Tax Court of Canada Judgments

Date: 20000517

Docket: 98-2518-IT-G

BETWEEN:

ERLING MARVIN OLSEN,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

O'Connor, J.T.C.C.

[1] These appeals were heard at Vancouver, British Columbia on April 12, 2000.

Issues

[2] The issue is what is the meaning of "connected" for purposes of section 84.1 of the Income Tax Act ("Act"). More specifically, what must be determined is whether the reference in section 84.1 of the Act to subsection 186(4) of the Act, dealing with when one corporation is controlled by another and thus connected, must also be considered as referring to subsection 186(2) which contains a definition for purposes of Part IV tax and extends the normal meaning of control.

[3] The appeal was presented on the basis of a Statement of Agreed Facts and an Agreed Combined Book of Documents. No witnesses were heard.

Facts

[4] The Statement of Agreed Facts provides as follows:

STATEMENT OF AGREED FACTS

The parties hereby agree that for purposes only of this Appeal and any appeal therefrom or any other proceeding taken in this matter, the facts set out herein are true. No evidence inconsistent with this Statement of Agreed Facts may be adduced at the hearing of these Appeals or at any appeals therefrom but additional evidence, not inconsistent with this Statement of Agreed Facts, may be adduced by either party.

1. The Appellant is an individual resident in Canada who resides at 10663 River Road, Delta, British Columbia, V4C 2R1, and at the relevant time was the President, a Director and controlling shareholder of Leader Fishing Ltd. ("Leader"), a corporation resident in Canada incorporated under the Company Act (B.C.) which carries on the business of fishing.

2. Leader had issued 120 Class "A" Voting ("Class "A" shares") and 120 Class "B" Non-voting Common ("Class "B" shares") shares.

3. The Appellant's children or children and spouses all resident in Canada owned all the issued shares of the following companies (the "Children's Companies") all of which are resident in Canada.

NAME	SHAREHOLDERS
(a) Pacific Fraser Fishing ("Pacific")	Launa Groulx (the Appellant's daughter
(b) Cornerstone Fishing Ltd. "Cornerstone"	Corrine Bjork (the Appellant's daughter
(c) Viking Fishing Ltd. "Viking"	Trevor Olsen (the Appellant's son)
(d) Viking West Industries Ltd. "Viking West"	Jason Olsen (the Appellant's son and his wife

4. The Appellant sold shares of Leader all of which were capital property and qualified small business corporation shares to the Children's Companies for consideration which was entirely non-share consideration as follows:

DATE OF AGREEMENT	PURCHASER	NUMBER AND CLASS OF SHARES	STATED PURCHASE PRICE
14 Jan 93	Cornerstone	5B	$ 95,580
16 Feb 93	Cornerstone	6A	154,420
31 Jan 94	Cornerstone	1A	28,885
14 Jan 93	Pacific	5B	95,580
16 Feb 93	Pacific	6A	154,420
31 Jan 94	Pacific	1A	28,885
31 Jan 94	Viking	2A	57,770
31 Jan 94	Viking West	2A	57,770
			$673.310

5. Each purchaser agreed to pay the purchase price in ten equal annual payments commencing on the date of the agreement together with interest at six percent (6%) in respect of the 1993 agreements and at five percent (5%) in respect of the 1994 agreements, on the balance remaining from time to time, provided that the purchaser could repay the balance owing without penalty and the Agreements were subject to escrow arrangements all as more particular set out in the Agreements found at Tabs 5, 6, 7, 8, 10, 11, 12 and 13 of the Combined Book of Documents.

6. The shares referred to in paragraph 4 hereof were transferred into the names of the purchasers in accordance with the Agreements at the time of the agreement.

7. The non-share consideration received by the Appellant for the sale of the shares pursuant to the Agreements with the Children's Companies was in excess of the adjusted cost base of the shares calculated according to the provisions of section 84.1 of the Income Tax Act.

8. The Appellant was related to each of the Children's Companies and to each of the Shareholders listed at paragraph 3 hereof.

9. The fair market value of the Leader shares sold to the Children's Companies was the Stated Purchase Price listed in paragraph 4.

