Husky Oil Limited v. The Queen

Husky Oil Limited v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2009-02-24
Neutral citation
2009 TCC 118
File numbers
2006-421(IT)G
Judges and Taxing Officers
Robert James Hogan
Subjects
Income Tax Act
Decision Content
Docket: 2006-421(IT)G
BETWEEN:
HUSKY OIL LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeal heard on September 29 and 30, October 1 and 2, 2008,
at Calgary, Alberta.
Before: The Honourable Justice Robert J. Hogan
Appearances:
Counsel for the Appellant:
Barry R. Crump
Michel Bourque
Counsel for the Respondent:
Donald G. Gibson
____________________________________________________________________
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1998 taxation year is dismissed, with costs to the Respondent, in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 24th day of February 2009.
"Robert J. Hogan"
Hogan J.
Citation: 2009 TCC 118
Date: 20090224
Docket: 2006-421(IT)G
BETWEEN:
HUSKY OIL LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
I. Introduction
[1] The Appellant and Balaclava Enterprises Ltd. (“Balaclava”), a significant shareholder of Mohawk Canada Limited (“Mohawk Canada”), joined forces to complete a takeover of Mohawk Canada. Balaclava transferred its interest in Mohawk Canada to a corporation, HB Acquisition Inc. (“HB Acquisition”), formed by the Appellant and Balaclava to complete the takeover. Balaclava received securities of HB Acquisition for its shares of Mohawk Canada and significantly less cash than was offered to the other Mohawk Canada shareholders.
[2] Balaclava and the Appellant agreed to allow Balaclava to acquire the Residual Assets (defined below) of Mohawk Canada through the amalgamation of its subsidiary, Mohawk Lubricants Ltd. (the owner of the Residual Assets) (“Mohawk Lubricants”), and a subsidiary of Balaclava. The parties disagree on the impact of the amalgamation. The Appellant argues that Mohawk Canada disposed of the shares of Mohawk Lubricants in a tax-free rollover under subsection 87(4) of the Income Tax Act (Canada) (the “Act”). The Respondent, on the other hand, submits that Mohawk Canada took back shares in the amalgamated entity that were worthless as part of a plan to defer capital gains tax for 25 years. This plan was also followed by Balaclava, which allegedly received worthless shares in HB Acquisition. As a result of these mutual promises to accept worthless shares, the Respondent argues, Mohawk Canada should be taxable on the disposition of the shares of Mohawk Lubricants for one or more of the following reasons:
a) Mohawk Canada gifted the value of its shares in Mohawk Lubricants for the benefit of its parent corporation, HB Acquisition, and/or Mohawk Canada received non-share consideration on the amalgamation involving Mohawk Lubricants, contrary to the prohibition contained in subsection 87(4) of the Act.
b) HB Acquisition appropriated the value of the Mohawk Lubricants shares for its own benefit contrary to the prohibition in subsection 69(4) of the Act.
c) Subsection 56(2) applies to the amalgamation.
II. Factual background
[3] At the outset of the trial, the parties provided me with a Statement of Agreed Facts (the “Statement of Agreed Facts”) along with supporting documents contained in a joint book of exhibits (the “Joint Book of Exhibits”). The Appellant called three witnesses, Mr. Thomas Lindsay, a senior vice-president of Balaclava and a director of Mohawk Canada, Mr. Robert Kopstein, a tax partner with Ladner Downs in Vancouver at the time of the transactions, and Mr. Ian McNair, who was the tax director at Husky Oil Limited (“Husky” or the “Appellant”). The Respondent called two witnesses, Ms. Sandra Pereversoff, a tax avoidance auditor with the Canada Revenue Agency (“CRA”) and Mr. Michael Weevers, the appeals officer who considered the Appellant’s Notice of Objection. I will quote from the Statement of Agreed Facts before summarizing the witnesses’ testimony and reviewing the relevant documentary evidence.
A. The Parties
1. The Appellant, Husky Oil Limited (“Husky”) is a corporation formed under the laws of Canada and is resident in Canada for the purposes of the Income Tax Act, R.S.C. 1985 (5th Supp., c. 1 (the “Act”). On January 1, 1999, Husky Oil Limited amalgamated with Mohawk Canada Limited. Prior to August 25, 2000, Husky was continued into the Province of Alberta. On August 25, 2000, Husky and Husky Oil Operations Limited and Renaissance Energy Ltd. were amalgamated, with the resulting corporation being Husky Oil Operations Limited.
2. Husky Mohawk Long Term Ltd. (“HMLT”) is a corporation formed under the laws of Canada on October 17, 1996. At all times, Husky owned all the issued and outstanding voting shares of HMLT. The terms of HMLT’s common and preferred shares are set out in HMLT’s Articles of Amendment . . . .
