Date: 20001109
Docket: A-80-99
CORAM: LINDEN J.A.
EVANS J.A.
MALONE J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
- and -
ROBERT B. FURUKAWA
Respondent
Heard at Calgary, Alberta, on Thursday, October 12, 2000.
Judgment delivered at Ottawa, Ontario on Thursday, November 9, 2000.
REASONS FOR JUDGMENT BY: EVANS J.A.
CONCURRED BY: LINDEN J.A.
MALONE J.A.
Date: 20001109
Docket: A-80-99
CORAM: LINDEN, J.A.
EVANS, J.A.
MALONE, J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
- and -
ROBERT B. FURUKAWA
Respondent
REASONS FOR JUDGMENT
EVANS J.A.
| A. INTRODUCTION |
This is an appeal by the Crown from a decision of the Tax Court of Canada (99 D.T.C. 474) allowing an appeal by Robert B. Furukawa against an assessment for the taxation year 1992. The Court held that the Minister was wrong to have disallowed a claim by the taxpayer for a deduction of $7,500 in respect of an investment that he had made to finance oil and gas exploration by Lumberton Mines Limited.
The taxpayer claimed that he had acquired shares in Lumberton that qualified as "flow-through shares" under the Income Tax Act, and that he was accordingly entitled to deduct $7,500 from his income tax liability, this being the portion of the company's exploration costs that it had renounced in his favour. Mr. Furukawa's claim was disallowed on the ground that, in addition to the shares in Lumberton, other benefits were offered to the investors, thus making the shares "prescribed shares" and, as such, excluded from the statutory definition of "flow-through shares".
The only issue in this case is whether those additional benefits "... may reasonably be considered to be ... a repayment or return by the corporation ... of all or part of the consideration for which the share was issued ..." within the meaning of subparagraphs 6202.1(1)(b)(iii) and (iv) of the Income Tax Regulations.
The Tax Court Judge held that the benefits could not be so considered. Accordingly, since the shares were not "prescribed shares", they qualified as "flow-through shares" and the taxpayer was entitled to the $7,500 deduction. The Minister has appealed to this Court from that decision.
| B. FACTUAL BACKGROUND |
The case was argued on an agreed statement of facts, which can be briefly described. Early in 1991, Lumberton prepared a "résumé" offering "unit interests" to potential investors in a $3,000,000 private placement financing of oil and gas exploration activities to be undertaken by Lumberton. In May 1991, Mr. Furukawa purchased a one-quarter interest in a single unit for $7,500, in conjunction with a group of three other investors who together purchased a double unit.
Lumberton subsequently issued 15,000 of its shares to Mr. Furukawa as his pro rata portion of the 120,000 shares in Lumberton promised to subscribers to the private placement financing who acquired a double unit. The 120,000 shares had an attributed value of $60,000. Lumberton spent all the proceeds of the sale of the units on Canadian Exploration Expenses ("CEE"), which it renounced in favour of the unit holders, including $7,500 to Mr. Furukawa, the amount that he had invested.
In its "résumé" Lumberton not only offered to issue 120,000 of its shares to investors who purchased a double unit, but also agreed to provide them with the following benefits:
| (i) a one-quarter acre building lot at Palmer Bar Golf Course, when completed, with an attributed value of $50,000; |
| (ii) two lifetime playing privileges on the Palmer Bar Golf Course, when completed, with an attributed value of $20,000; and |
| (iii) 1.4% Grassy, N.E. British Columbia pipeline interest at 15% discounted value, with an attributed value of $134,400. |
Thus, for an investment of $60,000, a purchaser of a double unit was promised benefits with an attributed value of $240,000. As the purchaser of a one-eighth portion of a double unit, Mr. Furukawa was entitled to a proportionate share of the total benefits, including, of course, the Lumberton shares. However, it is also agreed that the values attributed to the building lot, the playing privileges, and the pipeline interest, were inaccurate.
In a letter to the unit subscribers, dated December 3, 1992, Lumberton provided information on the current status of the various components of the units. Thus, it stated that Provident Ventures Corporation, a property developer in which Lumberton held an interest, had an agreement with Lumberton to provide sufficient lifetime golf course privileges to meet Lumberton's obligations to the unit holders. In addition, fairways had been "rough-cleared" and Provident was in preliminary discussions with others to obtain capital of $2.4 million to complete the golf course. Meanwhile, no mining was taking place on the land to be used for the golf course and the building lots, which Provident had agreed with Lumberton that it would provide to meet Lumberton's obligations to the unit holders.
