Birchcliff Energy Ltd. v. The Queen

Birchcliff Energy Ltd. v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2015-10-01
Neutral citation
2015 TCC 232
File numbers
2012-1087(IT)G
Judges and Taxing Officers
Robert James Hogan
Subjects
Income Tax Act
Decision Content
Docket: 2012-1087(IT)G
BETWEEN:
BIRCHCLIFF ENERGY LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on November 18, 19, 20 and 21, 2013,
at Calgary, Alberta.
Decided by: The Honourable Justice Robert J. Hogan
Appearances:
Counsel for the Appellant:
Patrick Lindsay
Jean-Philippe Couture
Counsel for the Respondent:
Robert Carvalho
Neva Beckie
Jonathan Wittig
JUDGMENT
In accordance with the attached reasons for judgment, the appeal from the reassessment made under the Income Tax Act for the 2006 taxation year is dismissed with costs.
Signed at Ottawa, Canada, this 1st day of October 2015.
“Robert J. Hogan”
Hogan J.
Citation: 2015 TCC 232
Date: 20151001
Docket: 2012-1087(IT)G
BETWEEN:
BIRCHCLIFF ENERGY LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
I. Overview [1] The present case is an appeal from a reassessment made by the Minister of National Revenue (the “Minister”) for the 2006 taxation year of Birchcliff Energy Ltd. (the “Appellant”). The genesis of this appeal is a dispute regarding the disallowance by the Minister of a deduction of $16,226,489 of non-capital losses claimed by the Appellant for its 2006 taxation year in the circumstances described below. The losses were incurred by a predecessor corporation, Veracel Inc. (“Veracel”), which was amalgamated with Birchcliff Energy Ltd. (“Birchcliff”) to form the Appellant as the last step of a complex series of transactions (the “Amalgamation Transactions”) implemented pursuant to the terms of a court‑sanctioned plan of arrangement.
[2] The Respondent defends the reassessment on the grounds that control of Veracel was acquired by a person or “group of persons” either upon or immediately prior to its amalgamation with Birchcliff. As a result, the Appellant is barred from using the losses by virtue of the restrictions (the “Loss Streaming Restrictions”) contained in subsection 111(5) of the Income Tax Act (the “Act”) because it did not carry on the business that gave rise to Veracel’s losses. In the alternative, the Respondent argues that the Appellant abusively circumvented the Loss Streaming Restrictions by avoiding a special rule that deems control to have been acquired, such that the general anti‑avoidance rule in section 245 of the Act (the “GAAR”) applies with a similar effect to that of the Loss Streaming Restrictions.
[3] This appeal was originally heard by Justice Jorré of this Court. With the consent of both parties, the appeal is to be decided by me on the basis of the transcript and the record.[1]
II. Factual Background [4] The facts are essentially as set out in a partial agreed statement of facts, which reads as follows:
The parties agree for the purposes of the determination of the issues herein that the following facts may be accepted as evidence without further proof thereof. Numerical references in brackets refer to the relevant tab in the Agreed List of Documents.
Veracel
1. Veracel Inc. (“Veracel”) was incorporated on August 10, 1994 as Morphometric Technologies Inc. under the Business Corporations Act of Ontario.
2. Veracel’s business was to develop, manufacture and market automated diagnostic instruments for medical applications (the “Medical Business”).
3. In April 2001, the company changed its name to Veracel.
4. On November 15, 2002, Veracel filed a proposal under the Ontario Bankruptcy and Insolvency Act that was accepted by the Ontario Superior Court of Justice. [2] On November 19, 2003, the Trustee certified that Veracel had fully performed the proposal.
5. Veracel ceased its Medical Business in 2002. No income was earned from the Medical Business after 2002.
6. In February 2004, Veracel solicited proposals in connection with its existing tax attributes. [4] Soon thereafter, Veracel started to work with David Tonken and Greg Matthews.
7. On November 5, 2004, Veracel, David Tonken, Greg Matthews and Emerging Equities Inc. executed a letter agreement in connection with a proposed transaction. [5] The proposed transaction was not completed.
8. As at the end of 2004, Veracel had the following tax attributes: non-capital losses of $16,226,489; scientific research and experimental development expenses of $15,558,003; and, investment tax credits of $1,874,979 (the “Tax Attributes”).
