Foix v. Canada

Foix v. Canada
Court (s) Database
Federal Court of Appeal Decisions
Date
2023-02-20
Neutral citation
2023 FCA 38
File numbers
A-234-21, A-235-21, A-236-21
Decision Content
Date: 20230220
Dockets: A-234-21
A-235-21
A-236-21
Citation: 2023 FCA 38
[ENGLISH TRANSLATION]
CORAM:
NOËL C.J.
DE MONTIGNY J.A.
LOCKE J.A.
BETWEEN:
MICHEL FOIX, NICOLAS SOUTY and SONIA LEBEL
Appellants
and
HIS MAJESTY THE KING
Respondent
Heard at Montréal, Quebec, on October 20, 2022.
Judgment delivered at Ottawa, Ontario, on February 20, 2023.
REASONS FOR JUDGMENT BY:
NOËL C.J.
CONCURRED IN BY:
DE MONTIGNY J.A.
LOCKE J.A.
Date: 20230220
Dockets: A-234-21
A-235-21
A-236-21
Citation: 2023 FCA 38
CORAM:
NOËL C.J.
DE MONTIGNY J.A.
LOCKE J.A.
BETWEEN:
MICHEL FOIX, NICOLAS SOUTY and SONIA LEBEL
Appellants
and
HIS MAJESTY THE KING
Respondent
NOËL C.J.
INTRODUCTION
[1] These are appeals from three decisions of the Tax Court of Canada (the Tax Court) (cited as 2021 TCC 52) confirming, on the basis of a single set of reasons authored by Justice Boyle (the trial judge), the reassessments made by the Minister of National Revenue pursuant to subsection 84(2) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the Act) in respect of Mr. Foix, Mr. Souty and Ms. Lebel (the appellants) for their 2012 taxation year.
[2] The appeals were consolidated by order dated November 23, 2021, docket A-234-21 being designated as the lead appeal. In conformity with this order, the present reasons will be filed in the lead appeal, and copies thereof will be filed as reasons for judgment in dockets A‑235-21 and A-236-21.
[3] The main issue is whether funds or property of two corporations owned directly or indirectly by the appellants were “distributed or otherwise appropriated in any manner whatever” to or for the benefit of the appellants within the meaning of subsection 84(2) of the Act despite there allegedly being no impoverishment of the two target corporations. If so, the Court will also have to determine whether these distributions or appropriations occurred on the reorganization or the discontinuance of the business of these corporations.
[4] For the reasons that follow, I conclude that the appeals cannot succeed. First, the trial judge correctly concluded, based on the evidence presented before him, that the two target corporations were impoverished as a result of the indirect distribution of their funds and that the scope of subparagraph 84(2) is wide enough to counter this type of distribution. Second, the appellants have failed to demonstrate that the trial judge erred in concluding that the businesses of the target corporations were reorganized or discontinued for purposes of subsection 84(2).
FACTS
[5] It is appropriate to review the facts underlying the trial judge’s decision in some detail.
[6] Watch4Net Solutions Inc. (W4N) was incorporated by Mr. Foix and Mr. Souty in 2000. It is the hybrid sale of this corporation’s shares and assets in May 2012 that led to the reassessments that are the subject of these appeals.
[7] At all times prior to the hybrid sale, all of W4N’s shares were directly or indirectly owned by Mr. Foix, Mr. Souty, their family trusts and their holding companies (TCC reasons, paras. 20–21).
[8] Mr. Souty held his shares of W4N directly. Mr. Souty’s wife, Sonia Lebel, held her shares of W4N as a beneficiary of Fiducie Familiale Nicolas Souty 2007 (Fiducie Souty) (TCC reasons, para. 22). Finally, Mr. Foix held his shares of W4N through Virtuose Informatique Inc. (Virtuose). At the time of the hybrid sale, Virtuose’s sole function was to hold shares of W4N for Mr. Foix (TCC reasons, para. 23).
[9] At the time of the hybrid sale, W4N had approximately 50 employees, two subsidiaries in Germany and England, and an annual income of around $15,000,000 (TCC reasons, paras. 28–29). Its main source of income rested in the exploitation of the Automated Performance Grapher software (the APG software) (TCC reasons, para. 5). This software monitors and manages the performance of networks, data centres and cloud infrastructures (TCC reasons, para. 43; Asset and Share Purchase Agreement (Hybrid Sale Agreement), preamble, Appeal Book, vol. 3, at 1194). W4N also, as part of its business, developed, installed and maintained other software programs and offered IT advisory services (TCC reasons, para. 5).
[10] The EMC Corporation (EMC US) and the EMC Corporation of Canada (EMC Canada) (together, the EMC group) are the purchasers of W4N’s assets and W4N’s and Virtuose’s shares. EMC Canada is the Canadian subsidiary of EMC US, a large American public corporation that had approximately 65,000 employees globally at the time of the hybrid sale (Transcript of Mr. Souty’s testimony, Appeal Book, vol. 7, at 2970, lines 21–24 and at 2973, lines 25–27; TCC reasons, para. 30).