As for the Grassy pipeline interest, the letter reported that Lumberton had received revenues, which it had distributed to subscribers. Moreover, the Husky pipeline was said now to be connected to the Grassy pipeline and, with the resulting increased throughput, the receipt of significant tariff revenues could be anticipated over a long period, provided that there were no water problems at the Husky wells.
This letter was copied to the Alberta Securities Commission, which had been investigating Lumberton for possible breaches of securities legislation arising from, among other things, misrepresentations in the "résumé" respecting the 1991 private placement financing. Under the terms of an eventual settlement of this dispute, Lumberton was to offer to buy back its shares from the investors on terms set out in the letter of December 3, 1992, including the surrender of the investors' rights to the benefits that they had been offered when they purchased the units.
As a result of the settlement reached between the Alberta Securities Commission and Lumberton, the company never delivered most of the promised benefits. Thus, the Palmer Bar Golf Course was not completed and the developer, Provident, changed its business to marketing bottled water. However, the respondent did receive $7.81 in 1991 as his portion of the Grassy pipeline revenue, and a total of $125 over the three years that he held the units.
Mr. Furukawa rejected Lumberton's 1992 offer, but accepted another in 1994, under which he received shares in Bearcat Explorations Ltd., Lumberton's parent company. In exchange, he gave up his Lumberton shares, and surrendered at no cost his rights to be assigned an interest in the Grassy pipeline, and to receive playing privileges at the golf club and a building lot.
Mr. Furukawa was not exactly an outsider to the affairs of Lumberton and its related companies. He was Lumberton's treasurer and a corporate director, and president and a director of Provident, the shares of which were publicly traded. As I have already noted, Provident had entered into agreements with Lumberton for the development of the golf course and provision of the building lots. In addition, he was a director of Bearcat, which owned a 78% interest in Lumberton.
| C. THE TAX COURT'S DECISION |
This matter has a lengthy history, which it is unnecessary to set out here. However, it is relevant to note that the decision under appeal was made pursuant to an order of this Court setting aside a decision by the late Sobier J.T.C.C. ([1996] 2 C.T.C. 2641) allowing the taxpayer's appeal from his 1992 assessment. The Court directed the trial to be continued before the Tax Court to determine the issue now before us, namely whether the Lumberton shares were "prescribed shares" within the meaning of subsection 6202.1(1) of the Regulations.
In the decision under appeal the Tax Court Judge held that Lumberton was legally obliged by the terms of the "résumé" to transfer property or to confer a benefit on Mr. Furukawa, albeit that the obligation was contingent. Hence, the Lumberton shares satisfied the first part of the statutory definition of "prescribed shares".
When determining whether the shares also satisfied the second limb of the definition, the Judge stated that the test was objective (supra, at page 478, paragraph 17):
| One must ask whether a reasonable person appraised of the circumstances would think that the attachments were a return of the consideration paid for the shares. |
Applying this test, and noting that the benefits had "little intrinsic value", he said (ibid.):
| .... an examination of its financial statements clearly indicates that Lumberton was not in a position to fulfill the obligations at that time or in the near or reasonable future. Hence, a reasonable person would probably attach very little significance in the whole scheme of things to the attachments. Realistically, the person would have very little expectation of getting any of the sweeteners. |
Accordingly, he concluded that the shares were not "prescribed shares" and allowed the taxpayer's appeal against the Minister's disallowance of the deduction of the portion of Lumberton's CEE that it had renounced in favour of Mr. Furukawa.
| D. THE LEGISLATIVE FRAMEWORK |
I reproduce below the only statutory provision immediately relevant to this appeal.
Income Tax Regulations, CRC 1978, c. 945, section 6202.1
| (1) For the purposes of paragraph 66(15)(d.1) of the Act, a share of a class of the capital stock of a corporation (in this section referred to as the "issuing corporation") is a prescribed share if it was issued after December 31, 1982 and ... (b) any person or partnership has, either absolutely or contingently, an obligation (other than an excluded obligation in relation to the share) ... (iii) to transfer property, or (iv) otherwise to confer a benefit by any means whatever, including the payment of a dividend, either immediately or in the future, that may reasonably be considered to be, directly or indirectly, a repayment or return by the corporation or a specified person in relation to the corporation of all or part of the consideration for which the share was issued or for which a partnership interest was issued in a partnership that acquires the share; |
| (1) Pour l'application de l'alinéa 66(15)d.1) de la Loi, est une action exclue l'action d'une catégorie du capital-actions d'une société -- appelée « _société émettrice_ » au présent article -- qui est émise après le 31 décembre 1982, si_: ... b) une personne ou une société de personnes a l'une des obligations suivantes, conditionnelles ou non, immédiates ou futures (à l'exception d'une obligation exclue relative à l'action), qu'il est raisonnable de considérer comme étant, directement ou indirectement, un remboursement ou une remise par la société ou par une personne apparentée à celle-ci de tout ou partie de la contrepartie pour l'action émise ou la participation dans la société de personnes qui acquiert l'action_: ... (iii) transférer un bien, (iv) conférer par ailleurs un avantage, de quelque façon que ce soit, y compris le versement d'un dividende; |
| E. ANALYSIS |
(i) failure to consider relevant evidence
Counsel for the Minister submitted that the Tax Court Judge had erred in law when, in finding as a fact that the benefits could not "reasonably be considered" to be the return of part of the consideration, he referred only to Lumberton's financial statements as evidence that it was unlikely that the benefits would ever materialise. In so doing, counsel submitted, the Judge overlooked important evidence, namely the letter of December 3, 1992 from Lumberton to the unit holders. The content of this letter might well have caused a reasonable investor to believe that the benefits promised were not mere "pie in the sky", but could "reasonably be regarded" as the return of a portion of the investment.