9. The issued and outstanding Veracel shares, as at December 31, 2004, consisted of 10,280,461 Common Shares and 7,299,424 Class A Preference Shares. [9; 44, Exhibit B]
10. Class A Preference shareholders were entitled to receive notice of and attend meetings, and vote at such meetings, on a 1:1 basis with holders of Common Shares. [64]
11. Veracel shareholders included the Business Development Bank of Canada, Ontario Development Corp., AGF and HSBC. [44, Exhibit B]
Birchcliff
12. On July 6, 2004, Birchcliff was incorporated as 1116463 Alberta Ltd. That company changed its name to Birchcliff Energy Ltd. on September 10, 2004.
13. On January 18, 2005, Scout Capital Corp. (“Scout”), a publicly listed company, amalgamated with the company then named Birchcliff Energy Ltd. (the “Scout Amalgamation”). The amalgamated company adopted the name Birchcliff Energy Ltd. (“Birchcliff”). When Birchcliff and Veracel amalgamated on May 31, 2005, as set out below, that company also adopted the name Birchcliff Energy Ltd. (“Amalco”).
14. On January 19, 2005, the common shares of this newly amalgamated company were listed for trading on the TSX Venture Exchange under the trading symbol “BIR”.
15. The Scout Amalgamation was done by way of a court approved Plan of Arrangement and involved the issuance of subscription receipts. [11]
16. David Tonken was the President and CEO of Scout from 1998 to 2002.
17. David Tonken is the brother of Jeff Tonken, the President and CEO of Birchcliff and of Amalco.
Purchase of initial oil and gas property
18. On February 14, 2005, Birchcliff entered into a letter agreement to purchase properties in the Peace River Arch area of Alberta for $2.75 million.
19. This purchase closed on May 5, 2005.
Agreement to purchase major oil and gas property
20. On March 9, 2005, Birchcliff entered into a letter agreement in connection with the purchase of oil and natural gas properties in the Peace River Arch area of Alberta for $255 million (the “Devon Properties”). [14] The related purchase agreement was executed on March 29, 2005 for a purchase price of $243 million.
21. It was anticipated that the acquisition of the Devon Properties would close on or before May 31, 2005.
22. Birchcliff approached several financial institutions including Scotia Capital in connection with financing the acquisition of the Devon Properties.
23. On March 29, 2005 Birchcliff and Scotia Capital signed a Commitment Letter wherein Scotia Capital committed financing in the form of a Revolving Loan in the amount of $70 million and a Bridge Loan in the amount of $149 million, to purchase the Devon Properties. [21] The Bridge Loan was never advanced.
24. KPMG prepared a schedule of revenue and expense for the Devon Properties identifying that, in 2004, the Devon Properties generated revenue exceeding $85 million which, after the payment of royalties and operating costs, generated net profit of more than $50 million. [10]
Veracel and Birchcliff sign a letter agreement
25. David Tonken brought Veracel and Birchcliff together for a possible transaction. He contacted Jim Surbey at Birchcliff and discussed Veracel’s situation with him. [132, 133]
26. On March 18, 2005, Birchcliff directors approved of entering into a purchase agreement for the Devon Properties and approved a proposed Arrangement Agreement with Veracel. [19]
27. Negotiations between Veracel and Birchcliff included the exchange of draft agreements, and revisions to such agreements, in correspondence dated March 21, 23, and 29, 2005.
28. On March 29, 2005, a Birchcliff press release announced that Birchcliff had entered into an acquisition agreement for the purchase of the Devon Properties for approximately $240 million. The press release described the Devon Properties and identified that the parties anticipated that the transaction would be completed by May 31, 2005. [25]
29. John Anderson of Veracel sent a letter dated March 29, 2005 to the shareholders of Veracel regarding “Reorganization of Veracel Inc.” [24]
30. On April 1, 2005, Birchcliff and Veracel signed a Letter Agreement. [27]
31. On April 3, 2005, Birchcliff issued a press release announcing that Veracel and Birchcliff had signed the Letter Agreement. [39]
32. By April 4, 2005, the new financing proposed in the letter agreement is being marketed. [34]
Steps to implement letter agreement
33. On April 12, 2005, Olympia Trust Company (“Olympia”) on behalf of Birchcliff advised the TSX Venture Exchange (“TSXV”) and the securities commissions in British Columbia, Alberta, Saskatchewan, Ontario and Nova Scotia that the annual and special meeting was set for May 24, 2005.
