CanUtilities Holdings Ltd v. The Queen

CanUtilities Holdings Ltd v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2003-08-28
Neutral citation
2003 TCC 193
File numbers
2001-4026(IT)G
Judges and Taxing Officers
Joe E. Hershfield
Subjects
Income Tax Act
Decision Content
Docket: 2001-4026(IT)G
BETWEEN:
CANUTILITIES HOLDINGS LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeals heard on common evidence with the appeal of Canadian Utilities Limited (2001-4030(IT)G) at Calgary, Alberta on February 3, 4 and 5, 2003
Before: The Honourable Justice J.E. Hershfield
Appearances:
Counsel for the Appellant:
Curtis R. Stewart, Michel Bourque,
Cliff D. O'Brien, Q.C.,
J. Patrick Peacock, Q.C.
Counsel for the Respondent:
Bonnie F. Moon, David Palamar and
Brooke Sittler
____________________________________________________________________
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1996 and 1997 taxation years are allowed, with costs, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the terms of the attached Reasons for Judgment.
Signed at Toronto, Canada, this 28th day of August 2003.
"J.E. Hershfield"
Hershfield, J.
Docket: 2001-4030(IT)G
BETWEEN:
CANADIAN UTILITIES LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeal heard on common evidence with the appeals of CanUtilities Holdings Ltd. (2001-4026(IT)G) on February 3, 4 and 5, 2003 at Calgary, Alberta
Before: The Honourable Justice J.E. Hershfield
Appearances:
Counsel for the Appellant:
Curtis R. Stewart, Michel Bourque,
Cliff D. O'Brien, Q.C.,
J. Patrick Peacock, Q.C.
Counsel for the Respondent:
Bonnie F. Moon, David Palamar and
Brooke Sittler
____________________________________________________________________
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1996 taxation year is allowed, with costs, and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the terms of the attached Reasons for Judgment.
Signed at Toronto, Canada this 28th day of August 2003.
"J.E. Hershfield"
Hershfield, J.
Citation: 2003TCC193
Date:20030828
Dockets: 2001-4026(IT)G
2001-4030(IT)G
BETWEEN:
CANUTILITIES HOLDINGS LTD.,
CANADIAN UTILITIES LIMITED,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hershfield, J.
[1] The appeals were heard together on common evidence. The appeals concern the disposition of shares owned by each of the Appellants in ATCOR Resources Ltd. ("ATCOR"). Prior to such disposition ATCOR was a public company listed on the Toronto Stock Exchange, controlled by a related group of shareholders that included the Appellants. The transactions effecting the disposition of the Appellants' ATCOR shares also effected the disposition of all other outstanding ATCOR shares (which were widely held) in favour of a single purchaser that I will identify momentarily as Forest Subco.
[2] The Appellants are also public companies having shares listed on the Toronto Stock Exchange. Both Appellants have historically paid regular dividends on their listed shares including shares that were widely held by various unrelated individuals and corporations.
[3] Prior to the transactions that effected the ultimate disposition of the Appellants' shares in ATCOR there was an amalgamation of a newly formed company, 3140334 Canada Ltd. ("Newco") and ATCOR. The amalgamated company continued under the name of the predecessor ATCOR. New shares were received by the Appellants (and by the other ATCOR shareholders) in the amalgamated ATCOR in exchange for their old shares on a tax-deferred basis. The new ATCOR shares held by the Appellants were then redeemed. Other ATCOR shareholders disposed of their shares in a similar fashion or were bought out directly by Forest Subco at the same price.
[4] Both Appellants, Canadian Utilities Limited ("CU") and Canutilities Holdings Ltd. ("CU Holdings"), received redemption proceeds for their new ATCOR shares on or about January 31, 1996. Funding for these redemptions and the redemptions and acquisitions of the balance of the outstanding ATCOR shares held by other ATCOR shareholders was provided by Forest Oil Corporation ("Forest"). Prior to the amalgamation, Forest had conditionally agreed to acquire all of the issued shares of ATCOR.
[5] Forest funded the redemptions of the ATCOR shares by providing funds to a newly formed subsidiary corporation, 3189490 Canada Ltd. ("Forest Subco"). Forest Subco in turn subscribed for shares in ATCOR after the amalgamation and after acquiring voting control of ATCOR. The subscription price was equal to the redemption price of the new shares in ATCOR held by the Appellants and by other ATCOR shareholders who were not selling their shares directly to Forest Subco. Such redemption price equalled the price Forest and the Appellants had, prior to the amalgamation, agreed to as the selling price of the ATCOR shares.
[6] Pursuant to subsection 84(3) of the Income Tax Act ("the Act"), the redemption of the Appellants' shares in ATCOR resulted in a dividend being deemed to have been received by them equal to the difference between the paid-up capital of the shares redeemed and their redemption price.
