Bagg v. Minister of National Revenue

Bagg v. Minister of National Revenue
Collection
Supreme Court Judgments
Date
1949-06-24
Report
[1949] SCR 574
Judges
Kerwin, Patrick; Rand, Ivan Cleveland; Kellock, Roy Lindsay; Estey, James Wilfred
On appeal from
Canada
Subjects
Taxation
Decision Content
Supreme Court of Canada
Bagg v. Minister of National Revenue, [1949] S.C.R. 574
Date: 1949-06-24
Carden S. Bagg Appellant;
and
The Minister Of National Revenue Respondent.
1949: February 11; 1949: June 24.
Present: The Chief Justice and Kerwin, Rand, Kellock and Estey JJ.
ON APPEAL FROM THE EXCHEQUER COURT OF CANADA
Revenue—Income tax—Undistributed income of company—Reduction and readjustment of capital stock—Whether undistributed income capitalized—Income War Tax Act, R.S.C. 1927, c. 97, s. 15, 16.
Having an undistributed income on band, a company, by Supplementary Letters Patent, reduced its capital by cancelling 200 unissued shares of a par value of $100 each and by reducing the par value of 1,800 issued shares from $100 each to $44 each. These 1,800 Shares were then converted into 1,800 preferred shares of a par value of $40 each and 1,800 common shares of a par value of $4 each. The Minister of National Revenue, treating the readjustment as effecting a capitalization of income, assessed a tax on appellant, as shareholder of the company, in respect of his share of that income received through the capitalization.
Held, The Chief Justice and Kellock J. dissenting, that the readjustment of the company's capital stock resulted in the undistributed income being capitalized within the meaning of sec. 15 of the Income War Tax Act.
APPEAL from the judgment of the Exchequer Court of Canada 1, O'Connor J., affirming the decision of the Minister of National Revenue confirming an assessment made under the Income War Tax Act.
Hazen Hansard K.C. for the appellant.
John Ahem K.C. and T. Z. Boles K.C. for the respondent.
The Chief Justice (dissenting):—The appellant filed an Income Tax Return showing his income for the year ended 31st December, 1938. He received a Notice of Assessment upon that return on the 26th of October, 1942.
He lodged with the Minister of National Revenue a Notice of Appeal dated the 20th of November, 1942, in which objection was taken to the assessed tax for the reasons therein set forth.
The respondent affirmed the assessment on the ground that in 1938 the appellant owned 518 shares of Domestic Gas Appliances Limited which were reduced or redeemed in that year within the meaning of Subsection 1 of Section 16 of the Act, and therefore the appellant was deemed to have received a dividend according to the provisions of that subsection.
Notice of the decision of the Minister was given to the appellant pursuant to Section 59 of the Act, wherein it was stated that the decision was based on the facts presently before the Minister.
On the 12th of February 1945, a Notice of Dissatisfaction was filed by the appellant through his solicitors, stating that the appellant desired his appeal to be set down for trial.
The effect of the decision of the Minister was that a tax in the sum of $6,887.64 should be levied upon the appellant in respect of his income for the year 1938, said sum including an additional tax of $2,288.06 and $587.78 for interest arising out of the addition made by the Notice of Assessment to the income of the appellant.
In the Notice of Dissatisfaction the reasons in support of the appeal are stated as being:
The appellant was the owner of 518 shares of the par value of $100 each of Domestic Gas Appliances Limited (hereinafter referred to as the "Company") of which 1,800 shares were outstanding and fully paid and non-assessable.
By Supplementary Letters Patent dated 3rd June, 1938, granted to the Company under the Dominion Companies' Act, all these outstanding shares were converted into 1,800 preferred shares of a par value of $40 each and 1,800 common shares of a par value of $4.00 each, and the remaining paid up capital of the Company, which was then lost or unrepresented by available assets, was cancelled. Accordingly the appellant became the owner of 518 preferred shares of the par value of $40 each and 518 common shares of the par value of $4.00 each. Subsequently all of the outstanding preferred shares of the Company were redeemed and the redemption price paid, namely: par plus a premium of 1 per cent, there being no dividends declared prior to the redemption date and then remaining unpaid. As an incident to the redemption of all of the preferred shares, the Company made application for Supplementary Letters Patent reducing the capital stock of the Company by the cancellation of all of the 1,800 preferred shares of the par value of $40 each, and these Supplementary Letters Patent decreasing the capital stock were issued on October 8, 1938. In the decision of the Minister, it is said that the 518 shares of the Company owned by the appellant in 1938 were reduced or redeemed within the meaning of Subsection 1 of Section 16 of the Act.
