Tremblay, T.C.J. [Translation]:—This appeal was heard on April 26, 1989 in the City of Montréal, Québec and the last argument was received on September 5, 1989.
7. Issue
It must be determined whether the appellant, Société d'investissement Desjardins (“SID”) correctly deducted a sum of $250,000 received as a dividend from Sico Inc. in computing its taxable income for the 1982 taxation year. According to the appellant, such a deduction was provided for in paragraph 112(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") when the dividend came from a Canadian company.
The respondent refused the deduction of the dividend, alleging that the appellant was a specified financial institution within the meaning of subsection 112(2.1) of the Act and that such an institution was not authorized to make the dividend deduction provided for in paragraph 112(1)(a) of the Act when the dividend was received on shares acquired in the ordinary course of the business carried on by the appellant. The appellant denied that the shares were acquired in the ordinary course of its business and this was accordingly the specific issue.
2. Burden of Proof
2.01 The appellant has the onus of showing that the respondent's assessments are incorrect. This burden of proof is based on several judicial decisions including a judgment of the Supreme Court of Canada in Johnston v. M.N.R., [1948] S.C.R. 486; [1948] C.T.C. 195; 3 D.T.C. 1182.
3. Facts
A large number of the facts alleged were not disputed.
3.01 SID is a joint stock corporation that was created pursuant to the Act respecting the Fédération des caisses populaires et d'économie Desjardins du Québec, S.Q. 1971, c. 80, as amended). Subject to the provisions of this Act, SID is governed by the provisions of Part ll or the Companies Act. SID is a private corporation within the meaning of paragraph 89(1)(f) of the Act and it began its operations in 1974.
3.02 According to its enabling legislation, the object of SID is to encourage the development of industrial and commercial businesses, whether or not they are co-operative in nature, and thus to promote the economic development of Québec.
In its annual report SID explains that its mission is to become a partner in dynamic enterprises with expansion projects by contributing new capital likely to promote these projects. The appellant states its mission as follows in the annual report:
. . .. Without seeking permanence in our investments, once the established objectives are achieved . . . we seek partners who feel that a corporation such as ours can provide them with valuable support in planning their development, both strategically and financially ... We would like to be perceived by the developing business as the most useful financial partner when they first seek outside capital.
3.03 The capital stock of SID consists of an unlimited number of ordinary shares with no par value. As of December 31, 1982 the Fédérations des caisses populaires et d'économie Desjardins, created under the Savings and Credit Unions Act, R.S.Q., c. C-4, held approximately 79% of the ordinary shares of SID.
3.04 When it began operations in 1974, SID's business consisted in lending money and subscribing for shares in Québec businesses. Following some unfortunate experiences, primarily that in which it made loans to Core Data Products Ltd. while taking a minority share-holding, it was decided to divide SID's operations in two. From late 1976 SID concentrated on the acquisition of minority holdings in Québec businesses and left to its subsidiary, Credit industriel Desjardins Inc. (CID) the task of operating a money-lending business. Thus, in late 1976 SID passed on to CID its mission as a lender.
3.05 Among SID's principal criteria in choosing its investments, it favours contributions of capital in the form of purchases of ordinary shares for the development of a business. Its investments amount to between $1,000,000 and $10,000,000, and for each investment it seeks a holding of between 20 per cent and 49 per cent of the business's participating and voting capital. SID is essentially a venture capital corporation. According to Mr. Gagné's testimony, SID held investments for an average of ten years.
3.06 In 1982 SID generated income primarily from dividends (approximately 75 per cent of its profits) received from corporations in which it had invested earlier. The remaining 25 per cent came from interest on these investments and interest earned on loans made between 1974 and 1976.
3.07 In order to perform its role as an active partner, SID concentrated its resources by investing in a limited number of businesses. As indicated in its annual report, filed as Exhibit A-6, SID held shares as of December 31, 1982 in Credit industriel Desjardins Inc., Sico Inc., Culinar, Société de gestion Sidly, Canam-Manac, Corporation Provost Ltée and its subsidiaries, and in Corporation de gestion La Vérendrye.
3.08 Sico was incorporated under Part I of the Québec Companies Act, and continued under Part IA of this Act by continuation certificate issued on December 16, 1982.
The transactions resulting in the redemption of the 100,000 Class A shares of Sico were as follows:
[not reproduced]
3.09 In 1975, when it still had a lending function, SID granted a loan of $2 000,000 to Sico and obtained from the principal shareholders of the latter company a right of first refusal with respect to shares that the shareholder might have wanted to assign to third parties.
3.10 During 1977 the Société générale de financement (SGF) had offered to purchase from Henri Deslauriers the voting and participating shares he held in Sico; moreover, SGF agreed to lend Sico a sum of $1,100,000 in return for the issuance to SGF of debentures convertible into participating shares.
3.11 In March 1977, under its right of first refusal, SID purchased 499,000 Class B shares of Sico stock from Henri Deslauriers, and this amounted to 49.9 per cent of the participating and voting shares of Sico (that is, ordinary shares within the meaning of subsection 248(1) of the Act).
3.12 On June 29, 1978 under a trust agreement officially dated June 15, 1977, Sico Inc. (Sico) issued to SID, also under a right of first refusal previously acquired by SID, 10 per cent convertible debentures for a total of $1,100,000. These debentures were convertible into 200,000 Class C shares of Sico in the twelve months preceding their due date, that is, between June 29, 1984 and June 29,1985 (Exhibit A-2); the Class C shares of Sico were participating but non-voting shares (Exhibit A-1).
3.13 Between 1977 and 1982, SID acquired other Sico shares from those offered by the other Sico shareholders. In fact, in December 1981, SID acquired 5,453 Class B shares and from that point on it owned 50 per cent of the voting shares of Sico (Exhibit A-7).
3.14 On December 16 and 21, 1982 the capital stock of Sico was modified (Exhibit A-3). The corporation was also continued under Part IA of the Companies Act (Exhibit A-4).
The authorized capital stock of Sico was now made up as follows:
(i) 100,000 non-voting, non-participating Class A shares with a par value of $5.50, redeemable as of December 31, 1982;
(ii) 1,000,000 Class B voting participating shares (resulting from the redesignation of the 899,992 Class A convertible shares and 100,008 Class B convertible shares of Sico's capital issued earlier;
(iii) 200,000 Class C shares
— 100,000 of which were convertible as of December 22, 1982 into
100,000 Class A shares;
— 100,000 of which were convertible into Class B shares as Class B shares were issued to Sico employees, but no later than June 28, 1985. 3.15 On December 22, 1982 the terms of the debentures convertible to Class C shares that were issued in June 1977 were changed to provide that the said debentures must be converted before December 31, 1982.
3.16 On December 22, 1982 SID converted the debentures it owned into 200,000 Class C shares. SID later converted 100,000 Class C shares into 100,000 Class A shares.
3.17 On December 31, 1982 Sico redeemed the 100,000 Class A shares held by SID for $8 per share, and this generated a deemed dividend received by SID totalling $250,000.
3.18 During 1983, in order to maintain its control of Sico, SID converted the 100,000 Class C shares it still held into 100,000 Class B shares as the employees of Sico subscribed for new Class B treasury shares of Sico.
3.19 Sico is a company that has always considered employee participation in its capital to be very important. Since 1973 the principal managers of the company had advocated establishment of a share purchase plan for employees. After SID gained control of Sico, which the witness Paul Parent described as “a chance mishap”, the employees of Sico contacted the company's management to propose a share purchase plan for employees in order to increase their interest in the company while allowing them to enjoy tax benefits under the Québec share savings plan. The directors of Sico accordingly contacted SID to inform it of the employees’ request and to negotiate the establishment of the share purchase plan (minutes of the Sico Board of Directors filed as Exhibits A-8 to A-16). An ad hoc committee was then set up, consisting of three representatives of Sico and one of SID. Both the principal witnesses, Messrs. Paul Parent and Raymond Gagné, were members.
3.20 In order to qualify for the share savings scheme, the employees had to subscribe for treasury shares of the company of which they were the first purchasers. Consequently, the subscription by the employees for Sico shares might have had the effect of diluting SID's position.
SID was accordingly concerned to encourage the application of this plan while avoiding any dilution in its holdings. Moreover, this concern was expressed in the letter from SID to Sico dated December 1, 1982 (Exhibit A-16):
1. Our objective remains to allow the employees of Sico to participate in greater numbers and for larger amounts in the ownership of the business since we believe that this is fundamentally healthy for Sico.
2. In order to facilitate the application of this plan, without changing the relative position of the shareholders, we shall continue to promote the redemption by Sico of one-half of the convertible debentures held by SID and to ensure that all these debentures become convertible into voting shares rather than non-voting shares.
3.21 Thus, in order to satisfy the request by Sico employees and managers, it was decided to advance the conversion of the debentures issued in 1977 to a date before December 31, 1982. These debentures were converted on December 22, 1982 into 200,000 Class C shares, 100,000 of which were, under the terms of the shares, convertible into Class A shares redeemable not later than December 31, 1982. The 100,000 Class C shares that remained were convertible into Class B shares as Class B shares were issued to the employees of Sico, but not later than June 28, 1985. In effect, the share purchase plan for the employees provided for an issue of 100,000 shares for employees. As the employees subscribed for 100,000 Class B shares, SID was able to purchase the same number of Class B shares and thus avoid a dilution of its share of the capital stock. This accounts for the conversion, according to Exhibit A-7, of 49,962 Class C shares in December 1983, 50,038 Class C shares in July 1983 and as many Class B shares.