10. The fair market value of the notes payable to the Appellant by each of Pacific, Cornerstone, Viking and Viking West at the respective dates of issue if sold to an independent arms-length purchaser aggregated $423,226.00 being $250,084.00 less than the face amount of the notes and the fair market value of the shares sold as follows:

	FMV	FMV
	Shares	Notes
1993
Cornerstone	$95,580	$60,840
Cornerstone	154,420	98,294
Pacific	95,580	60,840
Pacific	154,420	98,294	$318,268
1994
Cornerstone	$28,885	$17,500
Pacific	28,885	17,500
Viking	57,770	34,999
Viking West	57,770	34,999	104,998
TOTAL			$423,266

11. Neither the Appellant nor Leader owned any of the issued shares of any class of any of Pacific, Cornerstone, Viking and Viking West.

12. At no time did any one of Pacific, Cornerstone, Viking or Viking West own more than ten percent (10%) of the issued shares of Leader having full voting rights under all circumstances and at no time did any one of Pacific, Cornerstone, Viking or Viking West own shares of Leader having a fair market value of more than ten percent (10%) of the fair market value of all of the issued shares of Leader.

13. By assessment dated May 30, 1997, the Minister included in computing the income of the Appellant for 1993 $524,863.00 as the grossed-up amount dividends deemed received by the Appellant upon the sale of the Class "A" and Class "B" Common shares to Cornerstone and Pacific in 1993 which amount was calculated as follows:

Proceeds of disposition	$500,000
Cost for s.84.1	80,110
Actual amount of deemed dividend	419,890
125% thereof	$524,863

14. By assessment dated May 30, 1997, the Minister included in computing the income of the Appellant for 1994 $216,630.00 as dividends received by the Appellant upon the sale of the 6 Class "A" Common shares in 1994 which amount was calculated as follows:

Proceeds of disposition	$173,310
Cost for s.84.1	6
Actual amount of deemed dividend	$173,304
125% thereof	$216,630

15. The Appellant filed Notices of Objection to the 1993 and 1994 reassessments.

16. By notice dated June 19, 1998, the Minister confirmed the 1993 and 1994 assessments on the grounds that:

"in 1993, you disposed of shares of Leader Fishing Ltd. to each of Pacific Fraser Fishing Ltd. and Cornerstone Fishing Ltd., corporations with which you did not deal at arms length, and, immediately after the disposition, you and Pacific Fraser Fishing Ltd. and you and Cornerstone Fishing Ltd. were connected within the meaning of subsection 186(4). Therefore, paragraph 84.1(1)(b) deems each of Pacific Fraser Fishing Ltd. and Cornerstone Fishing Ltd. to have paid you a dividend. Based on the formula in paragraph 84.1(1)(b), you collectively received dividends amounting to $419,890.00. They are "taxable dividends" as defined in subsection 89(1). Therefore, an amount of $524,863.00, determined under subsection 82(1) is income from property under paragraph 12(1)(j). It has been included in your income according to section 3 in paragraph 82(1).

in 1994, you disposed of shares of Leader Fishing Ltd. to each of Pacific Fraser Fishing Ltd., Cornerstone Fishing Ltd., Viking Fishing Ltd. and Viking West Industries Ltd., corporations with which you did not deal at arms length, and immediately after the disposition, you and each of Pacific Fraser Fishing Ltd., Cornerstone Fishing Ltd., Viking Fishing Ltd. and Viking West Industries Ltd. were connected within the meaning of subsection 186(4). Therefore, paragraph 84.1(1)(b) deems each of Pacific Fraser Fishing Ltd., Cornerstone Fishing Ltd., Viking Fishing Ltd. and Viking West Industries Ltd. to have paid you a dividend. Based on the formula in paragraph 84.1(1)(b), you collectively received dividends amounting to $173,304.00. They are "taxable dividends" as defined in subsection 89(1). Therefore, an amount of $216,630.00, determined under subsection 82(1) in income from property under paragraph 12(1)(j). It has been included in your income according to section 3 and paragraph 82(1)."

Agreed at Vancouver, in the Province of British Columbia, this "11^th" day of April, 2000.

"signature"

________________________

E. MICHAEL McMAHON

Counsel for the Appellant

"signature"

_______________________

PATRICIA A. BABCOCK

Counsel for the Respondent

Submissions of Counsel for the Appellant

[5] Counsel for the Appellant submits that section 84.1 of the Act is an anti-avoidance provision and of a penal nature. He referred to several authorities on the interpretation of tax statutes and concludes that the reference to subsection 186(4) should not be interpreted as including a reference to subsection 186(2).

[6] If counsel for the Appellant is correct, the Appellant will escape liability for income tax in the years in question because the transactions will be treated as giving rise to capital gains, totally exempt from tax by reason of the exemption for qualified shares of a small business corporation.