The appellant contended that the subsection in question does not contain any definition of the words "reduce" or "redeem", nor is any to be found in the Income War Tax Act.
The operation whereby the appellant became the holder of 518 preferred shares was, according to him, merely a conversion of the 518 shares theretofore held by him. Nothing was bought back or recovered by the Company. That "reduce" or "redeem" is something different from "convert" may be seen by the fact that Subsection 1 of Section 16 was amended by Section 15, Chapter 14 of the Statutes of 1943-44 by the insertion therein of the words "or converts any class of the capital 'stock or shares thereof into any other class of capital stock, shares or other security therefor".
A perusal of the Supplementary Letters Patent dated June 3, 1938, will, it is contended, show that the preferred shares thereby created, on being reduced or redeemed, were not entitled to participate in the assets of the Company beyond the amount paid up thereon (i.e. $40 per share) plus a fixed premium of 1 per cent of the par value and a defined rate of dividend of 5 per cent per annum.
It is clear that the preferred shares were of a class coming within the provisions of Subsection 2 of Section 16; and it was alleged accordingly that Subsection 1 of Section 16 did not apply to the redemption of the preferred shares which were held by the appellant after issue of the Supplementary Letters Patent, and that, the appellant, upon such redemption, could not be deemed to have received a dividend under such subsection.
The conclusions of the Notice of Dissatisfaction were therefore, for those reasons, that the additional tax assessed, namely $2,288.06, and $587.78 for interest, was unlawfully imposed and should be cancelled and the assessment set aside. After the reply of the Minister to the Notice of Appeal, it was ordered that formal pleadings be filed in this cause. It was upon these pleadings that the appellant was tried before the Exchequer Court of Canada 2.
The allegation of the statement of defence filed by the respondent was that on June 3, 1938, the Company had on hand undistributed income in the amount of $38,091.61 or $21.15 for each of the original common shares, which undistributed income, as a result of the reduction or redemption, was deemed to be received by the shareholders of the Company, including the appellant herein, and became properly taxable pursuant to Subsection 1 of Section 16 of the Income War Tax Act. In the alternative, if the shares of the Company were not reduced or redeemed as aforesaid, in any case, as a result of the re-adjustment of the capital stock of the Company, in accordance with the Supplementary Letters Patent, the whole of the said undistributed income was capitalized and is therefore properly taxable in the hands of the shareholders of the Company, pursuant to Section 15 of the Income War Tax Act.
The respondent claimed therefore that, as of June 3, 1938, the appellant received an amount of $10,055.70, by way of the undistributed income of the Company, and was properly taxable thereon in the year 1938; that the assessment should therefore be affirmed and the appeal from the Minister's decision dismissed.
For the purposes of this case, the appellant admitted that on the 3rd day of June, 1938, the Company had an undistributed income in the amount of $38,091.61 mentioned in the Statement of Defence of the respondent.
The authorized capital of the Company was $200,000 divided into 2,000 shares of a par value of $100 each, of which, as of the 3rd of June 1938, 1800 had been issued as fully paid up.
Included in the capital assets was an item of good will of $180,000. Between 1921 and 1937 there were several write-offs of goodwill, totalling $140,000, and each in turn was charged to surplus. This resulted in a reduction of capital from $180,000 to $40,000 and changed a surplus of $38,091.61 into a deficit of $101,908.39.