[11] EMC US was a licensed reseller of the APG software. It also competed with W4N by using a similar though less powerful software (TCC reasons, paras. 30–31).
[12] In September 2006, EMC US made its first offer to acquire W4N for an amount ranging between $3,000,000 and $5,000,000. Mr. Foix and Mr. Souty turned down this offer because they believed that it was too low (TCC reasons, para. 32). In November 2011, EMC US again offered to acquire W4N after proposing to buy an exclusive licence for the APG software a few weeks earlier (TCC reasons, para. 34). Following negotiations, the parties agreed around the end of January 2012 on the sale of all of W4N’s shares for US$50,000,000 (TCC reasons, para. 35). The transaction was ultimately carried out in Canadian dollars at a time when both currencies were at par (Hybrid Sale Agreement, clause 1.3(c), Appeal Book, vol. 3, at 1205).
[13] According to the agreement, the EMC group agreed that W4N could distribute the excess cash that it had on hand to its shareholders prior to the sale (TCC reasons, para. 35). The letter of interest that documents the agreement is dated January 20, 2012, and was signed by Mr. Foix on January 23, 2012. It contains the following passage (Appeal Book, vol. 4, at 1804):
We have agreed that the Company [W4N] may distribute (in a manner that will not be reflected as an expense on any post-Closing income statement of the Company or EMC) excess cash to its stockholders prior to Closing, provided that the Company retains a mutually agreed upon amount of net working capital as of the Closing…
[14] In March 2012, EMC US prepared a draft of a share purchase contract (“Share Purchase Agreement”), which highlights the interest of the EMC group as to the amount of excess cash that the appellants could be authorized to withdraw (TCC reasons, paras. 37 and 61). The following terms were defined in the draft: Excess Cash Amount, Closing Cash Target Amount, Closing Cash Balance and Estimated Closing Cash Balance. The terms Closing Cash Balance and Estimated Closing Cash Balance are annotated as follows: “W4N to confirm” (Share Purchase Agreement, clause 1.1, Closing Cash Balance and Estimated Closing Cash Balance definitions, Appeal Book, vol. 4, at 1407 and 1409). The Share Purchase Agreement provided for a post-closing reconciliation between the target amount and the actual amount of the excess at closing. Comparable provisions are also found in the Hybrid Sale Agreement that was later entered into (TCC reasons, para. 37).
[15] The Share Purchase Agreement contemplated a pre-closing reorganization that was also of interest to the EMC group. Its terms and conditions were to be set out in Schedule 9.1 of the Share Purchase Agreement, but this schedule is blank and instead includes the note “To be discussed” (Share Purchase Agreement, Schedule 9.1, Appeal Book, vol. 4, at 1459). Clause 2 of the Share Purchase Agreement also contains the following note: “Parties to discuss Pre-Closing Reorganization” (Appeal Book, vol. 4, at 1415). The documents pertaining to this reorganization were to be provided to the purchaser in accordance with clause 9.1(r) of the Share Purchase Agreement (Appeal Book, vol. 4, at 1442; TCC reasons, para. 37).
[16] In April 2012, the parties agreed to convert the proposed transaction into a hybrid sale of W4N’s shares and assets. In the process, the total purchase price of W4N’s assets and shares increased to over $70,000,000 (Transcript of the examination of Mr. Thibodeau, Appeal Book, vol. 7, at 3195, lines 21–23; see also the Memorandum of the appellants, para. 21). The evidence does not indicate who suggested this change (TCC reasons, para. 38). According to the terms of the Hybrid Sale Agreement, which was governed by the laws of Quebec (Hybrid Sale Agreement, clause 19.6, Appeal Book, vol. 3, at 1272), W4N was to sell to EMC US its most significant assets, namely, its intellectual property pertaining to the APG software, its ongoing contracts (except those concluded with customers located in Canada), the shares of its subsidiaries, as well as all of the goodwill associated with its business. The remaining assets—contracts concluded with a customer located in Canada, machinery, equipment, furnishings, supplies, inventory, accounts receivable, claims, cash, cash equivalents, etc.—would remain the property of W4N (TCC reasons, para. 43; Hybrid Sale Agreement, clause 1.1, Purchased Contract and Purchased Customer Contract definitions, Appeal Book, vol. 3, at 1203; clauses 2.3(a) and 2.4(e), Appeal Book, vol. 3, at 1207–1208). EMC Canada would then purchase all of W4N’s capital stock directly from the shareholders. The final version of the Hybrid Sale Agreement is not dated, but took effect “as of” May 24, 2012 (TCC reasons, para. 40).
