October 07, 2011

CSI Development Corp. (Appellant) v. Her Majesty the Queen (Respondent)

99 DTC 1139
Tax Court of Canada
June 8, 1999

(Court File No. 97-1208(IT)G.)

Liability for Part III tax — Capital dividends in excess of taxpayer’s capital dividend account — Partnership of which corporate taxpayer the general partner disposing of substantially all its assets — Partnership allocating to taxpayer the full amount of the non-taxable portion (i.e., 25%) of the net eligible capital property proceeds received by it on the said disposition — Taxpayer adding such allocated amount to its capital dividend account, and declaring a capital dividend accordingly — Minister assessing taxpayer for Part III tax assuming that, as a result of the said addition, taxpayer’s capital dividend account overstated — Whether Minister’s position the correct one — Income Tax Act, R.S.C. 1985 (5th Supp.), c.?1, as amended, ss.?83(2), 89(1)(b) and 96.

The corporate taxpayer was in the business of designing, manufacturing, marketing and distributing electronic mail software. On February 1, 1991, substantially all the taxpayer’s assets and undertakings were transferred to a partnership (“CSLP” ) of which the taxpayer was the general partner. On April 5, 1991, a subsidiary of Microsoft Corporation purchased substantially all of CSLP’s assets. CSLP computed its taxable income for its fiscal period ending July 31, 1991, and allocated $1,041,198 of such taxable income to the taxpayer. CSLP also allocated to the taxpayer the full amount of the non-taxable portion (i.e. 25%) of the net eligible capital property proceeds received by it on the disposition of its software to the said Microsoft subsidiary. The taxpayer added this amount ($2,694,196) to its capital dividend account. The Minister took the position that the taxpayer was only entitled to add a fraction (i.e., $332,317) of the said non-taxable portion of the said eligible capital property proceeds to its capital dividend account. As a result, the Minister assessed the taxpayer for Part III tax on the assumption that its capital dividend account had been overstated on June 1, 1992, when it purported to pay out a capital dividend of $2,600,000. The taxpayer appealed to the Tax Court of Canada.

Held: The taxpayer’s appeal was dismissed. Paragraph 89(1)(b) of the Act was silent as to the treatment of the non-taxable portion of the capital gain of a private corporation that was a member of a partnership. Such paragraph did not provide for the addition of this capital to the corporation’s capital dividend account. The Minister recognized this irregularity and attempted to correct the unfairness involved by permitting a corporate taxpayer (such as the taxpayer) who is a member of a partnership to include in its capital dividend account its proportionate partnership share of the partnership’s non-taxable capital gain. (See Interpretation Bulletin IT-138R, para. 19). The taxpayer had received its portion of CSLP’s taxable income (i.e., $1,041,198), of which 25% was non taxable. In addition, the Minister had permitted the taxpayer to add the non-taxable 25% of the capital gain that it had received to its capital dividend account, recognizing the unfairness in paragraph 89(1)(b) of the Act. The Minister’s assessment was affirmed accordingly.