The Company's return for the year 1938 and the appellant's return for the same year were made accordingly; but it was only, as we were told, in the year 1941 that these write-offs of good will were disallowed by the Department. These disallowances resulted, from a taxation view point in the Company having undistributed income of $38,091.61. As result of the Supplementary Letters Patent dated the 3rd of June 1938, the authorized capital was decreased from $200,000 to $79,200.
(a) By cancelling the 200 unissued shares of a par value of $100 each and
(b) by cancelling paid-up capital to the extent of $56 per share upon each of the said 1800 issued shares and thereby reducing the par value of the said 1800 issued shares from $100 per share to $44 per share.
The Supplementary Letters Patent of the 3rd of June 1938 further authorized the Company to convert the 1,800 issued shares of the capital stock of the par value of $44 each into 1,800 preferred shares of a par value of $40 each, and 1,800 common shares of a par value of $4 each. They added that the authorized capital stock of the Company should be $79,200 divided into the above mentioned shares, "subject to the increase of such capital stock under the provisions of the Companies' Act."
Then, the Supplementary Letters Patent of the 3rd of June deal with the rights, permits, privileges, limitations, terms and conditions which the preferred shares shall carry and be subject to.
Subsequent Supplementary Letters Patent were issued on the 8th of October 1938. They recite that the operations authorized by the Supplementary Letters Patent dated the 3rd of June 1938 had been carried out, that the original Letters Patent incorporating the Company (30th December 1918), as amended by Supplementary Letters Patent granted on the 7th of February 1929, were amended and varied by adding thereto the private Companies' clauses and thereby converting the Company from a public Company into a private Company. Accordingly, these later Supplementary Letters Patent (8th October 1938) decree that the authorized capital stock of the Company shall be $7,200 divided into 1,800 issued common shares of the par value of $4 each "subject to the increase of such capital stock under the provisions of the Companies' Act." In view of that fact, the decrease to that amount of capital stock was effected by the cancellation of the paid-up capital represented by the 1,800 issued preferred shares at a par value of $40 each, which had been redeemed.
The relevant sections of the Act are as follows:—
(15). When, as a result of the reorganization of a corporation, or the readjustment of its capital stock, the whole or any cart of its undistributed income is capitalized, the amount capitalized shall be deemed to be distributed as a dividend during the year in which the reorganization or readjustment takes place and the shareholders of the said corporation shall be deemed to receive such dividend in proportion to their interest in the capital stock of the corporation or in the class of capital stock affected.
(16). Where a corporation having undistributed income on hand reduces or redeems any class of the capital stock or shares thereof, the amount received by any 'shareholders by virtue of the reduction shall, to the extent to which such shareholder would be entitled to participate in such undistributed income on a total distribution thereof at the time of such reduction, be deemed to be a dividend and to be income received by such shareholder.
16 (2). The provisions of this section shall not apply to any class of stock which, by the instrument authorizing the issue of such class, is not entitled on being reduced or redeemed to participate in the assets of the corporation beyond the amount paid up thereon plus any fixed premium and a defined rate of dividend nor to a reduction of capital effected before the sixteenth day of April, one thousand nine hundred and twenty-six.
The evidence showed that the undistributed income ($38,091.61) did not appear in either of the annual statements of the Company, that nothing was done with the undistributed income on the reduction and conversion, that the net assets behind the stock of the Company, as disclosed by the audited statement as of December 31, 1937, amounted to $75,000; and that there was no material change in the net assets behind the stock of the Company after the reduction and conversion of the 3rd of June, 1938, and prior to the redemption which took place on the 30th July 1938; that there was no reduction in the number of shares, but there was a reduction in the face value of $100,800; that all the shareholders received on the 3rd day of June, 1938, was a certificate for one preferred share of the par value of $40, and a certificate for one common share of the par value of $4 in exchange for a certificate of one common share of the par value of $100; that the new shares were issued as fully paid up.
No amount in money was paid to or received by the shareholders. The Assistant Chief Auditor, Corporation Assessor in the Montreal office of the respondent, explained that as the Company had written off goodwill in the amount of $140,000 between 1922 and 1937, leaving $40,000 out of the original capital of $180,000, the write-offs of goodwill, from a taxation standpoint, reduced the surplus in the books of the Company; but, as the write-offs were disallowed, that resulted in an undistributed income of $38,000 and that, in his opinion, the share capital reduced to $79,200 consisted of $40,000 being the balance left of the original capital plus the undistributed income of $38,091.61.
