2530-1284 Québec Inc. c. La Reine

2530-1284 Québec Inc. c. La Reine
Court (s) Database
Tax Court of Canada Judgments
Date
2007-05-23
Neutral citation
2007 TCC 286
File numbers
96-1457(IT)G
Judges and Taxing Officers
Gerald J. Rip
Subjects
Income Tax Act
Decision Content
Docket: 96-1457(IT)G
BETWEEN:
2530-1284 QUÉBEC INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
_______________________________________________________________
Appeal heard on common evidence with the appeals of
Ralph E. Faraggi (96-1458(IT)G), Robert Langlois (96-1459(IT)G) and 2529-1915 Québec Inc. (96-1460(IT)G) on
January 16, 17, 18 and 19, 2006 and January 23 and 24, 2006
at Montreal, Quebec.
Before: The Honourable Associate Chief Justice Gerald J. Rip
Appearances:
Counsel for the Appellants:
Bertrand Leduc
Lysane Tougas
Counsel for the Respondent:
Daniel Marecki
Christina Ham
____________________________________________________________________
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1987 taxation year is dismissed.
There will be one set of costs in favour of the respondent.
Signed at Ottawa, Canada, this 23rd day of May 2007.
"Gerald J. Rip"
Rip A.C.J.
Translation certified true
on this 31st day of July 2007.
Erich Klein, Revisor
Docket: 96-1458(IT)G
BETWEEN:
RALPH E. FARAGGI,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
____________________________________________________________________
Appeals heard on common evidence with the appeals of
2530-1284 Québec Inc. (96-1457(IT)G), Robert Langlois (96-1459(IT)G) and 2529-1915 Québec Inc. (96-1460(IT)G) on
January 16, 17, 18 and 19, 2006 and January 23 and 24, 2006
at Montreal, Quebec.
Before: The Honourable Associate Chief Justice Gerald J. Rip
Appearances:
Counsel for the Appellants:
Bertrand Leduc
Lysane Tougas
Counsel for the Respondent:
Daniel Marecki
Christina Ham
____________________________________________________________________
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1987 and 1988 taxation years are dismissed.
There will be one set of costs in favour of the respondent.
Signed at Ottawa, Canada, this 23rd day of May 2007.
"Gerald J. Rip"
Rip A.C.J.
Translation certified true
on this 31st day of July 2007.
Erich Klein, Revisor
Docket: 96-1459(IT)G
BETWEEN:
ROBERT LANGLOIS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
____________________________________________________________________
Appeals heard on common evidence with the appeals of
2530-1284 Québec Inc. (96-1457(IT)G), Ralph E. Faraggi (96-1458(IT)G) and 2529-1915 Québec Inc. (96-1460(IT)G) on January 16, 17, 18 and 19, 2006 and January 23 and 24, 2006 at Montreal, Quebec.
Before: The Honourable Associate Chief Justice Gerald J. Rip
Appearances:
Counsel for the Appellants:
Bertrand Leduc
Lysane Tougas
Counsel for the Respondent:
Daniel Marecki
Christina Ham
____________________________________________________________________
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1987 and 1988 taxation years are dismissed.
There will be one set of costs in favour of the respondent.
Signed at Ottawa, Canada, this 23rd day of May 2007.
"Gerald J. Rip"
Rip A.C.J.
Translation certified true
on this 31st day of July 2007.
Erich Klein, Revisor
Docket: 96-1460(IT)G
BETWEEN:
2529-1915 QUÉBEC INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
____________________________________________________________________
Appeal heard on common evidence with the appeals of
2530-1284 Québec Inc. (96-1457(IT)G), Ralph E. Faraggi (96-1458(IT)G and Robert Langlois (96-1459(IT)G) on January 16, 17, 18 and 19, 2006
and January 23 and 24, 2006 at Montreal, Quebec.
Before: The Honourable Associate Chief Justice Gerald J. Rip
Appearances:
Counsel for the Appellants:
Bertrand Leduc
Lysane Tougas
Counsel for the Respondent:
Daniel Marecki
Christina Ham
____________________________________________________________________
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1987 taxation year is dismissed.
There will be one set of costs in favour of the respondent.
Signed at Ottawa, Canada, this 23rd day of May 2007.
"Gerald J. Rip"
Rip A.C.J.
Translation certified true
on this 31st day of July 2007.
Erich Klein, Revisor
Citation: 2007TCC286
Date: 20070523
Docket: 96-1458(IT)G
BETWEEN:
RALPH E. FARAGGI,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
and
Docket: 96-1459(IT)G
ROBERT LANGLOIS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
and
Docket: 96-1460(IT)G,
2529-1915 QUÉBEC INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
and
Docket: 96-1457(IT)G
2530-1284 QUÉBEC INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Rip A.C.J.