3. HB Acquisition Inc. (“HB Acquisition”) was a corporation formed on or about April 1, 1998 under the laws of Canada. HB Acquisition’s initial share capital consisted of common shares. The characteristics of the common shares are set out in HB Acquisition’s Articles of Amendment dated June 29, 1998 and September 18, 1998 . . . .
4. Balaclava Enterprises Ltd. (“Balaclava”), now known as Belkin Enterprises Ltd., is a corporation formed under the laws of the Province of British Columbia and is resident of Canada for the purposes of the Act.
5. BEL Acquisition Inc. (“BAI”) is a corporation formed under the laws of the Dominion of Canada and is resident in Canada for the purposes of the Act. BAI is a wholly-owned subsidiary of Balaclava.
6. 3470750 Canada Inc. (“347”) is a corporation formed under the laws of the Dominion of Canada on or about June 11, 1998, and is resident in Canada for the purposes of the Act. At all material times 347 was a wholly-owned subsidiary of BAI.
7. Mohawk Canada Limited (“Mohawk Canada”) was a public corporation formed under the laws of the Dominion of Canada and was resident in Canada for the purposes of the Act. Mohawk Canada carried on the business of an automotive fuel retailer (the “Retail Business”) and its common shares were listed on the Toronto Stock Exchange.
8. Mohawk Lubricants Ltd. (“Mohawk Lubricants”) was a corporation formed under the laws of British Columbia on October 19, 1981 and continued under the Canada Business Corporations Act on July 2, 1998, and it was resident in Canada for the purposes of the Act. Mohawk Lubricants, a wholly-owned subsidiary of Mohawk Canada, carried on the business of re-refining and distributing recycled oil. Mohawk Lubricants also owned certain other assets (shares of Pound-maker Agventures Ltd. [the “Pound-maker shares”], a certain Jade Royalty and certain Jade Inventory) [the “Jade Investment”] and its recycled oil business and other assets are collectively referred to as the “Residual Assets”.
9. At all times material to this Appeal, Husky and HB Acquisition were not related to Balaclava, BAI, and 347, and Balaclava, BAI and 347 were not related to Mohawk Canada and Mohawk Lubricants.
10. Prior to July 8, 1998 Husky and HB Acquisition were not related to Mohawk Canada and Mohawk Lubricants.
11. Where the expression “related” is used in this Agreement, the parties agree that the expression refers to its meanings in and for the purposes of subsections 251(1) and 251(2) of the Act.
12. Upon HB Acquisition tendering its notice to take up and pay for Mohawk Canada shares tendered to the joint bid, on July 6th, 1998, as further particularized at paragraph 35 herein, Husky and HB Acquisition became related to Mohawk Canada and Mohawk Lubricants.
B. Facts Relating to Mohawk and Events Leading up to Transaction
13. At all material times prior to July 8, 1998, a control block comprising 42% of Mohawk Canada’s common shares was held directly or indirectly by one shareholder, Hugh B. Sutherland (“Sutherland”), while a further 23% of the common shares of Mohawk Canada (or debentures convertible into common shares of Mohawk Canada) were owned by Balaclava. The remaining 35% of Mohawk Canada common shares were widely held by the investing public, including common shares owned directly or indirectly by employees of Mohawk Canada.
14. In June 1997, the board of directors of Mohawk Canada (the “Mohawk Board”) established a special committee of the Mohawk Board (the “Special Committee”) to assist the Mohawk Board in developing and evaluating strategic alternatives available to Mohawk Canada to enhance shareholder value.
15. After considering a number of alternatives, the Mohawk Board accepted the Special Committee’s recommendation that financial advisors be retained to explore a sale, merger, or other business combination involving Mohawk Canada’s Retail Business. CIBC Wood Gundy Securities Inc. (“Wood Gundy”) was appointed as financial advisor to the Special Committee and Mohawk Canada announced its strategic intentions in a press release to the public on or about September 23, 1997.
16. From September 1997 through January 1998, Wood Gundy actively solicited bids for the acquisition of the Retail Business of Mohawk Canada. By early December 1997, Wood Gundy had received non-binding expressions of interest from seven parties, including Husky, who had reviewed a confidential information memorandum concerning Mohawk Canada’s Retail Business. On December 9, 1997, the Mohawk Board allowed several of these parties, including Husky, access to data rooms to allow them to engage in detailed due diligence investigation of the Retail Business before being invited to make a final acquisition proposal.