3.22 In December 1985, SID divested itself of its holding in Sico when that company launched a public issue by means of a prospectus.
4, Act—Case Law—Analysis
4.01 Act
4.01.1 The provisions of the Income Tax Act involved in this appeal are subsections 112(1) and 112(2.1). They read as follows in 1982:
112. (1) Where a corporation in a taxation year has received a taxable dividend from
(a) a taxable Canadian corporation, or
(b) a corporation resident in Canada (other than a non-resident-owned investment corporation) or a corporation exempt from tax under this Part and controlled by it,
an amount equal to the dividend may be deducted from the income of the receiving corporation for the year for the purpose of computing its taxable income.
112. (2.1) No deduction may be made under subsection (1) or (2) in computing the taxable income of a particular corporation (in this section and sections 248 and 258 referred to as a" specified financial institution”) that is
(a) a corporation described in any of paragraphs 39(5)(b) to (f) or an insurance corporation,
(b) a corporation that is controlled by one or more corporations described in paragraph (a), or
(c) a corporation associated with a corporation described in paragraph (a) or (b),
in respect of a dividend received by the specified financial institution on a share that was, at the time the dividend was paid, a term preferred share, other than a dividend paid on a share of the capital stock of a corporation that was not acquired in the ordinary course of the business carried on by the institution.
4.01.2 Historical context of subsection 112(2.1) and term preferred shares The respondent acknowledges that the historical context described by the appellant at pages 6, 7 and 8 of its submission is correct. It reads as follows:
According to the general rule applying to corporations, inter-company dividends are not subject to any tax because the beneficiary must include the amount of the dividend in computing its income for the year (s. 12(1)(i) ) but they may be deducted under subsection 112(1) of the Act.
Subsection 112(2.1) was introduced in 1979 (S.C. 1979, c. 5, s. 6) to prevent a deduction in the computation of taxable income in respect of dividends received by specified financial institutions (or by corporations controlled by specified financial institutions), the principal business of which is lending money. We merely have to read paragraphs 39(5)(b) to (f) to determine what these specified financial institutions are: banks, trust companies, credit unions, insurance corporations, corporations whose principal business is the lending of money or the purchasing of debt obligations or a combination thereof.
Traditionally, these financial institutions granted loans to their customers. The interest paid on these loans had to be included in computing the income of the financial institutions and was taxable at the rate applying to the institution in question. These institutions then devised a tax-free funding formula. Rather than making loans, they subscribed for preferred shares, redeemable at their option, in the capital stock of their customers; the dividends paid on these shares could be deducted in computing the income of the said financial institutions. Since the income earned from these shares was not taxable, the performance rate of the dividends on these shares was generally lower than the interest rate that this institution would ordinarily have charged its customer.
The serious loss of revenue caused by this tax-free funding mechanism for the government led Parliament to introduce the concept of "term preferred shares", dividends on which were no longer deductible in computing the recipient's income.
Section 248 of the Act gives a very lengthy and extremely technical definition of term preferred share, which includes, inter alia, a share that the issuing corporation is required to redeem or which the holder may force it to redeem. In other words, the preferred shares for which the financial institutions subscribed were more in the nature of a debt than equity in a business. Parliament accordingly introduced section 112(2.1) to ensure that the dividend received on a term preferred share would be taxable in the hands of the recipient in the same way as interest.
To ensure that financial institutions would not circumvent the legislation and subscribe for such preferred shares through a subsidiary, the definition of specified financial institution was broadened to include corporations controlled by these financial institutions.
4.02 Case law
The following cases were referred to by the parties:
1. Kit-Win Holdings (1973) Ltd. v. The Queen, [1981] C.T.C. 43; 81 D.T.C. 5030 (F.C.T.D.);
2. British Columbia Telephone Co. v. M.N.R., [1986] 1 C.T.C. 2410; 86 D.T.C. 1286 (T.C.C.);
3. Re Pacific Mobile Corp., [1985] C.B.C. 55, page 32 (sub nom. American Biltrite (Canada) Ltée v. Robitaille);
4, The Queen v. E.V. Keith Enterprises Ltd., [1976] C.T.C. 21; 76 D.T.C. 6018 (F.C.T.D.);
5. Morguard Properties Ltd. v. City of Winnipeg, [1983] 2 S.C.R. 493; 3 D.L.R. (4th) 1;
6. In re Amritsar, Punjab Co-operative Bank v. Lahore Income Tax Commissioner, [1940] A.C. 1055;
7. General Reinsurance Company Ltd. v. Tomlinson, [1970] 2 All E.R. 436;
8. M.N.R. v. Independence Founders Ltd., [1953] 2 S.C.R. 390; [1953] C.T.C. 310; 53 D.T.C. 1170;
9. Tip Top Tailors Ltd. v. M.N.R., [1957] S.C.R. 703; [1957] C.T.C. 309; 57 D.T.C. 1232;
10. The Queen v. RoyNat Ltd., [1981] C.T.C. 93; 81 D.T.C. 5072 (F.C.T.D.).
4.03 Analysis
4.03.1 Summary of parties' arguments
According to the respondent, the dividend of $250,000 in question was received on shares acquired in the ordinary course of the business carried on by the appellant.
According to the appellant, this allegation was erroneous in fact and in law since:
(i) the class A shares were not acquired in the ordinary course of the business carried on by SID;
(ii) moreover, the word “ institution” used at the end of subsection 112(2.1) of the Act does not specify SID but rather the shareholders who control SID, in this case the Fédérations des caisses populaires et d'économie Desjardins du Québec; these class A shares were not acquired in the ordinary course of the business carried on by these federations and the respondent did not adduce any evidence to the contrary.
4.03.2 Argument concerning the meaning of "institution"
4.03.2(1) The appellant's argument reads as follows:
(a) The purpose of subsection 112(2.1), as we have established, is to prevent financial institutions (or their subsidiaries) from converting into dividends what would otherwise be interest, by purchasing term preferred shares rather than granting loans, as they normally do; this purpose is achieved by preventing a financial institution from deducting the amount of the dividend received on such shares in computing its income, except where the term preferred share
was not acquired in the ordinary course of the business carried on by the institution.
The respondent justified his assessment by claiming that the Class A shares in Sico were acquired by SID in the ordinary course of the business it carried on; according to the Department, the word "institution", used at the end of subsection 112(2.1), must be interpreted as meaning "the specified financial institution” that received the dividend rather than the financial institutions that controlled SID, but the appellant challenges this assertion.
(b) The ban on deducting dividends received on term preferred shares also applies to the subsidiaries of the financial institutions and associated corporations since it would have been too easy for financial institutions to have their subsidiaries, the business of which did not consist of lending money, acquire such shares and thus circumvent the ban in subsection 112(2.1) of the Act.
However, in order to interpret the exception for shares that were not purchased in the ordinary course of the "institution's" business, we submit that the ordinary course of the financial institution’s business must be considered and not that of its subsidiaries or associated corporations.
We submit that it was not by accident that Parliament failed to repeat the expression “ specified financial institution” at the end of subsection 112(2.1) of the Act.
The introductory paragraph of 112(2.1) states that the given corporation, that is, the one receiving the dividend, is called a “specified financial institution” in that section. Why then would Parliament have used only the word "institution" in the exception for this purpose?
(c) Moreover, if the word institution” used at the end of the said subsection must be interpreted to mean “specified financial institution", it would be easy to circumvent this provision. A bank could have its subsidiary, the principal business of which was to hold title to various properties used by the bank, purchase term preferred shares. If we had to consider the “ordinary course of the business carried on by the subsidiary”, it would escape the prohibition in subsection 112(2.1) of the Act since it would not have acquired the term preferred shares in the ordinary course of the business it carried on, namely, holding property.
However, if, as we claim, we must consider the ordinary course of the financial institution’s business rather than that of the subsidiary to determine whether the exception in subsection 112(2.1) of the Act applies, we find, given our example, that the property-holding subsidiary could not deduct the dividends received on the term preferred shares from its income since these shares would have been acquired in the ordinary course of the business carried on by the bank (‘the institution”). Thus, the bank could not do indirectly what it could not do directly.
(d) Our interpretation is also supported by the wording of paragraph 112(2.2)(f) of the Act, as it read in 1982, since Parliament here speaks expressly of a
share owned . . . by a specified financial institution that acquired the share in the ordinary course of its business.
Furthermore, we must consider that, if Parliament had wished to refer to the business of the specified financial institution in subsection 112(2.1) of the Act, it would have done so as explicitly as it did in subsection 112(2.2) The provisions in subsections 258(1) and (3) of the Act are examples that indicate that, when Parliament refers to the shareholder of the corporation paying the dividend, it does so precisely:
Subsection 258(1):
For the purposes of this Act, where at any time after November 16, 1978 the paid-up capital of a term preferred share owned by
(a) a specified financial institution, or. . .
was reduced otherwise than by way of redemption, acquisition or cancellation of the share or of a transaction described in subsections 84(2) or 84(4.1), a dividend shall be deemed to have been received by the shareholder at that time equal to the amount received by him on the reduction of the paid-up capital of the share, unless the share was not acquired in the ordinary course of the business carried on by the shareholder.