Introduction
[1] In 1987 Mr. Robert Langlois and Mr. Ralph Faraggi, lawyers in the Montreal law firm of Stikeman Elliott, formulated and promoted plans to create capital dividend accounts ("CDA" or "CDAs") in several corporations for "sale" or "transfer" to arm’s length third party corporations for a profit. Mr. Langlois was a tax lawyer at the firm; Mr. Faraggi was a corporate lawyer. Together they applied their knowledge in preparing the plans and putting them into effect.
[2] The plan contemplated using newly formed corporations with nominal assets to subscribe for shares in other newly formed corporations and then create CDA through a combination of share subscriptions, redemption of shares, capital gains by sale of shares and purported elections under subsection 83(2) of the Income Tax Act ("Act"), among other things. Then, through another sequence of share subscriptions and share redemptions, third parties at arm's length to the appellants would receive capital dividends.
[3] In short, after the "creation" of capital gains several corporations would make elections under subsection 83(2) of the Act and declare tax-free dividends on classes of preferred shares. Near the end of the exercise the aggregate CDAs of these corporations would find their way to an appellant corporation. A third-party corporation would subscribe for shares in an appellant corporation. These shares would have a nominal par value, say $0.01 per share, and a high redemption amount, say $1,000 per share. The third-party corporation would pay $1,210 per share and an appellant corporation would redeem the share for $1,000, electing under subsection 83(2) of the Act that the deemed dividend of $999.99 (subsection 84(1) of the Act) be paid out of the appellant company's capital dividend account. The third-party corporation would then have a capital dividend account and pay its shareholders, after making its own subsection 83(2) election, $1,000 tax-free. Before the transaction, the third-party corporation had no amount in a capital dividend account and could only pay its shareholders a taxable dividend of $1,210; the tax rate in Quebec for individual shareholders was 41.87 per cent. After the transaction the shareholders received $1,000 tax-free; the third-party corporation effectively paid $210 for the tax-free $1,000 dividend. The effective cost to the third-party corporation and its shareholders for the $1,000 dividend was 21 per cent, an economic saving of 20.87 per cent.
[4] Mr. Langlois and Mr. Faraggi are appealing their income tax assessments for 1987 and 1988 and corporations 2530-1284 Québec Inc. ("1284 Inc.") and 2529‑1915 Québec Inc. ("1915 Inc.") are appealing assessments for 1987.
[5] The Minister of National Revenue ("Minister") assessed 1284 Inc. and 1915 Inc. on the basis that they earned a profit of $4,677,717 and $8,105,344, respectively, in their 1987 taxation years from carrying on businesses or ventures in the nature of trade, that is, selling fictitious CDA to third parties. The profits (the $210 in the example described in paragraph 3) were included in the corporate appellants’ respective incomes for 1987 as business income in accordance with section 3 and subsection 9(1) of the Act. The corporate appellants, the respondent adds, did not and could not receive capital dividends from the corporations they allege paid them such dividends because the corporations did not realize any capital gains nor did they receive any dividends out of another corporation’s capital dividend account. Any capital gains, and any elections made pursuant to subsection 83(2) of the Act, by any of the corporations in these transactions were fictitious and shams, says the respondent.
[6] With respect to the appellants Mr. Langlois and Mr. Faraggi, the Minister assessed on the basis that each received taxable dividends of $8,114,350 in 1987 and $155,912 in 1988 notwithstanding that the paying corporations purported to elect under subsection 83(2) of the Act that the dividends were to be paid out of their respective CDA. The respondent claims that the paying corporations never realized capital gains nor had they received dividends out of the CDA of other corporations; the paying corporations did not have CDA from which they could pay tax-free dividends to shareholders. Any such purported capital gains or dividends from CDA received from other corporations were fictitious and shams. The individual appellants received taxable dividends, not tax-free dividends, according to the respondent.
[7] The Minister also assessed the appellants penalties by virtue of subsection 163(2) of the Act, alleging that each appellant was part of a vast fraud led by persons who were reckless and grossly negligent such that each appellant knowingly or under circumstances amounting to gross negligence made false statements in returns, forms, certificates and statements filed or made in respect of the 1987 taxation year (and 1988 with respect to the individual appellants) by camouflaging the origin of the CDAs. Mr. Langlois and Mr. Faraggi omitted to declare the taxable dividends of $8,114,350 and $155,912 received in 1987 and 1988, respectively, and are each liable to penalties pursuant to subsection 163(2) of the Act of $304,147 for 1987 and $10,564 for 1988. Appellants 1284 Inc. and 1915 Inc. omitted to declare business income for 1987 of $4,677,717 and $8,105,344, respectively, and are liable to penalties pursuant to subsection 163(2) of the Act of $421,579 and $763,316, respectively.