[7] While the deemed dividends received by the Appellants on the redemptions were not taxed under Part I of the Act due to section 112, they were subject to tax under Part IV of the Act. Such tax is fully refundable pursuant to section 129 when the dividends received (or an equivalent amount) are flowed through, as dividends, to the next tier of shareholders; that is, when the recipient of the dividend subjected to Part IV tax pays out an equivalent dividend. Both Appellants paid sufficient dividends after receiving the redemption proceeds to obtain full refunds of their respective Part IV tax liability. CU's refund was fully effected by virtue of dividends paid by it in 1996. CU Holdings' refund was fully effected by virtue of dividends paid by it in 1996 and 1997. The effect of the deemed dividend treatment, application of section 112 and Part IV and the refund of Part IV tax was that neither Appellant paid any un-refunded tax in respect of the disposition of their ATCOR shares. But for the dividend treatment afforded by the redemption, such dispositions would have resulted in material taxable capital gains having been realized by both Appellants on the direct sale of their ATCOR shares to Forest.[1] Circumstances and careful transaction structuring undertaken with knowledge of such circumstances allowed for this result.
[8] The Minister applied subsection 55(2) of the Act and reassessed each Appellant's 1996 taxation year on the basis that it received proceeds of disposition rather than dividends on the disposition of their shares in ATCOR. The reassessments which are under appeal bring the taxable capital gain into each Appellant's 1996 taxation year, both of which end December 31. Further, the reassessments in applying subsection 55(2) ignore the deemed dividend so as to eliminate Part IV tax liability and dividend refunds in 1996 and, in the case of CU Holdings, the dividend refunds in 1997. The elimination of the refund claimed by CU Holdings in respect of its 1997 year was effected by a 1997 reassessment which is also under appeal. Resolution of the 1996 appeal will consequentially resolve the 1997 appeal.
[9] Subsection 55(2) is an anti-avoidance provision targeting this very type of transaction, except as expressly excepted. At the relevant times it read as follows:
55. (2) Where a corporation resident in Canada has after April 21, 1980 received a taxable dividend in respect of which it is entitled to a deduction under subsection 112(1) or 138(6) as part of a transaction or event or a series of transactions or events (other than as part of a series of transactions or events that commenced before April 22, 1980), one of the purposes of which (or, in the case of a dividend under subsection 84(3), one of the results of which) was to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at fair market value of any share of capital stock immediately before the dividend and that could reasonably be considered to be attributable to anything other than income earned or realized by any corporation after 1971 and before the transaction or event or the commencement of the series of transactions or events referred to in paragraph (3)(a), notwithstanding any other section of this Act, the amount of the dividend (other than the portion thereof, if any, subject to tax under Part IV that is not refunded as a consequence of the payment of a dividend to a corporation where the payment is part of the series of transactions or events).
[10] In the context of these appeals, this anti-avoidance provision provides that where a dividend arising under subsection 84(3) (as in the cases at bar) results in a significant reduction in the capital gain that would, but for the dividend treatment afforded by subsection 84(3), have been realized on a disposition of the shares otherwise than by way of redemption, the dividend is not treated as a dividend but as sale proceeds giving rise to a capital gain. However, the subsection contains exceptions to its application. The exception at issue in these appeals applies where the deemed dividend arising on the redemption is subject to Part IV tax. That qualification being met, as in the cases at bar, is not sufficient however if: (1) there is a refund of such Part IV tax as a consequence of a dividend paid (by the recipient of the deemed dividend) to a corporation; and, (2) the payment of the dividend (by the recipient of the deemed dividend) is part of the same series of transactions and events that resulted in the deemed dividend receipts. It is the application of these conditions to excepting the application of subsection 55(2) that frames the issues in these appeals. The wording of subsection 55(2) supports the view taken by the parties in these appeals that this exception to the application of subsection 55(2) will prevail, given that the qualification that the deemed dividend be subject to Part IV tax has been met, if either of the conditions described in (1) or (2) above have not been met. Eliminating the negatives employed in the drafting of the subject subsection, the issue in this case might be stated as follows: if the Part IV refunds are as a consequence of dividends paid to corporations and are part of the series of transactions and events that gave rise to the deemed dividend receipts (i.e. the amalgamation and the share redemptions), the reassessments will prevail.[2] If either of these conditions have not been met the appeal will succeed.
[11] CU and CU Holdings both maintain that the dividends that they paid that gave rise to the refunds of Part IV tax were not part of the series of transactions and events that included the redemption of their ATCOR shares that gave rise to the deemed dividend treatment. Further, CU having paid dividends to both corporations and individuals maintains that the dividends paid by it in 1996 to individuals (as opposed to corporations) accounted for the full amount of the refunds received in 1996 so that the exception to the application of subsection 55(2) referred to above applies in respect of the full amount of the deemed dividend it received in 1996 even if the dividends paid by it in 1996 were part of the series. CU Holdings having paid dividends to both corporations and individuals maintains a similar position to the full extent of dividends paid by it to individuals in 1996 and 1997. The Respondent argues in respect of both Appellants that the dividends giving rise to the refunds were part of the series of transactions and events giving rise to the deemed dividend treatment on the redemption of the ATCOR shares and that the dividends paid by the Appellants to corporations (as opposed to individuals) accounted for the full amount of the refunds.
