W.N. 202.

In the present instance the preferred shares which were issued in accordance with the resolutions of the Company were redeemable in cash by the Company and were so redeemed at once after their issue was authorized and the money was paid to the trustees. These shares did not form part of the capital of the Company and therefore the surplus profits represented by them were not capitalized. The steps taken by the Company were induced because of the provisions of the Income Tax Act. When redeemable preferred shares are issued pursuant to Section 59 of the Dominion Companies Act, Section 61 provides that the redemption of such shares is not to be deemed a reduction of the paid-up capital stock of the company if such redemption is made according to the conditions stipulated : Masten and Fraser on Company Law, 1941 ed., p. 329. To use the language, in part, of Lord Herschell in Bouch v. Sproule, supra, and applying it to contrary circumstances, it was obviously contemplated and was, I think, certain that no money would in fact remain in the hands of the company as paid-up capital. The substance of the whole transaction and the intention of the company as well as the form or manner in which it was carried out shows that the balance of surplus profits represented by the twenty thousand dollars in question, was not converted into capital by newly-created shares but was distributed as a dividend to the trustee shareholders. The real value and substance of the arrangements were to distribute the surplus profits of the company in the form of money, and they were not dealt with so that, to use the words of Lord Russell in the Hill case, supra, they could ‘‘never be paid to the shareholders except upon a reduction of capital or a winding up’’. The issue of redeemable shares was in the nature of a conduit pipe to convey or transfer the surplus profits accumulated by the company to the pockets of the shareholders as cash. The sum in question received by the trustees as shareholders of the Company is to be held to be income in their hands for the benefit of those entitled to income by the terms of Mrs. Fleck’s will. The costs of all parties should be paid out of the estate, those of the executors as between solicitor and client.