[8] The corporate appellants claim they did not carry on any business and the capital gains reported were real, were determined in accordance with the provisions of the Act. Valid elections were made, also in accordance with the Act, in particular subsection 83(2). There was no sham.
[9] The individual appellants say that the corporations who paid them dividends had bona fide capital gains and made proper elections under subsection 83(2) of the Act: the dividends they received in 1987 and 1988 from the corporations were dividends paid out of valid CDAs of these corporations.
[10] The appeals were heard on common evidence.
The Deeds
[11] The corporations participated in two series of transactions, one on August 13, 1987 ("Series 1") and one other ("Series 2"), which was carried out in two phases in September. All corporations in these transactions were incorporated under Part 1A of the Quebec Companies Act.[1] The Companies Act permitted corporations to have par value shares; par value shares apparently were necessary for the proposed transactions to take place in the way they did. Also, the Quebec legislation permitted a corporation to issue shares without immediate payment by the subscribing shareholder.[2] The authorized capital of the corporations in each series of transactions consisted of an unlimited number of common shares without par value and twelve classes of an unlimited number of non-voting preferred shares, classes "A" to "L", inclusive, each preferred share usually having a par value of $0.01 and redeemable, depending on the class of preferred share, for $100.01 or $1,000.01 each, subject to adjustment. Dividends on the preferred shares could not exceed a fixed amount. The classes of preferred shares were identical except that they ranked in alphabetical order concerning dividends and return of capital on liquidation or dissolution. Class "A" shares, for example, had priority over Class "B" shares which had priority over Class "C" shares and so on. At the beginning of the series of transactions the companies had no assets, except for nominal amounts paid by shareholders upon subscribing for common shares. Only after the corporate appellants had dealt with the third party corporations did they have any appreciable assets, the money being assessed as profits from a business.
[12] The corporations were organized: common shares were issued, directors were elected, the usual by-laws were adopted. Mr. Langlois and Mr. Faraggi were directors of all of the companies.
[13] The corporations participating in the first series and Phase 2 of the second series[3] were:
Letter
Corporate name
Designation
Appellant
2529-1915 Québec Inc.
1915 Inc.
A Inc.
2528-5644 Québec Inc.
2528 Inc.
B Inc.
2529-0099 Québec Inc.
0099 Inc.
C Inc.
2529-0107 Québec Inc.
0107 Inc.
D Inc.
2529-0115 Québec Inc.
0115 Inc.
E Inc.
2529-0123 Québec Inc.
0123 Inc.
F Inc.
2529-0131 Québec Inc.
0131 Inc.
G Inc.
2529-0149 Québec Inc.
0149 Inc.
H Inc.
2529-0156 Québec Inc.
0156 Inc.
I Inc.
2529-0164 Québec Inc.
0164 Inc.
J Inc.
2529-0172 Québec Inc.
0172 Inc.
K Inc.
2529-0180 Québec Inc.
0180 Inc.
L Inc.
2529-0198 Québec Inc.
0198 Inc.
M Inc.
2529-0206 Québec Inc.
0206 Inc.
[14] The corporations in the first phase of Series 2[4] were:
Letter
Corporate name
Designation
Appellant
2530-1284 Québec Inc.
1284 Inc.
N Inc.
2530-1276 Québec Inc.
1276 Inc.
O Inc.
2530-1292 Québec Inc.
1292 Inc.
P Inc.
2530-1300 Québec Inc.
1300 Inc.
Q Inc.
2530-1318 Québec Inc.
1318 Inc.
R Inc.
2530-1326 Québec Inc.
1326 Inc.
S Inc.
2530-1334 Québec Inc.
1334 Inc.
T Inc.
2530-1342 Québec Inc.
1342 Inc.
U Inc.
2530-1359 Québec Inc.
1359 Inc.
V Inc.
2530-1367 Québec Inc.
1367 Inc.
W Inc.
2530-1375 Québec Inc.
1375 Inc.
X Inc.
2530-1383 Québec Inc.
1383 Inc.
Y Inc.
2530-1391 Québec Inc.
1391 Inc.
Z Inc.
2530-1409 Québec Inc.
1409 Inc.
[15] Mr. Langlois and Mr. Faraggi and 2411-4340 Québec Inc. ("4340 Inc.")[5] each held one-third of the common shares of 0206 Inc. and 1915 Inc. 1276 Inc. was the sole common shareholder of 1300 Inc., 1318 Inc., 1326 Inc., 1334 Inc., 1342 Inc., 1359 Inc., 1367 Inc., 1375 Inc., 1383 Inc., 1391 Inc., and 1409 Inc. Mr. Langlois and Mr. Faraggi were the common shareholders of the other corporations.