[12] Before addressing these issues it might be helpful to make a few general comments on the application of Part IV and subsection 129(1) in the context of the facts of these cases. Subsection 186(1) of the Act imposes Part IV tax of one-third of "assessable dividends" received by a private corporation or by a "subject corporation" except where the payer corporation is connected with the receiving corporation. While both Appellants are public corporations, they are also "subject corporations" as defined in subsection 186(3). More particularly, it has been acknowledged that an individual, Ronald Southern, at all material times controlled directly or indirectly both Appellants. That being the case, the parties concede that the question of being "subject corporations" is not at issue. Further, as the order of the transactions set out below dictates, the Appellants, although "connected" with the deemed dividend payer (ATCOR) prior to and immediately after the amalgamation in 1996, were not "connected" with ATCOR at the time of the redemption of the shares in ATCOR which is the time that the deemed dividends in question are deemed to have been paid under subsection 84(3). That is, prior to the redemption, Forest Subco had acquired all of the voting shares of ATCOR so that ATCOR was not "connected" with either Appellant as that relationship is defined in subsection 186(4) of the Act. Further, there is no question that the deemed dividends were "assessable dividends" as that term is defined in subsection 186(3) since the Appellants were "subject corporations" in receipt of taxable dividends fully deductible under section 112. Accordingly, the Part IV tax liability is not in issue in these appeals except to the extent that the application of subsection 55(2) results in its non-application. As to the refund of Part IV tax, subsection 186(5) extends the application of subsection 129(1) to dividends paid by public corporations, such as the Appellants, that are "subject corporations" by deeming them to be private corporations for the purposes of section 129.
The Transactions & Events
[13] Resolution of the issue of whether the dividends paid by the Appellants which gave rise to the Part IV refunds were part of the series of transactions and events that gave rise to the deemed dividend treatment of the proceeds received on the redemption of the ATCOR shares, requires a review of all the transactions and events that surround the redemption and the payment of dividends by the Appellants. The determination of such factual matters has been made easier as the parties have executed an Agreed Statement of Facts. In addition to the Agreed Statement, a Joint Book of Documents was filed and the Appellants called five witnesses. Before reviewing the testimony of these witnesses, I will summarize the relevant facts as agreed to and as reflected in the Joint Book of Documents.
A. The Players
ATCO Ltd. ("ATCO")
[14] While I have not mentioned this company, it is necessary to mention it briefly. It is a management holding company incorporated under the laws of Alberta. It has a number of subsidiaries involved in many businesses primarily relating to electric power and natural gas. It is controlled by Ronald Southern and is a subject corporation within the meaning of subsection 186(3) of the Act. It is related to both CU and CU Holdings. Indeed, it indirectly owns 100% of the voting shares of CU Holdings. Together with CU Holdings, it (ATCO), indirectly owns 67% of the voting shares of CU. ATCO also owned shares directly in ATCOR but such holdings are not relevant in the context of these appeals.
CU
[15] CU through its operating subsidiaries is engaged in electric energy and natural gas utility operations. One of its holdings was publicly traded shares in ATCOR.
[16] CU has two classes of common shares and a number of classes and series of preferred shares. Its Class A common shares are non-voting and its Class B common shares are voting. Both classes of CU common shares are listed on the Toronto Stock Exchange. Both classes of common shares are ranked equally as to dividends.
[17] Throughout CU's taxation year ending December 31, 1996, approximately 58.5% of its non-voting Class A common shares and 32% of its voting Class B common shares were widely held by members of the public, including both individuals and corporations. The remainder of the CU common shares were held by corporations related to CU including CU Holdings. That is, 68% of the voting shares and 48.5% of the non-voting shares were closely held.
[18] At December 31, 1996, there were 11 separate classes and/or series of CU preferred shares issued and outstanding, the aggregate redemption amount of which was $534,500,000. Each class or series of CU preferred shares had fixed dividend rates. With the exception of one series of CU preferred shares, all were listed and traded on the Toronto Stock Exchange. Throughout CU's taxation year ending December 31, 1996, 99.9% of the CU preferred shares were widely held by members of the public, including both individuals and corporations.
[19] CU has paid dividends on its common shares since 1950 (with the exception of 1955 and 1956)and has paid fixed rate dividends on its preferred shares in accordance with their terms. CU has increased its annual common share dividend for 30 consecutive years. Dividends are paid on a quarterly basis.
[20] In the period of 1994 to 1998, CU paid quarterly dividends on the issued and outstanding CU common shares and CU preferred shares. The yearly totals of such dividends are as follows:
Year
CU
Common
Shares
CU Preferred
Shares
1994
$89,470,015
$45,189,139
1995
$92,439,215
$41,767,186
1996
$94,571,891
$36,964,119
1997
$99,579,121
$30,559,583
1998
$103,908,817
$28,689,000
[21] Dividends paid in 1996 to shareholders that were not corporations totalled $56,919,973.00 (43.273%) and dividends paid in 1996 to shareholders that were corporations totalled $74,616,036.00 (56.727%). (Tab 53, Volume 5 of Joint Book of Documents.)
CU Holdings
[22] CU Holdings is a holding company the sole assets of which were publicly traded shares of CU and ATCOR.
[23] CU Holdings has one class of common shares and one class of cumulative redeemable preferred shares issuable in series. All issued common shares were held indirectly by ATCO. They were not publicly traded.
[24] At all relevant times, there were three series of preferred shares issued, the aggregate redemption amount of which was $299,999,925.00 at December 31, 1996. Throughout CU Holdings' taxation years ending December 31, 1996 and December 31, 1997, 99.3% of its preferred shares were widely held.
[25] Each series of CU Holdings' preferred shares had specified dividend entitlements. Dividends were paid on a quarterly or monthly basis depending on the series. In the period of 1994 to 1998, CU Holdings paid dividends on its issued and outstanding preferred shares. The yearly totals of such dividends are as follows:
Year
CU Holdings
preferred shares
1994
$11,916,000
1995
$19,867,800
1996
$15,800,696
1997
$14,388,597
1998
$16,341,600
The Agreed Statement does not admit to any dividends having been paid on CU Holdings' common shares.