34. On April 14, 2005, GMP Securities Ltd. signed a letter of offer to Veracel to agree to place subscription receipts. [32]
35. On April 14, 2005, the Underwriting Agreement became effective, among Veracel and GMP Securities Ltd., as lead underwriter, Sprott Securities Inc. and Scotia Capital Inc. (collectively the “Underwriters”), with respect to an equity financing of up to $136,000,000 plus a further $10,000,000 in a separate flow-through equity financing. [42]
36. On April 18, 2005, Veracel and Birchcliff executed the Arrangement Agreement. Exhibit A to the Arrangement Agreement is the Plan of Arrangement. [44]
37. During April 2005, Veracel received concurrence of shareholders to proceed with the Arrangement Agreement. [40]
Notices and approvals
38. On April 18, 2005, Birchcliff notified the TSXV in connection with the proposed transactions. [45]
39. On April 18, 2005, Veracel notified shareholders of a special meeting in connection with proposed transactions. [46]
40. On April 19, 2005, Birchcliff notified the Alberta Securities Commission (“ASC”) that counsel to Birchcliff would attend the Alberta Court on April 22, 2005 to apply for an Interim Order in connection with the Plan of Arrangement.
41. On April 21, 2005, the Veracel directors approved the Arrangement Agreement, the Private Placement, the “New Equity Financing” and other matters. [47]
42. On April 21, 2005, the Birchcliff directors approved of the Information Circular and other matters. [48]
43. On April 21, 2005, in accordance with the Arrangement Agreement, Birchcliff filed a Petition with the Alberta Court applying for an Interim Order directing that a shareholders meeting be called to vote on the proposed Arrangement. [49] An affidavit of Jim Surbey was filed in connection with this Petition. [52]
44. On April 21, 2005, an MRRS Decision document was issued. [50]
45. On April 22, 2005, the Alberta Court issued the Interim Order.
46. A copy of the Interim Order and related documents [was] provided to the ASC by letter dated April 22, 2005.
47. On April 22, 2005 the Information Circular was published. [51]
48. A corporate administrator from Olympia declared, on May 5, 2005, that the Information Circular and a Proxy were mailed to each Birchcliff Shareholder on April 26, 2005 and confirmation of same was provided to the TSXV and to securities commissions in British Columbia, Alberta, Saskatchewan and Ontario.
49. An April 25, 2005 press release announced that the Underwriters had exercised their option to sell the additional 8 million Veracel Subscription Receipts, to increase the equity financing up to $136,000,000. [54] The Underwriters’ confirmation of same was issued May 4, 2005. [68]
50. On April 26, 2005, Birchcliff by letter applied to the Committee on Uniform Security Identification Procedures (“CUSIP”) for approval of a new CUSIP number for the Common Shares of Amalco that were to be issued in exchange for shares of Veracel and Birchcliff on the amalgamation.
51. The new CUSIP number was issued on May 2, 2005. A specimen Amalco Common Share certificate with the new CUSIP number and a specimen Amalco Series 1 Preferred Share certificate were prepared on May 20, 2005.
Further Veracel approvals
52. On April 29, 2005, the shareholders and investors of Veracel met and passed the following resolutions: [56]
a. to elect Robert Allan, John Anderson and David Tonken as directors;
b. to issue 3,775,000 [common shares] to each of David Tonken and Greg Matthews on condition of the Arrangement closing (the “Private Placement”);
c. to amend then terminate the Unanimous Shareholders Agreement;
d. to authorize the Letter Agreement with Birchcliff;
e. to approve the amendment to the articles of Incorporation to create Class B common shares;
f. to transfer all assets to Newco in exchange for Newco shares and then to distribute those shares to Veracel shareholders;
g. to continue to Alberta;
h. to authorize the Arrangement Agreement with Birchcliff;
i. to authorize the “New Equity Financing”; and
j. to waive rights, privileges and conditions attached to Class A Preferred Shareholders.
53. On April 29, 2005, the directors of Veracel passed the following resolutions: [55]
a. to approve the Letter Agreement and Arrangement with Birchcliff;
b. to transfer all assets to Newco in exchange for Newco shares and then to distribute those shares to Veracel shareholders;
c. to authorize David Tonken and John Anderson to implement the “Arrangement”;
d. to issue 3,775,000 [common shares] to each of David Tonken and Greg Matthews; and
e. to authorize the “New Equity Financing”.