17. Upon completion of this due diligence process described in . . . paragraph 16, three parties, one of which was Husky, were invited by the Mohawk Board to submit proposals for the acquisition of the Retail Business. By February 11, 1998 the Mohawk Board, in consultation and with the recommendation of Wood Gundy and legal counsel, decided to enter into exclusive negotiations with Husky, as well as Balaclava, with a view to implementing a plan of arrangement under the Canada Business Corporations Act whereby Husky would acquire the Retail Business.
18. At all material times Husky made it clear that it would not participate in any transaction that would result in it acquiring the Residual Assets. However, Balaclava was prepared to consider acquiring the Residual Assets as Balaclava was engaged in a business complementary to the re-refining business of Mohawk Lubricants that comprised the main part of the Residual Assets.
19. On February 11, 1998, the Mohawk Board established an independent committee (the “Independent Committee”) to examine and make recommendations to the Mohawk Board on any proposal to acquire the Residual Assets. The Independent Committee retained RBC Dominion Securities Inc. (“RBC Dominion”) to assist the Independent Committee in its mandate and to provide a fairness opinion in connection with any proposal to acquire the Residual Assets.
20. Initially, Husky was only prepared to pay $90 million for the Retail Business of Mohawk Canada, but later increased it to $103 million.
21. As a result of the negotiations amongst the Mohawk Board, including its Independent and Special Committees and their financial advisors, and Balaclava, a transaction structure (the “Structure”) was created that would see:
(a) Husky acquire the Retail Business for its stated (and firm) acquisition price of $103 million;
(b) Balaclava acquire the Residual Assets; and
(c) Husky and Balaclava participate in a joint bid for the common shares of Mohawk Canada at Husky’s acquisition price of $103 million.
22. By late April 1998, Husky advised the Special Committee that it was prepared to explore the possibility of a joint acquisition of all the common shares of Mohawk Canada through a joint takeover bid with Balaclava. The Mohawk Board then expanded the mandate of the Independent Committee to review and to make recommendations concerning any joint takeover bid made by Husky and Balaclava (the “Joint Bid”). The Independent Committee was assisted in assessing the Joint Bid by Wood Gundy who were also retained to provide a fairness opinion from a financial perspective to the shareholders of Mohawk Canada concerning a Joint Bid.
C. The Joint Bid
23. By early June 1998:
(a) Husky and Balaclava entered into a joint bid agreement (the “Joint Bid Agreement”) for a takeover bid of all of the outstanding common shares of Mohawk Canada not owned by Balaclava, BAI or HB Acquisition at a cash price of $7.25 per share. The $7.25 cash offer (the “Offer”) was not available to BAI as it was a joint bidder. It was a condition precedent to the Offer that 90% of the Mohawk Canada common shares be deposited to the Offer. . . .
(b) Sutherland, HB Acquisition as the offeror under the Joint Bid Agreement, and Husky entered into an agreement (the “Lock-Up Agreement”) under which Sutherland agreed to deposit, or cause to be deposited to the Offer, all of his common shares (or debentures convertible into common shares) of Mohawk Canada. . . .
(c) HB Acquisition, Husky, Balaclava, BAI, and Mohawk Canada entered into an agreement (the “Support Agreement”) under which HB Acquisition agreed to make the Offer and Mohawk Canada agreed to recommend to its shareholders that they accept the Offer. . . .
(d) the Independent Committee received a fairness opinion from Wood Gundy (the “Wood Gundy Fairness Opinion”) that the Offer contemplated under the Joint Bid Agreement was fair, from a financial point of view, to the Mohawk Canada shareholders . . . and,
(e) the Independent Committee received a fairness opinion from RBC Dominion (the “RBC Dominion Fairness Opinion”) that Balaclava’s proposed acquisition of the Residual Assets, and specifically the price offered by Balaclava in its acquisition of the Residual Assets, was fair, from a financial point of view, to the Mohawk Canada shareholders. . . .
24. If sufficient common shares of Mohawk Canada were deposited under the Offer, Balaclava agreed, and was obligated, to convert all debentures held by it into common shares of Mohawk Canada and to transfer to HB Acquisition 2,854,267 common shares of Mohawk Canada. At the $7.25 per share offer price, these shares were to be transferred in exchange for instruments totalling $20,693,436.00 as follows:
(a) 9,565,402 shares of HB Acquisition at $1.00 per share;
(b) cash in the sum of $5,193,436.00, equivalent to $1.82 per Mohawk Canada common share owned by Balaclava; and
(c) a promissory note by HB Acquisition payable to BAI in the sum of $5,934,598.00.