[26] Dividends paid in 1996 to shareholders that were not corporations totalled $2,992,256.00 (18.9%). Dividends paid in 1996 to shareholders that were corporations totalled $12,808,440.00 (81.1%). Dividends paid in 1997 to shareholders that were not corporations totalled $2,657,373.00 (18.5%). Dividends paid in 1997 to shareholders that were corporations totalled $11,731,223.00 (81.5%). (Tab 54, Volume 5, Joint Book of Documents.)
ATCOR
[27] ATCOR was engaged in oil and gas exploration, production, processing and marketing.
[28] Prior to January 31, 1996, the capital of ATCOR consisted of non-voting Class A common shares and voting Class B common shares. The Class A shares and the Class B shares were both listed on the Toronto Stock Exchange. On January 31, 1996, there were 27,272,536 Class A shares and 10,835,416 Class B shares issued and outstanding. The ownership of such shares was as follows:
ATCOR Class A Shares ATCOR Class B Shares
Widely-held 19,377,315 1,406,570
ATCO
0 2,500
CU
6,350,583 5,531,708
CUHL
1,544,638 3,894,638
Total 27,272,536 10,835,416
[29] Collectively, ATCO, CU and CUHL (the "Majority Shareholders") owned, directly or indirectly, approximately 29% of the non-voting Class A shares and approximately 87% of the voting Class B shares. The Articles of ATCOR were not put in evidence. However, given that both classes of shares were treated equally on the buy-out, it seems safe to assume holders participated rateably in any distribution of corporate earnings and assets.
Forest and Forest Subco
[30] Forest is a natural gas and oil company incorporated in New York in 1924. It has been a public company since 1969 and at all relevant times was listed and traded on the Nasdaq National Market.[3] Forest Subco was incorporated under the laws of Canada. At all relevant times it was a wholly owned subsidiary of Forest.
Newco
[31] Newco was incorporated under the laws of Canada and prior to its amalgamation with ATCOR its one issued and outstanding share, one common voting share, was held by ATCO.
Arm's Length Dealings
[32] At all material times prior to, on and after the closing date, none of the Majority Shareholders were related to Forest or Forest Subco within the meaning of section 251 of the Act and each of the Majority Shareholders dealt at arm's length with Forest and Forest Subco.
B. The Proposal
[33] On August 30, 1995 ATCO and Forest entered into a Confidentiality Agreement regarding a proposed transaction for the sale of ATCOR to Forest. In October 1995 Forest or its financial advisers communicated three different proposals for the acquisition of the ATCOR shares. The agreed upon structure approved by the directors of ATCOR on December 12, 1995 is set out in an Acquisition Agreement dated December 12, 1995 between Forest, ATCOR and the Majority Shareholders. Such agreed upon structure is also described in ATCOR's management proxy circular dated December 15, 1995.
[34] The management proxy circular accompanied a notice of a special meeting of shareholders of ATCOR to be held on January 16, 1996 (the "Notice & Circular"). The purpose of the special meeting of shareholders was to consider and vote upon the amalgamation of ATCOR and Newco.
[35] A letter accompanying the Notice and Circular made it clear that the amalgamation, if approved, would trigger the subsequent transactions covered under the Acquisition Agreement with the result that ATCOR shareholders would be bought out for $4.88 per ATCOR share and Forest Subco would own all of the issued and outstanding shares of the amalgamated entity. The letter states that Forest intended to complete an equity offering in the United States in January of 1996 and that the amalgamation and subsequent transactions were conditional upon Forest's ability to raise the required funds. The letter informs shareholders of ATCOR that a special committee of the Board of Directors of ATCOR, having received independent financial advice, recommended the approval of the amalgamation. In addition, the Board of Directors of ATCOR received a separate fairness opinion from a different independent financial adviser before recommending approval of the proposed transactions at the proposed price.
[36] Under the proposed Amalgamation Agreement predecessor ATCOR shares were exchanged for shares of amalgamated ATCOR. Newco's issued and outstanding shares (to be held by ATCO) were to be converted into common shares of amalgamated ATCOR. Under the Acquisition Agreement such common shares were to be acquired by Forest Subco for an aggregate price of $1.00. Under the Amalgamation Agreement holders of predecessor ATCOR shares could elect to exchange on a one for one basis their ATCOR shares for Class A Special Shares, Class B Special Shares or Class C Special Shares of amalgamated ATCOR. The Class A Special Shares, Class B Special Shares and Class C Special Shares were redeemable at $4.88 per share. Under the Acquisition Agreement, Forest Subco would acquire all tendered ATCOR shares at $4.88 per share. All untendered shares would be redeemed.[4]
[37] Under the Amalgamation Agreement the Class A Special Shares were allocated a paid-up capital amount of $2.65 each and the Class B Special Shares were allocated a paid-up capital amount of $1.40 each. On redemption, the deemed dividend in respect of the Class A Special Shares would therefore be $2.23 per share ($4.88 minus $2.65) and the deemed dividend in respect of the Class B Special Shares would be $3.48 per share ($4.88 minus $1.40). I note at this point as well that CU's adjusted cost base of the shares it received on the amalgamation was $2.68 per share and CU Holdings' adjusted cost base of the shares it received on the amalgamation was $1.43 per share. The allocation of the paid-up capital at per share amounts approximately equal to the Appellants' respective per share adjusted cost bases resulted not only in the fixing of the deemed dividend amounts each would be deemed to receive on redemption but effectively eliminated the capital gain on the disposition of their shares in ATCOR.[5]
[38] The paid-up capital in respect of the Class C Special Shares was determined by formula that ensured that such paid-up capital could not exceed the paid-up capital of all the ATCOR shares as calculated under the Act immediately before the amalgamation.