That opinion of the Assistant Chief Auditor, in my humble view, takes no account of the fact that if the write-offs were disallowed, it follows that the amount of those write-offs ($140,000), in the result, no longer reduced the original capital of $180,000 to the balance of $40,000.
As consequence of the disallowance by the officers of the Department of the respondent, the original capital was reduced only to the extent of the write-offs which were allowed. And, as the write-offs allowed amounted to $100,000, what was left of the original capital was not $40,000 but $80,000 in round figures, or, to accept the figures of the Company, $79,200 which is precisely what the Supplementary Letters Patent of the 3rd of June 1938 authorized, and what the Supplementary Letters Patent of the 8th of October 1938 recognized. The latter Supplementary Letters Patent, taking into consideration the rédemption of the preferred shares of the par value of $40 each, which had been issued in the meantime, consequent upon the authorization contained in the former Supplementary Letters Patent, decreed that the capital stock of the Company shall, in the future, be $7,200 divided into 1,800 issued common shares of the par value of $4 each.
It may be said, in passing, that, with respect, the learned trial judge in the Exchequer Court 3, wrongly assumed that the disallowance by the Department had been made in each of the years in which the write-offs of goodwill had been made. The evidence shows that it was only in 1941, or three years after the returns made by the Company and by the appellant, that the write-offs were disallowed. However, he recognizes that the sole date and transaction in issue is that of the 3rd of June 1938.
The learned judge therefore asks himself whether the appellant received "an amount by virtue of the reduction" which took place on the 3rd of June 1938, within the meaning of Section 16 (1). He comes to the conclusion that that subsection does not apply; but his view was that as the preferred shares were reduced on 31st July 1938, they then came within the class denned in Subsection 2 of Section 16, and he expressed the opinion that Subsection 2 refers to the shares issued on conversion and not to the original shares. The second question examined by the learned judge was whether the undistributed income was "capitalized" as a result of the reduction and conversion of June 3, 1938, within the meaning of Section 15.
On that point he says that the appellant contended first that if the undistributed income was capitalized, it was capitalized between 1922 and 1937, when the capital asset of goodwill was written-off.
To this the learned judge declares that the Company may add undistributed income to capital by increasing the paid-up capital in each share, thereby increasing the par value of each share. He also says that, in his opinion, "using the undistributed income for the purpose of writing off goodwill did not capitalize it".
The appellant's second contention was that the reduction and conversion did not capitalize the undistributed income. To this the learned judge begins by stating: "it is correct that on the reduction the unissued shares were cancelled and no new additional shares were issued and the paid-up capital in each share was in part cancelled and not increased". But, in his opinion, the reduction did result in the capitalizing of the undistributed income. It is there that I find myself unable to follow the reasoning contained in the judgment appealed from. In my view, the learned judge then confused assets with capital. The judgment is to the effect that if the Petition for the Supplementary Letters Patent had disclosed that $140,000 had been lost or was unrepresented by assets and the capital remaining was only $40,000, although the Company had in addition undistributed income of $38,091.61, the capital stock would have been decreased to $40,000 and not $79,200. And he goes on to say: "this would have been accomplished by cancelling the 200 unissued shares and by cancelling paid-up capital of $77.15 per share of the 1,800 issued shares, thereby reducing the par value of each from $100 to approximately $22.85. If the Company then desired to convert the undistributed income into capital, the capital stock would then have been increased from $40,000 to $79,200 by increasing the paid-up capital to the extent of $21.15 per share upon each of the 1,800 shares, thereby increasing the par value from $28.25 to $44.00 per share of the said 1,800 shares."