25. Under the Joint Bid Agreement, Mohawk Canada, Balaclava, and BAI negotiated an option and put agreement (the “Option and Put Agreement”) pursuant to which Mohawk Canada granted an option to BAI to acquire the shares of Mohawk Lubricants, which owned the Residual Assets, for consideration that included a non-interest bearing promissory note in the amount of $9,565,402.00 maturing in 2023. In addition, under this agreement, BAI granted a put option to Mohawk Canada under which BAI could be required to purchase the common shares of Mohawk Lubricants for the same consideration. . . .
26. Husky was not a shareholder of Mohawk Canada when the Option and Put Agreement was negotiated.
27. The Option and Put Agreement was amended by an agreement dated July 7, 1998 amongst Mohawk Canada, Balaclava, BAI, and Husky (the “Amended Option and Put Agreement”) which modified the Option and Put Agreement in the following manner:
(a) Mohawk Canada, instead of receiving an [sic] non-interest bearing promissory note issued to it for Balaclava’s acquisition of the Residual Assets, would instead receive preferred shares issued pursuant to an amalgamation of Mohawk Lubricants and 347; and
(b) BAI would receive preferred shares of HB Acquisition that were redeemable for a non-interest bearing note maturing in 2023 as part of the consideration for transferring its shares in Mohawk Canada to HB Acquisition, instead of directly receiving a promissory note having the identical terms.
. . .
28. The Amended Option and Put Agreement was made after Husky and HB Acquisition had entered into the Support Agreement and after they had mailed the takeover bid.
29. Under both the Option and Put Agreement and the Amended Option and Put Agreement BAI agreed it would not, prior to June 1, 2023 demand payment of the principal of the promissory note of $5,934,598.00 from HB Acquisition unless the amalgamation of Mohawk Lubricants did not occur by September 30, 1998 and Balaclava gave notice to redeem its 9,565,402 common shares at $1.00 per share.
D. Pre-Closing Transactions
30. On or about May 20, 1998, Balaclava transferred 2,286,086 common shares of Mohawk Canada and $2.5 million of convertible debentures issued by Mohawk Canada to BAI in exchange for 100 common shares of BAI.
31. Balaclava and BAI jointly elected to have the provisions of section 85(1) of the Act apply to the transfer described in paragraph 30. The agreed amount was $11,128,034, which amount was equal to the adjusted cost base (“ACB”) of the common shares to Balaclava.
32. On July 3, 1998, Mohawk Canada transferred all of the shares it owned of Pound-maker Agventures Ltd., the Jade Royalty and the Jade Inventory to Mohawk Lubricants in exchange for 2,538,740 preferred shares issued by Mohawk Lubricants from treasury.
33. On July 5, 1998, Mohawk Lubricants declared a series of 48 separate dividends in the amount of $100,000 each. The dividends were paid by the issuance of 4,800,000 preferred shares issued by Mohawk Lubricants from treasury. As the issued and outstanding shares of Mohawk Lubricants had “safe income” equal to or in excess of the declared dividends, the provisions of subsection 55(2) of the Act were not applicable.
34. As at July 5, 1998, Mohawk Canada owned 1 common share and 7,338,740 preferred shares of Mohawk Lubricants, the ACBs of which were $2,552,441 and $7,338,740 respectively.
E. Closing Transactions
35. On July 6, 1998, 9,420,050, Mohawk Canada common shares (excluding the Mohawk Canada common shares held by BAI) (the “Tendered Shares”), were validly deposited pursuant to the Offer. In total, 98.2% of the total outstanding Mohawk Canada common shares (held by BAI, Sutherland and the investing public) were deposited pursuant to the Offer.
36. On July 6, 1998, Husky, through an indirect wholly-owned subsidiary, Husky Mohawk Holdings Ltd., subscribed for 103,000,000 common shares of HB Acquisition for $103,000,000 (“Husky Subscription”). Out of the $103,000,000, HB Acquisition used $73,559,202 to acquire the Tendered Shares.
37. On July 7, 1998, BAI sold 2,854,267 common shares of Mohawk Canada to HB Acquisition in exchange for $5,193,436 in cash (on hand as a result of the Husky Subscription), a non-interest bearing demand promissory note in the amount of $5,934,598 (the “BAI Note”) and 9,565,402 common shares issued by HB Acquisition from treasury at a value of $1 per common share. The 9,565,402 common shares represented 8.5% of all the issued and outstanding common shares of HB Acquisition. . . .
38. BAI and HB Acquisition jointly elected to have the provisions of subsection 85(1) of the Act apply to the disposition described in paragraph 37. The agreed amount was $11,128,034, which amount was equal to the adjusted cost base (“ACB”) of the Mohawk Canada common shares to BAI.