54. On April 29, 2005, Veracel filed Articles of Amendment to allow for the issuance of Class B Common Shares.
55. On April 29, 2005, Veracel share certificates were issued representing 3,775,000 [common shares] to each of David Tonken and Greg Matthews in accordance with the Private Placement. [57]
56. On May 2, 2005, Veracel continued from Ontario to Alberta. [64]
Financing to raise $136,000,000
57. On May 2, 2005 Veracel completed a “Due Diligence Questionnaire” for the Underwriters regarding the transaction with Birchcliff. [61]
58. On May 2, 2005 Birchcliff completed a “Due Diligence Questionnaire” for the Underwriters regarding the transaction with Veracel. [62]
59. On May 4, 2005, the Subscription Receipt Indenture among Veracel, the Underwriters and Olympia became effective. [69]
60. On May 4, 2005, the Representation Agreement between Birchcliff and the Underwriters became effective. [70]
61. A memorandum was issued regarding the transfer of $130,500,000, to be received by the Underwriters for the sale of 32,625,000 Subscription Receipts, which provided that, once all parties and counsel agreed the closing documentation had been tabled, such funds would be wire transferred from the Underwriters’ account to Olympia’s account. [73] The other $5,500,000 was to be received from the President’s List subscribers. [67]
62. On May 4, 2005, the Subscription Receipt financing closed and 34,000,000 Subscription Receipts were issued to 133 investors. [111]
63. On May 4, 2005, the closing of the $136,000,000 financing was announced. [71]
64. A Subscription Receipt Agreement was completed by each of the 133 investors [60, 80, 81] and each investor was issued a Subscription Receipt. [58, 66, 77, 78, 82]
65. On May 4, 2005, by Treasury Order, Veracel directed Olympia to issue the Subscription Receipts. [74]
66. On May 4, 2005, Veracel and Olympia acknowledged receipt by Olympia of $136,000,000 in aggregate from the Underwriters ($130,500,000) and from the President’s List subscribers ($5,500,000). [75, 76, 79]
Further Birchcliff approvals
67. On May 10, 2005, Birchcliff warrant holders and stock option holders approved the Arrangement and the Arrangement Agreement. [84, 85]
68. On May 16, 2005, Birchcliff notified the ASC that Birchcliff intended to apply to the Court on May 24, 2005 for a Final Order.
69. On May 24, 2005, the Birchcliff shareholders’ meeting was held and Olympia, as scrutineer, issued a report identifying that holders of more than 50% of the outstanding shares of Birchcliff attended the meeting in person or by proxy and that 100% of the 54 votes cast were in favour of the Amalgamation and acquisition of the Devon Properties.
Completion of the plan of arrangement and related matters
70. On May 24, 2005, an Affidavit was sworn in support of the Final Order. [90]
71. On May 24, 2005, the Court approved the Final Order, which provided that the Arrangement was approved and would be effective in accordance with its terms, and binding on all persons, upon the filing of the Articles of Arrangement. A copy of the Order was provided to the ASC.
72. On May 25, 2005, Veracel directors approved of the form and allotment of the Veracel Class B Common Shares and other matters. [91]
73. On May 25, 2005, Veracel and the Underwriters directed Olympia to deposit the $136,000,000 into Olympia’s account at the Bank of Nova Scotia. [92]
74. On May 30, 2005, Birchcliff directors approved the filing of Articles of Amendment to create Series 1 Preferred Shares dated May 30, 2005. [95]
75. On May 30, 2005, Articles of Amendment were filed, creating Series 1 Preferred Shares, and a Certificate of Amendment was issued by the Alberta Corporate Registrar (the “Registrar”). [96]
76. The Series 1 Preferred Shares provided for redemption and retraction at a price equal to $1,500,000, less certain liabilities, divided by the total number of Veracel Common Shares and Veracel Class A Preference Shares outstanding prior to filing of the Articles of Arrangement. [96]
77. On May 30, 2005, the Depositary Agreement between Veracel and Olympia became effective. [97]
78. Veracel and Birchcliff jointly confirmed for Olympia that the redemption price for the Series 1 Preferred Shares of Amalco was $0.05969 and confirmed the exchange ratio for each holder of Veracel Common Shares and Class A Preference Shares that elected to receive Amalco Common Shares would have an exchange ratio of 1:0.01492. [114]
79. Veracel shareholders issued Letters of Transmittal in order to elect whether to receive Amalco common shares or Amalco Series 1 Preferred Shares. [94]
80. On May 31, 2005, Veracel and the Underwriters issued the Transaction Notice and Direction which is received by Olympia. [102, 103]
81. On May 31, 2005, Birchcliff issued a Certificate, acknowledged by Olympia, confirming that the capital stock of Birchcliff at the close of business on May 30, 2005 continued to consist of 20,248,337 Common Shares.