Subsection 258(3):
For the purposes of paragraphs 12(1)(c) and (k) and sections 113 and 126 and subject to subsection (4), each amount that is
(a) a dividend received on a term preferred share by a specified financial institution from a corporation not resident in Canada, or. . .
To conclude, in order for subsection 112(2.1) to apply, it would have been necessary for the respondent to be sure that the class A shares were purchased by SID in the ordinary course of the business carried on by the group of financial institutions that control SID.
In 1982 up to 80 per cent of SID was controlled by a group of persons consisting of the 11 Fédérations des caisses populaires et d'économie Desjardins; the Caisse de dépôt et placement du Québec held approximately 20% of the voting shares of SID. Needless to say, the shares of Sico at issue here were not acquired in the ordinary course of the business carried on by the said federations since they were not parties to the transactions that occurred in December 1982. SID is a venture capital corporation that carries on its own business. No doubt, the various Desjardins federations were even unaware of the transactions concluded in December 1982.
(e) Moreover, under the Savings and Credit Unions Act, as it applied in 1982 (R.S.Q., c. C-4),
a federation is an organization of at least 12 savings and credit unions (s. 123); each union itself is formed of members who are the savers (ss. 18 and 28);
the object of a federation is to safeguard the similar interests of its members and for such purpose, it may
(a) exercise the powers of a union;
(b) establish educational, publicity and technical assistance services;
(c) make agreements with an affiliated union to supervise or manage its affairs for a fixed period;
(d) determine the amount and the mode of payment of the subscriptions of its affiliated unions;
(e) supply persons interested in forming a union with the necessary information to ensure its efficacy and facilitate its formation;
(f) assist unions affiliated with it by guaranteeing the carrying out of their commitments. (section 129).
The ordinary course of a federation’s business is thus to look after the interests of the unions. A federation also has the power, subject to specific restrictions (see ss. 137, 139, 140, 141), to invest in company shares, but this is not the ordinary course of its business.
The premise on which the assessment was based was incorrect. This is sufficient reason in itself to set it aside (Kit-Win Holdings (1973) Ltd. v. The Queen, 81 DTC 5030 [at p. 5038):
This opinion [Johnston v. M.N.R., [1948] CTC 195, 3 DTC 1182, [1948] S.C.R. 486] has been interpreted and relied upon as authority for the proposition that a taxpayer has the onus of proof with respect only to the findings or assumptions made by the Minister or his assessors on his behalf at the time that the assessment was made. The Minister’s assessment is based upon the assumptions made by him and the effective manner by which the taxpayer can establish error in the assessment made upon him is "to demolish the basic fact upon which” the assessment was made.
If he shows that the facts assessed by the Minister did not exist and even if they did exist those facts do not bring the taxpayer within the operation of the taxing provision relied upon the assessment must fail.
4.03.2(2) Respondent's reply concerning the meaning of “institution” The respondent's reply reads as follows:
The wording of subsection 112(2.1) is clear. If we try to extract the various components, we find, inter alia:
— that it does not allow a particular corporation, called a“ specified financial institution”, to make the deduction in subsections 112(1) and (2) when the dividend is received on a term preferred share;
-— that a "specified financial institution” is a corporation specified in paragraphs 39(5)(b) to (f) of the Income Tax Act and also a corporation controlled by one or more corporations referred to in paragraphs 39(5)(b) to (f);
— that the rule governing refusal of the deduction is of general application, the only exception being where the dividend is paid on a share that was not acquired in the ordinary course of the business carried on by the institution.
The word “institution” at the end of the provision can refer only to “specified financial institution”. It was not necessary to add the words "specified financial” before “institution” because it is clear in the context that “institution” can refer only to the expression "specified financial institution”, which Parliament had already used twice in the same sentence.
We fail to see any ambiguity in the meaning of "institution" in the context of this sentence.
Moreover, how could there be ambiguity when the word “ institution” is not used at all in the other provisions creating the term preferred shares scheme? In fact, the word "institution" is not used in paragraphs 39(5)(b) to (f) of the Income Tax Act, to which subsection 112(2.1) specifically refers, and in the other provisions to which counsel for the appellant referred in his notes (pp. 16 and 17), Parliament speaks of "specified financial institution.”
If I fully understand the argument of counsel for the appellant, it takes him outside the text. He does not give the word the meaning it has in the context of the sentence but, rather, he seems to affirm that if Parliament indeed said what it seems to have wanted to say, it was mistaken.
Parliament erred because it allowed "specified financial institutions” to circumvent the provision too easily.
In other words, counsel tried to obfuscate what was clear and then attempted to clear up the problem by way of an example. In doing so, he distorted the meaning of the provision.
The reason why Parliament did not use the expression " specified financial institution" a third time at the end of subsection 112(2.1) is that the word” " institution” was sufficient in the context for an understanding of the idea conveyed. While paragraph 112(2.2)(f) refers to the "ordinary course of its business”, this part of the sentence takes up only three lines and there is no ambiguity. In subsection 112(2.1) the sentence takes up twelve lines and it was more necessary to use the wording "the ordinary course of the business carried on by the institution” rather than "the ordinary course of its business". The latter formulation could have caused confusion.
To summarize, the definite article “the” placed before the word "institution" is used as a demonstrative. The grammarian Grévisse has stated:
The definite article is sometimes used as a demonstrative before nouns designating an object or being already referred to . . ." (Le bon usage, (1980) TIth edition, p. 336, No. 608).
In the sentence with which we are dealing, the style used by Parliament would have been much more cumbersome if it had said “of the said specified financial institution” or "of this specified financial institution” when "the institution” conveys its idea very well. As was noted by the late Mr. Justice L.-P. Pigeon in the courses he gave to the legal counsel of the Québec Government:
It is also necessary to avoid all legal jargon that is not indispensable. As far as possible, legislation, and this includes regulations and contracts, should be drafted using the ordinary words of everyday vocabulary. Learned words should not be used unless they are absolutely essential. Moreover, it is quite pointless to include expressions that do not add to the meaning and that make a sentence more cumbersome when their only purpose is to give the text a legal air; examples are “the said”, “such” etc. These words are sometimes necessary but only very rarely. If they are not indispensable, they should be avoided, as should "aforesaid", “ below-mentioned”, “hereinafter”, "hereinbefore" etc. These are all expressions that are not used in everyday language and are not generally needed in legal language.” (Rédaction et interprétation des lois, Québec: Official Publisher, at p. 37)
4.03.2(3) Appellant's reply concerning the meaning of "institution" This part of the appellant's reply reads as follows:
The appellant repeats each of the arguments made in paragraph 5.1 of its notes (pages 14 to 19) and maintains that the word “institution”, used at the end of subsection 112(2.1) of the Act, refers to the financial institution of the Fédérations des caisses populaires Desjardins du Québec.
It cannot be argued, as counsel for the respondent did, that the style would have been much more cumbersome if Parliament had said "of the said specified financial institution” or "of thisspecified financial institution”. Parliament did not have to use the demonstrative; it merely had to add the words emphasized below “in the ordinary course of the business carried on b the specified financial institution". This is particularly true when Parliament took the trouble in the introductory paragraph of this provision to indicate that the particular corporation, that is, the one that cannot deduct the taxable dividend, is called a “specified financial institution” in the section in question as well as in sections 248 and 258. Given the way in which Parliament worded the provision, how can it be argued that, by using the word "institution", Parliament wished to suggest that the word “institution” meant” specified financial institution”, despite the introductory paragraph? In this sense, the quotation from Mr. Justice L.-P. Pigeon is of no help in resolving the dispute. Parliament does not speak in vain. In the work quoted by my friend (Rédaction et interprétation des lois, Québec: Official Publisher), Pigeon J. states the following at p. 35:
There is a strong tendency today to draft contracts or undertakings in the form of letters. When the letter is a contract, the rules of legislative drafting must necessarily be applied, but in the case of genuine letter writing, the principles of literary drafting will apply. One of these principles is that excessive repetition of the same word should be avoided. Consequently, in literary writing we must strive to vary our writing [and] we must strive to vary our expression. This is what should never be done in legislative drafting, or more correctly in legal drafting.ln legal drafting, when the same word or expression is not used identically, the courts presume not that the author wished to vary his expression but that he wished to make a distinction or to change the meaning . . . While it is legitimate to use the various meanings of each word, it is necessary to avoid doing so within one and the same legal document, although this is quite permissible in literary writing. Consequently, in one and the same statute or document you should never use the same expression with different meanings. Another expression or another word must be used to say something different, even though the dictionary might justify use of the same word. There are accordingly two constraints imposed by legislative drafting: never use the same word with two different meanings and never use two different words to express the same idea.
To conclude, the appellant reiterates that not only was the premise on which the assessment was issued incorrect (see Kit-Win Holdings (1973) Ltd., mentioned at page 19 of our notes), but also this provision cannot be interpreted so as to reduce the appellant's rights (that is, its general right to deduct the dividend received) in the absence of absolutely clear wording (Morguard Properties Ltd. et al., quoted at page 25 of the appellant's notes).
4.03.2(4) Decision concerning the meaning of “institution”
The first aspect of the dispute before us is to determine the correct interpretation of "institution" at the very end of subsection 112(2.1).