[39] I might observe that at this point, when the paid-up capital allocations were made, the Appellants would have known the exact amount of the dividend each of them would be deemed to have received on the redemption of their shares in ATCOR as well as the probable dividend payments each would make to the effect that they would have known at this point with some certainty what the Part IV tax liability would be and what the Part IV tax refunds would be in 1996 and 1997. The Notice and Circular sets out, in some detail, the income tax consequences of the subject redemptions including the Part IV liability of subject corporations although it does not refer to Part IV tax refunds.
C. The Completed Transactions
[40] On January 16, 1996, a special meeting of the shareholders of ATCOR was held during which the shareholders considered and passed a special resolution approving and adopting the amalgamation of ATCOR and Newco.
[41] On January 25, 1996, Forest made an equity offering in the United States, Canada and internationally.
[42] On January 31, 1996, Forest successfully completed an equity offering of 13,200,000 shares of its common stock at $11(US) per share. It used the net proceeds of $126,500,000.00 (US) together with a credit facility in the amount of $8,300,000.00 (US) to fund the acquisition of ATCOR.[6]
[43] In accordance with the Acquisition Agreement, ATCOR and Newco amalgamated on January 31, 1996 under the provisions of the Canada Business Corporations Act, R.S.C. 1985, c. C-44 ("CBCA").
[44] On the amalgamation, ATCO's one common share in Newco was converted into one common share of ATCOR. By virtue of ownership of this share, being the only issued voting share of ATCOR, ATCO controlled ATCOR immediately after the amalgamation.
[45] On the amalgamation, the 27,272,536 issued and outstanding ATCOR Class A Shares and 10,835,416 issued and outstanding ATCOR Class B Shares were converted to Class A Special Shares, Class B Special Shares and Class C Special Shares so that immediately after the amalgamation, the shares of ATCOR were held as follows:
Common
Class A Special Shares
Class B Special Shares
Class C Special Shares
ATCO
1
2,500
CU
11,882,291
CU Holdings
5,439,276
Widely-held
_
6,926,232
2,217,176
11,640,477
TOTAL:
1
18,808,523
7,658,952
11,640,477
[46] After the amalgamation Forest Subco purchased ATCO's one ATCOR common share for $1.00. By virtue of this purchase Forest Subco acquired control of ATCOR.
[47] Immediately after the sale of the ATCOR common share, CU and CU Holdings were no longer connected with ATCOR within the meaning of subsection 186(4) of the Act.
[48] After acquiring control of ATCOR, Forest Subco subscribed for and purchased 1,000,000 ATCOR Common Shares for an aggregate subscription price of $129,161,278.00.
[49] ATCOR then proceeded to redeem all of the 18,808,523 ATCOR Class A Special Shares and 7,658,952 ATCOR Class B Special Shares for redemption proceeds of $4.88 per share for total redemption proceeds of $129,161,278.00. Included in such redemption were the 11,882,291 ATCOR Class A Special Shares held by CU ($57,985,580.00) and the 5,439,276 ATCOR Class B Special Shares held by CU Holdings ($26,543,667.00).
[50] Forest Subco then acquired the 11,640,477 outstanding ATCOR Class C Special Shares from all holders for $56,805,527.76, being $4.88 per share.
D. The Normal Course Dividends
[51] The Appellants paid normal course dividends in 1996 and 1997 as set out in paragraphs 20 and 25 above.