But, as the learned judge himself says: "that procedure did not take place". And I regret that I can not follow the reasoning which the learned judge deduces from that finding of fact. He asserts that the Company represented that the loss was only $100,800 and not $140,000, and that $79,200 was represented by available assets "whereas only $40,000 was represented by available assets." And he then comes on to say that, as a result, it was clear that the same position was reached as if the capital stock had first been decreased to $40,000 and then increased to $79,200 by first cancelling the paid-up capital in each of the issued 1,800 shares of $77.15 and then increasing the paid-up capital in each share by $21.15.
But, of course, to that reasoning it must first be observed that the Company, when it petitioned for the Supplementary Letters Patent of the 3rd of June 1938, could not represent anything else than it did, since at that time the disallowance of write-offs had not yet taken place. It was made by the Department only in 1941. At the date of the petition and of the issue of the Supplementary Letters Patent of the 3rd of June 1938, the Company represented the facts exactly as they then appeared in its books; and, upon that representation, it was authorized to decrease its capital stock from the sum of $200,000 to the sum of $79,200, by cancelling paid-up capital to the extent of $56 per share, it being stated that $100,800 had been lost or was unrepresented by available assets. The Company was further authorized to convert the 1,800 issued shares of the capital stock of the par value of $44 each into 1,800 preferred shares of the par value of $40 each, and 1,800 common shares of the par value of $4 each.
The Company did exactly what they had been authorized to do by the Supplementary Letters Patent of the 3rd of June 1938. And the representation it made to obtain that authorization was strictly in accordance with the facts and figures as they then appeared in its books.
Furthermore, on the 31st of July 1938, the Company redeemed the preferred shares. The capital stock of the Company was thereby brought down to the $7,200 divided into 1,800 issued common shares of the par value of $4 each; and this was taken to be henceforth the authorized capital stock of the Company in accordance with the Supplementary Letters Patent of the 8th of October 1988.
The learned trial judge very properly recognized this by saying that under the Letters Patent the paid-up capital upon each share was $44, as a result of the cancellation of the paid-up capital to the extent of $56 upon each share. But it was exactly what the Company had been authorized to do by those Supplementary Letters Patent.
It would appear therefore, first that the learned judge, by his judgment, assumes a state of facts contrary to that which was recognized by the Supplementary Letters Patent, and to what actually took place.
In my view, he could not base the conclusions of his judgment on what he thinks that the Company should have done or might have done, instead of what the Company actually did, and did in accordance with the authorization granted to it by the Supplementary Letters Patent.
In other words, he can not declare that what is stated in these Supplementary Letters Patent, as the true capital resulting from the operations authorized thereby, was not in fact the true capital; and that if the Company had acted otherwise, the result would have been different.
It seems to me that we must truly accept the authorization contained in the Supplementary Letters Patent as they are stated therein. They decree that by the operation thus authorized, the capital of the Company would be and was reduced to $79,200; and it is not here nor there to say that only $40,000 was represented by available assets.
There is no evidence to establish that statement in the judgment appealed from and, moreover, that statement is directly contrary to what is stated in the Supplementary Letters Patent and what was authorized. It should be sufficient to add that, even if at that time the write-offs had already been disallowed, the disallowance only amounted to decreasing the write-offs by $40,000, which would mean that instead of having properly written off $140,000 of the goodwill asset, the Company should have written off $100,000; and the asset of goodwill back of the capital was therefore $79,200 instead of only $40,000. The result must then be as stated in the representations of the Company to the Secretary of State, and in the Supplementary Letters Patent consequently issued, that the capital remained at the figure of $79,200.
But the Department in 1941, when disallowing the write-offs, elected to treat the amount whereby they were disallowed not as a reduction in the capital, but as an amount representing undistributed income. Not to say anything of the arbitrary method whereby a sum of $40,000 re-added to the goodwill asset was transformed into an amount of undistributed income, even then accepting that method (as the Company did), whether you call it increased goodwill asset or undistributed income, still it can not be said that that amount did not represent available assets whereby the capital reduced to $79,200 was guaranteed.
I confess my inability to follow the reasoning of the Department that a disallowance of the writing off of some part of the goodwill asset could result in the creation of that amount of undistributed income.