82. On May 31, 2005, Veracel issued a Certificate, confirming that the issued and outstanding Veracel shares continued to consist of 17,830,461 Common Shares and 7,299,424 Class A Preference Shares for a total of 25,129,885 outstanding shares. [108]
83. On May 31, 2005, Articles of Arrangement were filed by Veracel and Birchcliff and the Registrar confirmed such filings.
84. On May 31, 2005, Gordon Cameron, Werner Siemens, Larry Shaw and Jeffery Tonken signed consents to act as directors of Amalco.
85. On May 31, 2005 John Anderson, Robert Allan, and David Tonken resigned as officers and directors of Veracel. These directors and Veracel signed mutual releases effective on the same day. [107, 109, 110]
86. On May 31, 2005, Olympia acknowledged receipt of the Treasury Order. [116, 117]
87. On May 31, 2005, the Underwriters were paid, and acknowledged receipt of payment [of], their fee of $6,580,475, in accordance with the Underwriters’ agreement with Veracel. [99]
88. On May 31, 2005, Olympia received $1,031,884.87, representing the redemption price for the outstanding Amalco Series 1 Preferred Shares. [100]
89. On May 31, 2005, Amalco filed the Articles of Arrangement [115], Final Order, Plan of Arrangement, and Articles of Amalgamation with the TSXV and the securities commissions in British Columbia, Alberta, Saskatchewan, Ontario and Quebec.
90. On June 3, 2005, Amalco issued a press release announcing that Amalco had completed the Flow-Through Financing. [122]
91. On June 3, 2005, Amalco issued a TSXV Bulletin announcing that Amalco shares were issued in exchange for Veracel and Birchcliff shares and identifying that the Amalco Common Shares would commence trading on the TSXV on June 6, 2005. [123]
Reassessment and related matters
92. The Appellant claimed a portion of the Tax Attributes in its 2006 taxation year.
93. By Notice of Reassessment dated November 30, 2011, the Minister reassessed Birchcliff to disallow the deduction of $16,226,489 of non‑capital losses (the “Reassessment”) claimed in the 2006 taxation year.
94. The Reassessment was based on assumptions related to allegations of sham and acquisition of control. GAAR was not a basis for the Reassessment.
95. The Appellant filed a Notice of Objection dated December 2, 2011.
96. By Notice of Appeal filed March 13, 2012, the Appellant appealed the 2006 taxation year to this Court.
[5] All defined terms used herein have the meaning given in the partial agreed statement of facts unless otherwise indicated.
[6] The cursory description of the transaction steps provided in the partial agreed statement of facts is not helpful without a good understanding of the background context of these transactions. In this regard, the Appellant and the Respondent paint a very different picture of the circumstances and objectives that influenced the transaction steps leading up to and culminating in the amalgamation of Veracel and Birchcliff. Each party’s position regarding the factual context is summarized below.
III. Respondent’s Position [7] The Respondent points out that there is no dispute that Veracel was a dormant corporation that had accumulated a large amount of non-capital losses, scientific research and experimental development expenses and investment tax credits (the “Tax Attributes”) from the Medical Business that it had previously carried on. The evidence shows that Veracel sent out a request for proposals to sell its Tax Attributes for the benefit of its existing shareholders. The Respondent contends that in early 2004 David Tonken and his partner, Greg Matthews, were engaged as advisors to Veracel to market the Tax Attributes.
[8] David Tonken and Greg Matthews were the managing directors of Cavalon Capital Partners Ltd. (“Cavalon”). The Respondent states that Cavalon was in the business of the monetization of tax losses.
[9] David Tonken sought out potential partners in a transaction with Veracel who might be interested in acquiring Veracel’s Tax Attributes. He brokered an initial transaction with Emerging Equities Inc. (“EEI”), which ultimately fell through. David Tonken then contacted Jim Surbey, the vice-president of corporate development and corporate secretary of Birchcliff, to inform him of Veracel’s Tax Attributes and Veracel’s willingness to make the Tax Attributes available to a profitable company.[2]
[10] Birchcliff, the other predecessor corporation in the amalgamation, was a public entity that had entered into an agreement to purchase the Devon Properties. At that time, it was already on a successful path in establishing its oil and gas business. Prior to the amalgamation, Birchcliff had obtained a commitment for financing for the Devon Properties acquisition in the form, inter alia, of the Bridge Loan. Birchcliff did not intend to draw on the Bridge Loan. The plan was to raise equity rather than draw on the Bridge Loan, or to use the proceeds from the equity financing to repay the Bridge Loan if the Devon acquisition was closed prior to completion of the equity financing.