E. The Reassessments
[52] In computing its income tax liability under Part I of the Act for its taxation year ending December 31, 1996, CU included the amount of $26,497,509.00 (the "CU Deemed Dividend") in its T2 return pursuant to subsection 84(3) of the Act in respect of the redemption of its ATCOR Class A Special Shares. Such amount was then deducted under subsection 112(1). CU computed its Deemed Dividend as follows:
Amount paid on redemption of ATCOR Class A Special Shares (11,882,291 x $4.88) $57,985,580.00
Less paid-up capital of ATCOR Class A Special Shares redeemed (11,882,291 x $2.65) 31,488,071.00
$26,497,509.00
[53] In computing its income tax liability under Part I of the Act for its taxation year ending December 31, 1996, CU Holdings included an amount of $18,928,680.00 (the "CU Holdings Deemed Dividend") in its T2 return pursuant to subsection 84(3) of the Act in respect of the redemption of its ATCOR Class B Special Shares. Such amount was then deducted under subsection 112(1). CU Holdings computed its Deemed Dividend as follows:
Amount paid on redemption of ATCOR Class B Special Shares (5,439,276 x $4.88) $26,543,666.00
Less paid-up capital of ATCOR Class B Special Shares redeemed (5,439,276 x $1.40) 7,614,986.00
$18,928,680.00
[54] In computing their liability for tax under Part IV of the Act for their taxation year ending December 31, 1996, CU and CU Holdings treated their respective Deemed Dividend as an assessable dividend not received from a corporation connected with it and paid Part IV tax under paragraph 186(1)(a). CU Holdings also paid tax under Part IV pursuant to paragraph 186(1)(b) equal to the portion of CU's refund under subsection 129(1) that was attributable to the dividend CU paid CU Holdings. CU paid Part IV tax of $8,832,503.00 (one-third of the CU Deemed Dividend) and CU Holdings paid $9,266,097.00 (one-third of the CU Holdings Deemed Dividend plus the tax under paragraph 186(1)(b)). CU offset its liability under Part IV of the Act by a dividend refund of $8,832,503.00 claimed by CU as a consequence of the dividends paid in 1996 on its common and preferred shares (the normal course dividends). CU Holdings partially offset its tax liability under Part IV by a dividend refund of $5,269,117.00 claimed by CU Holdings as a consequence of the dividend payments made on its preferred shares in 1996 (the normal course dividends). The remainder of CU Holdings' tax paid under Part IV was refunded in 1997 as a consequence of dividend payments made on its preferred shares in 1997.[7]
[55] By the Reassessment dated May 22, 2001, the Minister:
(i) increased CU's tax payable under Part I of the Act by $5,646,814.00 for CU's 1996 taxation year by adding an amount of $19,605,780.00 to CU's income on the basis that under subsection 55(2) the amount of the CU Deemed Dividend was to be treated as proceeds of disposition with resulting capital gains treatment. The Minister computed the income inclusion as follows:
Proceeds of Disposition (11,882,291 shares x $4.88 per share) $57,985,580.00
Adjusted Cost Base (11,882,291 shares x $2.68 per share) $31,844,539.00
Capital Gain $26,141,041.00 Taxable Capital Gain ($26,141,041 x 75%) to be added to income $19,605,780.00
(ii) reduced CU's tax liability under Part IV of the Act by $8,832,503.00 [8];
(iii) decreased CU's dividend refund under subsection 129(1) of the Act by $8,832,503.00;
(iv) made consequential adjustments for interest and penalties.
[56] By the Reassessment dated May 22, 2001, the Minister:
(i) increased CU Holdings' tax payable under Part I of the Act by $4,095,982.00 for CU Holdings' 1996 taxation year by adding an amount of $14,066,082.00 to CU Holdings' income on the basis that under subsection 55(2) the CU Holdings' Deemed Dividend was to be treated as proceeds of disposition with resulting capital gains treatment. The Minister computed the income inclusion as follows:
Proceeds of Disposition (5,439,276 shares x $4.88 per share) $26,543,666.00
Adjusted Cost Base (5,439,276 shares x $1.432 per share) 7,788,890.00
Capital Gain $18,754,776.00 Taxable Capital Gain ($18,754,776 x 75%) to be added to income $14,066,082.00
(ii) reduced CU Holdings' tax liability under Part IV of the Act by $9,266,097.00. As in respect of CU, there was no assessable dividend if subsection 55(2) applied and no tax under paragraph 186(1)(b) to the extent CU's refund had been eliminated by the CU reassessment;
(iii) decreased CU Holdings' dividend refund under subsection 129(1) of the Act by $5,269,117.00; and
(iv) made consequential interest adjustments.
[57] By reassessment for CU Holdings' 1997 taxation year the Minister decreased CU Holdings' dividend refund under section 129 of the Act as a consequence of the reduction of CU Holdings' refundable tax on hand given the reduction in Part IV tax liability under the 1996 reassessment.
The Appellants' Witnesses
[58] The Appellants called five witnesses who participated in the ATCOR/Forest transactions. The witnesses were called to attest to the fact that the disposition of ATCOR shares was carried out for business and commercial reasons and that the structure of the transactions including the amalgamation and share redemptions were carried out for commercial reasons to facilitate the disposition. Further, their testimony was intended to confirm that the payment of the CU and CU Holdings dividends in 1996 and 1997 was not at all dependent on the ATCOR/Forest transactions and that those dividends would have been paid in any event in the normal course regardless of whether or not the ATCOR/Forest transactions had ever taken place. As to the latter point, counsel for the Respondent acknowledged during the course of the hearing that they did not take issue with the fact that the CU and CU Holdings dividends in 1996 and 1997 would have been paid regardless of the ATCOR/Forest transactions and that there was no dependency on the ATCOR/Forest transactions as a means of funding the payment of the CU and CU Holdings dividends in 1996 and 1997. On the other hand, the Respondent did not acknowledge that the structure of the transactions with Forest, including the amalgamation process and redemption of ATCOR shares, was carried out strictly for commercial reasons.
[59] At this point I would note that the relevance of the purpose of the structure of the transactions with Forest was not argued. In applying subsection 55(2) in the case of a dividend under subsection 84(3) the test is whether one of the results of the series of transactions or events was to effect a significant reduction in the capital gain that, but for the deemed dividend arising under subsection 84(3), would have been realized on a disposition of the shares at fair market immediately before the redemption. In the case of the application of subsection 84(3) then the purpose of the series of transactions or events is not open to question. On the other hand the import of a tax purpose might bolster an argument that the CU and CU Holdings normal course dividends paid in 1996 and 1997 ought to be included in the ATCOR/Forest series of transactions by virtue of the fact that a tax purpose for the structure of that series would connect such dividends with that series. This would change the focus away from excluding the normal course dividends by reason of not being dependent on the other transactions toward including such dividends by reason of being connected by a purpose. A predictable, foreseen event known to follow in a particular sequence might be brought into the series where the event is purposefully used to advantage. I will deal with this issue later in these Reasons but I raise it now to give perspective to the testimony of the Appellants' witnesses.