39. On July 7, 1998:
(a) Husky, Husky Mohawk Holdings Ltd., Balaclava, BAI and HB Acquisition entered into a Shareholders’ Agreement, under which the parties agreed to not transfer any common shares of HB Acquisition other than in the manner contemplated in the Shareholders’ Agreement and the Amended Option and Put Agreement. . . .
(b) Husky, Balaclava, BAI and Mohawk Canada entered into the Amended Option and Put Agreement . . . under which BAI was granted an option to acquire all of the common shares of Mohawk Lubricants pursuant to an amalgamation of Mohawk Lubricants and 347. Under the terms of the Amended Option and Put Agreement, BAI could assign its option to any person affiliated or associated with BAI.
40. On July 8, 1998:
(a) BAI exercised its option under the Amended Option and Put Agreement to acquire the shares of Mohawk Lubricants by way of amalgamation (the “Amalgamation”);
(b) 347, Mohawk Lubricants, Mohawk Canada, Husky and Balaclava entered into an amalgamation agreement (the “Amalgamation Agreement”), under which 347 and Mohawk Lubes would amalgamate to form Mohawk Lubricants Ltd. (“Lubes Amalco”). . . .
(c) Upon the Amalgamation, Mohawk Canada received 7,338,740 Class A preferred shares of Lubes Amalco for the preferred shares it held in Mohawk Lubricants and 8,161,260 Class B preferred shares and one Class C preferred share of Lubes Amalco for the common shares it held in Mohawk Lubricants;
(d) Upon the Amalgamation, BAI received one common share of Lubes Amalco in exchange for its common share of 347; and
(e) the share capital of Lubes Amalco is described in the Certificate and Articles of Amalgamation dated August 1, 1998 . . .
41. Following the Amalgamation, the shareholders of Lubes Amalco were as follows:
Shareholder
Common
Class A Preferred
Class B Preferred
Class C Preferred
Mohawk Canada
nil
7,338,740
8,161,260
1
BAI
1
nil
nil
nil
F. Post-Closing Transactions
42. On September 29, 1998, BAI transferred 9,565,403 common shares of HB Acquisition to HMLT in exchange for 9,565,403 preferred shares of HMLT issued from treasury. BAI and HMLT jointly elected to have the provisions of subsection 85(1) of the Act apply to the transfer.
43. The terms of HMLT’s preferred shares described in paragraph 42 are set out in HMLT’s articles of Amendment . . . .
44. On September 30, 1998, HMLT transferred 9,565,403 common shares of HB Acquisition to Husky in exchange for 9,565,403 preferred shares of Husky issued from treasury. HMLT and Husky jointly elected to have the provisions of subsection 85(1) of the Act apply to the transfer.
45. On November 30, 1998:
(a) Lubes Amalco gave notice that it would redeem and did redeem the 7,338,740 Class A preferred shares owned by Mohawk Canada. The redemption price was paid by the issuance by Lubes Amalco of a non-interest bearing promissory note due in 2023 in the amount of $7,338,740 (the “Mohawk Note”). . . .
(b) HB Acquisition and Mohawk Canada entered into an Assignment and Assumption Agreement pursuant to which Mohawk Canada agreed to pay the BAI Note in consideration for which HB Acquisition gave Mohawk Canada a promise to pay $5,934,598 on demand to Mohawk Canada. . . .
(c) BAI and Lubes Amalco entered into an agreement pursuant to which BAI assigned its rights under the BAI Note to Lubes Amalco in consideration for which Lubes Amalco gave BAI a non-interest bearing promissory note due in 2023 in the amount of $5,934,598 (the “Assignment Note”). . . .
(d) Mohawk Canada and Lubes Amalco agreed to set off and cancel the BAI Note and the Mohawk Note with Lubes Amalco issuing in favour of Mohawk Canada a new non-interest bearing promissory note due in 2023 in the amount of $l,404,142 (the “Set-off Note”). . . .
G. Other
. . .
H. Assessments, Reassessments and Objections Leading to the Appeal
47. The assessment under appeal was made by Notice of Reassessment under the Act dated February 26, 2004 with respect to the Appellant’s taxation year ending December 31, 1998. The Appellant filed a Notice of Objection in a timely fashion. The Minister confirmed the assessment under appeal by Notification of Confirmation made November 10, 2005.
[4] I will be using the defined terms from the Statement of Agreed Facts throughout my reasons for judgment unless I indicate otherwise.
Mr. Lindsay’s Evidence
[5] Mr. Thomas Lindsay was called as a witness to provide the Court with an overview of the circumstances that gave rise to the acquisition of Mohawk Canada.
