Date: 19980824
Docket: 96-2817-IT-G
BETWEEN:
MEAGER CREEK HOLDINGS LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
O'Connor, J.T.C.C.
[1]This appeal was heard at Vancouver, British Columbia on July 23 and July 24, 1998 pursuant to the General Procedure of this Court.
[2]The issue is whether subsection 55(2) of the Income Tax Act ("Act") was applicable to dividends totalling $1.8 million paid by two wholly owned subsidiaries to their parent corporation in the 1991 fiscal year with the result that the dividends were to be treated as proceeds of disposition on a subsequent sale by the parent of one-third of the shares of the subsidiaries.
[3]Counsel for the Appellant called as witnesses the two principals of the various companies, namely, Kenneth Pickering ("Pickering") and Paul Turner ("Turner") as well as the external accountant for the various companies, Nigel Burridge, C.A. ("Burridge"), one of Burridge's associates, Cheryl Harris ("Harris") and another non-connected chartered accountant, Charles D. Proctor ("Proctor"). Counsel for the Respondent called no witnesses. With the consent of both counsel numerous documents were filed as exhibits.
INTRODUCTORY FACTS AND NARROWING OF THE ISSUE:
[4]At the relevant times,
(a) Meager (whose shares were owned by Pickering and Turner and their wives) owned 100% of the shares of Tyee Management Ltd. ("Tyee") and 100% of the shares of Pemberton Valley Holdings Ltd. ("Pemberton").
(b) Tyee and Pemberton each owned 50% of the shares of the operating company CRB Logging Co. Ltd. ("CRB"). These shares comprised the only assets of Tyee and Pemberton.
(c) All of the companies were incorporated and resident in Canada.
(d) Although originally there was some concern that the reassessment by the Minister of National Revenue ("Minister") in November, 1994 may have been statute barred, this was not a concern at the hearing.
(e) It was established that all of the required conditions for the application of subsection 55(2) of the Act existed save two. The outstanding two conditions are firstly, whether the transactions in question described below constituted a series of transactions or events and secondly, whether one of the purposes of the $1.8 million dividends was to reduce the capital gain on a subsequent sale by Meager of shares of Tyee and Pemberton.
FURTHER MATERIAL FACTS:
[5]Meager was incorporated under the Companies Act of British Columbia on January 15, 1988.
[6]On April 29, 1988 Meager acquired all of the shares of Tyee and Pemberton (both incorporated in 1979) for a price of $3.8 million. As mentioned the sole assets of Tyee and Pemberton were the shares of CRB (incorporated in 1954).
[7]Pickering was hospitalized from December, 1988 to March, 1989 after having been diagnosed with leukaemia. Due to this, Pickering felt he was not pulling his weight in running the business and as a result he, in October, 1989, offered to sell his interest in the business to Turner. Turner rejected the offer.
[8]On February 15, 1990 after CRB had declared certain dividends to Tyee and Pemberton, Tyee and Pemberton each declared a dividend of $900,000 to Meager. These latter dividends were set up on the books of the companies as a receivable (Meager) and payables (Tyee and Pemberton) and were reported in Meager's 1990 fiscal year and corporate income tax return as having been received. T5's reflecting the dividends were filed by Tyee and Pemberton. The dividends were only actually paid later and then loaned back to CRB. These facts appear to have been an issue for the Minister at first but at the hearing of this appeal the issue disappeared because the Appellant dropped its alternate argument that the reassessments in issue were time barred.
[9]The said dividends declared by Tyee and Pemberton were declared on the recommendation of Burridge, the accountant for Meager. Tyee and Pemberton were only two of 28 companies that Burridge recommended declare dividends on or about February 15, 1990. (See Tab 68 of Exhibit A-2, second page, which indicates the companies Burridge recommended pay dividends).