Submissions of Counsel for the Respondent

[7] Counsel for the Respondent submits, in essence, that the reference in section 84.1 simply to subsection 186(4) must, of necessity, include a reference to the definition section in subsection 186(2). If so, the deemed dividend treatment will apply and the Appellant will be liable for taxes on the taxable amount of the deemed dividends.

[8] The arguments of counsel for the Respondent were presented verbally. Her written notes summarizing the verbal presentation read as follows:

S. 84.1 (1)Where a taxpayer resident in Canada, Olsen, disposed of shares that were his capital property, of any class, of Leader, a corporation resident in Canada [the subject corporation] to the corporations of Olsen's children with whom Olsen was not per Section 251 dealing at arm's length [the purchaser corporations] and, immediately after the disposition the subject corporation, Leader, would be connected [within the meaning of s. 186(4) but read payer corp. as subject corp. and particular corp. as purchaser corp.] to the corporations of Olsen's children

(c) for the purposes of this Act, a dividend shall be deemed to be paid to Olsen by the corporations of Olsen's children and received by Olsen from the corporations of Olsen's children at the time of the disposition per the formula as set out in this section

...

If the corporations are connected as set out in Section 186(4) then Section 84.1 applies.

S. 186(4)For the purposes of this Part, a payer corporation [Leader the subject corporation] is connected with a particular corporation [purchaser corporations of Olsen's children] at any time in a taxation year of the particular corporation [purchaser corporations of Olsen's children] if

(a) the payer corporation [Leader the subject corporation] is controlled (otherwise than by virtue of a right referred to in paragraph 251(5)(b) by the particular corporation [Leader the subject corporation] at that time;

Thus to determine in the context of Section 186(4) if Leader is connected with the corporations of Olsen's children you have to resort to Section 186(2) which defines when a corporation is controlled. No other section of the Act can be used to determine if Leader is connected to the purchaser corporations of Olsen's children for the purposes of Section 186(4).

S. 186(2)For the purposes of this Part, other than determining if Leader is a subject corporation, one corporation [Leader] is controlled by another corporation [Olsen's children's corporation] if more than 50% of its issued share capital (having full voting rights under all circumstances) belongs to the other corporation, to persons with whom the other corporation does not deal at arm's length [Olsen and his children], or the other corporation [Olsen's children's corporation] and persons with whom the other corporation does not deal at arm's length [Olsen].

Here more than 50% of Leader is controlled by Olsen and his children's corporation, all parties not dealing at arm's length with one another, and thus Leader is controlled as required by Sections 186(4) and 84.1 and thus the Minister correctly determined that a deemed dividend had been paid to Olsen, in the amount of the value of the shares, for both of the 1993 and 1994 taxation years.

Analysis and Decision

[9] I have been advised that there are no decided cases on the points in issue. However, I have been referred to Revenue Canada Release No. 5-6946 which, so far as material, reads as follows:

COMMENTS

1. It is your view (i.e., the view of a participant in the conference) that section 84.1 of the Act would not apply in the above scenario to deem a dividend to be paid to the individual by HOLDCO at the time of the individual's disposition of the Preferred Shares to HOLDCO. Moreover, it is your view that section 245 of the Act would not apply to redetermine the aforesaid tax consequence to the individual.

In support of your views, you submit that section 84.1 of the Act would not apply since HOLDCO is not "connected" to OPCO by virtue of a strict technical reading of section 84.1 of the Act, (i.e. subsection 84.1(1) restricts the meaning of "connected" to the meaning assigned by subsection 186(4); HOLDCO and OPCO would only be "connected" via the extended meaning in subsection 186(2), which subsection 84.1(1) does not refer to). ...

We (i.e., the representatives of Revenue Canada) do not share your views.

It is our view that for the purposes of section 84.1 of the Act, it is appropriate to use subsection 186(2) of the Act to give meaning to the word "controlled" ...

Paragraph 186(4) (a) states that a payer corporation, (OPCO in this case), is connected with a particular corporation, (HOLDCO in this case), if the payer corporation is controlled by the particular corporation.

Since more than 50% of OPCO's voting shares, immediately after the individual's disposition of the Preferred Shares to HOLDCO are to be held by the son, (with whom HOLDCO does not deal at arm's length), OPCO would be controlled by HOLDCO, within the meaning in subsection 186(2) of the Act. Therefore, OPCO would be connected with HOLDCO immediately after the individual's disposition of the Preferred shares to HOLDCO and accordingly Section 84.1 of the Act would apply.

...