Series 1
[16] In the first series of transactions there was a chain or group of 13 corporations, each owning a class of preferred shares of the corporation immediately below it in a direct vertical line. 2528 Inc. was at the head of the chain. Transactions between these corporations were intended to create capital gains and deemed dividends. The corporations purported to make elections under subsection 83(2) of the Act that the deemed dividends be paid out of CDA. The appellants state that dividends were paid or were deemed by the Act to be paid up the chain of corporations until the aggregate of dividends, all out of CDAs, reached 2528 Inc. In turn, 2528 Inc., paid a dividend out of its capital dividend account, being the aggregate of all the other corporations’ CDAs, to 1915 Inc. 1915 Inc. then "sold" to third parties the bulk of amounts of CDA it received from 2528 Inc. The following is an abridged step-by-step description of the transactions the appellants say took place in August:[6]
The initial transactions took place in a conference room at the Place Ville-Marie branch of the Royal Bank of Canada on August 13. Before the transactions in Series 1 started, Messrs. Langlois and Faraggi had obtained an overdraft of $10,000,100 from the Royal Bank.[7] They paid for their common shares in 1915 Inc., for example, with their own funds and loaned money to some other corporations to permit them to subscribe for common shares.
a) A Inc. issued a certified cheque in the amount of $10,000,100 drawn on its account at the Royal Bank to subscribe for 10,000 Class "L" shares of B Inc. B Inc. deposited the $10,000,100 in its bank account. B Inc. then declared a stock dividend of 10,000 Class "K" shares on its Class "L" shares to A Inc.
b) B Inc. issued a certified cheque in the amount of $10,000,100 drawn on its account at the Royal Bank to subscribe for 10,000 Class "L" shares of C Inc. C Inc. deposited the $10,000,100 in its bank account.
c) C Inc. issued a certified cheque in the amount of $10,000,100 drawn on its account at the Royal Bank to subscribe for 10,000 Class "L" shares of D Inc.
d) C Inc. declared a stock dividend of 10,000 Class "K" shares on its Class "L" shares to B Inc. The adjusted cost base of each Class "L" share was $0.01: subsection 52(3) of the Act. The stock dividend was valued at $10,000,000.
e) B Inc. sold the Class "K" shares to A Inc. for a consideration of $10,000,000; the consideration paid for the purchase was a non‑interest-bearing $10,000,000 promissory note payable on demand. Thus, B Inc. purported to make a capital gain of $9,999,900.[8]
The appellants’ files at Revenue Canada were eventually reviewed by Mr. Michel Dupuis, an auditor with Revenue Canada and its successor, the Canada Revenue Agency. Mr. Dupuis testified that when A Inc. issued promissory notes aggregating $110,000,000 for the Class "K" shares, it had cash assets of $100 only.
f) Similarly, each of C Inc., D Inc., E Inc., F Inc., G Inc., H Inc., I Inc., J Inc., K Inc., and L Inc. issued a certified cheque in the amount of $10,000,100 drawn on its account at the Royal Bank to subscribe for 10,000 Class "L" shares of corporations D Inc. to M Inc. respectively, followed by a stock dividend of 10,000 "K" shares on each corporation’s Class "L" shares (the owners being C Inc. to L Inc.). All the Class "K" shares were then allegedly sold to A Inc. for a consideration of $10,000,000 in each case, payable by a promissory note, for a total of $110,000,000. Each of B Inc. to L Inc. claimed a capital gain of $9,999,900, or $109,998,900 for the eleven corporations. The aggregate taxable capital gains of B Inc. to L Inc. on the alleged sales of the Class "K" shares were $54,999,450, which is also the aggregate amount of the purported CDA of these corporations.
g) M Inc. paid a cash dividend of $10,000,000 on the Class "K" shares to its shareholder A Inc. which used this money to reimburse the Royal Bank.
h) Corporations B Inc. to L Inc. amended their articles of incorporation ("statuts de constitution") increasing the par value of each of their Class "K" shares from $0,01 to $500. The increase in par value of the shares allegedly triggered deemed dividends to the holder of the Class "K" shares, A Inc., of $54,998,900[9] or $4,999,900 from each corporation: subsection 84(1) of the Act.
i) Each of C Inc. to M Inc. purported to elect pursuant to subsection 83(2) of the Act that the deemed dividend of $4,999,900 on the increase in the par value of the Class "K" shares be paid out of its CDA. A Inc. received dividends of $54,998,900, purportedly out of the CDA.
j) On or about September 14, in order to offset the taxable capital gains, the following transactions were performed to create capital losses in the corporations B Inc. to L Inc. (i) B Inc. sold its 10,000 Class "L" shares that it owned in C Inc. to Mr. Faraggi for a consideration of $100. Since the cost base of these shares was $10,000,100, there was a purported capital loss of $10,000,000, $5,000,000 of which was an allowable capital loss. The allowable capital loss offset the taxable capital gain of $5,000,000 that B Inc. realized when it sold the Class "K" shares. (ii) Sales of Class "L" shares owned by corporations C Inc. to L Inc. in corporation D Inc. to M Inc. similarly took place one after the other to reduce their earlier capital gains to nil.