First, it should be noted that the Supreme Court of Canada recently laid down the rule of construction to be used in tax disputes in Stubart Investments Ltd. v. The Queen, [1984] S.C.R. 578; [1984] C.T.C. 294; 84 D.T.C. 6305. The following passage very clearly states the principle expressed in this decision (at page 316 (D.T.C. 6323)):
Gradually, the role of the tax statute in the community changed, as we have seen, and the application of strict construction to it receded. Courts today apply to this statute the plain meaning rule, but in a substantive sense so that if a taxpayer is within the spirit of the charge, he may be held liable. See Whiteman and Wheatcroft, supra, at page 37. While not directing his observations exclusively to taxing statutes, the learned author of Construction of Statutes (2nd ed. 1983) at page 87, E.A. Driedger put the modern rule succinctly:
Today there is only one principle or approach, namely, 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.
Virtually the same wording was used in Lor-Wes Contracting Ltd. v. The Queen, [1986] 1 F.C. 346; [1985] 2 C.T.C. 79; 85 D.T.C. 5310, at 83 (D.T.C. 5313; F.C. 352), as is shown by the following passage: "The only principle of interpretation now recognized is a words-in-total-context approach with a view to determining the object and spirit of the taxing provisions."
Therefore, what might the object of subsection 112(2.1) of the Act be? This provision is geared primarily to preventing a corporation called a "specified financial institution", which may be a lending institution or a corporation controlled by or associated therewith, from claiming the deduction resulting from receipt of dividends on term preferred shares (subsection 112(2)). This prohibition applies when it is clear that the said shares were acquired in order to set up a tax-exempt administrative mechanism that would nevertheless provide them with a return that is at least as advantageous as the loans usually made to their customers. The legislative background (paragraph 4.01.2) of subsection 112(2.1) seems to show that the abuse of such a mechanism, which causes the government enormous tax losses, is the situation that Parliament wished to remedy.
However, Parliament admitted one exception. If this lending institution or a subsidiary thereof receives dividends on term preferred shares for some exceptional reason, it is clear that this would not fall within the situation that Parliament intended to remedy. Although such an interpretation raises possible questions concerning the frequency with which dividends must be received in order to bring the principle in subsection 112(2.1) of the Act into play, this Court is of the opinion that Parliament intended to give the courts responsible for applying this provision a certain amount of flexibility.
The appellant maintains that the expression “ institution” at the very end of the subsection does not refer to the corporation affected by the prohibition on deductions for dividends received but rather to a completely different thing, in this case an organization of 11 Fédérations des caisses populaires et d'économie Desjardins.
The appellant seemed to base its argument on a method of interpretation centred exclusively on a literal and grammatical approach to the wording of subsection 112(2.1), the result of which, to say the least, involves a dubious logic. In effect, since any legislative provision that contains both the general principle and the exception thereto forms a consistent and logical whole, how can the subject referred to in the general prohibition and the subject that can rely on the exemption from this principle be different persons? Such an approach also proves to be contrary to the method of interpreting taxing statutes recognized by the Supreme Court in Stubart Investments Ltd. This Court accordingly feels that a search for the object behind subsection 112(2.1) of the Act rules out the argument based on the fact that use of the single word “institution” on two occasions, as opposed to use of the term "specified financial institution” in the same section, implies that a different meaning must be given to the two expressions. Although it is a factor that must be taken into consideration, this argument is not sufficient to overturn an interpretation based on a search for the object consistent with the terms used that ensures a logical and coherent application of the provision mentioned above. It would be unfortunate if certain deficiencies in legislative drafting made it possible to give provisions a Clearly illogical scope under cover of a method of interpretation that was abusively restrictive and literal.
Moreover, it is surprising to find that the former wording of subsection 112(2.1), the amendments to which in 1980-81 affected only the list of the corporations subject to application of the principle contained in this provision, used the expression "particular corporation" both in the introductory paragraph and at the very end of the provision:
112. (2.1) No deduction may be made under subsection (1) or (2) in computing the taxable income of a particular corporation that is
(a) a corporation described in any of paragraphs 39(5)(b) to (f) or an insurance corporation,
(b) a corporation in which a corporation described in paragraph (a) has an equity percentage (within the meaning that would be assigned by paragraph 95(4)(b) if
(i) the rules in paragraph 94(1)(d) were applicable to all trusts, wherever resident, and
(ii) the references in subparagraph 95(4)(a)(i) to "number of shares” and “number of issued shares” were read as references to “number of issued shares other than shares that were not term preferred shares on November 17, 1978, but would have been term preferred shares on that day, had they not been issued before that day, or that are not term preferred shares by reason of having been issued pursuant to an agreement in writing made before November 17, 1978 and, in either case, that were issued in a transaction between persons dealing at arm's length”
of not less than 10%, or
(c) a corporation whose principal business is the ownership of shares, and that ‘is or would be, if all corporations described in paragraphs (a) and (b) were members of a related group, controlled by a related group of corporations described in paragraph (a) or (b),
in respect of a dividend received on a term preferred share by the particular corporation other than a dividend paid on a share of the capital stock of a corporation that was not acquired in the ordinary course of the business carried on by the particular corporation.
Thus, since the sole amendment to the part of subsection 112(2.1) of the Act that interests us was the insertion of the expression "specified financial institution" to replace “ particular corporation”, this Court feels that Parliament clearly intended the term “institution” in the present version of subsection 112(2.1) to refer to the same entity as the expression "specified financial institution" previously used on two occasions in the text of this provision.
Finally, the authors also seem to be unanimous as to the interpretation to be given to subsection 112(2.1) of the Act:
Subsection 112(2.1) provides that subsections 112(1) and (2) do not apply to permit the deduction by a corporation of taxable dividends received on a "term peferred share” if the recipient corporation is a“ specified financial institution” as defined. The disallowance of this deduction does not apply if the share on which the dividend was paid was not acquired by the corporation in the ordinary course of the business carried on by that corporation. The term "specified financial institution" is described in more detail in the commentary at #16,346 and the definition of a "term preferred share” is described in more detail at #16,348.
[CCH Canadian Tax Reporter, Vol. 3 page 15291 paragraph 16345]
It is clear that the corporation receiving the dividends, the “recipient corporation" is the same as "that corporation", i.e., the corporation that acquired the term preferred shares on which the dividends were paid.
A similar conclusion may be drawn from the comments of the Canada Tax Service, where it is clear that the terms used in this provision, namely, " certain described corporations in respect of a dividend received on a 'term preferred share"' and“ recipient corporation” refer to the same corporate entity:
112. (2.1) By virtue of subsection 112(2.1), no deduction may be made under subsection (1) or (2) in computing the taxable income of certain described corporations in respect of a dividend received on a "term preferred share", which expression is defined in subsection 248(1). By way of exception, such a dividend is deductible if paid on a share of the capital stock of a corporation that was not acquired in the ordinary course of the business carried on by the recipient corporation.
[Richard De Boo Canada Tax Service—Stikeman, Vol. 6, pages 112-1143]
In conclusion, this Court feels that the term “ institution”, as used in the current wording of subsection 112(2.1) of the Act, following a search for its object, must in all logic relate to the notion of "specified financial institution” as defined in the wording of this provision. Moreover, since this was the intent of Parliament, why did it not simply use the expression “ specified financial institution” rather than " institution” ?
4.03.3 Argument concerning the meaning of "ordinary course of business?'
4.03.3(1) Appellant's argument
The appellant's argument reads as follows:
SID did not acquire the class A shares of Sico in the ordinary course of its business
Should the Court not accept our interpretation of the word" institution” in subsection 112(2.1), it must determine whether the Sico shares were acquired in the ordinary course of the business carried on by SID. We respectfully submit that the evidence adduced at the hearing showed beyond any doubt that SID did not acquire the class A shares of Sico in the ordinary course of its business.
What was the ordinary course of the business carried on by SID? SID is a venture capital corporation, the business of which is to acquire minority holdings of voting and participating shares in Quebec businesses. Thanks to the management and financing expertise it provides, which was acknowledged by the witness Paul Parent of Sico, SID acts as a partner in a business, not in respect of the management and everyday operations of this business but rather in respect of its general orientation. It is allowed to do this by the positions held by its managers in the business's Board of Directors. SID invests for the medium and long term. Since 1976 SID had carried on no money-lending business; it no longer carried on a business of purchasing and selling shares. It held and still holds investments in businesses.
On this last point, it is quite revealing to find that Mr. André Michaud, the respondent's auditor, seems to have felt that the ordinary course of SID’s business was to purchase and sell shares, primarily because of the fact that in 1980 SID had purchased 282 ordinary shares of a company called Industeck and 412 shares, which he called preferred although he did not have the supporting documents, and disposed of this holding 218 days later. On this point it should be noted that Mr. Raymond Gagné confirmed that SID disposed of its holding in this company because of the company's bankruptcy; moreover, Mr. Gagné denied that SID held preferred shares of this company. He indicated that SID held its investments for an average of 10 years. The holdings of which SID disposed resulted in most cases from the misfortunes of the companies in which it had invested when they became bankrupt or insolvent. Mr. Gagné mentioned the names of Petro-Sun, Industeck, Core Data, Aquaparc, Asbestonos, Corporation La Vérendrye, Sonex- eau and Plastique Macaple. On the other hand, SID disposed of its holding in Québecair and Nordair after several years when its wish to merge the two air carriers failed to gain the approval of both levels of government. It also disposed of its holding in Sico in 1985 when the latter made a public issue and listed its shares on the stock exchange; it had been a shareholder since 1977.