[60] The first witness called by the Appellant was Bill Britton, a lawyer with Bennett Jones in Calgary. The ATCO companies were a long time client of Mr. Britton and the firm. Mr. Britton was responsible for the administration of legal services provided by Bennett Jones to the ATCO companies. In 1995 and 1996 he was a director of ATCO, CU, CU Holdings and ATCOR.
[61] As in past transactions, including the acquisition of CU in 1980, Mr. Britton's role included assuming responsibility to carry out various acquisitions and dispositions subject ultimately to the approval of senior management and the Board of Directors of the various companies that might have been involved in the particular acquisition or disposition being overseen or directed by Mr. Britton.
[62] Mr. Britton testified that although one of the reasons for acquiring ATCOR was to facilitate an income stream to help finance CU's dividend obligations on its preferred shares, ATCOR's financial results were not in line with a growth strategy targeted for the ATCO companies. It was determined that ATCOR's contribution was not sufficient and was fluctuating so as to cause unacceptable variations in the growth strategy. Fluctuations were said to be attributable to fluctuating oil and gas prices that in turn affected reserve values. Further, Mr. Britton suggested that due to its holdings in ATCOR there was a diminished interest by investment bankers following CU. This was corroborated by Mr. William Sembo. It was also a question of return on invested time. There were 14 directors of ATCOR and attending to ATCOR affairs took considerable time and attention without the rewards sought. For all these reasons, in or about May of 1995 Mr. Britton was asked by Ron Southern and by the then CFO of ATCO, Cam Richardson, to explore the market in terms of selling ATCOR.
[63] Mr. Britton testified that the intention from the outset was to explore the market on the basis of including all ATCOR shareholders in the sale. That is, there was no intention to exclude the public shareholders. This approach he said was dictated to some extent by securities law which is protective of minority interests and by what Mr. Britton referred to as a responsible "motherhood" attitude. As to the latter, I note that correspondence dated June 1, 1995 (at tab 25, volume 3 of the Joint Book of Documents), suggests that an offer was first to be sought for the Majority Shareholders of ATCOR and that the likelihood of an offer to other shareholders would be dealt with separately at a future date. Perhaps this approach helped ensure the best possible price for all shareholders.
[64] Mr. Britton testified that although there were some assets that the Majority Shareholders wanted to retain (which required that the purchaser and minority ATCOR shareholders approve the carving out of some assets of ATCOR), the objective was to find a buyer that could absorb the operations so as to maintain the best value and preserve jobs. The consideration he said was to be cash.
[65] Mr. Britton, on a confidential basis, talked to the CEOs of a number of potential candidates. As well, he and Mr. Richardson contacted three securities firms requesting proposals regarding the sale of ATCOR. In June of 1995 three proposals were received. They address the role that the respective firm would play. They refer to divestiture options in very general terms, marketing strategies, pricing and generally promote their prospective role should they be retained to assist in the sale. One proposal goes further. It deals with the tax-free transfer of assets to be retained by the Majority Shareholders of ATCOR and ultimately recommends a cash sale of ATCOR shares as tax deferrals on share exchanges did not seem necessary given what they believed was a high cost base of the ATCOR shares held by the Majority Shareholders. This only confirms what I think would be obvious in any event; a sale strategy even in its early stages would recognize the influence of tax strategies in steering the structure of the transaction.
[66] Mr. Britton testified that, for reasons of confidentiality, none of the three security firms from whom marketing proposals were requested were engaged to assist with finding a buyer. Mr. Britton continued to seek out potential buyers on his own and found Forest on his own. After initial meetings a confidentiality agreement was entered into in August of 1995 between the President of Forest and Mr. Britton. Following preliminary due diligence, Forest sent a proposal on October 4, 1995. It was a proposal to acquire all the ATCOR shares in exchange for Forest shares at a price of $4.63 per share. An alternate proposal to include cash consideration was subject to a contingency, namely the cash portion of the alternate offer was contingent on Forest raising funds.
[67] Mr. Britton testified that he believed such contingency created difficulties under Canadian securities law. It was Mr. Britton's understanding at least that unlike U.S. law, Canadian law prohibited a sale subject to a financing condition.
[68] On October 24, 1995 Forest's U.S. legal advisers wrote to arrange a meeting to finalize negotiations. That letter still referred to cash plus share consideration as the consideration for the purchase of ATCOR shares. Mr. Britton testified that Forest was then told of the cash requirement and a similar but revised letter was sent by Forest's advisers on October 31, 1995. It delayed the closing schedule, indicated cash consideration for the purchase of ATCOR shares (with a vendor option to receive share consideration) and stipulated that the consideration would be paid on a tax effective basis for all parties. There remained in both letters the contingency regarding Forest raising funds under a public offering. While Mr. Britton testified that this contingency was a problem, there was no indication in the revised correspondence that this had been raised as a problem area. One might reasonably assume, it seems to me, that the manner of dealing with the issue (namely the amalgamation structure) had already been considered by the Appellants' advisers.