k) On August 20, 1987, 1915 Inc. borrowed $23,216.61 from its three shareholders and on or about August 21, 1915 Inc. subscribed for 495,660 Class "L" shares of A Inc. for $55,023,216, paid as to $23,216.61 by cheque and the balance by an interest-bearing demand note.[10]
l) The directors of A Inc. declared a dividend of $49,566,000 to be paid to the owner of the Class "L" shares, 1915 Inc., and filed an election pursuant to subsection 83(2) of the Act that the dividend of $49,566,000 be paid out of its CDA.[11]
m) In August and September 1915 Inc. and A Inc. paid dividends to each of Mr. Langlois and Mr. Faraggi; the dates, amounts and shares on which the dividends were paid are as set out in Appendix 3 to these reasons. (Notwithstanding that elections were made under subsection 83(2) of the Act, the respondent says these are taxable dividends.)
n) (i) Later, in August and September, 1915 Inc. transacted with several arm’s length corporations which had a substantial surplus that could only be paid out to their shareholders as taxable dividends. To avoid the burden of distributing taxable dividends, these corporations subscribed for different classes of preferred shares of 1915 Inc. which were redeemed in a similar manner to that described in paragraph 3 of these reasons.
(ii) The subscription prices varied not only for the class of shares subscribed for but even for the price of the same class of preferred shares. For example, on September 4, 1987 Mr. Langlois and Mr. Faraggi each purchased 64 Class "I" shares of 1915 Inc. for $1.00 each. Their assistants at Stikeman Elliott also purchased Class "I" shares for $1.00 each. However, on the same day a corporation at arm’s length to the appellants subscribed for 10,400 Class "I" shares of 1915 Inc. for $11,585,845.75.
(iii) During August, September and November 1987 and on December 30, 1988 Mr. Langlois and Mr. Faraggi received dividends aggregating $8,114,350 in 1987 and $155,912 in 1988 from 1915 Inc, 5644 Inc., 1292 Inc. and 1276 Inc. On September 4, 1987, the day Mr. Langlois and Mr. Faraggi each subscribed for 64 Class "I" shares of 1915 Inc. for $64, the directors of 1915 Inc. declared and paid a dividend of $1,000 on each Class "I" share, electing under subsection 83(2) of the Act.[12] Other companies also paid dividends on common shares.
[17] Thus, shareholders of the arm’s length corporations purportedly received dividends tax-free instead of receiving taxable dividends. The difference between the cost of a share, say $1,210, and the redemption amount, say $1,000, that is, $210, aggregated $8,105,344, with adjustments, in respect of all of the shares so issued and redeemed. According to the respondent, the $8,105,344 was business income to 1915 Inc. and was available for 1915 Inc. to distribute to its shareholders or retain for other purposes.[13]
[18] Mr. Faraggi described the transactions in Series 1, once step a) at paragraph 16, took place:
[TRANSLATION]
. . . So the first transaction was the subscription by 5644, 2528-5644, which subscribed for ten thousand (10,000) Class L shares, I think, in 0099. And then, the cheque was written and it may have been the bank that prepared the cheque or maybe I did. In any case, I signed the cheque and they went, the runners who were in the room, they left, they went to the counter; they had the cheque for $10,000,000 certified. They . . . I don't recall whether they came back to show us the cheque; actually they did come back to show us the cheque. We saw only the certified cheque; the deposit slip was prepared for 099. Then they left with it. So at that point we had 2528 which had subscribed for the shares in 0099, and so there was no doubt a resolution of 2528 authorizing it to subscribe for ten thousand (10,000) shares in 0099. That resolution was signed and it was put aside. 2529 0099 received a subscription letter, a subscription letter from 5644 for ten thousand (10,000) Class L preferred shares of 0099. The resolution was signed for the subscription for the shares and 2528 presented this letter to 099. At that point, the deposit, we had the cheque from 2528, which was now certified. The deposit was prepared and they left to make the deposit. The resolution of 0099 authorizing the issue of ten thousand (10,000) Class L preferred shares of 0099 was signed. Then, as far as I can remember, 099 subscribed for ten thousand (10,000) Class L preferred shares of 0107. So a cheque of 0099 payable to the order of 2529 0107 Québec Inc. was written. The cheque . . . the runner left, had the cheque certified and came back. We had the certified cheque, we saw that the cheque was certified. The deposit was prepared. Oh, in the meantime . . . it must be said that we waited to see, we made sure the deposit had returned to 0099. We saw that the deposit — the sum of $10,000,000 had been deposited — had been stamped by the bank. “Fine, the money is there.” We moved on to the next subscription and so on for about an hour and a half, the time it took to carry out all the transactions.