Exceptionally, SID held preferred shares of Canam-Manac. This exceptional situation was explained by the fact that SID already held a minority share in this company and, because of the difficult economic situation around 1981, it injected new capital into preferred shares so as not to take control of this company to the detriment of the majority shareholders at that time. The fact remains, however, that this was an exceptional situation and it could certainly not be argued that the acquisition of preferred shares (and again the respondent did not show that they were term preferred shares, as was the case in Sico) formed part of the ordinary course of the business it carried on.
The debentures initially issued in 1977 were convertible into participating nonvoting shares. The 1982 amendment to the terms of these debentures, their conversion and the redemption at a premium of the class A shares of Sico in late 1982 were carried out solely to comply with the request of the employees of Sico to increase their holdings in the company's capital stock, while taking advantage of the provisions of the Québec share savings scheme. To attain this objective, it was also necessary to take account of SID's objectives, that is, to avoid any dilution of its holdings of the capital stock of Sico. This was why the debentures originally issued could be converted into voting and participating shares of SID as the employees acquired similar shares. By acting as it did, SID did not need an additional investment to maintain its position. Furthermore, all the transactions had the merit of not changing the shareholders’ interests.
It is very important to note that the exception in subsection 112(2.1) of the Act refers to the “ ordinary course of the business carried on" and not "the ordinary course of business". The distinction is fundamental since SID's decision to participate in the reorganization of Sico's capital to accelerate the conversion of the debentures that it held may have been made” in the ordinary course of business” but not "in the ordinary course of the business carried on by SID”.
In British Columbia Telephone Company v. M.N.R. (86 D.T.C. 1286), the appellant carried on a business that involved selling telephone service to its customers. In computing its income, the appellant claimed a deduction for inventory in respect of certain equipment, namely, goods sold to other telephone companies at cost. To be entitled to the deduction, the taxpayer had to show whether these goods were held by it for sale "in the ordinary course of the business carried on by the company". The Court recognized the distinction between the ordinary course of business and the ordinary course of the business carried on by a taxpayer [p. 1290)]:
The term used in subsection 20(1)(gg) is not "ordinary course of business?', but "ordinary course of the business?', that is, the ordinary course of the business carried on by the taxpayer. Thus, I must consider the business of B.C. Telephone to determine whether the property sold by it to Okanagan Telephone and other corporations was in the ordinary course of its business.
In a bankruptcy matter before the High Court of Australia, Rich, J. wrote that for the transactions to be considered in the ordinary course of business supposes “ that according to the ordinary and common flow of transactions in affairs of business there is a course, an ordinary course. It means that the transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary business as carried on, calling for no remark andarising out of no special or particular situation": Downs Distributing Co. Pty., Ltd. v. Associated Blue Star Stores Pty., Ltd. (In Liquidation), (1948), 76 C.L.R. 463, at page 477. Street, J. of the Supreme Court of New South Wales stated that “ the transaction must be one of the ordinary day to day business activities, having no unusual or special features, and being such as a manager of a business might reasonably be expected to be permitted to carry out on his own initiative without making prior reference back or subsequent report to his superior authorities, such as, for example, to his board of directors.”: Re Bradford Roofing Industries Pty., Ltd. (1966), 84 W.N. (Pt. 1) (N.S.W.) 276 at page 285; Street, J. borrowed with minor adaptations the words of Rich, J.: "the requirement is that the transaction must fall into place as part of the undistinguished common flow of the company's business, that it should form part of the ordinary course of the company's business as carried on, calling for no remark and arising out of no special or particular situation”. In the instant case the reorganization of Sico's capital and the redemption of the class A shares held by SID certainly did not take place in the ordinary course of SID's business ('the transaction must be one of the ordinary day to day business activities, having no unusual or special features . . . the requirement is that the transaction must fall into place as part of the undistinguished common flow of the company's business.”)
Moreover, if matters had taken their normal course, SID would have waited until the debentures fell due before converting them into participating shares in Sico. The premature conversion and the redemption of part of the shares were thus unusual occurrences caused by the desire to encourage greater participation by Sico employees in their company's capital stock. How, then, can the Minister of Revenue claim that these unforeseen and unusual events occurred in the ordinary course of SID's business?
There is no judicial decision that has really defined the meaning of the ordinary course of the business of a company. Moreover, as was stressed by the Supreme Court of Canada in Re Pacific Mobile Corporation; Robitaille v. American Biltrite (Canada) Ltd., [1985] CBC 55, p. 32 (at p. 33]:
It is not wise to attempt to give a comprehensive definition of the term "ordinary course of business” for all transactions. Rather, it is best to consider the circumstances of each case and to take into account the type of business carried on between the debtor and creditor.
We approve of the following passage from Monet J.A.'s reasons discussing the phrase "ordinary course of business” at p. 205:
It is apparent from these authorities, it seems to me, that the concept we are concerned with is an abstract one and that it is the function of the courts to consider the circumstances of each case in order to determine how to characterize a given transaction. This in effect reflects the interplay between law and fact.
In another case, The Queen v. E.V. Keith Enterprises Ltd., 76 D.T.C. 6018, the taxpayer was a management company that had invested in other companies involved in real estate development and in construction; moreover, the taxpayer had granted loans for a number of years to individuals and firms with which it did business. The taxpayer claimed a provision for bad debts in respect of a loan, but the Department refused it. The Federal Court accordingly had to decide whether the loan had been granted in the ordinary course of the defendant's business. It answered in the affirmative on the basis of the repetition of similar transactions earlier [at p. 6020].
... it remains that the loan was of a class that the Defendant had the power to make and had established, over the years, a pattern of making in the ordinary course of its business, and that Allyn James, notwithstanding the relationship, was within the class of persons to whom such financial accommodation had been regularly extended.
Finally, we should note that subsection 112(2.1) is an exception to the general principle stated in subsection 112(1) concerning the deductibility of taxable divi- dends received by a taxable Canadian corporation. As was noted by the Supreme Court of Canada in Morguard Properties Ltd. et al. v. City of Winnipeg, [1983] 2 S.C.R. 493 [at p. 5071:
For centuries, statutes levying taxes and like imposts on the citizen have been read strictly in the sense that the Legislature must, in order to reduce a right in the taxpayer, say so in unmistakably clear terms.
Conclusions
Whereas the word “institution” used in subsection 112(2.1) of the Act refers to the shareholders of SID, contrary to the premise on which the respondent relied in assessing the taxpayer;
Whereas SID is a venture capital business that makes medium- and long-term investments in participating voting shares (ordinary shares within the meaning of the Act) in Québec companies;
Whereas SID does not carry on any business purchasing and selling shares but acts as a partner providing technical support for Québec businesses;
Whereas it is not part of SID's mission to grant loans to Québec businesses, either in cash or in the form of term preferred shares;
Whereas the sole purpose of the reorganization in 1982 was to enable employees to subscribe for the share capital of Sico without at the same time diluting SID's holding in the company;
Whereas the transactions concluded in December 1982 were not in the ordinary course of the business carried on by SID;
Therefore
To Refer the assessment back to the Minister of Revenue so that it may be allowed to deduct the $250,000 claimed with respect to the dividend deemed to have been received from Sico Inc. in computing its taxable income, ':
4.03.3(2) Respondent's argument concerning the meaning of "ordinary
course of business”
The respondent's argument reads as follows:
Shares Acquired In The Ordinary Course Of The Business Carried On By Société
Desjardins
Exhibit 1-2 entitled "General information on Société d'investissement Desjardins and its subsidiaries" dated January 25, 1978, states its purposes and objects, according to the Act, as being:
Section 12: The purpose of the Corporation shall be to create and administer an investment fund with the object of establishing and developing industrial and commercial undertakings, of a cooperative nature or not, and thus promote the economic progress of the province of Québec.
Section 13: The Corporation may in particular:
(a) acquire securities and any evidences of indebtedness and title of participation;
(b) establish, provide and lease and hire technical, management and research services for itself or for others.
In a publicity leaflet (Exhibit A-17) Société d’Investissement Desjardins explains that it is looking for" high profitability measured by increases in share value and by dividend flow”.
The financial statements and the statement of income of Société d’Investissement Desjardins for its 1982 taxation year (Exhibit 1-1) disclose, inter alia:
1. that Société d'investissement Desjardins held shares in 10 corporations [Form 125(9)];
2. that the shares held included non-voting shares of 4 corporations [125(9)]; 3. that its gross operating income included dividends totalling $1,468,498 in 1982 and $1,459,492 in 1981 (Unconsolidated results);
4. that its assets included obligations (unconsolidated balance sheet) totalling $4,706,925 in 1981 and $3,873,950 in 1981 (note 5 to the financial statements);
5. that its assets also included notes and term deposits totalling $6,931,000 in 1982 and $9,466,000 in 1981 (Unconsolidated balance);
6. that the value of its holdings totalled $54,360,101 in 1982 and $48,742,842 in 1981 (note 6 to the financial statements);
7. that at page 1 of its statement of income for 1982 Société d'investissement Desjardins described itself as a" holding company” and stated that its total income was broken down as follows (which contradicts the statement on page 9, paragraph (e) of the notes of counsel for the appellant):
| — interest | 69.5% |
| — dividends | 37.9% |
| -— other | 2.6% |
| The evidence also showed: | |
— that Société d'investissement Desjardins held preferred shares of Indus- teck;
— that the debentures for $1,100,000 issued to Société d'investissement Desjardins by Sico on June 29, 1978 were convertible into participating non-voting class C shares of Sico;
-— that despite Mr. Gagné's statements that since early 1977 Société d'investissement Desjardins was restricted to acquiring shares and left the business of lending money to C.I.D., it loaned $1,100,000 guaranteed by debentures to Sico in June 1978 (Exhibit A-2) and, according to what can be noted in its statement of income, 69.5% of its income consisted of interest; furthermore, the document entitled "General information on Société d'investissement Desjardins" (Exhibit 1-2) contains the following statements:
although Société d'investissement Desjardins transferred the major part of its loan portfolio, it did not intend to abandon this activity (p. 4-1976) and
it must be remembered that Société d'investissement Desjardins also works in the loan field. (p. 5);;
— that despite Mr. Gagné's statements that Société d'investissement Desjardins wished to hold only between 20% and 49% of the shares of the corporations in which it invested, it actually controlled three corporations in 1982, had acquired control of CORE in 1976 (Exhibit 1-2, p. 6) and, according to Mr Gagné's statement, wished to retain control of Sico although it encouraged the purchase of shares by Sico employees.