[17] The reorganization of W4N’s and Virtuose’s capital stock unfolded in accordance with the Hybrid Sale Agreement (Hybrid Sale Agreement, Prior Reorganization definition, Appeal Book, vol. 3, at 1202; Exhibit C, Appeal Book, vol. 3, at 1303). The relevant transactions took place between April 24 and May 30, 2012, and are set out in the appendix to the trial decision.
[18] The hybrid sale occurred between 11:30 p.m. on May 30 and 12:30 a.m. on May 31, 2012 (TCC reasons, para. 41). The preamble to the Hybrid Sale Agreement sets out four steps (Appeal Book, vol. 3, at 1194–1195). It is appropriate to review each of these steps in order to understand why the trial judge described the transactions as “indirect, structured, simultaneous and inter‑related” (TCC reasons, para. 58).
[19] The four steps unfolded as follows:
(i) The Fiducie Closing took place at 11:30 p.m. on May 30, 2012. As part of this step, EMC Canada purchased the W4N shares held by Fiducie Foix and Fiducie Souty. In exchange for the shares, EMC Canada issued and delivered two promissory notes to Fiducie Foix and Fiducie Souty (the Fiducie Share Notes) of $2,489,591 each (TCC reasons, para. 45; Hybrid Sale Agreement, clause 1.1, Fiducie Closing Date definition, Appeal Book, vol. 3, at 1198; clause 2.2(a), Appeal Book, vol. 3, at 1206; Exhibit G, Appeal Book, vol. 3, at 1370–1373).
(ii) The Asset Closing happened 15 minutes later, at 11:45 p.m. At that time, EMC US purchased W4N’s intellectual property, certain of its contracts and its goodwill (Hybrid Sale Agreement, clause 1.1, Asset Closing Effective Time definition, Appeal Book, vol. 3, at 1195; clause 2.3, Appeal Book, vol. 3, at 1207). In exchange for these assets, EMC US issued and delivered to W4N (i) two Capital Dividend Promissory Notes, each in the amount of $11,000,000, and (ii) a Balance Note in the amount of $19,750,000. EMC US also assumed the equivalent of $2,300,000 of W4N’s liabilities. The total consideration for the assets therefore stood at $44,050,000 (Hybrid Sale Agreement, clause 1.1, Total Asset Consideration definition, Appeal Book, vol. 3, at 1204; clause 2.5, Appeal Book, vol. 3, at 1208; clause 2.8, Appeal Book, vol. 3, at 1208–1209; Exhibit A, Appeal Book, vol. 3, at 1292–1293; Exhibit B, Appeal Book, vol. 3, at 1295–1300; Transaction Escrow Agreement, clause 6, Appeal Book, vol. 3, at 1350).
(iii) The Change of Control Closing occurred at 12:15 a.m. on May 31. At that time, EMC Canada purchased 550 Class D shares from both Mr. Souty and Virtuose, for a total of 1,100 Class D shares; thereby gaining control of W4N. In exchange for the shares, EMC Canada issued and delivered to Mr. Souty and Virtuose two Change of Control Share Notes of $550 each (Hybrid Sale Agreement, clause 1.1, Change of Control Closing Effective Time, Change of Control Closing Date and Total Change of Control Share Consideration definitions, Appeal Book, vol. 3, at 1196 and 1204; clauses 2.10(a) and 2.10(b), Appeal Book, vol. 3, at 1209; Exhibit I, Appeal Book, vol. 3, at 1377–1380; Transaction Escrow Agreement, clause 8, Appeal Book, vol. 3, at 1350).
(iv) The Final Closing was completed 15 minutes later, at 12:30 a.m. At that time, EMC Canada purchased the remainder of W4N’s shares, as well as all of Virtuose’s shares (Hybrid Sale Agreement, clause 1.1, Final Closing Effective Time definition, Appeal Book, vol. 3, at 1198; clause 2.12, Appeal Book, vol. 3, at 1209). In exchange for the shares, EMC Canada paid $13,189,796—i.e., the Total Final Share Consideration—to W4N’s and Virtuose’s shareholders (Hybrid Sale Agreement, clause 2.12, Appeal Book, vol. 3, at 1209).
[20] As is discussed below, the issue surrounding what became of the debt evidenced by the Balance Note (see subpara. 19(ii) above) is at the heart of the debate before us. The Hybrid Sale Agreement and the Transaction Escrow Agreement provide for the payment by the EMC group of all promissory notes at 12:30 a.m. on May 31, except the Balance Note. Here is how each of the notes was processed at Final Closing at 12:30 a.m. on May 31:
(i) The two notes that were issued for the shares held by Fiducie Foix and Fiducie Souty were paid by the Transaction Escrow Agent (Escrow Agent) (Hybrid Sale Agreement, clause 2.13(a), Appeal Book, vol. 3, at 1210; Transaction Escrow Agreement, clause 11, Appeal Book, vol. 3, at 1350–1351; Schedule G, Appeal Book, vol. 3, at 1367–1368). The Escrow Agent then marked both notes as “Cancelled” before returning them to “the Purchasers” (Transaction Escrow Agreement, clause 11, Appeal Book, vol. 3, at 1350–1351; Hybrid Sale Agreement, clause 2.13(b), Appeal Book, vol. 3, at 1210). This term includes both EMC US and EMC Canada (Transaction Escrow Agreement, Appeal Book, vol. 3, at 1349) and, as for all notes except for the two Capital Dividend Promissory Notes, no indication is made as to which of the two corporations is to receive the cancelled notes.
