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Chris Falk Stefanie Morand <strong>McCarthy</strong> Tétrault LLP could have applied the Losses to offset the capital gain. If the taxpayer then wound-up Canco so as to access the value of the underlying assets, he would have been deemed to have received a dividend equal to the amount by which the FMV of the property distributed on the winding-up exceeded $101 (i.e., the PUC of the shares). This deemed dividend would have been subject to Part XIII withholding tax. While the wind-up would have resulted in a capital loss to the taxpayer, subsection 40(3.7) would have applied to deny the loss to the extent of the deemed dividend. 43 If, after having emigrated from Canada, the taxpayer instead transferred the shares of Canco to a Canadian corporation with which he did not deal at arm’s length in exchange for a promissory note equal to the FMV of the shares, subsection 212.1(1) would have applied to deem the taxpayer to have received a dividend equal to the amount by which the promissory note exceeded $101 (i.e., the PUC of the shares). Again, this deemed dividend would have been subject to Part XIII withholding tax. If, prior to emigrating from Canada, the taxpayer by-passed Brother and simply transferred the shares to Holdco in exchange for a promissory note, section 84.1 would have deemed the taxpayer to have received a dividend equal to the amount by which the promissory note exceeded $101 (i.e., the PUC and ACB of the shares). If the taxpayer wound-up Canco prior to emigrating from Canada, subsection 84(2) would have deemed the taxpayer to have received a dividend equal to the amount by which the FMV of the property distributed on the winding-up exceeded $101 (i.e., the PUC of the shares). Accordingly, in each alternative (other than a third-party sale which was not available), the taxpayer would have been deemed to have received a dividend taxable under either Part I or Part XIII of the Act. The Decision – Subsection 84(2) The first issue considered by Mr. Justice Hershfield was whether subsection 84(2) applied to recharacterize as a dividend the amount received by the taxpayer for the Canco shares. As summarised by Mr. Justice Hershfield, the Crown advanced three arguments in support of its position that subsection 84(2) applied in the circumstances. Specifically, the Crown relied on: • the phrase “in any manner whatever” in the preamble of subsection 84(2); • the Tax Court of Canada’s earlier decision in RMM; and • a “purposive rather than literal construction of the subject provision”. 44 Each of these arguments was rejected by Mr. Justice Hershfield. 43 44 Provided the shares were still taxable Canadian property at the time of the wind-up, section 119 would have applied to permit a credit of Part XIII withholding tax paid in respect of the winding-up dividend against the tax, if any, payable by the taxpayer on the capital gain that arose on the deemed disposition of the shares on emigration. Supra, note 5, at para. 47. 560600/422632 MT DOCS 11864055v1G 14
Chris Falk Stefanie Morand <strong>McCarthy</strong> Tétrault LLP In response to the Crown’s first argument, Mr. Justice Hershfield concluded that the express language of subsection 84(2) “ensures that it is only a shareholder at the time of the distribution or appropriation who can be deemed to be the recipient of the dividend”. 45 In the case at bar, the property that the taxpayer received at the beginning of the series of transactions was the Brother Note, which was not property of Canco. When amounts were subsequently paid by Canco to the taxpayer, the taxpayer was no longer a shareholder of Canco and the taxpayer received the amounts qua creditor. Further, Canco’s property was distributed by way of dividend to Holdco. Mr. Justice Hershfield held that the phrase “in any manner whatever” relied on by the Crown does not have the effect of “redirecting” to whom dividends are paid; rather, “[i]t is the manner of effecting the distribution to the shareholder at the time of that distribution that the subject provision is aimed”. 46 Accordingly, it was not relevant that the Brother Note was repaid using Canco funds. As for the Crown’s reliance on RMM where Mr. Justice Bowman, as he then was, concluded that subsection 84(2) applied, Mr. Justice Hershfield acknowledged that the facts in RMM were not easily distinguished from the case at bar. However, he noted that the decision in RMM stands in contrast to Mr. Justice Bonner’s decision in McNichol where the facts were also similar to those in issue. While Mr. Justice Bowman sought to distinguish McNichol in RMM, Mr. Justice Hershfield rejected the distinction and concluded that “the McNichol approach which was to look to section 245 when subsection 84(2) does not apply on a strict construction of its language, is the correct approach”. 47 In respect of the Crown’s third argument, Mr. Justice Hershfield concluded that a “purposive contextual analysis” of subsection 84(2) did not support a less literal interpretation of the provision. He stated (at paragraphs 66 and 67): In my view, there is nothing in the language of subsection 84(2) that warrants a finding of a rationale other than liquidating distributions out of a corporation’s earnings to its shareholders – holding a particular class of shares – are to be treated as dividends to the extent the distribution exceeds the paid-up capital of the particular class of shares held by persons receiving the distribution. […] […] The surplus strip here was having the Appellant’s shares acquired with corporate funds funnelled through a related corporation as a tax-free dividend. This classic strip in the old system was subject to a specific anti-avoidance provision; namely section 138A of the old, pre- 1972 Act. That provision was replaced in 1972 with section 247 which was repealed in 1988. The section that survived is, of course, section 245. That is the provision to look at in these circumstances. Essentially that is what Justice Bonner concluded in McNichol and I agree. (italics original) And later (at paragraph 82): In the circumstances of this case, there is nothing in subsection 84(2) of the Act that invites the CRA or this Court to change either who the recipient of the benefit is, or the legal status or capacity of the recipient. To re-characterize or ignore the Appellant’s legal status in this case invites consideration of the application of section 245 of the Act. Subsection 245(5) allows just 45 46 47 Ibid., at para. 50 (emphasis added). Ibid., at para. 48 (emphasis added). Ibid., at para. 59. 560600/422632 MT DOCS 11864055v1G 15
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