[6] Mr. Lindsay testified that the Mohawk Canada board members (the “Board”) met to discuss the low trading range of the Mohawk Canada shares in the spring of 1997. The stock was thinly traded on the TSX and the Board felt that the trading price did not reflect Mohawk Canada’s inherent value.
[7] He explained that a low stock price meant that Mohawk Canada’s cost of capital was higher than its competitors’, making it expensive for Mohawk to raise capital for the purpose of refurbishing its 360 service stations.
[8] A special committee (the “Special Committee”) of the Board was set up to review strategic options and to make recommendations to the Board as to how shareholder value could be maximized. The options considered by the Special Committee included the rearrangement of Mohawk Canada’s capital structure and the sale or merger of Mohawk Canada’s Retail Business.
[9] Mr. Lindsay testified that the Board spent three months reviewing the strategic alternatives. The Special Committee finally recommended to the Board that Mohawk Canada hire financial advisors to guide it through a sales process. CIBC Wood Gundy and First Capital were hired to assist the Board. The financial advisors prepared a book on Mohawk Canada that was given to interested parties who were likely to submit expressions of interest. Husky was identified as an interested party as it had made overtures to acquire Mohawk Canada in the past.
[10] Mr. Lindsay explained that Mohawk had a very good footprint in Western Canada with 360 service stations, and the Board was confident that the process would result in an offer at a substantial premium over Mohawk Canada’s trading range of $3.50 to $4.50 per share.
[11] However, the task of selling Mohawk Canada was not without its own unique set of challenges. A preliminary analysis had indicated that all of the likely buyers would be interested in making offers for some or all of Mohawk Canada’s Retail Business. They were not interested in the Residual Assets.
[12] In January of 1998, Mohawk Canada’s financial advisors recommended to the Board that Mohawk Canada should enter into exclusive negotiations with Husky. Husky had made an initial offer of $90 million to acquire the Retail Business in an asset-based transaction. This was the best offer received.
[13] Mr. Lindsay testified that he worked on several plans to deal with the Residual Assets that included keeping these assets in Mohawk Canada after the Retail Assets had been sold or transferring the assets to a new corporation that would be transferred to Mohawk Canada’s shareholders as a dividend in kind, thus paving the way for a sale of the shares of Mohawk Canada. The latter option was preferred as it would have resulted in the lowest amount of corporate taxes having to be paid. It became quickly apparent that neither option would work. Mr. Sutherland’s desire for an all‑cash transaction in the $7.50 per share range could not be met. Additionally, the investment bankers advised the Board that the new public corporation would be too small to attract public shareholder interest.
[14] Mr. Lindsay came up with the final plan, under which Balaclava would end up owning Mohawk Lubricants (being the main asset) the Jade Inventory and the Pound‑maker shares (previously defined as the Residual Assets). Husky would purchase Mohawk Canada, which would continue to own the Retail Business, the Minnedosa Ethanol Plant and an insurance policy. This plan meant that Mr. Sutherland and the public shareholders would receive an all-cash payment for their shares while Balaclava would receive a much smaller cash payment and the Residual Assets for its interest in Mohawk Canada. As Balaclava was a significant shareholder of Mohawk Canada, an independent committee of the Board was appointed to oversee the fairness of the transaction, with RBC acting as its financial advisor to provide a fairness opinion on the related-party transaction.
[15] Mr. Lindsay testified that while Balaclava was in the solid waste recycling business, it did not have experience operating an oil recycling plant. Balaclava was willing to acquire the Residual Assets in order to allow the broader transaction to proceed. Mr. Lindsay explained that this was a better alternative to a failed transaction in which Balaclava would be left holding a significant interest in a company whose stock was thinly traded at prices significantly below what Mr. Lindsay believed was Mohawk Canada’s inherent value.
[16] Mr. Lindsay testified that as a board member he was well aware of his fiduciary duties to maximize value for all shareholders. In light of that, he delegated the role of negotiating the transaction for Balaclava to Mr. Gordon Pow, the CFO of Balaclava. He expected that Mr. Pow would consult with him only if he had a problem negotiating the terms of the transaction with the independent committee and its advisors. He did not get involved in the design of the structure nor in the details leading to its implementation. His CFO turned to Balaclava’s legal counsel, Ladner Downs, for commercial and tax advice. KPMG, Balaclava’s auditors also played a role in the transaction.
Mr. Kopstein’s Evidence
[17] Mr. Kopstein testified that his firm was approached by Mr. Pow to advise Balaclava on how a joint bid could be structured between Balaclava and Husky using a transaction structure which would allow Husky to acquire the Retail Business and Balaclava the Residual Assets.