(ii) The two Capital Dividend Promissory Notes of $11,000,000 held by Gestion Souty and Mr. Foix were paid by the Escrow Agent (Hybrid Sale Agreement, clause 2.13(e), Appeal Book, vol. 3, at 1210; Exhibit H, Appeal Book, vol. 3, at 1375; Transaction Escrow Agreement, clause 11, Appeal Book, vol. 3, at 1350–1351). The Escrow Agent then marked both notes as “Cancelled” before returning them to EMC Canada (Hybrid Sale Agreement, clause 10.1(d)(v)(D), Appeal Book, vol. 3, at 1251; Transaction Escrow Agreement, clause 11, Appeal Book, vol. 3, at 1350–1351).
(iii) The two Change of Control Share Notes held by Mr. Souty and Virtuose were paid by the Escrow Agent (Hybrid Sale Agreement, clause 1.1, Total Change of Control Share Consideration definition, Appeal Book, vol. 3, at 1204; clause 2.13(c), Appeal Book, vol. 3, at 1210; Transaction Escrow Agreement, clause 11, Appeal Book, vol. 3, at 1350–1351; Schedule G, Appeal Book, vol. 3, at 1367). The Escrow Agent marked both notes as “Cancelled” before returning them to “the Purchasers” (Transaction Escrow Agreement, clause 11, Appeal Book, vol. 3, at 1350–1351; Hybrid Sale Agreement, clause 2.13(d), Appeal Book, vol. 3, at 1210).
(iv) In contrast with the other notes, the Hybrid Sale Agreement and the Transaction Escrow Agreement do not provide that the Balance Note will be paid to its holder (TCC reasons, second paragraph of subpara. 45(ii) and para. 64, note 3). Indeed, clause 2.2(c) of the Hybrid Sale Agreement stipulates that upon the Fiducie Closing at 11:30 p.m., the EMC group will transfer to the Escrow Agent the amount required to pay (i) the Total Fiducie Consideration ($4,979,182); (ii) the two Capital Dividend Promissory Notes ($22,000,000); (iii) the Total Change of Control Share Consideration ($1,100); and (iv) the Total Final Share Consideration ($13,189,796) (Hybrid Sale Agreement, clause 1.1, Fiducie Closing Date definition, Appeal Book, vol. 3, at 1198; clause 2.2(c), Appeal Book, vol. 3, at 1207). However, the Hybrid Sale Agreement does not provide for the transfer of the amount required in order to pay the Balance Note (Hybrid Sale Agreement, clause 2.2(c), Appeal Book, vol. 3, at 1207; clause 2.11, Appeal Book, vol. 3, at 1209). Similarly, Schedule G of the Transaction Escrow Agreement does not provide for the transfer of the $19,750,000 amount reflected by the Balance Note as it does for the debts evidenced by the other notes (Appeal Book, vol. 3, at 1367–1368). Yet clause 11 of the Transaction Escrow Agreement provides that at 12:30 a.m. on May 31, 2012, the Escrow Agent is to return all of the notes—including the Balance Note—to “the Purchasers” after marking them as “Cancelled” (Appeal Book, vol. 3, at 1350–1351). Despite this mention, W4N’s unaudited financial statements for the period ending at close of day on May 31, 2012—i.e., after the hybrid sale was completed—show a receivable in the amount of $22,050,000, which amount, by all indications, is constituted by the debt evidenced by the Balance Note ($19,750,000) and the W4N liabilities ($2,300,000) that were assumed by EMC US (see subpara. 19(ii) above).
[21] On June 1, 2012, the day following the hybrid sale, W4N, Virtuose and EMC Canada amalgamated and—with the exception of Virtuose, which, from that moment on, ceased to act as a holding company—continued to operate under the name EMC Canada (the Successor Corporation). From that moment on, EMC US exploited the APG software globally under its name and through its worldwide subsidiaries, including W4N’s former subsidiaries, and the remaining components of W4N’s business became part of the Successor Corporation’s business (TCC reasons, para. 47).
[22] In the tax returns filed for their 2012 taxation year, each of the appellants reported a capital gain from the sale of W4N’s and Virtuose’s shares and claimed the capital gains deduction provided for under subsection 110.6(2.1) of the Act so as to fully offset the gain. The entitlement to this deduction is not in issue; only the application of subsection 84(2) in order to transform the gains into dividends is (Transcript of the cross-examination of Mr. Séguin, Appeal Book, vol. 7, at 3463, lines 17–28 and at 3464, lines 1–14).