The above comments are expressions of opinion only and as such are not to be construed as advance income tax rulings nor are they binding on the Department.

In my view, the analysis of Revenue Canada in the foregoing Release is incorrect and subsection 186(2) should not be looked to to determine the meaning of control in subsection 186(4). The following are my principal reasons:

1. By its very wording, subsection 186(2) states "for the purposes of this Part". Part IV deals with deemed dividends in certain circumstances. The legislature could simply have stated for the purposes of this Part and section 84.1. It did not do so. The expanded definition in subsection 186(2) is not a definition for purposes of the Act such as subsection 248(1). It is restricted to Part IV which relates to refundable tax on dividends not taxable under Part I.

2. A former version of section 84.1 applicable prior to April 10, 1978 made specific reference to control as determined within the meaning of subsection 186(2). Perhaps the legislature did not think it necessary to continue that reference but I would suggest the removal of that reference is of significance. It would have been simple to continue the reference, thus removing any doubt in the matter.

3. Section 84.1 is an anti-avoidance provision and penal in nature. It should be strictly interpreted. It refers only to subsection 186(4) and does not make any reference to subsection 186(2).

4. There exists a gap in the legislation, i.e., not making it clear that subsection 186(2) should be looked to. Courts are reluctant to fill in legislative gaps which the legislature can do at any time.

5. In CCH Canadian Tax Reporter, Vol. 5A, the following is stated at page 26,257 and I accept same as a correct statement of the law:

A definition of control for purposes of Part IV (section 186) is found in subsection 186(2), but that definition is not a definition of general application; that is, it has no relevance outside of Part IV and any provisions that may especially refer to it.

6. The rules of interpretation, especially as set out by the Supreme Court in Corporation Notre Dame de Bon-Securs, 95 DTC 5017 at 5021 to 2023 favour the Appellant. The following extracts are noted:

In light of this passage there is no longer any doubt that the interpretation of tax legislation should be subject to the ordinary rules of construction. At page 87 of his text Construction of Statutes (2nd ed. 1983), Driedger fittingly summarizes the basic principles: "... the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament". The first consideration should therefore be to determine the purpose of the legislation, whether as a whole or as expressed in a particular provision. The following passage from Vivien Morgan's article "Stubart: What the Courts Did Next" (1987), 35 Can. Tax J. 155, at pp. 169-70, adequately summarizes my conclusion:

There has been one distinct change [after Stubart ], however, in the resolution of ambiguities. In the past, resort was often made to the maxims that an ambiguity in a taxing provision is resolved in the taxpayer's favour and that an ambiguity in an exempting provision is resolved in the Crown's favour. Now an ambiguity is usually resolved openly by reference to legislative intent.

...

The rules formulated in the preceding pages, ... may be summarized as follows:

— The interpretation of tax legislation should follow the ordinary rules of interpretation;

— A legislative provision should be given a strict or liberal interpretation depending on the purpose underlying it, and that purpose must be identified in light of the context of the statute, its objective and the legislative intent: this is the teleological approach;

— The teleological approach will favour the taxpayer or the tax department depending solely on the legislative provision in question, and not on the existence of predetermined presumptions;

— Substance should be given precedence over form to the extent that this is consistent with the wording and objective of the statute;

— Only a reasonable doubt, not resolved by the ordinary rules of interpretation, will be settled by recourse to the residual presumption in favour of the taxpayer.

7. The meaning of control does not require a reference to subsection 186(2). The courts have defined control. The question is what control does subsection 186(4) refer to and, in my opinion, the ordinary meaning of control applies, not the expanded subsection 186(2) meaning.

8. At the very least there is a reasonable doubt not totally resolved by the ordinary rules of interpretation. Therefore the Appellant is entitled to the residual presumption in favour of the taxpayer.

[10] In conclusion the appeal is allowed, with costs, and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the gains realized by the Appellant in the 1993 and 1994 years on the disposition of shares of Leader were capital gains and not deemed dividends.

[11] Another issue that was argued was the value of the shares. That issue would only have come into play had the Minister been successful. Counsel for the Respondent contended that the value should be strictly based on the stipulated price and not on the value of the notes, whereas counsel for the Appellant submitted the opposite. I do not believe it necessary to decide this issue but, if I had to, I would have found for the Appellant, namely that the consideration the Appellant received should be based on the value of the notes and not on the stipulated price of the shares.

Signed at Ottawa, Canada this 17^th day of May 2000.

"T.P. O'Connor"

J.T.C.C.