All in all, the evidence showed that Société d'investissement Desjardins wished to make profits by investing in the shares of corporations but was eminently flexible in its approach. It chose to lend money, purchase participating and voting shares or to invest in preferred or non-voting shares, depending on the circumstances. In a holding company of this kind it would be rather surprising if the situation were otherwise.
In the circumstances it is clear that the shares acquired in December 1982 after the debentures were changed and converted into redeemable shares and redeemed cannot be taken in isolation. These shares were acquired and sold in a search for "high profitability measured by increases in share value and by dividend flow”, which is the objective of Société d'investissement Desjardins, according to its information leaflet (Exhibit A-17, right-hand column).
Concerning the meaning of the expression “ ordinary course of the business carried on” by the specified financial institution, Mr. Geoffrey S.R. Dyer states ‘the following at page 25 of an article published in “ Corporation Tax Conference—1986" (Tab B below):
. . . Obviously, it is a question of fact whether a purchase of shares by a specified financial institution does or does not take place in the ordinary course of the institution’s business. Indeed, in the nontax area, there is considerable authority for the proposition that these words, which may have a very wide meaning, must be interpreted within the context in which they are used (an ordinary principle of statutory construction) and that different contexts can produce dramatically different meanings. In the case of a purchase of term preferred shares by a financial institution, some assistance may be found in those tax cases that consider whether particular securities transactions carried on by financial institutions are on account of capital or income. The very nature of the business of a financial institution will make it difficult in most cases to contend that a purchase of term preferred shares was beyond the ordinary course of this business. In the case of a specified financial institution that is not itself engaged in the financing business but is associated with a financial institution, however, there could be considerably more scope to contend that its term preferred share investment was acquired outside the normal course of this business.
In the September-October 1982 issue of Canadian Tax Journal (Tab C, below), Messrs. Jack Boultbee and Douglas Ewens state at page 749:
Unfortunately, this term (ordinary course of the institution’s business) is not defined, although it is perhaps sufficient to say that most investments made by such institutions are made in the ordinary course of business.
To my knowledge, there is no judgment dealing directly with the meaning of the expression found in subsection 112(2.1) of the Act. However, there are decisions where judges have expressed an opinion in cases where they had to determine whether certain activities of businesses involved in finance were carried on in the ordinary course of business.
In Punjab Cooperation [sic] Bank Limited [sic], Amritgar [sic] v Commission [sic] of Income Tax, [1940] A.C. 1055 (Tab D), the basic tax issue was whether the profits made by a bank on the sale of securities and shares were taxable.
The bank argued that the profits made were not taxable because they had not been generated in carrying on its banking business. According to the bank, the securities and shares were reserves for emergencies and, in fact, they had disposed of many securities because several depositors had withdrawn their holdings and the bank had also had to deposit large sums of money with the Reserve Bank of India. The bank maintained further that it was not in the securities business and the profit was accordingly not taxable.
The Privy Council upheld the decision of the Tax Commissioner that the bank had been involved in the securities and shares business since the end of the previous year. According to the Privy Council, however, it was not necessary to find that the bank was carrying on a business separate from its usual business and it felt rather that the profits generated came from the normal activities of the banking business. At pages 1072 and 1073 the Privy Council said:
If. . . some of the securities of the bank are realized in order to meet withdrawals by depositors, its seems to their Lordships to be quite clear that this is a normal step in carrying on the banking business, or, in other words, that it is an act done in what is truly the carrying on of the banking business. . . It accords exactly with one of the findings in the statement of the Commissioner agreeing with the views both of the Income-tax officer who first dealt with the case and of the Assistant Commissioner. He observed “that the purchase and sale of shares and securities are so much linked with the deposits and withdrawals of clients that, with the existing Articles of Association, the purchase and sale of shares and securities are as much part of the assessee's business as receiving deposits from clients and paying them off are, and that, therefore, the profits which arise from the former transactions are as much business profits as the profits arising from the latter transactions are.
The parallel that can be drawn between this judgment of the Privy Council and the case before this Court will be immediately obvious. In reality, the facts in the Société d'investissement Desjardins case are even stronger because in the case of a bank it can be said that its primary task is to receive deposits and to lend money. The holding of securities would then be merely collateral to its primary activities, whereas in the case of Société d'investissement Desjardins the holding of bonds, debentures, shares and other securities of the same kind is the whole business activity of the company.
We should also refer to the judgment in General Reinsurance Company Ltd. v. Tomlinson, [1970] 2 All E.R. 436, (Tab E). By and large, this case involved a reinsurance company that accumulated funds that were invested, inter alia, in a portfolio of shares and other securities. The dispute concerned the question as to whether the profits made on the sale of the shares and securities was taxable.
After reviewing the case law, including Punjab, Foster J. of the Chancery Division noted at page 446:
In this case the Commissioners have come to the conclusion that realized profits and the dividends and interest on the dollar securities have been obtained in the carrying on of the business. In my judgment, the Commissioners were fully justified in coming to that conclusion on the facts and I think that their conclusion was, in fact, the only true and reasonable conclusion.
We should also draw the Court's attention to two judgments of the Supreme Court of Canada showing that it is difficult to isolate part of the activities of a corporation from the ordinary course of its business. These are M.N.R. v. Independence Founders Ltd., 53 D.T.C. 1177, and Tip Top Tailors Ltd. v. M.N.R., 57 D.T.C. 1232.
First, in Independence Founders (Tab F), Kellock J. of the Supreme Court described the business carried on by Independence Founders. This corporation purchased securities that it gave to the Royal Trust in a “unit” and in return received " Royal Trust shares”. These Royal Trust shares were deposited with Prudential Trust and Independence sold its customers certificates representing ownership rights in the Royal Trust shares as an investment. The customers could present these shares to Prudential Trust and obtain cash or other Royal Trust shares. During the years in dispute, Independence could no longer acquire the necessary securities to acquire the Royal Trust shares and it accordingly changed its method of operation and purchased Royal Trust shares issued by Prudential Trust and sold them at a profit.
Was the profit made by Independence capital in nature or was it business income? The Supreme Court held that it was business income. At page 1180, right-hand column, Kellock J. states the following:
The principle stated by Lord Maugham in Punjab Co-operative Bank v. Income Tax Commissioner, [1940] A.C. 1055, in words used in the California Copper case ... is applicable, namely, enhanced values obtained from realization or conversion of securities may be so assessable, where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business.
In Tip Top Tailors Ltd. (Tab G) the company was in the business of buying woollen fabric in Great Britain and it purchased pounds sterling to pay for its acquisitions. In late 1947, since it felt that the pound sterling was going to decline in value, it purchased a larger quantity than was required for the immediately planned purchase of fabric. It made a profit of $170,000 on the devaluation of the pound. It was necessary to determine whether the profit of $170,000 made on the devaluation was part of Tip Top Tailors’ income.
The Supreme Court held that it was business income. At page 1236, last complete paragraph, and at page 1237, Locke J. stated the following:
I agree with the learned trial judge that it was a scheme for profit-making in one necessary part of the appellant's trading operations, namely, the purchase of sterling funds and part of an integrated commercial operation being the purchase of the supplies and the payment for them in that currency. It was apparently treated as such in the preparation of the appellant's accounts for the years in question since if it was simply a speculation in sterling exchange divorced from the company's trading operations the interest payable on the bank loan would not have been deductible as an operating expense.
Finally, we should note the judgment of Addy J. in The Queen v. RoyNat Ltd., [1981] C.T.C. 93 (Tab H). There were two issues in this case but only the second is of interest to us. In the headnote to the case we see that RoyNat carried on a money lending business. In the course of carrying on its business RoyNat received from borrowers securities, shares and options to purchase shares.
RoyNat argued that the profit made on the sale of the shares was a capital gain, while the Minister contended that it was business income. At page 104 Addy J. summarized his findings of fact and then reviewed the Canadian case law. At page 107 he states that the profits were generated from transactions or operations that formed an integral part of RoyNat's activities.
That case was very similar to the case of Société d'investissement Desjardins. The difference between them lies essentially in the fact that Société d'investissement Desjardins seems to have been more active than RoyNat in the field of acquiring shares as a form of investment.