[10]Pickering's evidence was to the effect that Burridge had encouraged him to have the dividends declared because Burridge was fearful that the federal budget about to be adopted might impose a tax on dividends which Burridge, of course, wanted his corporate clients with accumulated surpluses to avoid. Burridge explained this further. He indicated that he was not actually fearful of the reintroduction of the previous Part II tax on small business corporations but rather feared an across the board 10% flat rate on dividends with respect to all companies both small and large. Burridge explained that this potential tax, described as a distribution tax, was the sole reason for the dividends being declared on February 15, 1990. Turner's testimony was to the effect that he went along with the decision of Burridge and Pickering. Harris explained that at first she did not totally recollect the reason for the dividends but that on reflection she remembered that it was Burridge's concern about the budget that was the reason behind the declaration of dividends by the 28 companies on the rather odd date of February 15, 1990 (The budget was announced on February 21, 1990). Proctor confirmed that Burridge had talked to him on several occasions regarding various budgets and Burridge's ongoing concern about a distribution tax. He confirmed that he did not specifically remember talking about the 1990 budget but that in all likelihood that conversation had probably occurred as it had on several other occasions.
[11]Burridge was cross-examined quite rigorously with respect to his letter of July 27, 1994 to H. Pranjivan of Revenue Canada (Tab 71 of Exhibit A-2) wherein he indicated that he was concerned with the possibility of a Part II tax being reintroduced. Counsel for the Respondent submitted that if that was Burridge's concern there was no actual reason for that concern as she established that had the Part II tax been reintroduced there would have been no adverse income tax effect on the companies in question. Burridge explained that he used the reference to the Part II tax reintroduction simply to follow along with the approach that had been taken by Mr. Pranjivan. He testified on several occasions that he was not really fearful of a Part II tax reintroduction but rather, as mentioned, of the imposition, since the government was in a deficit position, of a 10% flat tax on future dividends applicable to all corporations.
[12]Subsequent to October, 1989, and up to August, 1990, no discussions were held with respect to any potential sale of the business and there was no solicitation for offers for such shares.
[13]In August, 1990 Pickering again suggested that Turner might wish to buy Pickering's shares. He testified that because of his health, he still felt he was not pulling his weight in the operations of the business; further he was contemplating entering hospital for the purposes of a bone marrow transplant scheduled for September, 1990 and that would further keep him out of the active business for a considerable period of time. Turner refused but suggested to Burridge and Pickering that Pickering and Turner might be interested in selling their 100% interest in the business to a third party.
[14]Burridge suggested to Pickering and Turner that a third party by the name of Jay Carratt ("Carratt") had in June of 1990 sold shares in a logging company and might be interested in acquiring the interests of Pickering and Turner in their business.
[15]Pickering approached Carratt and offered to sell him a 100% interest in the business. Carratt, although interested, was unable to obtain sufficient financing and it was agreed that Carratt (eventually through a numbered company) would acquire one-third of the interest in the business.
[16]A share sale agreement between Meager and 387897 B.C. Ltd., a company wholly owned by Carratt was executed on December 31, 1990 whereby the numbered company acquired one-third of the shares of Tyee and Pemberton for $1,200,000.
[17]By Notices of Reassessments dated November 9, 1994, Revenue Canada assessed the Appellant on the basis that the dividends paid on February 15, 1990 by Tyee and Pemberton were received by the Appellant as part of a series of events or transactions, one of the purposes of which was to reduce the capital gain that would otherwise have arisen on the sale of the Tyee and Pemberton shares. The result of the reassessment was to subject the entire amount of the dividends related to the shares sold (one-third) to subsection 55(2) of the Act and to reclassify such dividends as proceeds of disposition. The reassessment does not attempt to treat as a capital gain (pursuant to paragraph 55(2)(c)) the remaining two-thirds of the dividends.
[18]The Appellant objected to the said Notices of Reassessment by Notices of Objection dated November 14, 1994.
[19]The Notices of Reassessment were confirmed by Revenue Canada by Notification of Confirmation dated June 27, 1996.