The capital, as authorized by the Supplementary Letters Patent, as a result of the disallowance of the writing off, was merely brought down to $79,200, and not to $40,000.
However, the appellant also contended that if we are to admit that the $38,091.61 was undistributed income before the reduction, it remained undistributed income after the reduction and reconversion, and that it was not converted into capital by the reduction.
There again, if we are to accept that contention, it would not follow at all that such undistributed income was capitalized on the reduction, nor that the operation was thereby brought under Section 15 of the Act. There was no reorganization of the corporation. Even if we say that the operation amounted to a "readjustment of the capital stock", the undistributed income having remained so after the reduction and conversion, as is assumed in this argument, cannot be treated as having been converted into capital by the reduction or as having been "capitalized". Therefore, (Section 15 does not apply.
As to Section 16 (1) the judgment appealed from is to the effect that it does not apply to the facts of the present case, and I agree with that conclusion.
It is not perhaps decisive that in 1943 by Statute 7, Geo. VI, Ch. 14, Section 16 (1) was amended in order to insert the words: "or converts any class of the capital stock or shares thereof into any other class of capital stock, shares or other security thereof, the amount or the value of any consideration or right" etc.
It is apparent that the amendment was to cover exactly the situation that we have in the present case. It may be said that if the amendment was made, it was because the Section as it read previously did not cover the case sought to be met by the amendment. If that were so, cadit quaestio. If however it is argued that the amendment was made only to make the matter clearer or indisputable, my answer to that would be that as Section 16 (1) read previously, it did not cover the precise case that we have here. As for Section 16 (2), its purpose is only to exclude from the application of Section 16 (1) certain cases which are not the case now before us.
For these reasons, I would allow the appeal, set aside the judgment appealed from, declare that the assessment made against the appellant was illegally imposed, and declare that in the return of the appellant nothing should be added in respect of the conversion of shares of the capital stock of Domestic Gas Appliances Limited, the whole with costs against the respondent both in this Court and in the lower Court. Kerwin J.:—Mr. Carden S. Bagg appeals against a decision of the Exchequer Court 4 affirming the assessment against him under the Income War Tax Act in respect of his income for the year 1938. The first dispute involves-what the respondent contends was the capitalization of the undistributed income of Domestic Gas Appliances Limited (of which the appellant was a shareholder) as a result of the readjustment of its capital stock in 1938 and is based upon section 15 of the Act as it stood at the relevant time:
15. When, as a result of the reorganization of a corporation or the readjustment of its capital stock, the whole or any part of its undistributed income is capitalized, the amount capitalized shall be deemed to be distributed as a dividend during the year in which the reorganization or readjustment takes place and the shareholders of the said corporation shall be deemed to receive such dividend in proportion to their interest in the capital stock of the corporation or in the class of capital stock affected.
The Company, incorporated by letters patent under the Dominion Companies Act, had an authorized capital of $200,000 divided into 2,000 shares of $100 each, of which 1,800 had been issued and of which the appellant was the owner of 518. On June 3., 1938, supplementary letters patent were issued doing two things:—
1. The authorized capital was decreased from $200,000 to $79,200, such decrease being effected
(a) by cancelling the 200 unissued shares of a par value of $100each and
(b) by cancelling a paid-up capital to the extent of $56 per share upon each of the said 1,800 issued shares and thereby reducing the par value of the said 1,800 issued shares from $100 per share to $44 per share.
2. The said 1,800 issued shares of the par value of $44 each were converted into 1,800 preferred shares of a par value of $40 each and 1,800 common shares of a par value of $4 each.
In accordance with the supplementary letters patent, the 518 shares owned by the appellant were converted in 1938 into 518 preferred shares of a par value of $40 each and 518 common shares of a par value of $4 each. Still later in the same year the preferred shares, and in 1941 the common shares, were redeemed. In the latter year, the Minister ascertained that while $140,000 for goodwill had been originally included in the company's capital assets, that sum had been entirely written off by the Company in various amounts between 1922 and 1937. He, thereupon, disallowed the various items making up the total. The result of this was that in 1938, immediately before the supplementary letters patent, the Company had a surplus of $38,091.61, which, as between the parties to these proceedings, was formally admitted to be undistributed income.'