[23] On April 4, 2017, the Minister of National Revenue issued reassessments with respect to Mr. Foix’s, Mr. Souty’s and Ms. Lebel’s 2012 taxation year, treating the following amounts as deemed dividends:
(i) for Ms. Lebel, $1,590,705 attributed to her as part of the amount of $2,481,412 received by Fiducie Souty from EMC Canada upon the Fiducie Closing for the sale of its W4N Class F shares (TCC reasons, subpara. 44(iii); Amended Reply to the Notice of Appeal, subpara. 28(p)vii), Appeal Book, vol. 1, at 0113; Memorandum of the Crown, paras. 20i) and ii));
(ii) for Mr. Souty, $800,450 received from EMC Canada upon the Final Closing for the sale of his W4N Class D and E shares (TCC reasons, subpara. 44(ii)); and
(iii) for Mr. Foix, $800,000 received from EMC Canada upon the Final Closing for the sale of his Virtuose Class A and C shares (TCC reasons, subpara. 44(i)).
Each of the reassessments assumes that an amount at least equal to these sums was distributed to or otherwise appropriated by the appellants.
[24] The appellants appealed these reassessments on the basis that the conditions for the application of subsection 84(2) were not met.
THE TAX COURT DECISION
[25] The trial judge held otherwise. He set out two cumulative conditions in order to determine whether subsection 84(2) applies on the facts of this case: (i) Were funds or property “distributed or otherwise appropriated in any manner whatever to or for the benefit of the shareholders” of W4N? (ii) If so, did the distribution or appropriation occur “on the winding-up, discontinuance or reorganization” of W4N’s business?
[26] In order to find that the first condition was met, the trial judge first gave subsection 84(2) a broad scope, stating that courts take a fungible approach to cash and cash equivalents owned by a corporation when they are faced with transactions that are “indirect, structured, simultaneous and inter-related”. In particular, he relied on Canada v. MacDonald, 2013 FCA 110 [MacDonald (FCA)], reversing MacDonald v. The Queen, 2012 TCC 123 [MacDonald (TCC)]; RMM Canadian Enterprises Inc. v. Canada, [1997] T.C.J. No. 302 (QL) [RMM Equilease]; Smythe et al. v. Minister of National Revenue, [1970] S.C.R. 64 [Smythe]; and Merritt v. Minister of National Revenue, [1941] Ex. C.R. 175 [Merritt (Ex C)], aff’d in part by Minister of National Revenue v. Merritt, [1942] S.C.R. 269 (S.C.C.) [Merritt (SCC)]. In his view, this line of cases interprets the scope of subsection 84(2) to be sufficiently large to target “indirect” distributions of funds or property (TCC reasons, para. 58). In so saying, he drew a distinction between the present case and Canada v. Vaillancourt-Tremblay, 2010 FCA 119 [Vaillancourt‑Tremblay], where it was held that the fungible approach did not extend to newly issued securities of a public company that were never owned by the target corporation (TCC reasons, para. 58).
[27] The trial judge found that this broad interpretation is justified in this case because the appellants, with the assistance of the EMC group, initiated and executed a series of transactions that were all carried out in contemplation of one another in order to extract W4N’s excess cash (TCC reasons, para. 60 in fine, paras 62–64).
[28] In the trial judge’s view, it is clear that the indirect distribution of W4N’s funds to the appellants was made possible by the role that the EMC group played as a facilitator (TCC reasons, para. 63). This group approved both the prior reorganization and the amount of excess cash that could be withdrawn from W4N by its shareholders without requiring an adjustment at closing (TCC reasons, para. 61).
[29] The trial judge pointed to evidence on the record showing that the EMC group acted as a facilitator. In particular, he noted (i) the letter of January 20, 2012, in which the parties agreed that W4N would distribute to its shareholders the excess cash, i.e., the funds that exceeded what was needed to operate the business (TCC reasons, para. 60); (ii) the Share Purchase Agreement, in which the definition of Closing Cash Balance and the exhibit concerning the pre‑closing reorganization include, respectively, the annotations “W4N to confirm” and “To be discussed”; and (iii) the fact that the steps of the pre-closing reorganization are set out in the Hybrid Sale Agreement (TCC reasons, para. 61).