Counsel's argument was that, while the letter referred to the "current status" of the benefits, as of some nineteen months after Mr. Furukawa had subscribed for the units, it was nonetheless relevant as an indication of the seriousness of Lumberton's intention from the beginning to provide them, and of the steps being taken by the company to deliver on its contractual undertakings. In other words, the letter cast light, not only on the intentions of the promoters in December 1992, when the letter was written, but also on their intentions in May 1991, when the taxpayer had purchased a portion of a unit.
In my opinion, the omission from the Tax Court Judge's reasons of any discussion of the letter is not fatal, because I do not attach great evidential weight to the letter. First, while the letter is undoubtedly some evidence of the seriousness of the company's intention to provide the promised benefits, the pertinent question is not whether Lumberton intended to deliver the benefits to the unit holders, but whether its financial position realistically enabled it to do so.
Second, the progress described in the letter with regard to the construction of the golf course and the provision of the building lots is vague and preliminary in nature. More important, there is no evidence that even these modest steps towards eventual delivery had been taken in May 1991 when Mr. Furukawa acquired his share in the unit.
The same is true of the letter's description of the "current status" of the interest in the Grassy pipeline to which unit holders were entitled: there is no indication that the connection to the Husky pipeline had occurred or was imminent in May 1991. The $7.81 return paid to Mr. Furukawa in March 1992 for the period commencing in May 1991 was very modest, to say the least. The promise of future growth in the tariff was expressly said to be dependent on the avoidance of water-related production problems at Husky's wells.
(ii) erroneous finding of fact
In addition, counsel submitted that the Judge committed an overriding and palpable error in concluding on the evidence before him that the promised benefits could not "reasonably be considered" the return of part of the consideration paid for the shares.
Thus, he argued, the promised benefits had economic value, albeit not as high as that attributed to them in Lumberton's "résumé". While unit holders' entitlement to golf course privileges and to an option on the building lots remained contingent, actual, if small, payments were made on the Grassy pipeline interest. Moreover, if Lumberton failed to deliver in accordance with its contract, unit holders would have a legal remedy in damages.
I am not persuaded that the Judge's findings of fact contain any overriding and palpable error. Both the uncertainty as to whether or when the golf course and building lots benefits would materialise, and the small sum actually received on the Grassy pipeline interest, support the Judge's finding that the additional benefits could not reasonably be considered by a reasonable investor as the return of part of the $7,500 paid by Mr. Furukawa for the shares. The Judge also relied, as he was entitled to, on Sobier J.T.C.C.'s unchallenged finding (supra, at page 2648) that
| the intrinsic value of some of these benefits was very little at the time that the Lumberton shares were purchased. |
On the other hand, the financial statements on which the Judge also relied are hardly compelling evidence of the ability of Lumberton in May 1991 either to deliver the benefits that it had promised, or, in the event of non-delivery in breach of contract, to satisfy the unit holders' claims. The unaudited statements are for the years ending November 1991 and 1992, and are undated. However, there is no reason to believe that the dismal revenue position of Lumberton at the end of 1991 had been markedly brighter in the first four months of the year.
In any event, it should be noted that Lumberton's liability to provide the golf course playing privileges and the building lots was contingent on the completion of the course. It did not promise that the golf course would be completed.
Therefore, on the basis of the material before the Tax Court Judge on the intrinsic value of the promised benefits and the likelihood that they would in fact be delivered in the reasonable future, I am not persuaded that his finding of fact was vitiated by palpable and overriding error, the standard of review normally applied by appellate courts to findings of fact by trial courts.