[18] Mr. Kopstein testified that Husky’s initial proposal to acquire the Retail Business through an asset purchase was unacceptable to the Mohawk Board. An asset-based transaction would have given rise to a significant tax liability resulting in a significant corporate tax liability for Mohawk Canada. The financial and tax model showed that with such a transaction structure the shareholders of Mohawk Canada would end up with a net cash purchase price significantly below Mr. Sutherland’s desired price of $7.25 per share.
[19] Mr. Kopstein explained that Balaclava was unwilling to surrender part of its interest in Mohawk Canada for the Residual Assets as this would lead to capital gains tax. Since Balaclava was to receive significantly less cash than the public and Mr. Sutherland, he was instructed to come up with a transaction structure which would allow Balaclava to defer its gain.
[20] The first part of the transaction structure (the “Initial Transaction”) called for Balaclava to sell its interest in Mohawk Canada for the consideration described in paragraph 24 of the Statement of Agreed Facts, consisting of 9,565,402 common shares of HB Acquisition, cash in the amount of $5,193,436 and a non‑interest‑bearing promissory note issued by HB Acquisition in the amount of $5,934,598 (the “HB Acquisition Promissory Note”). The second leg of the transaction structure called for Balaclava or an authorized subsidiary of Balaclava to acquire Mohawk Lubricants and the other Residual Assets for $15.5 million payable through the issue of two non-interest-bearing promissory notes in the amounts of $9,565,403 (the “First Promissory Note”) and $5,934,598 (the “Second Promissory Note”) respectively, payable in 25 years. This transaction step would be concluded only after the takeover bid was completed. The HB Acquisition Promissory Note and the Second Promissory Note would be offset and cancelled, leaving Balaclava (or its subsidiary) holding 9,565,402 common shares in HB Acquisition and Mohawk Canada holding the First Promissory Note. To complete the transaction, Balaclava would exchange the common shares of HB Acquisition for preferred shares of a Husky affiliate. While the preferred shares were retractable at the option of the holder, Husky could cause Balaclava (or its subsidiary) to accept the First Promissory Note in full and final payment of the redemption price.
[21] Mr. Kopstein testified that at that point he believed he had completed his main tax mandate. Under the Initial Transaction structure, Husky would have paid $103 million for all of the common share interest in Mohawk Canada. Balaclava would own the Residual Assets as well as 9,565,402 preferred shares in a Husky affiliate. The capital gain on Balaclava’s interest in Mohawk Canada would be deferred until Balaclava asked for a retraction of the preferred shares, and HB Acquisition and Mohawk Canada could be amalgamated with Husky. While the sale of the Residual Assets to Balaclava would take place in a taxable transaction, Mr. Kopstein was told that Mohawk Canada would have a sufficient tax shelter to offset the gain.
[22] The Initial Transaction structure was reflected in the Joint Bid Agreement signed between Husky and Balaclava, and in the purchase and sale agreement and the Option and Put Agreement, both appended as schedules to the Joint Bid Agreement. The Option and Put Agreement and the purchase and sale agreement were to be executed by Mohawk Canada after completion of its takeover, as the Board was not responsible for overseeing potential post-closing transactions. These post-closing transactions would be approved by the new board of directors controlled by Husky. Husky Oil and Balaclava provided, in the Joint Bid Agreement, undertakings to give effect to each of the aforementioned agreements.
[23] Mr. McNair called Mr. Kopstein in early July, after the offering circular had been mailed to the Mohawk Canada shareholders, to tell him that Mohawk Canada was more profitable than expected and that Mohawk Canada would incur tax liability on the sale of the Residual Assets. Mr. Kopstein testified that Mr. McNair was frustrated with the fact that Mohawk Canada was going to have to pay tax on the sale, which was an outcome that Husky had not bargained for. Mr. Kopstein suggested to Mr. McNair that the capital gain could be avoided by simply substituting preferred shares for the promissory notes that Mohawk Canada was to receive under the Initial Transaction structure. However, Mr. Kopstein explained that he needed his client’s approval to begin work on a revised plan. Mr. Kopstein called Mr. Pow of Balaclava, who approved the new initiative provided it would not prejudice Balaclava’s position.
[24] Mr. Kopstein worked with his corporate and securities partners to come up with the details of the revised plan. After completing their analysis of the tax, corporate and securities law considerations, a revised structure was proposed (the “Revised Structure”) under which Mohawk Lubricants, the owner of the Residual Assets, would amalgamate with 347, an indirect subsidiary of Balaclava. Mohawk Canada would receive preferred shares of Lubes Amalco as described in paragraph 41 of the Statement of Agreed Facts. The Revised Structure called for the redemption of the 7,338,740 Class A preferred shares received by Mohawk Canada for a non-interest-bearing promissory note in the amount of $7,338,740 payable on June 1, 2023. Following this redemption, Mohawk Canada was left holding 8,161,260 Class B preferred shares and one Class C preferred share in Lubes Amalco. The Revised Structure was reflected in the Amended Option and Put Agreement executed after completion of the sale of Mohawk Canada and was fully implemented after the completion of the planned amalgamation.