[30] In finding that the EMC group assisted the appellants, the trial judge rejected Mr. Foix’s and Mr. Souty’s testimony that the EMC group had no interest in any transaction related to the withdrawal of W4N’s excess cash and that the EMC group alone sought to convert the transaction into a hybrid sale (TCC reasons, paras. 37–38 and 61). He also expressed having “significant doubts” as to the reliability and the credibility of their testimony regarding (TCC reasons, para. 14; see also para. 38):
… (i) EMC’s intentions, (ii) EMC’s role in how the proposed transaction evolved between EMC’s initial November 2011 offer and the structure agreed to in late April or May of 2012, (iii) EMC’s interest in moving from the Share Purchase Agreement structure it originally proposed and drafted to the final hybrid Asset and Share Purchase Agreement Structure, (iv) EMC’s interest (or alleged disinterest) in the pre-acquisition reorganization of the shareholdings and capital structure of W4N ...
Despite their testimony to the contrary, the trial judge found that part of the transactions that facilitated the withdrawal of the excess cash was in fact initiated and led by Mr. Foix, Mr. Souty and their advisors (TCC reasons, para. 62).
[31] In order to find that the second condition was also met, the trial judge first construed the word “reorganization” not as a legal term, but as a commercial term that presupposes the conclusion of the conduct of the business in one form and its continuance in a different form (TCC reasons, paras. 65–68, citing Merritt (Ex C) at 182, aff’d on this point by Merritt (SCC) at 274; Smythe; MacDonald (FCA), para. 28; Kennedy v. M.N.R., [1972] 72 D.T.C. 6357 (Trial Division) [Kennedy (FCTD)] at 6362, aff’d on this point by Kennedy v. M.N.R., 73 D.T.C. 5359 (Appeal Division of the Federal Court) [Kennedy (FCA)], para. 8; McMullen v. The Queen, 2007 TCC 16, paras. 18–19; and Descarries v. The Queen, 2014 TCC 75 [Descarries], paras. 32–34).
[32] Relying on his understanding of the applicable test, he found that W4N’s business was reorganized on two occasions. First, W4N reorganized its business and its capital structure in the course of the reorganization that preceded the hybrid sale. Second, W4N’s business could no longer be exploited as it was before the amalgamation, because its business was continued by two different entities: EMC US and the Successor Corporation. According to the trial judge, subsection 84(2) is only concerned with that part of the business that was continued by W4N’s Successor Corporation. It follows that W4N’s business was reorganized on that account as well (TCC reasons, para. 73).
[33] In any event, the trial judge held that the evidence before him did not allow him to find, on a balance of probabilities, that EMC US continued to carry on W4N’s business in the same manner and in the same form after the amalgamation (TCC reasons, paras. 48–49 and 73).
[34] The trial judge found that the second condition was also met in the case of Virtuose because after the hybrid sale and Virtuose’s amalgamation with W4N and EMC Canada, the Successor Corporation ceased to perform its only function, namely, holding W4N shares for Mr. Foix as a holding company (TCC reasons, para. 50). It follows that Virtuose’s business was discontinued within the meaning of subsection 84(2).
POSITION OF THE PARTIES
– The appellants
[35] The appellants first emphasize that the general anti-avoidance rule (GAAR) (subsection 245(2) of the Act) was not invoked. They add that no sham has been alleged and that the figures are not in question (Memorandum of the appellants, para. 8).
[36] The appellants claim that the trial judge made two errors. First, the trial judge erred in holding that they received funds or property from W4N and Virtuose when neither of these corporations was impoverished in the course of the transactions (Memorandum of the appellants, para. 5).
[37] In their view, the first condition of subsection 84(2) requires that the corporation impoverish itself for the benefit of its shareholders in order for there to be a distribution or an appropriation (Memorandum of the appellants, para. 37). To hold otherwise would result in a duplication of the paid-up capital (Memorandum of the appellants, para. 57) and would condone a form of double taxation (Memorandum of the appellants, paras. 59, 64 and 67).
[38] They argue that in this case, W4N and Virtuose continued to hold all of their assets after their shares were sold (Memorandum of the appellants, para. 45) and that the amounts that ended up in the appellants’ hands through the hybrid sale came from the EMC group and not from W4N (Memorandum of the appellants, paras. 4, 70 and 80). It follows that W4N was not impoverished (Memorandum of the appellants, paras. 45 and 69–71, 75–77 and Appendix A). In support of this conclusion, the appellants rely on McNichol v. Canada, [1997] T.C.J. No. 5 (QL), [1997] 2 C.T.C. 2088 [McNichol], para. 11; Vaillancourt‑Tremblay, paras. 34–35 and 40–41; Descarries, para. 28; Geransky v. The Queen, 2001 CanLII 480, [2001] T.C.J. No. 103 (QL) [Geransky], subpara. 21(c); and Robillard (Estate) v. The Queen, 2022 TCC 13 [Robillard], para. 50.
[39] On another note, the appellants contend that the notion of “excess cash” devised by the trial judge (TCC reasons, para. 60) excludes the $19,750,000 debt, with the result that W4N would have apparently distributed more funds than it had (Memorandum of the appellants, paras. 69 and 76).