SUBMISSIONS OF THE APPELLANT:
[20]Counsel for the Appellant reviewed the evidence and argued that because of the dates involved there was clearly no series of transactions or events. In other words, the dividends had been declared in February, 1990 and the first clear indication of a sale only occurred in August or September of 1990 and the actual agreement selling the shares was only executed on December 31, 1990. Thus, no sale was contemplated when the dividends were declared, therefore no series of transactions or events. Counsel referred to 454538 Ontario Limited et al. v. MNR, 93 DTC 427 where Sarchuk, J. of this Court stated:
The phrase "series of transactions or events" must be read in its grammatical and ordinary sense reflecting the context in which it is found, the scheme and object of the Act and the intention of Parliament. Bearing this stricture in mind it seems reasonable to conclude that in order for the events to form part of a series they must follow each other in time and must somehow be logically or reasonably connected to one another. Furthermore the [taxpayer corporation and the holding corporations] themselves must intend that the series of transactions be linked together to achieve the specific result in this case being the disposition of the shares ... to [the purchaser] in the circumstances and in the manner previously described. This approach is consistent with the dictionary definitions of the words, "series", "transaction" and "event".
[21]Counsel also argued that not one of the purposes of the dividend was to reduce the potential capital gain. He referred to the evidence establishing that the sole reason for the dividends was the fear of the budget introducing a distribution tax.
[22]Counsel cited the following passage from Her Majesty the Queen v. Placer Dome Inc., 96 DTC 6562 and submitted that the Appellant had satisfied the three basic propositions set forth in that passage:
The principal difference between a subjective and objective appreciation of the term "purposes" is that the former extends a personal invitation to the taxpayer to testify as to his or her state of mind at the time the transaction or transactions were carried into effect. In theory, a subjective appreciation could mean that identical transactions carried out by different taxpayers may incur different tax results. However, it must be recognized that in law few things are measured wholly in subjective terms. Let me explain.
Accepting for the moment that s. 55(2) employs the term "purposes" in its subjective sense, there are three basic propositions relevant to the analysis. First, the onus or burden rests on the taxpayer to establish the inapplicability of s. 55(2) of the Act. Second, mere denial (without explanation or elaboration) by a taxpayer that his or her purpose was to effect a significant reduction in capital gain is not by itself a sufficient basis on which to discharge that burden. Third, it is not necessary that the taxpayer adduce corroborative or additional evidence which shows or tends to show that his or her testimony is true. On these three points see, respectively,C.P.L. Holdings Ltd. v. Minister of National Revenue, supra; Canada. v. Covertite Ltd., [1981] C.T.C. 464 (F.C.T.D.); and McAllister Drilling Ltd. v. Minister of National Revenue, [1994] 2 C.T.C. 211; 81 F.T.R. 139 (T.D.).
Practically speaking, it is evident that once it is established that a transaction has the effect of reducing significantly a capital gain it is proper for the Minister to infer that the taxpayer had such a purpose. To rebut that inference the taxpayer (or his advisors) must offer an explanation which reveals the purposes underlying the transaction. That explanation must be neither improbable nor unreasonable. All the while it must be remembered that s. 55(2) of the Act speaks of "one of the purposes" of the transaction. Consequently, the taxpayer must offer a persuasive explanation that establishes that none of the purposes was to effect a significant reduction in capital gain. It is in this sense that uncorroborated but credible testimony can be sufficient proof of taxpayer intention: see Vern Krishna, The Fundamentals of Canadian Income Tax, 5th ed., (Toronto: Carswell 1995), at 1391.
POSITION OF THE RESPONDENT:
[23]Counsel for the Respondent pointed out that there must be inferred from the large amount of the dividend that one of its purposes must have been to reduce a possible capital gain. In fact, she established that as a result of the dividend and the subsequent sale of one-third of the shares at $1.2 million, Meager actually incurred a capital loss.
[24]She argued further that the approach of Pickering to Turner to sell Pickering's shares because of his serious health problems indicated a general intention on Pickering's part to sell as early as October, 1989 and that this commenced the series.
[25]Counsel also pointed to the differences in the French and English versions of subsections 55(2) and 248(10). She pointed out, correctly, that both the English and French versions of the Act are valid and that one should look at both versions in interpreting a particular section of the Act. Her position essentially was since the French versions used non-legal expressions such as "operation" and "événement" a broad interpretation should be given to subsection 55(2) as opposed to a strict and narrow interpretation.