Mr. McNair’s Testimony
[25] Mr. McNair testified that he was part of the Husky team involved in the Mohawk Canada transaction. His primary responsibility was quarterbacking the tax due diligence and reviewing the plans for the acquisition of Mohawk Canada and the disposition of the Residual Assets by this corporation. He was not involved in the preparation of the tax plan as this was Mr. Kopstein’s responsibility. Initially, his tax due diligence showed that Mohawk Canada would not be taxable on the sale of the Residual Assets in light of the information obtained from Mohawk Canada’s tax advisors, Ernst and Young.
[26] By early June, as summarized in his memorandum of June 3, 1998[1], Mr. McNair had discovered that Mohawk Canada was more profitable than expected and would pay approximately $1.5 million in tax as a result of the sale of the Residual Assets. He corroborated Mr. Kopstein’s testimony on the circumstances leading to the Revised Structure. His understanding of the Revised Structure is that both Mohawk Canada and BAI would be able to defer tax until the preferred shares they hold are redeemed. This event would likely occur only in 2023, which is the maximum deferral period built into the terms and conditions of the preferred shares.
Ms. Pereversoff’s Evidence
[27] Ms. Pereversoff testified that she was asked to review the Mohawk Canada transaction by the CRA large case auditor assigned to the Husky audit. She found it peculiar that two unrelated parties could avoid capital gains tax by taking back similar preferred shares. She concluded that the amalgamation violated the exception in subsection 87(4) of the Act (the “87(4) Exception”).
[28] The admissibility of her testimony was challenged by Mr. Crump, counsel for the Appellant, on the grounds that she was not qualified to give an opinion on the fair market value of the shares of Mohawk Lubricants and Lubes Amalco. She acknowledged that she was not qualified to do so but pointed out during her testimony that the value that she ascribed to the shares of Mohawk Lubricants was the value used by the parties to the transaction.
Mr. Weevers’ Evidence
[29] Mr. Weevers testified that he disagreed with Ms. Pereversoff’s basis for denying rollover treatment to Mohawk Canada for the purposes of subsection 87(4) of the Act. He believed that Ms. Pereversoff had wrongly concluded that a “benefit” had been conferred on HB Acquisition within the meaning of the 87(4) Exception because she believed that HB Acquisition had been relieved of an obligation to pay cash for the shares disposed of by BAI. Apparently, she wrote this in a letter that was not provided in evidence. Mr. Weevers believed that rollover treatment should be denied on the grounds that Mohawk Canada received non-share consideration on the amalgamation. Mr. Weevers had difficulty explaining his position on this issue during his cross‑examination. He finally agreed that the non-share consideration that he identified when he reviewed the file was BAI’s agreement to accept common shares of HB Acquisition which were subsequently exchanged by BAI for preferred shares of HMLT.
[30] Mr. Weevers’ decision to add subsections 56(2) and 69(4) as alternative grounds for his confirmation of the reassessment was made because he had received directions from a CRA department in Ottawa to do so.
III. Issues to be decided by the Court
[31] The issues for determination in this appeal were framed by the pleadings as follows:
(i) Whether the FMV of the shares of Lubes Amalco received by Mohawk Canada on the amalgamation of Mohawk Lubricants and 347 was less than the FMV of the Mohawk Lubricants shares prior to their disposal by Mohawk Canada and whether it is reasonable to regard all or a part of the excess . . . as a benefit which Mohawk Canada wished to confer on HB Acquisition so that the exception in s. 87(4) of the Act applies to deny rollover treatment;
(ii) Whether Mohawk Canada received non-share consideration for its disposition of its shares of Mohawk Lubricants on the amalgamation of Mohawk Lubricants and 347 so that the rollover provision in s. 87(4) of the Act does not apply;
(iii) Whether property owned by Mohawk Canada represented by its shares of Mohawk Lubricants, was appropriated for the benefit of HB Acquisition with Mohawk Canada receiving consideration in the form of preferred shares of Lubes Amalco having a FMV less than the shares of Mohawk Lubricants, so as to engage the provisions of s. 69(4) of the Act; and
(iv) Whether Mohawk Canada intended to confer a benefit to HB Acquisition when BAI’s shares of Mohawk Canada were transferred to HB Acquisition so as to engage the provisions of s. 56(2) of the Act