Q. Yes.
A. And then, well, perhaps I should go into a bit more detail in order to . . . because then there was the subscription in 0099, by 0099 for the shares of 107 and then 0107 declared a dividend of Class K preferred shares in favour of 0099. And then, there was a sale of these ten thousand (10,000) Class K preferred shares, a sale by 0099 to 2528-5644, of the 10,000 Class K preferred shares that 0099 had received, after a dividend was declared by 0107. And this sale was for a consideration of $10,000,000. And so on from 0107 to 0115 to 0123 to 0131, 0142, 0156, etc. up to 0 . . .
Q. 206.
R. Up to 0206, but 0206 did not sell any shares; it did not have a capital gain.
Q. No, but the chain stopped . . .
R. Yes.
Q. . . . at 0206?
R. At 0206, yes.
Q. O.K.
Series 2
[19] In phase 1 of Series 2, N Inc. created CDAs with companies P Inc. to Z Inc. In Series 2, phase 2, P Inc. was used to create capital dividend accounts with companies B Inc. to L Inc. The following is a condensed version of the transactions in phases 1 and 2 of Series 2 that the appellants say took place on September 9, 1987 and some days later.
The Series 1 transactions put the individual appellants in a cash position. On September 9, Mr. Langlois and Mr. Faraggi deposited sums of $3,239,500 and $2,650,500, respectively, in their personal bank accounts at the main Montreal branch of the Canadian Imperial Bank of Commerce and on the same day loaned these amounts to 1276 Inc.; the sum of $5,890,200 was deposited in the bank account of 1276 Inc. at the Royal Bank purportedly on September 9 after 3 p.m., and was used to fund the transactions in Series 2. Bank accounts were opened by the particular companies on September 9, also, the appellants say, after 3 p.m.[14]
Phase 1
a) N Inc. subscribed for 5,890 Class "L" shares of Z Inc. for a consideration of $5,890,200. This money was deposited in Z Inc.’s bank account.
b) Z Inc. paid a stock dividend of $5,890,000 by issuing 5,890 Class "K" shares on the Class "L" shares that N Inc. owned. The Class "K" shares had a paid‑up capital of $0.01 per share, but a fair market value of $5,890,200.
c) N Inc. sold the 5,890 Class "K" shares of Z Inc. to P Inc. for $5,890,200. P Inc. paid for Z Inc.’s Class "K" shares by issuing 5,890 Class "L" shares, which purportedly had a value of $5,890,200. N Inc. became the owner of 5,890 Class "L" shares of P Inc. and P Inc. became the owner of 5,890 Class "K" shares of Z Inc. This sale purported to create a capital gain of $5,889,941.10 for N Inc., which gave rise to a taxable capital gain of $2,944,970.55 for N Inc.
d) P Inc. paid a stock dividend of 5,890 Class "K" shares having a purported value of $5,890,000 to the owner of its 5,890 Class "L" shares, that is, to N Inc.
e) N Inc. sold the 5,890 Class "K" shares of P Inc. to Q Inc. for $5,890,000. The latter paid for these Class "K" shares by issuing 5,890 Class "L" shares (of Q Inc.), which again gave rise to a capital gain of $5,889,941.10 for N Inc.
f) N Inc. and each of Q Inc. to Y Inc. entered into transactions in the same manner as above, thus giving rise to purported aggregate capital gains to N Inc. in the amount of $58,899,411. N Inc.’s taxable capital gain and amount available for its capital dividend account was $29,449,705.50.
g) Z Inc. paid a stock dividend of $5,890,000, issuing 5,890 Class "J" shares on its 5,890 Class "K" shares that P Inc. owned. The Class "J" shares had a paid‑up capital of $0.01 and a purported fair market value of $5,890,200.
h) P Inc. sold to L Inc. the 5,890 Class "J" shares of Z Inc. for $5,890,200 and received in return 5,890 Class "J" shares in L Inc. This sale purported to create a capital gain of $5,890,200 for P Inc.
i) L Inc. paid a stock dividend of $5,890,000 to the holder of its Class "J" shares by the issuance of 5,890 Class "I" shares to P Inc.; the paid‑up capital of each Class "I" share was $0.01 and all of the Class "I" shares so issued had a purported fair market value of $5,890,000.
j) P Inc. then sold the 5,890 Class "I" shares of L Inc. to K Inc. in consideration of 5,890 Class "J" shares of K Inc. This transaction purported to create a capital gain of $ 5,890,200.
k) K Inc. declared a stock dividend of $5,890,000 on the 5,890 Class "J" shares owned by P Inc., issuing 5,890 Class "I" shares to P Inc.
l) Each of J Inc., I Inc., H Inc., G Inc., F Inc., E Inc., D Inc., C Inc., and B Inc. paid in order a stock dividend of $5,890,000 to the holder of its Class "J" shares by issuing 5,890 Class "I" shares to P Inc., the holder of the Class "J" shares of all these companies. P Inc. sold its Class "I" shares to the next company in the chain in return for Class "J" shares, as in j) above. Each of these sales purported to create a capital gain of $5,890,200 for the vendor corporation, P Inc.; P Inc.'s aggregate capital gain was $64,789,352.10. The alleged aggregate taxable capital gain for P Inc. was $32,394,676.05.