[40] Turning to Virtuose, the appellants submit that in order for subsection 84(2) to apply, the Court must find that Virtuose’s property or funds were distributed to Mr. Foix. However, Virtuose’s only assets were shares of W4N, and no such shares were distributed to Mr. Foix as part of the hybrid sale (Memorandum of the appellants, paras. 72–73). In the appellants’ view, it follows that there was no impoverishment or distribution (Memorandum of the appellants, para. 5).
[41] Of significance is that the appellants do not challenge on appeal the trial judge’s finding that the EMC group acted as a third-party facilitator. Rather, they argue that the findings made by the trial judge in this regard are [translation] “irrelevant” because in any event, the element of impoverishment, which must be present for subsection 84(2) to apply, is missing (Memorandum of the appellants, paras. 78–79). This is a dramatic change of course given that the appellants took the position before the trial judge that impoverishment is not a prerequisite when a [translation] “third-party accommodator” is involved, but that it was not necessary to delve into this issue because according to their assessment of the evidence, the EMC group did not play this role (Transcript of the appellants’ arguments at trial, Appeal Book, vol. 8, at 3526, lines 14–21 and at 3540, lines 3–10). It is not surprising, therefore, that the trial judge’s reasons focus on the role that the EMC group played as a facilitator.
[42] Second, the appellants argue that the trial judge erred in finding that W4N’s business was reorganized and that Virtuose’s business was discontinued despite evidence showing that the EMC group assumed and pursued all of their operations (Memorandum of the appellants, para. 5).
[43] The appellants allege that the trial judge misapplied the test set out in Kennedy (FCTD) by disregarding the distinction between a corporate reorganization and the reorganization of the business carried on by that corporation (Memorandum of the appellants, paras. 81, 87, 90 and 98). According to them, no reorganization takes place for purposes of paragraph 84(2) when legal changes are brought to the corporate structure without any change being made to the manner in which the [translation] “commercial activities” are conducted (Memorandum of the appellants, paras. 88, 90 and 94). Had the trial judge considered how W4N’s business was continued by both EMC US and the Successor Corporation, he would have found that W4N’s business was not reorganized (Memorandum of the appellants, para. 96).
[44] Applying this test to the facts of this case, the appellants maintain that they have established that W4N’s business was continued [translation] “with the same employees, the same offices, the same service and maintenance contracts, the same software, the same markets, the same resellers, the same technology partners and the same competitors” (Memorandum of the appellants, paras. 23 and 101). According to them, the trial judge’s conclusion that a reorganization took place despite this evidence results from an improper allocation of the burden of proof (Memorandum of the appellants, para. 103).
[45] With respect to Virtuose, the appellants submit that the trial judge erred in law in finding that its business was discontinued after the amalgamation with W4N and EMC Canada without taking into consideration the legal effect of an amalgamation, which is to ensure the sustainability of the activities carried on by the amalgamated corporations (Memorandum of the appellants, para. 85).
– The Crown
[46] The Crown, for its part, submits that the trial judge correctly held that the two conditions precedent for the application of subsection 84(2) of the Act were met in this case with respect to both W4N and Virtuose.
[47] According to the Crown, it could be seen from the beginning that the Balance Note in the amount of $19,750,000 would be cancelled and that the debt evidenced by that note would never be paid, since that amount was redirected so as to end up in the hands of the appellants (Memorandum of the Crown, paras. 65, 67 and 78; Transcript of the Crown’s argument, Appeal Book, vol. 8, at 3567, lines 21–24 and 27–28, at 3585, lines 21–28, at 3586, line 1, at 3595, lines 5–14 and at 3656, lines 23–26).
[48] The Crown further submits that contrary to the appellants’ contentions, the trial judge, in the course of his analysis, did in fact consider that the $19,750,000 debt was part of the excess cash that was distributed to the appellants, this amount being, in the words of the trial judge, a “cash equivalent” (Memorandum of the Crown, paras. 69–70, referring to the second paragraph of subpara. 45(ii) and to para. 64 of the TCC reasons).
[49] Turning to Virtuose, the Crown asserts that the trial judge correctly found that funds belonging to W4N were distributed by Virtuose to Mr. Foix at the time of the hybrid sale. In the Crown’s view, it would be unduly formalistic to hold otherwise (Memorandum of the Crown, paras. 73–74 and 79).
[50] Insofar as the second condition is concerned, the Crown maintains that the trial judge properly assessed the evidence before him and made no error in focusing on the continuation of W4N’s activities carried on by the Successor Corporation rather than on the activities that were continued by the EMC group as a whole (Memorandum of the Crown, para. 82).
[51] Still with respect to Virtuose, the Crown argues that the business it conducted was discontinued following the hybrid sale since its sole function up to that time—holding W4N shares as a holding company for Mr. Foix—was thereby brought to an end (Memorandum of the Crown, subpara. 84(c)).