[11] The Respondent reasons that David Tonken was quite familiar with how a loss utilization transaction could be implemented. A direct acquisition by Birchcliff of the issued and outstanding shares of Veracel was not an option as that would trigger an acquisition of control of Veracel. As a result, the Loss Streaming Restrictions would have barred the Appellant from using Veracel’s non‑capital losses by reason of the fact that the Medical Business which gave rise to the losses was not being carried on by the Appellant with a reasonable expectation of profit.
[12] The Respondent also notes that, had Birchcliff and Veracel simply been amalgamated without further tax planning, Veracel would by virtue of the special deeming rule set out in subparagraph 256(7)(b)(iii) of the Act have been deemed to have undergone an acquisition of control prior to the amalgamation.
[13] The Respondent reasons that, to overcome this obstacle, an elaborate tax plan was developed, culminating in Veracel’s amalgamation with Birchcliff. The Respondent observes that the deeming rule in subparagraph 256(7)(b)(iii), which deems control of a particular predecessor corporation to have been acquired on an amalgamation, does not apply if the shareholders of that corporation collectively receive a majority of the voting shares of the amalgamated entity (the “Majority Voting Interest Test”) as consideration for the exchange of their shares in the particular predecessor corporation.[3] According to the Respondent, this is where clever but nonetheless ineffective tax planning came into play. To avoid an acquisition of control of Veracel, the Amalgamation Transactions were implemented in such a way as to allow the Appellant to argue, at least on paper, that Veracel’s shareholders received a majority of the voting shares of the Appellant. To achieve this purpose, the equity financing required by Birchcliff to acquire the Devon Properties was arranged through Veracel with the assistance of Birchcliff’s representatives. The new investors (the “New Investors”) were presented with Birchcliff’s business plan.[4] They invested on the strength of Birchcliff’s business. Pursuant to the tax plan, Veracel rather than Birchcliff issued subscription receipts to the New Investors. These receipts were then exchanged for Class B common shares of Veracel (the “Class B shares”) immediately prior to its amalgamation with Birchcliff. The Class B shares were then exchanged for common shares of the Appellant upon amalgamation. Because the New Investors required assurance that they would own shares in the corporation that carried on the oil and gas business, the Amalgamation Transactions were carried out in sequential order under the terms of a court‑sanctioned plan of arrangement implemented only after all securities approvals and other approvals had been obtained. Under the plan of arrangement, the New Investors became shareholders of Veracel for a fleeting moment.
[14] The Respondent argues vigorously that the Appellant failed to avoid the Loss Streaming Restrictions because the issuance of the Class B shares by Veracel immediately prior to the amalgamation was a sham. In that regard, the Respondent contends that the parties to the Amalgamation Transactions did not intend that the New Investors acquire shareholder rights in Veracel. As a result, the Class B shares must be ignored. On that basis, the amalgamation triggered an acquisition of control of Veracel because the Veracel shareholders did not receive shares representing a Majority Voting Interest in the Appellant.
[15] In the alternative, if the Court concludes that the sham doctrine does not apply such that the Class B shares are found to have been effectively issued, the Respondent argues that an acquisition of control of Veracel nonetheless occurred because the New Investors constituted a “group of persons” that acquired control of Veracel immediately prior to its amalgamation with Birchcliff.
[16] Finally, in the further alternative, the Respondent claims that the GAAR applies to override the Amalgamation Transactions designed to avoid an acquisition of control of Veracel. The GAAR argument was raised only after the Minister confirmed the reassessment.
IV. Appellant’s Position [17] Relying principally on David Tonken and Jim Surbey’s testimony, the Appellant alleges that David Tonken and Greg Matthews were tasked with more than the monetization of Veracel’s Tax Attributes. Their mandate called for the implementation of a so‑called “restart” transaction whereby Veracel would raise new capital for the purpose of pursuing a new business opportunity. Because the capital was raised from a large number of unrelated investors acting independently, Veracel did not undergo an acquisition of control. The underlying suggestion is that it was pure happenstance that Veracel’s plan to restart, which the Appellant claims was developed prior to David Tonken’s first meeting with Birchcliff’s executives, was complementary to Birchcliff’s desire to raise new capital for the Devon Properties acquisition.
[18] With that contextual background in mind, the Appellant argues that the issue by Veracel of the Class B shares to the New Investors cannot be ignored under the sham doctrine. For a sham to exist, there must be deceit. The New Investors intended to become and did become Class B shareholders of Veracel.