However, the judgment in The Queen v. E.V. Keith Enterprises Ltd., to which counsel for Société d'investissement Desjardins refers in his notes, seems to us to provide stronger support in favour of the assessment than the argument made by the appellant. In fact, in this case the judge noted that money lending was an activity that the corporation could carry on pursuant to the documents by which it was created and, moreover, the corporation had in fact been involved in this activity for a number of years. Société d'investissement Desjardins was set up, inter alia, to invest in securities and Mr. Gagné stressed the importance of this aspect of the appellant's activities. It is accordingly unnecessary to consider whether the acquisition of shares was a normal activity of Société d’Investissement Desjardins: it is certain that this was the case.
The case of B.C. Telephone v. M.N.R., which was relied upon by the Counsel for the appellant, was decided in a very different context from the instant case. The distinction made by Judge Rip of this Court between "the ordinary course of business” and the “ ordinary course of business carried on by a company” does not give us a better understanding of the expression in subsection 112(2.1) of the Income Tax Act. It seems to us that the judge was more concerned to stress, as did the Supreme Court in Re Pacific Mobile Corporation (also referred to at page 24 of the appellant's notes) that “it is not prudent to attempt to give an exhaustive definition of the expression 'in the ordinary course of business' that would apply to all cases". It is preferable to consider the circumstances in each case and to take into account the type of business carried on by the debtor and creditor.
Judge Rip’s statements in B.C. Telephone relate to particular circumstances in that the company sold equipment at cost and thus did not make a profit. However, selling equipment without making a profit does not seem to be an activity that would normally fall within "the ordinary course of business”. In B.C. Telephone, however, these activities were integrated into the business carried on because the company obtained better prices by purchasing larger quantities than it required and selling the surplus to other companies providing telephone service.
In the instant case, the "type of business” carried on by Société d'investissement Desjardins must be examined. This company did not purchase equipment for resale. Société d'investissement Desjardins did not create inventories of furniture that it sold in the market place. It carried on a business that to a large extent involved investing capital in corporations in the form of shares. This was an integral part of the business it carried on. It is understood that it is not possible to compare what Société d'investissement Desjardins does with what B.C. Telephone does. The result is that it is much preferable to look for judicial precedents that deal with businesses similar to that carried on by Société d’Investissement Desjardins, as we did earlier, rather than moving away from it with judgments such as that in B.C. Telephone.
Conclusions
Société d'investissement Desjardins is without any doubt a specified financial institution referred to by Parliament in subsection 112(2.1) of the Income Tax Act. It is clear from reading the provision that the expression "institution" occurring at the end of the subsection cannot mean anything other than "specified financial institution”, in this case Société d'investissement Desjardins.
Concerning the question as to whether the Sico shares were acquired by Société d'investissement Desjardins in the ordinary course of carrying on its business, we feel that we have shown that this was indeed the case. The cases referred to support as Clearly as is possible the position taken by the Department of Revenue. If we adopt the interpretation suggested by counsel for the appellant, we reach the, to say the least, very dubious conclusion that a "specified financial institution" could not be subject to subsection 112(2.1) when it acquires term preferred shares for the first time. According to him, this is a transaction that would have to be ruled out of the ordinary course of the business carried on by the specified financial institution. In other words, if I have correctly understood his argument, subsection 112(2.1) would apply only to the specified financial institution that carried on a business based on the acquisition of term preferred shares.
This is certainly not the meaning that should be given to the expression “ ordinary course of the business carried on by the institution” and once again we draw the attention of the Court to the text of Mr. Dyer (Supra, at p. 7), who wrote that in practically all cases a specified financial institution could not claim that the acquisition of term preferred shares did not form part of the ordinary course of the business carried on because of the very nature of the business carried on by these institutions.
We accordingly request that the appeal be dismissed.
4.03.3(3) Appellant's reply concerning the meaning of "ordinary course of business"
The appellant's reply reads as follows:
Counsel for the respondent places a great deal of emphasis on the text of Mr. Geoffrey Dyer published in ' Corporate Tax Conference” in 1986. According to him, Mr. Dyer “wrote that in practically all cases a specified financial institution could not claim that the acquisition of term preferred shares did not form part of the ordinary course of the business carried on . . .". I respectfully submit that counsel for the respondent has misread Mr. Dyer's article. This passage from Mr. Dyer's text concerns a financial institution (such as the Fédérations de caisses populaires Desjardins) and not specified financial institutions, which, according to Mr. Dyer's article, can show much more easily that the acquisition of shares did not take place in the ordinary course of the business carried on by the institution. Let us look again at the passage in question [at p. 25]:
The very nature of the business of a financial institution (as opposed to a specified financial institution) will make it difficult in most cases to contend that a purchase of term preferred shares was beyond the ordinary course of this business. In the case of a specified financial institution (which is what the appellant is since it is controlled by financial institutions) that is not itself engaged in the financing business but is associated with a financial institution, however, there could be considerably more scope to contend that its term preferred share investment was acquired outside the normal course of this business.
Counsel for the respondent stressed the first sentence in the above text, but it does not apply to the appellant. The appellant's case is really covered by the second sentence of the passage. In an article published in the 1983 issue of “Canadian Tax Journal”, Mr. Jack Boultbee commented as follows on the expression “ ordinary course of the business” [at p. 846]:
It seems that for something to be in the ordinary course of a business, it must be a business that is carried on with some activity and continuity (otherwise it would not have a "course" of business). A holding company that merely holds shares of subsidiaries (and possibly is involved in the management of those subsidiaries) usually does not have a business of buying shares with such frequency that it could be thought to acquire the shares in the ordinary course of that business. In general, Revenue Canada has agreed with this position and has stated that it will not ordinarily apply the provisions of subsection 112(2.1) to shares of subsidiary corporations held by banks or other specified financial institutions.
In the instant case the appellant reiterates that it does not have an ordinary course of business consisting of purchases and sales of shares. The shares it holds are held as investments.
Furthermore, it is very hard to imagine that a corporation could purchase shares of its subsidiary (such as SID shares of Sico) and claim that this purchase was made in the ordinary course of its business. It was, moreover, for this reason, that Mr. Boultbee mentioned in 1983 that dividends paid from the shares of a subsidiary of a bank did not generally give rise to the application of subsection 112(2.1) of the Act.
For this reason, inter alia, the case law referred to by the respondent is not relevant in this case. In the decisions in Punjab Co-operation Bank Ltd., Amritgar [sic], General Reinsurance Company Ltd., Independence Founders Limited and Tip Top Tailors Ltd. it was necessary to determine whether the sales of securities created a capital gain or business income.
This distinction does not exist in the instant case since SID was not in the business of purchasing and selling shares.
The appellant reiterates that the tests relied on by the Court in British Columbia Telephone Company (page 22 of the appellant's notes) are relevant since the Court interpreted the expression used in paragraph 20(1)(gg) (‘ordinary course of the business”), which was identical to that in subsection 112(2.1), which is at issue before this Court.
For these reasons the appellant maintains the conclusions stated at page 26 of its notes and requests the Court to refer the assessment back to the Minister of Revenue so that it may be allowed the deduction of $250,000 claimed in respect of the deemed dividend received from Sico Inc. in computing its taxable income.
4.03.3(4) Decision on the meaning of the expression “in the ordinary
course of the business"
Concerning the second aspect of the dispute before us, this Court feels that the acquisition of the term preferred shares did not occur in the ordinary course of the business of Société d'investissement Desjardins.
4.03.3(4)(a) First, it must be realized that it is the acquisition of the term preferred shares that is the subject of our analysis. A hasty glance at subsection 112(2.1) of the Act is sufficient to persuade us of the truth of this assertion.
(2.1) No deduction may be made under subsection (1) or (2) in computing the taxable income of a particular corporation (in this section and sections 248 and 258 referred to as a "specified financial institution") that is
(a) a corporation described in any of paragraphs 39(5)(b) to (f) or an insurance corporation,
(b) a corporation that is controlled by one or more corporations described in paragraph (a), or
(c) a corporation associated with a corporation described in paragraph (a) or (b),
in respect of a dividend received by the specified financial institution on a share that was, at the time the dividend was paid, a term preferred share, other than a dividend paid on a share of the capital stock of a corporation that was not acquired in the ordinary course of the business carried on by the institution.
In short, what were the circumstances leading to the acquisition of the term preferred shares? If we are to answer this question adequately, it is essential that we take into account the importance of the pressures exerted by the employees of Sico on the terms that might have arisen in the change in the company's capital stock.
These amendments to the capital stock of Sico made by by-law No. 42 (Exhibit A-3), which were directly responsible for SID's acquisition of the term preferred shares of Sico, provided, inter alia, that the Class C shares were convertible on December 22, 1982 into Class A shares that were themselves to be redeemed by Sico on December 31, 1982.
A presentation of the decisive stages preceding the allocation of the deemed dividend of $250,000 that is the subject of this dispute will enable us to give a clearer presentation of the Court's position.
In 1975 SID was granted a right of first refusal by the principal shareholder of Sico Inc. (paragraph 3.09).
On June 29, 1978, under its right of first refusal, SID became the holder of debentures of Sico Inc. amounting to $1,100,000. The issue of these debentures was governed by a trust agreement that came into effect retroactively on June 15, 1977 (paragraph 3.12).
After SID acquired control of Sico (paragraph 3.13), a series of measures was contemplated by the directors of Sico Inc. to give employees a much greater participation in the business (Exhibits A-8 and A-14).
The date of conversion of the debentures issued was moved up at the request of the employees and managers of Sico Inc. The deadline for conversion was scheduled for December 31, 1982 (paragraph 3.15 and 3.21).