(iii) non-factual errors
The appeal was argued on the basis that, since the disputed question was one of fact, "palpable and overriding error" was the appropriate standard of review. However, I should also observe that, since primary facts are not in dispute, the case involves the application of a statutory standard ("may reasonably be considered a return of part of the consideration for the shares") to the facts found by the Judge. This is a question of mixed fact and law: Canada (Director of Investigation & Research, Combines Investigation Branch) v. Southam Inc., [1997] 1 S.C.R. 748.
The legal element in the decision-making process is an understanding of the statutory scheme for the favourable tax treatment of "flow-through shares" that must inform the inferences to be drawn from the facts. Thus, for example, the factors to be considered in determining whether particular shares satisfy the definition of "prescribed shares" must be identified by reference to the purpose of the provision: this involves a question of statutory interpretation and thus one of law.
Since this Court has not applied a deferential standard of review to the determination of questions of law by the Tax Court, it is appropriate to examine the decision to see whether it proceeded on some erroneous interpretation of the relevant statutory provisions.
On the other hand, given the nature of the statutory language under consideration in this case, the task of assigning the appropriate weight to each of the relevant factors in a given matrix of facts is more in the nature of fact-finding. Accordingly, since it was agreed that the Judge formulated the legal test correctly, and did not otherwise misstate the law, the Court should not intervene unless it can be inferred from the result reached that he must have taken into consideration irrelevant factors, omitted those that he ought to have considered, or weighed the relevant factors in an unreasonable manner.
To turn to the interpretation of the relevant provision of the Regulations, it should first be noted that the Income Tax Act provides for "flow-through shares" in order to encourage investment in oil and gas exploration, so as to make Canada self-sufficient in these vital sources of energy. Small oil companies typically lack the capital necessary to conduct exploration activities and to take advantage of the tax write-offs available for CEE. Traditional lenders, such as banks, have generally been unwilling to finance high risk ventures.
Accordingly, as an inducement to smaller investors to finance CEE, Parliament authorised the exploration company to renounce in favour of share holders its CEE tax write-off. This, in effect, reduced by approximately half the capital that high income investors had at risk in these shares.
Subparagraphs 6202.1(1)(b)(iii) and (iv) were designed to prevent investors from obtaining the tax advantage of a "flow-through share" when part of their investment was in effect returned to them, thus depriving the company of the full benefit of the additional capital to spend on oil and gas exploration. In particular, the definition of "prescribed shares" was intended to exclude from the category of "flow-through shares" investments that were more in the nature of debt than equity.
The evidence in this case was that all of the investment was used for exploration. Nor did the counsel for the Crown argue before us, as he had below, that the provision of the benefits was financed from corporate funds that would otherwise have been available to Lumberton for oil and gas exploration.
It is also true that the purpose of the statutory scheme was to attract risk capital to the industry and that, accordingly, investors who did not put all their invested capital at risk, because they obtained some benefit over and above the value of the shares, should not be able to claim the extraordinary tax advantage accruing to holders of "flow-through shares". The benefits promised by Lumberton might thus be regarded as sheltering part of Mr. Furukawa's investment from the risk attendant on oil and gas exploration, and, consequently, as bringing them within the definition of "prescribed shares".
In my opinion, however, this rationale is too baldly stated. The definition of "prescribed shares" does not include every benefit offered to the investor, but only those that may "reasonably be considered" to be a return of part of the consideration provided for the shares. As I have already indicated, this objective standard does not include benefits of very little intrinsic economic value or those that are in fact unlikely ever to be provided.
Hence, since the facts found by the Tax Court Judge reasonably supported the inferences that he drew from them and he did not misstate the law, there is no basis for concluding that his decision was erroneous in law. On the facts of this case, it would not be inconsistent with the statutory purpose underlying the "flow-through share" provisions to allow the taxpayer the $7,500 deduction that he claimed. The promised benefits might "reasonably be considered", not as "a return of part of the consideration" to the investors who purchased the units, but as sales gimmicks or "sweeteners" offered in a crowded market as a marketing tool to distinguish Lumberton's offering.
At the end of the hearing, the Court invited counsel to make written submissions on the question of costs. Because this matter concerned the disallowance of only a $7,500 deduction, it had been set down to be heard under the Tax Court's informal procedure, to which special costs rules apply. However, before the hearing started, it was transferred at the Minister's request to the Court's general jurisdiction, since there were fifty other cases that were likely to turn on the result of Mr. Furukawa's appeal.
Having read the submission of counsel, I see no reason for exercising my discretion in other than the normal way: as the successful party, Mr. Furukawa should receive the reasonable and proper costs incurred in successfully pursuing this appeal.
For all these reasons, I would dismiss the appeal with costs.
"John M. Evans"
J.A.
"I agree
A.M. Linden J.A."
"I agree
Brian Malone J.A."