ANALYSIS
[52] The appeals as framed raise three issues:
Were funds or property of W4N and of Virtuose distributed to or otherwise appropriated by or for the benefit of their shareholders despite there allegedly being no corresponding impoverishment of the two corporations?
If so, is subsection 84(2) sufficiently large in scope to counter the type of distribution or appropriation that took place in this case?
If so, did these distributions or appropriations take place on the reorganization or the discontinuance of their respective businesses?
In my view, all three questions must be answered in the affirmative.
[53] Two preliminary comments are in order. Subsection 84(2) is one of the oldest anti‑avoidance measures in the Act. It has appeared in the Act in terms similar to those used today since 1924 (An Act to amend The Income War Tax Act, 1917, 14-15 Geo.V, c. 46, s. 5), when it was adopted in response to English court cases holding that profits earned and taxed as dividends upon distribution to shareholders during the life of a corporation could be distributed without tax on that corporation’s winding-up (House of Commons Debates, 14th Parliament, 3rd Session, vol. 3 (June 10, 1924), at 3047 (Hon. Mr. Baxter); see, e.g., Inland Revenue Commissioners v. George Burrell, [1924] 2 K.B. 52 (UK)). The dated existence of this provision explains the abundance of case law that has guided its application over the years, sometimes inconsistently. It is appropriate to first quote the actual text of this provision, with emphasis on its key words:
(2) Where funds or property of a corporation resident in Canada have at any time after March 31, 1977 been distributed or otherwise appropriated in any manner whatever to or for the benefit of the shareholders of any class of shares in its capital stock, on the winding-up, discontinuance or reorganization of its business, the corporation shall be deemed to have paid at that time a dividend on the shares of that class equal to the amount, if any, by which
(2) Lorsque des fonds ou des biens d’une société résidant au Canada ont, à un moment donné après le 31 mars 1977, été distribués ou autrement attribués, de quelque façon que ce soit, aux actionnaires ou au profit des actionnaires de tout [sic] catégorie d’actions de son capital-actions, lors de la liquidation, de la cessation de l’exploitation ou de la réorganisation de son entreprise, la société est réputée avoir versé au moment donné un dividende sur les actions de cette catégorie, égal à l’excédent éventuel du montant ou de la valeur visés à l’alinéa a) sur le montant visé à l’alinéa b):
(a) the amount or value of the funds or property distributed or appropriated, as the case may be, exceeds
a) le montant ou la valeur des fonds ou des biens distribués ou attribués, selon le cas;
(b) the amount, if any, by which the paid-up capital in respect of the shares of that class is reduced on the distribution or appropriation, as the case may be,
b) le montant éventuel de la réduction, lors de la distribution ou de l’attribution, selon le cas, du capital versé relatif aux actions de cette catégorie;
and a dividend shall be deemed to have been received at that time by each person who held any of the issued shares at that time equal to that proportion of the amount of the excess that the number of the shares of that class held by the person immediately before that time is of the number of the issued shares of that class outstanding immediately before that time.
[Emphasis added.]
chacune des personnes qui détenaient au moment donné une ou plusieurs des actions émises est réputée avoir reçu à ce moment un dividende égal à la fraction de l’excédent représentée par le rapport existant entre le nombre d’actions de cette catégorie qu’elle détenait immédiatement avant ce moment et le nombre d’actions émises de cette catégorie qui étaient en circulation immédiatement avant ce moment.
[Non soulignés dans l’original.]
[54] It is also useful to recall at the onset of the analysis that questions of law are to be reviewed on a standard of correctness whereas findings of fact or of mixed fact and law cannot be overturned in the absence of a palpable and overriding error, absent an extricable question of law (Housen v. Nikolaisen, 2002 SCC 33, [2002] 2 S.C.R. 235, paras. 8 and 26–37).
1. Were funds or property of W4N and of Virtuose distributed to or otherwise appropriated by or for the benefit of their shareholders despite there allegedly being no corresponding impoverishment of the two corporations?
[55] One must first ask: “What was purportedly distributed?” Indeed, the appellants take the position that the term “excess cash” as used by the trial judge [translation] “seems to exclude the notes” and, more specifically, the Balance Note (Memorandum of the appellants, para. 76, note 100, citing the TCC reasons, para. 64). According to them, the trial judge used this term only to refer to the amount of $4,505,288 constituted by W4N’s cash, accounts receivable and investment tax credit (Memorandum of the appellants, para. 20, notes 50 and 75; see also W4N’s financial statements as at May 31, 2012, Appeal Book, vol. 9, at 3773). Given that on the basis of their assessment, a total amount of $6,583,274 would have been distributed, the trial judge’s finding results in a mathematical impossibility in that W4N could not distribute more funds than it had (Memorandum of the appellants, para. 20, notes 49 and 69).
[56] In so saying, the appellants overlook the trial judge’s clear and unequivocal finding that the debt evidenced by the Balance Note was part of the excess cash that was distributed