October 07, 2011

Citibank Canada (Appellant) v. Her Majesty the Queen (Respondent)

2001 DTC 111
Tax Court of Canada
January 15, 2001

(Court File No. 1999-3261(IT)G.)

Deductions — Dividends — Preferred shares of two Canadian corporations acquired by corporate taxpayer, a chartered bank — Such shares granting holders thereof the right to convert to common shares at a ratio determined at the time of conversion — Whether such shares providing a “form of guarantee, security or similar indemnity or covenant”, and hence falling within the definition of “term preferred shares”, thereby disentitling taxpayer to deduct the dividends received thereon — Income Tax Act, R.S.C. 1985 (5th Supp.), c. 1, as amended, ss. 82(1), 89(1), 112(1), 112(2.1), 121 and 248(1).

The corporate taxpayer was a Schedule II chartered bank. It acquired certain preference shares issued by two Canadian corporations, each of which had at least one class of shares listed on a stock exchange in Canada. In computing its taxable income for 1990, the taxpayer deducted (under section 112 of the Act) the dividends received by it on the said preference shares. In assessing the taxpayer for 1990, the Minister characterized those shares as “term preferred shares”, and disallowed the deduction of the dividends received thereon. The Minister took the position that such shares were “term preferred shares” , since the conditions granting holders thereof the right to convert to common shares (at a ratio determined at the time of conversion) provided, in essence, a “form of guarantee, security or similar indemnity or covenant” within the meaning of the definition of “term preferred share” in subparagraph 248(1)(a)(iii) of the Act. The taxpayer appealed to the Tax Court of Canada.

Held: The taxpayer’s appeal was allowed. Counsel for both parties stated that this was the first case in which a court had been asked to construe any part of the definition of “term preferred share”. That definition, moreover, is lengthy, and prolix in the extreme. It represents “the triumph of detailed, particularized, excessive drafting over common sense”. In addition, the Minister confirmed (in answer to the taxpayer’s demand for particulars) that it was only the pricing formula of the conversion feature associated with the preferred shares in issue which had caused him to conclude that such shares were term preferred shares. The Minister did not claim that any person or partnership other than the issuing corporation had provided any form of guarantee or security with respect to the subject shares. However, the expert evidence called by the taxpayer was to the effect that the conversion formula in question did not provide assurance to the holder that he would recover his cost of the shares. Three reasons were given: (a) if the issuing corporation could not pay a satisfactory dividend, the holder would convert to common shares; (b) the price of the common shares would have dropped to reflect the weakened financial position of the issuer, and the holder would receive on conversion a correspondingly greater number of common shares; and (c) the holder would have difficulty selling his greater number of common shares in a falling market. In addition, a guarantee is given by a third party, whereas in the case at bar, there was no third party involved. There was not even a promise by the issuing corporation to repay the amount advanced by the taxpayer to purchase the shares in question. Furthermore, if the Minister wished to argue that those shares were like debt instruments, he should have been able to demonstrate that the issuing corporation had offered some kind of property (other than its own common shares after conversion) to secure to the holder recovery of the issue price. Here there was no security or any form of security. The object of the “term preferred share” definition, moreover, is to identify a preference share which is like a debt instrument without, at the same time, scooping up all preference shares which financial institutions may purchase unconnected with any loan or near loan transaction. Finally, the Minister had put forward an object and purpose argument to show that the subject shares went against the spirit of the legislation. Why could the taxpayer not argue that those same shares flowed with (and not against) the spirit of the legislation, when it had drafted the terms and conditions thereof with such care, in order to bring them outside the forbidden area of the definition? For all of the foregoing reasons, the preferred shares in question were not “term preferred shares”. The taxpayer, therefore, was entitled to deduct the dividends received thereon. The Minister was ordered to reassess accordingly.

Held: The taxpayer’s appeal was dismissed. The taxpayer’s position was that the 1979 exchange of the original licences for the replacement licences either did, or did not, give rise to a disposition. If it did, then the proceeds of disposition would have to be adjusted in accordance with the provisions of subsection 20(1) of ITAR. If it did not, then the cost base of the replacement licences to be added to class 33 was equal to the value of the original licences in 1979, which was $4,697,491. Subsection 20(1) of ITAR provides that where, after 1971, a taxpayer disposes of depreciable property acquired prior to 1972, and owns it without interruption from December 31, 1971 until such time after 1971 as he disposes of it, the proceeds of disposition are to be determined in accordance with a specific formula if the original cost of the depreciable property is less than both the actual proceeds of disposition and the V Day value. On the other hand, the taxpayer also conceded that the replacement licences in this case had been properly classified as “timber resource properties” by both the Minister and the Tax Court Judge. This concession, however, was irreconcilable with the argument that subsection 20(1) of ITAR was applicable. That subsection only applies if depreciable property is owned by a taxpayer “without interruption” from December 31, 1971 until 1987, which was not the case here. In this case the replacement licences could only be “timber resource properties” if they had been acquired after May 6, 1974 (the effective date of the legislation amending paragraph 13(21)(d.1) of the Act). This was because, to have a “timber resource property”, a taxpayer must have acquired a right to cut timber in Canada after that date, whereas the taxpayer’s timber cutting rights (which were extended in 1979, and after May 6, 1974) were considered to have been “acquired” by it in 1979 (in accordance with the ratio in The Queen v. Kettle River Sawmills Limited et al. (92 DTC 6525) (FCA)). As a result, the replacement licenses were not owned by it without interruption after December 31, 1971. It was obvious, therefore, that, having in mind the taxpayer’s concession (with regard to the characterization of the replacement licences as “timber resource properties”), subsection 20(1) of ITAR could not apply. As mentioned, the taxpayer’s second proposition was that (in the absence of a disposition in 1979) the cost of the replacement licences was equal to the fair market value of the original licences at the time at which they were given in exchange. In support of this proposition, the taxpayer was contending that it had “given up” the value of the original licences to acquire the replacement licences. Such an argument, however, ran contrary to what was decided by the Federal Court of Appeal in the Kettle River Sawmills Limited case. In that case the Federal Court of Appeal found that the taxpayers had not given up anything at all to obtain the renewed licences forming the subject matter of the appeal. Similarly, in the case at bar, the taxpayer had not given up anything to get the replacement licences. Under sections 20 and 33 of the British Columbia Forest Act, the original licences were made to expire by statute. This required that the replacement licences be issued automatically. And they gave the same rights to cut over the same area as the original licences. In light of all of the foregoing, the decision of the Tax Court Judge had to remain undisturbed, as did the Minister’s reassessment which had been ordered by the Tax Court Judge.