[19] Furthermore, the New Investors did not act as a “group of persons” that acquired control of Veracel. The Respondent alleges that they constitute a “group of persons” because they entered into the Subscription Agreement, which endorsed the plan of arrangement and granted a proxy to Jeff Tonken or Jim Surbey to vote all of the subscription receipts or Class B shares in favour of the plan of arrangement. That, according to the Appellant, is not enough to congeal the New Investors into a “group of persons”. The New Investors acted independently in acquiring their shares and granting the proxy.
[20] Finally, the Appellant invoked a number of arguments to rebut the Respondent’s claim that the GAAR applies in support of the Minister’s reassessment.
V. Credibility and Factual Findings [21] There are between David Tonken’s testimony and the documentary evidence relied on by the Respondent significant inconsistencies, which serve to undermine his credibility. The first inconsistency relates to the nature of Cavalon’s business and its participation in the transactions at issue in this appeal. David Tonken contended that tax loss monetization was only a small part of Cavalon’s advisory business. During cross-examination, he was confronted with the contents of a memorandum to the Original Veracel Shareholders written by John Anderson. Mr. Anderson was the former chief financial officer of Veracel. He was hired to act as a consultant to Veracel on the transactions proposed by Mr. Tonken and his partner. Mr. Anderson wrote:
The historical background to the proposed Plan of Arrangement is as follows. The Veracel/XYZ transaction has been arranged by Cavalon Capital Partners Ltd. (“Cavalon”). Cavalon is a private company engaged in the business of the monetization of tax losses through reorganizing public and private companies and has assembled the parties to the proposed transaction and will oversee the transaction. . . .[5]
[Emphasis added.]
[22] Mr. Tonken maintained that the memorandum was inaccurate. Mr. Tonken also testified that Cavalon was an “unrelated party” to the transactions.
[23] However, Mr. Anderson specifically names Cavalon as the party who put together the initial proposed transaction between Veracel and EEI:
Cavalon originally proposed to combine Veracel with oil and gas assets and a management group as way of maximizing value for the Veracel shareholders. . . . Most recently, Cavalon arranged for a transaction with an oil well service company through Emerging Equities Inc. (“EEI”), a transaction that was described in a previous memorandum sent to the Veracel shareholders. . . .
[24] Mr. Tonken’s testimony that Cavalon was not involved is further undermined by a chain of emails between him, Mr. Anderson and Bob Allan[6] which indicates otherwise. In an email to Mr. Allan, David Tonken writes:
Gentlemen:
We are working on a letter of intent with Birchcliff Energy Ltd.
. . .
They are interested in using Veracel as part of a financing they are working on. A draft will be provided likely by Thursday. Birchcliff will cover all reorganization costs and net them against a total value of $1,984,200 for Veracel. Present shareholders will receive 70% and Cavalon will receive 30%, in cash or shares of Birchcliff, as elected by each shareholder.
John, please call me to discuss . . . .
. . .
Regards,
David[7]
[Emphasis added.]
[25] When this email was put to David Tonken, he acknowledged that this is what the email said and made no further observation.[8]
[26] Another inconsistency relates to Veracel’s motivation in undertaking the Amalgamation Transactions. Mr. Tonken’s testimony suggested that Veracel wanted to restart in the oil and gas industry and minimized the importance of monetizing Veracel’s Tax Attributes. He disagreed with the statement that Veracel wished to wind up its affairs and monetize its tax pools. He was then confronted with another letter, from Mr. Anderson to the Canada Revenue Agency appeals officer, Beverley Philipp, from which he again distanced himself. The letter reads, in part, as follows:
. . . My involvement in this transaction was initially to advise the Board of Veracel as to their attempt at monetizing their tax pools. The company was at a point where they wished to wind up their affairs. . . .
. . . They had accumulated tax pools in excess of $30 million and wanted to somehow monetize the value of these pools.[9]
[Emphasis added.]
[27] Mr. Tonken testified that this letter may have reflected Mr. Anderson’s position and beliefs, but it did not coincide with his own view of Veracel’s intention, which was that Veracel wanted to restart in the oil and gas industry. Mr. Tonken’s explanation is inconsistent with Mr. Anderson’s explanation to the appeals officer.
[28] Other documentary evidence demonstrates that the monetization of the Tax Attributes was a more significant motivating factor than suggested by Mr. Tonken.
[29] The evidence shows that David Tonken and Veracel first became acquainted shortly after February 24, 2004 when Mr. Tonken received a Request for Proposal letter[10] written by Veracel, which sought the utilization of Veracel’s tax losses. The request reads as follows:
This is a request for a proposal to utilize the tax losses of Veracel Inc.
. . .