[69] A press release was issued on November 22nd announcing negotiations for the sale of ATCOR. While the proposal was not finalized and a final price had not been agreed upon at the time of the press release, Mr. Britton confirmed that there was reasonable confidence by then that a deal would be worked out with Forest. That again suggests that a resolution of the financing contingency problem had already been considered by the Appellants' advisers.
[70] The issuance of the press release also meant, according to the testimony of Mr. Britton, that there was reasonable confidence that an agreement would be struck that would be approved by a requisite majority of votes of each class of outstanding ATCOR shares (including the non-voting shares of which the Majority Shareholders only owned some 29%). That is, in order for there to be a deal, the co-operation of the public shareholders of ATCOR was necessary. It seems likely then that a structure sensitive to the requirements of public shareholders, as well as to the Majority Shareholders, must have already been considered by the Appellants' advisers.
[71] Mr. Britton went on to testify that in early December 1995 two firms were retained to provide fairness opinions on the proposed sale. The engagement letters show that the terms and structure of the sale (the price, the amalgamation and the redemption versus sale option to be made available to all shareholders) were known by this time. Neither the terms of engagement nor the opinions included in the Joint Book of Documents make reference to the Amalgamation Agreement per se or any tax consequences associated with the amalgamation structure. The opinions confirmed the view nonetheless that the acquisition was fair to all shareholders. Following receipt of such opinions the Acquisition Agreement was entered into on December 12 with appended documentation that included the proposed Articles of Amalgamation and Amalgamation Agreement.
[72] Although conceding that the Appellants would have taken tax advice from his firm's tax group, Mr. Britton would not admit to any knowledge of, or to remembering any particulars of, tax planning by his firm in respect of the subject transactions. He stated that the structure was not dictated by the Appellants but was worked out as a problem solver and was dictated by Forest. This was corroborated to some extent by another witness, David Baxter, who worked on the transaction on Forest's behalf. Further, I note that correspondence from ATCOR's counsel tends to support that the structure was recommended by them. On the other hand, as is supported by further testimony dealt with below, there is little question that the Appellants' advisers had input on details of the structure which were of no interest to Forest. Even as to the amalgamation structure itself it seems likely that the Appellants' advisers were on the same page as Forest's advisers. Indeed, they were likely a page or two ahead of Forest's advisers on these issues as they related to vendor income tax issues. The readiness of the Appellants' advisers to produce the various required documents, the Notice and Circular, the Amalgamation and Acquisition Agreements and the like which ensured acceptable income tax options for shareholders, both public shareholders and the Majority Shareholders, support this view as do the testimony of Mr. Baxter and, more particularly, Mr. MacNeil, to which I will refer to shortly.
[73] Mr. Britton also testified as to the historical dividend practices and payments of both CU and CU Holdings. There is no dispute as to this aspect of his testimony.
[74] The second witness, Daniel Baxter, is a lawyer with the firm MacLeod Dixon that acted for Forest at the relevant times. They were retained in early November 1995. At that point the deal was agreed on only to the extent of a cash price for the purchase of all ATCOR shares subject to financing.
[75] Mr. Baxter testified that three different structures were considered as a means to purchase the ATCOR shares. A takeover bid, an amalgamation where the shareholders received redeemable securities or a plan of arrangement. Forest determined that it wanted to proceed with the amalgamation structure. It is not necessary for me to elaborate on the considerations that went into this decision. I am satisfied that commercial considerations alone drove this decision. The purchase of a public company that was subject to financing by a public offering by a foreign purchaser would have its complexities, particularly where the transaction was targeted to close within a few months. The amalgamation structure accomplished the commercial objectives in a coordinated and efficient manner. Not even hindsight would suggest a more efficient commercial course of action.
[76] Like Mr. Britton, Mr. Baxter was not familiar with the tax considerations that might have gone into the fine-tuning of the amalgamation structure. He admitted, however, that he would see no reason, except possibly for tax considerations, to set-up different classes of redeemable shares on the amalgamation. Indeed, he acknowledged that the direct purchase of a single class of redeemable post amalgamation shares of ATCOR by Forest (Forest Subco) would have satisfied Forest's commercial objectives. He acknowledged however, that setting up different classes of shares in this type of buy-out structure was common.
[77] The next witness, William Sembo, is the Vice-Chairman of RBC Capital Markets in Calgary. In 1995 he was a Vice-President and Director of RBC Dominion Securities in Calgary. He was responsible for providing general corporate finance advice to the ATCO companies. He was involved with both the marketing proposal and the fairness opinion prepared by RBC referred to above. With respect to the fairness opinion he testified that it was their firm's view that the terms of the proposed transaction were fair from the financial point of view to all shareholders. He said the firm satisfied itself that there were no collateral benefits to ATCO or any of its affiliated companies under the terms of the transaction but that they did not consider the income tax consequences to the ATCOR shareholders in respect of their dispositions.
[78] He went on to testify that in its role as an investment adviser RBC followed the activities and developments of the ATCO group of companies and published reports to the public on this group based on its research. He testified that utility and pipeline companies were evaluated by the investing public on the basis of dividend policy and dividend yield. He confirmed that there was a pattern of regular growth of dividends in the ATCO group and that that was the market expectation. He testified that the expectation of growth was large