Phase 2
The following took place on September 9 and later:
m) O Inc. subscribed for 29,173 Class "L" shares of N Inc. for $29,468,000, payable by a demand promissory note.
n) O Inc. subscribed for 32,070 Class "J" shares of P Inc. for $32,295,000, payable by a demand promissory note.
o) Payment for substantially all of the amounts represented by the promissory notes, plus interest, was demanded on September 12 and on the same day N Inc. declared cash dividends of $29,173,000 on its Class "L" shares and of $32,070,000 on its Class "I" shares, which compensated for the payment of the demand notes.
p) N Inc. filed forms of election, pursuant to subsection 83(2) of the Act, with respect to the dividends of $29,173,000 and $32,070,000. O Inc. purportedly received dividends of $61,243,000 from the CDA of N Inc.
q) On September 13, 1284 Inc. subscribed for 45,125 Class "L" shares of O Inc. for $50,820,451.25; payment was made by a demand promissory note.
r) Also on September 13, 1915 Inc. subscribed for 9,806 Class "L" shares of O Inc. for $11,043,664.16, and payment was made by a demand promissory note.
s) On September 14, O Inc. demanded payment from 1284 Inc. of $1,000 per Class "L" share subscribed, that is, $45,125,000 and demanded payment from 1915 Inc. of $9,806,000. At the same time, N Inc. demanded payment from 1284 Inc. of the amount of $45,133,354.08, plus interest, due to it under the demand note signed by 1284 Inc. and payment from 1915 Inc. of the amount of $9,807,815.40, plus interest, due to it under the demand note signed by 1915 Inc.
t) Also on September 14, O Inc. purported to declare a cash dividend of $54,931,000 to holders of its Class "L" shares, which amount was paid to 1284 Inc. as to $45,125,000 and to 1915 Inc. as to $9,806,000.[15] Forms of election pursuant to subsection 83(2) of the Act were filed with Revenue Canada.
u) On or about September 24, N Inc. sold to Mr. Faraggi 5,890 Class "L" shares in each of P Inc., Q Inc., R Inc., S Inc., T Inc., U Inc., V Inc., W Inc., X Inc., Y Inc. and Z Inc. it had previously acquired for $600, attempting to trigger a capital loss for N Inc. of $58,899,400. On the same day, P Inc. sold to Mr. Faraggi 5,890 Class "K" shares in C Inc., D Inc., E Inc., F Inc., G Inc., H Inc., I Inc., J Inc., K Inc., L Inc. and M Inc. for $660, attempting to trigger a capital loss of $64,789,340 for P Inc.
[20] Each of 1915 Inc. and 1284 Inc. transacted with corporations with which it dealt at arm's length to "sell" or "transfer" capital dividends in a manner similar to that described in paragraph 3 of these reasons.[16] The Minister treated the difference between the amounts the third party corporations paid for shares and the amounts they received on redemption of the shares as profits from a business to 1915 Inc. and 1284 Inc. in 1987. The amounts so assessed were $8,105,344 to 1915 Inc. and $4,677,717 to 1284 Inc. The various transactions between 1915 Inc. and 1284 Inc. whereby they issued shares to arm's length parties and then redeemed the shares are listed in Appendices 1 and 2, respectively, to these reasons.
The Plans
[21] The event giving rise to the series of transactions under review appears to have been a transaction observed by Mr. Langlois at the Stikeman Elliott offices in January 1987. A non‑resident-controlled Canadian corporation which had substantial capital gains "transferred" its capital dividend account to a Canadian-controlled corporation. When Mr. Langlois reviewed the transaction later that evening in January with Mr. Faraggi he was enthralled at the prospect of a similar transaction possibly being structured for the advantage of other clients of the firm.
[22] By July Mr. Langlois had prepared a "blue print" setting out a scheme whereby capital gains could be created in corporate entities and then capital dividends be transferred from one corporation to another. Mr. Langlois anticipated that he and Mr. Faraggi might each make about $200,000 from such a scheme. Mr. Langlois and Mr. Faraggi had been approached by Messrs. Brian McDougall and Tom Sawyer, who indicated they knew persons who would be interested in acquiring CDAs. A corporation apparently controlled by Messrs. McDougall and Sawyer was allotted one‑third of the common shares of 1915 Inc. to permit them to participate in any profits resulting from the proposed transactions. Third party corporations that "acquired" CDA would be clients or friends of Mr. Langlois and Mr. Faraggi or persons who were referred directly or indirectly by Messrs. McDougall and Sawyer. Messrs. McDougall and Sawyer contacted a brokerage firm which was quite interested in the project.