[26]She also advanced the theory that the principals concerned need not have a specific sale in mind. They could be contemplating any possible future sale and to avoid a tax on the potential capital gain, declare dividends.
[27]She also explained that one of the basic principles underlying the Act, as set out in the Carter Commission, was integration which would not abide double taxation. The distribution tax in question would have constituted double taxation and since that violated the principle of integration one should not take seriously the testimony of Burridge and the others that the reason behind the declaration of the dividend was the budget. In other words she contended that it was highly unlikely that a person should anticipate a budget introducing a provision which would violate the principle of integration and result in double taxation.
ANALYSIS:
[28]Subsections 55(2) and 248(10) provide as follows:
55. (2) Where a corporation resident in Canada has after April 21, 1980 received a taxable dividend in respect of which it is entitled to a deduction under subsection 112(1) or 138(6) as part of a transaction or event or a series of transactions or events (other than as part of a series of transactions or events that commenced before April 22, 1980), one of the purposes of which (or, in the case of a dividend under subsection 84(3), one of the results of which) was to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at fair market value of any share of capital stock immediately before the dividend and that could reasonably be considered to be attributable to anything other than income earned or realized by any corporation after 1971 and before the transaction or event or the commencement of the series of transactions or events referred to in paragraph (3)(a), notwithstanding any other section of this Act, the amount of the dividend (other than the portion thereof, if any, subject to tax under Part IV that is not refunded as a consequence of the payment of a dividend to a corporation where the payment is part of the series of transactions or events)
(a) shall be deemed not to be a dividend received by the corporation;
(b) where a corporation has disposed of the share, shall be deemed to be proceeds of disposition of the share except to the extent that it is otherwise included in computing such proceeds; and
(c) where a corporation has not disposed of the share, shall be deemed to be a gain of the corporation for the year in which the dividend was received from the disposition of a capital property.
248. (10) For the purposes of this Act, where there is a reference to a series of transactions or events, the series shall be deemed to include any related transactions or events completed in contemplation of the series.
The French versions of these subsections refer to "operation(s)" rather than "transactions(s)" and "événement(s)" rather than "event(s)".
[29]I accept the credibility of the witnesses for the Appellant. All but Proctor were subjected to rigorous cross-examinations and although certain inconsistencies were shown, these were not in my opinion crucial. Witnesses Burridge, Pickering and Harris were consistent in their position that it was the budget which provoked the declaration of the dividends and not any possibility of a sale with the resultant reduction in the capital gain. The fact that 26 other companies in similar situations as Meager, Tyee Pemberton and CRB, were advised by Burridge immediately before the budget to declare dividends is a strong indication that the purpose behind the declaration of dividends was to avoid any distribution tax that the budget might have contained rather than a desire to effect a reduction in a capital gain on a disposition of shares.
[30]Moreover, I do not agree that a series of transactions or events occurred. The dividends were declared in February, 1990 but the sale discussions only began in August, 1990 with the sale of one-third of the shares of Tyee and Pemberton occurring December 31, 1990. Admittedly Pickering in October, 1989 offered to sell his shares to Turner. However, this was related to Pickering's health problems and was not indicative of a contemplated sale of the business in whole or in part to any prospective purchaser. Further, in my view, the French versions of the subsections in question do not alter these conclusions.
[31]Also, I cannot accept Respondent's argument that any possible future sale can suffice to bring subsection 55(2) into play. There must be a series of transactions or events contemplated. To accept Respondent's argument could open the door to the subsection being applied to almost any declaration of inter-corporate dividends.
[32]As discussed in the Placer Dome case, the word "purposes" requires a subjective intent and in my view the evidence establishes that none of the principals or parties involved had in mind the purpose contemplated in subsection 55(2).
[33]Consequently, the appeal is allowed with costs.
Signed at Ottawa, Canada this 24th day of August, 1998.
"T.P. O'Connor"
J.T.C.C.