After several years of development work and pre-clinical trials, it was decided by the Shareholders that unless a suitable clinical development partner could be found, the Company would need to suspend operations. . . .
The Company is now dormant; it continues to own its intellectual property, prototype units, and data. The Company files, records, and physical embodiments are in safe storage in a suitably secure facility. The Company has no operations at this point.
Tax losses totaling some $34.8 million including R & D carry-overs, plus $1.9 million Investment Tax credits are available and the Shareholders of the Company want proposals for utilization of these losses.
. . .
The Shareholders will only entertain proposals that are not contingent on utilization of the future losses and involve compensation, which includes an upfront cash component and equity in the transaction.
The current Shareholders are prepared to continue in a role to support an arrangement and transaction that would utilize the losses.
[30] I observe that the request for proposal does not mention any intention on Veracel’s part to “restart”. The letter only states that Veracel is soliciting offers to use its tax pools.
[31] David Tonken wrote an email to Mr. Allan on March 2, 2005[11] in which he stated that Birchcliff was looking for a “loss co” and that this was the role Veracel would play in the transaction:
Dear Bob:
We have another group looking at the Veracel pools. They have bid on a $200 million asset package and want to include a loss co. They are aware of the USA issue and their lawyers at BLG have requested a copy of the most recent executed USA along with the 2001 federal tax return.
We believe we should pursue this opportunity. Would you please call me . . . to discuss.
. . .
David
[Emphasis added.]
[32] When this email was put to David Tonken in cross-examination, he confirmed that the pools referred to tax pools, that the group was Birchcliff and that the “loss co” was Veracel.
[33] As alluded to above in the statement of the Respondent’s position, a deal had initially been arranged between EEI and Veracel, which ultimately failed. Mr. Tonken similarly understated the importance of the Tax Attributes to the EEI transaction. Mr. Tonken testified that EEI had financing problems and that the deal failed because EEI could not raise a deposit. Notably, however, the memorandum from Mr. Anderson to the Original Veracel Shareholders dated March 29, 2005[12] states that the EEI transaction failed due to issues with Veracel’s Tax Attributes:
. . . Most recently, Cavalon arranged for a transaction with an oil well service company through Emerging Equities Inc. (“EEI”), a transaction that was described in a previous memorandum sent to the Veracel shareholders. Cavalon fully disclosed to EEI the issues relating to the Veracel tax pools and the financial risks relating to the tax pools were reflected in the terms of the proposed transaction. Nevertheless, the EEI transaction did not proceed because the professionals reviewing the tax pools on behalf of the oil well service company advised that the issues relating to the tax pools could not be resolved in sufficient time to complete the transaction. . . . As well, Cavalon has expended considerable time and effort in examining and clarifying the issues relating to Veracel’s tax pools.
Cavalon is confident that the XYZ transaction can be completed notwithstanding the difficulties associated with Veracel’s tax pools and its corporate structure.
[Emphasis added.]
[34] When this letter was put to David Tonken in cross-examination, he denied that the EEI transaction failed due to problems with the Tax Attributes and maintained that it failed due to financing issues. He was unable to point to any documentary evidence that the deal failed due to financing problems. He did, however, admit that questions and issues relating to Veracel’s Tax Attributes were raised in the deal with Birchcliff, namely, the existence of backup records establishing the expenditures and the possible tax effects of the Unanimous Shareholders Agreement among the Original Veracel Shareholders.
[35] After the failed EEI transaction, David Tonken went back to the drawing board to try to broker another transaction. He ultimately began discussions with Birchcliff. The discussions led to Veracel and Birchcliff signing a letter agreement on April 1, 2005[13] which set out their agreement with respect to the reorganization of Veracel and its amalgamation with Birchcliff. In the letter agreement, Veracel undertook to use all commercially reasonable efforts to raise new equity financing. The equity financing would be done by issuing subscription receipts which would be exchangeable for Class B shares of Veracel, which would then be exchanged for Amalco common shares. The Amalco preferred shares, on the other hand, would be redeemable for cash upon the closing of the plan of arrangement, up to a maximum of $1.5 million. The Original Veracel Shareholders could opt for these preferred shares if they did not want to follow Birchcliff into the oil and gas industry. The evidence shows that all but three Original Veracel Shareholders pursued this option,[14] which calls into question Mr. Tonken’s testimony that the transactions with Birchcliff were intended to be a “restart”.
[36] On April 14, 2005, Veracel entered into an underwriting agreement[15] with the Underwriters who were engaged to raise money through 26,000,000 subscription receipts at the price of $4 per rec