The Banks
[23] After discussions with interested parties, Mr. Langlois and Mr. Faraggi planned to transfer $50,000,000 of CDA to third party corporations. They anticipated that they would require a bank loan of $10,000,000 to get things started.
[24] At the end of July or in early August, Mr. Faraggi approached his account manager at the main Montreal branch of the Canadian Imperial Bank of Commerce ("CIBC") for a "daylight" loan[17] of $10,000,000. The CIBC was Stikeman Elliott's bank and the bank was a client of the firm; most, if not all, lawyers at the firm did work for the bank, according to Mr. Faraggi.
[25] As soon as the loan request was made, the CIBC officials apparently got in touch with Stikeman Elliott's managing partner at the time, Mr. James Grant, and informed him of the loan request. According to Mr. Faraggi, the bank asked Mr. Grant to support the loan. He refused to commit to the loan and the CIBC did not pursue the matter with Mr. Faraggi; the loan request was effectively rejected.
[26] Mr. Langlois then approached Richard Légaré, who was then executive director at the Place Ville-Marie branch of the Royal Bank of Canada, for a loan of $10,000,000. Mr. Légaré referred Mr. Langlois and Mr. Faraggi to Alain Lapointe who, in August 1987, was commercial loan account manager at the Place Ville-Marie branch.
[27] Mr. Lapointe met with Mr. Langlois and Mr. Faraggi, who explained their plans. They wanted to issue a cheque for $10,000,000 from an account with no balance and deposit the money in another account and then repeat the process several times until the $10,000,000 was eventually deposited back in the original account. Mr. Lapointe described the origin of the $10,000,000 as he understood it:
[TRANSLATION]
A. It came . . . let me explain it to you. Let’s say we have three accounts: A, B, C, and a cheque for 10 million is drawn and deposited in account B, a cheque for 10 million is drawn on account B and deposited in account C, and a cheque is drawn on account C that is deposited in account A. So, to cover the original cheque that was issued from account A, there is a deposit of 10 million that comes from account C. So . . .
Q. Yes, but what about the first cheque?
A. Yes.
Q. The very first one, because as I understand it, it's a cascade. But the very first, does the first cheque for 10 million exist?
A. Yes.
Q. Where does that 10 million come from? I am not talking about the cheque that comes back and I am not talking about the second one, but the very very first one.
A. The fact that a cheque is issued does not necessarily mean that there is money in the account to cover the cheque at the time it is issued.
[28] Mr. Lapointe believed the deposits would have been made almost at the same time. [TRANSLATION] "There is a theoretical delay between transactions and that's the aspect I really wanted to assess." Mr. Lapointe discussed the proposal with his supervisor and the request was approved. The Royal Bank advised the individual appellants that the cost for the $10,000,000 was $10,000 plus another $500 for opening accounts for the companies involved. The bank demanded no security and none was given.
[29] The cheques issued by the companies in Series 1 were certified cheques. Mr. Faraggi said the cheques were certified at his request. Mr. Lapointe testified that in certifying a cheque the bank guarantees that funds are in the bank account on which the cheque is drawn at the time the cheque is certified, and the bank maintains the amount of the cheque in the account, or that, if there are insufficient funds in the account, the bank nevertheless will honour the cheque. A certified cheque in the amount of $10,000,000, he agreed with the appellants' counsel, has a value of $10,000,000. When a cheque is not certified, Mr. Lapointe stated, there may or may not be money in the account.
[30] In the appeals at bar, Mr. Lapointe explained,
[TRANSLATION]
What is different with this case is the fact that both the cheques and the deposits were made simultaneously at the same time and were given to the bank at the same time. So when the cheque was issued, not only did we know but also we were aware that there was a deposit of 10 million that had been made into that account to cover the cheque.
He was not concerned that a certified cheque could be endorsed to a third party:
[TRANSLATION]
No, no, because the series of transactions, as I explained to you, A to B, B to C and C to A, etc., took place in the presence of the bank and the cheques and the deposits were all returned to us and we kept them in order to process them by computer.
The only reason the bank certified the cheques, Mr. Lapointe explained, was that all the cheques, deposits, withdrawals and deposits back to accounts were at all times under the control of the bank.
[31] Asked whether the bank would have offered Mr. Langlois and Mr. Faraggi an option to repay the $10,000,000 the day after the transactions in Series 1, that is, September 14, Mr. Lapointe replied negatively, explaining that in such a case there would have been a loan for $10,000,000 for one day and the bank would not take such a risk without guarantees.
[32] According to Mr. Lapointe, at the beginning of the transactions in Series 1 there were zero dollars in the accounts of all the companies and after