The members of Sico Inc.'s Board of Directors favoured a change in the capital stock, the conditions of which were laid down by an ad hoc committee. SID was an influential member of this study group as appears in an extract from the minutes of a meeting of the Board of Directors of Sico Inc. held on April 21, 1982 (Exhibit A-9):
Structure of capital stock
At the request of the President, the President and General Manager summarized for the directors the action taken to date with respect to the project to restructure the company's capital stock with a view, inter alia to increasing employee participation. He also informed them of the Advisory Committee's recommendation to the President and General Manager that an ad hoc committee be established, made up of representatives of the main groups of shareholders, to continue with the study of various aspects of this question.
On a motion duly made and seconded, it was unanimously Resolved:
1. to authorize the establishment of an ad hoc Committee to study the various aspects of the Board of Directors’ project to restructure the company’s capital stock with a view, inter alia, to increasing employee participation and to make recommendations;
2. that the said Committee should consist of representatives of Société d'investissement Desjardins, Parisco Inc and employees of the company, who shall agree on the appropriate terms and conditions in this regard; and
3. that the said Committee decide on its own procedure but shall not be considered to be a committee of the Board of Directors.
A by-law concerning the modification of the capital stock was adopted by the Board of Directors on December 15, 1982 (Exhibit A-13).
The decisive aspects of Sico Inc.'s new capital stock (Exhibit A-3, paragraph 3.14) may be found in paragraph 3.5.1, where it is stated that Class C shares should be converted on December 22, 1982. Paragraph 3.2.1 states that the Class A shares (including the Class C shares that may have been converted earlier) should be redeemed by Sico Inc. on December 31, 1982.
This Court accordingly feels that it is unthinkable not to take into consideration the relationship between the pressure exerted by the employees of Sico Inc. and the changes made in this company's capital stock and to the date on which the debentures issued were converted.
— Whereas SID's position on the alternatives designed to satisfy the staff of
Sico Inc., namely, the conversion of debentures that had been issued to it into Class C shares, was clearly established in the letter sent to it (Exhibit A-16, paragraph 3.20);
— Whereas the number of Class C shares convertible into Class A and B
shares was 200,000;
— Whereas the number of convertible voting shares (Class B shares) was
100,000 and, according to the by-law modifying the capital stock of Sico Inc. (Exhibit A-3), the conversion would be carried out at the same pace as voting shares would be issued to the employees;
— Whereas the maximum number of voting shares intended to be issued to
Sico Inc’s employees was set at 100,000;
— Whereas, finally, following the modification in the capital stock of Sico
Inc., the Class A shares were clearly created to be eliminated from the paid-up capital of Sico Inc., this Court can only conclude that the acquisition of the term preferred shares (Class A shares) by SID was merely a response to the particular situation resulting from the pressures exerted by the employees of Sico Inc. on the Board of Directors of that company.
In short, there was nothing to support the assertion that the acquisition of term preferred shares in this case might have been made in the ordinary course of the business carried on by SID.
4.03.3(4)(b) Moreover, if we assume that SID is to a large extent responsible for the changes made in the capital stock of Sico Inc., that SID was consequently fully aware of the eventual impact of these changes on its own situation, can it be argued that the acquisition of such term preferred shares was a logical part of SID's investment philosophy? This Court is of the opinion that this question can be answered only in the negative. In effect, Société d'investissement Desjardins defined its philosophy (Exhibit A-17) as follows:
—— SID is looking for high profitability measured by increases in share value
and by dividend flow.;
—- SID's action is directed toward markets that offer attractive growth potential
and healthy profits.
It also seems to be admitted that, in order properly to perform its role as an active partner in the management of a limited number of businesses, SID preferred medium- and long-term investments. The average time for which SID's investments were held was ten years. How can it be argued that the acquisition of term preferred shares, which occurred in this case on December 22, 1982, was consistent with the general investment philosophy of SID when the same shares were to be redeemed by Sico Inc. on December 31, 1982? The acquisition of Class A shares by SID must be viewed as an isolated transaction that cannot in any way be considered as having taken place in the ordinary course of its business.
This Court is accordingly of the opinion that the circumstances surrounding this case and the particular status of SID make it possible to state that the acquisition of the term preferred shares in Sico met the intention behind the exception in subsection 112(2.21) of the Act. In fact, this provision was clearly enacted to avoid the improper use by lending institutions of shares similar to loans the dividends on which were tax-freewhile the interest on the sums loaned had to be included in the income of these corporations. The malice rule that emerges from this provision is accordingly the abuse of this tax-free transaction. However, an exceptional situation that might at a pinch be described as accidental should not suffer from application of the principle in subsection 112(2.1) of the Act.
4.03.3(4)(c) Relying primarily on a passage in an article by Geoffrey Dyer and on a number of decisions of the Privy Council in Britain and the Supreme Court of Canada, counsel for the respondent argued that it was difficult to isolate part of a corporation's activities from the ordinary course of its business. This Court feels, however, that neither of the authorities on which the argument of the Minister of National Revenue was based applies here.
In effect, the attention of this Court was drawn to another passage in Geoffrey Dyer's article, which was included at page 8 of the respondent's arguments. It reads as follows:
In the case of a purchase of term preferred shares by a financial institution, some assistance may be found in those tax cases that consider whether particular securities transactions carried on by financial institutions are on account of capital or income. The very nature of the business of a financial institution will make it difficult in most cases to contend that a purchase of term preferred shares was beyond the ordinary course of this business. In the case of a specified financial institution that is not itself engaged in the financing business but is associated with a financial institution, however, there could be considerably more scope to contend that its term preferred share investment was acquired outside the normal course of this business.
[Emphasis added.]
Although SID did not completely stop its lending activities, it is clear that this was not its primary function. In fact, the creation of Crédit industriel Desjardins Inc. in 1977 concentrated the lending and credit activities in the latter institution. SID's primary activity was to invest in shares of a limited number of businesses with a view to a high rate of return. It seems therefore that the description in Dyer's article of" specified financial institution that is not engaged in the financing business but is associated with a financial institution” is much more in keeping with the characteristics of SID. The presumption that the acquisition of term preferred shares was made in the ordinary course of SID's business cannot be applied, as the respondent seemed to argue. On the contrary, it is quite probable that such an acquisition was not made in the ordinary course of its business. The circumstances surrounding the acquisition of the term preferred shares and the apparent contradiction between SID's investment philosophy and the characteristics of the Class A shares following the change in Sico's capital stock are both factors that support this assertion.
4.03.3(4)(d) Furthermore, this Court is also of the opinion that the case law relied upon by the respondent (paragraph 4.02) cannot apply in this case to determine the scope of the expression " in the ordinary course of the business" in subsection 112(2.1) of the Act.
In the decisions in Punjab, supra, and General Reinsurance Company Ltd., Supra, which required the classification of income from the sale of certain securities, the courts felt that the nature of banking operations and the insurance business required a certain form of investment by them in portfolios of shares or foreign currency. In short, the profits obtained by realizing the securities cannot be dissociated from the type of business that requires the presence of these investments. The following passage from page 446 of the decision in General Reinsurance Company Ltd. clearly illustrates this principle:
Such an acquisition and subsequent realization is a normal step in carrying on the insurance business, or in other words an act done in what is truly the carrying on of the business of the society.
The principle stated and approved by the court in the Punjab case and the Californian Copper case that enhanced values obtained from realization or conversion of securities may be assessable where what is done is not merely a realization or change of investment but an act done in what is the carrying on or carrying out of a business, is, I think, the true principle to be applied in this case.
The Tip Top Tailors Ltd. decision, supra, raised a rather similar principle. In fact, it was held that the acquisition of a line of credit in foreign currency could not be separated from the textile-buying transactions that were the business's source of income. The following passage from page 318 (D.T.C. 1236-37) is particularly eloquent:
I agree with the learned trial judge that it was a scheme for profit-making in one necessary part of the appellant's trading operations, namely, the purchase of sterling funds and part of an integrated commercial operation being the purchase of the supplies and the payment for them in that currency. It was apparently treated as such in the preparation of the appellant's accounts for the years in question since if it was simply a speculation in sterling exchange divorced from the company's trading operations the interest payable on the bank loan would not have been deductible as an operating expense.
This case law, based on the search for a certain connection between the disputed transaction and the business's current activities, is quite relevant in identifying the profits made by the business. However, can it be concluded on the basis of this last trend in the case law that the term preferred shares acquired by SID cannot be isolated from all the investments making up its portfolio? This Court feels that the answer to this question may be found in the wording of subsection 112(2.1) of the Act. In effect, Parliament clearly wanted to make a distinction between specified financial institutions for which the acquisition of term preferred shares was a regular operation and those for which such a transaction was an exception. In fact, if the respondent's argument is given free rein, the last part of the subsection simply has no force or effect since any acquisition of term preferred shares by a specified financial institution should be subject to the exemption from the deduction allowed by the said subsection. In other words, the acquisition of term preferred shares by a specified financial institution primarily involved in the acquisition of shares could only have occurred in the ordinary course of business.
This reasoning can only lead us to reject the cases relied upon, which cannot be applied in light of subsection 112(2.1) of the Act.
5. Conclusion
The appeal is allowed with costs and the whole is referred back to the respondent for reconsideration and reassessment.
Appeal allowed.
Email this Base Content - Case