The appellant does not deny that within the meaning of section 15 there was a readjustment of the Company's capital stock by the supplementary letters patent on June 3, 1938, but contends that the $38,091.61 undistributed income was not capitalized as a result of the readjustment. The Company's balance sheet as at December 31, 1938, which was filed as Exhibit 2, shows $9,100.31 of assets, made up of cash in bank, accounts receivable, and deferred charges. On the liability side is $1,097.43 for accounts payable, and provision for income taxes, and then, under the head "Capital Stock" appears the following:—
Preferred 5 per cent Non-cumulative Shares—
Authorized and Issued—
1,800 Shares of $40 each………………………………….………… 2,000
Less
Redeemed during year………………………………..……………… 72,000
Common—
Authorized and Issued—
1,800 Shares of $4 each………….……………………………… 7,200
We are not concerned with the redemption of the $72,000 preferred shares which occurred in the year 1938 some time after June 3rd, except to note that that redemption must have been carried out by paying the necessary sum in cash. A comparison of Exhibit 2 with Exhibit 1, which is the Company's balance sheet as of December 31, 1937, makes it apparent that if one had been prepared as of June 2, 1938, it would have shown $72,000 more on the assets side and on the liabilities side would have appeared preferred shares of the same amount without a deduction for the redemption. Making allowance for an operation of five months in place of twelve, the total assets would thus have been approximately $81,100.31. It is true that at that time, as a result of the various write offs, the Company showed on its books a substantial deficit and that the disallowance by the Minister had not then occurred, but the Company, itself, by the supplementary letters patent reduced its capital by approximately the amount of the deficit and, as I have already stated, for the purposes of this case the appellant admits that the Company had on hand $38,091.61 undistributed income. Under section 15, the two questions to be determined are whether that income was capitalized and, if so, was it as a result of the readjustment of the Company's capital stock. The answers to both depend upon what the Company did and the evidence of William Edward Johnson makes that matter clear. The charter of the Company was surrendered in 1941 but he had been an accountant with the Company and was called as a witness by the appellant to state that no payment was made by the Company to the shareholders as a result of the readjustment,—apparently having in mind the provisions of section 16 of the Act. But the first two questions and the answers thereto on his cross-examination are as follows:—
Q. Can you tell us what happened to the undistributed. income of $38,091.61 which existed at the date when the change in the capital set-up of the Company took place?
A." Could I 'have that question again? (Question read by reporter). Well, the effect of the letters patent which were issued was to reduce or write off the capital of the Company by $100,800, thereby reducing the capital to $79,000, or $77,000. I just do not recall the amount. Now, you asked me what happened to the $38,000. Well it is assumed then that $38,000 still remained in the Company and formed part of the $79,000.
Q. That is right? the $38,000 formed part of the $79,000? A. That is right.
If the problem be treated as one of fact, the testimony of this witness is conclusive and, in so far as they are matters of law, upon the fact deposed to by him, that the Company changed the undistributed income into capital, the answer in law is that that change or capitalization was as a result of the readjustment of June 3, 1938.
The conclusion renders it unnecessary to consider the provisions of section 16. The appeal should be dismissed with costs.
Rand, J.:—The question in this appeal is whether the company in reducing its share capital brought about a capitalization of undistributed income within the meaning of section 15 of the Income Tax Act and the answer has been left by the parties to be drawn from the barest skeleton of fact.
The original capital of the company was $200,000 divided into 2,000 shares of $100 each. Of these, 1,800 were issued as paid up and the original capital assets as set forth on the balance sheet included an item of $140,000 for goodwill. From time to time between 1921 and 1937 this amount was written off, but the details do not appear. On June 3, 1938 following an application under section 61 of the Companies' Act supplementary letters patent effected a reduction of capital, first of the 200 unissued shares and then of the paid-up par value of the 1,800 shares from $100 to $44. This new capital of $79,200 was in turn converted into 1,800 shares of preferred stock of a par value of $40 and 1,800 shares of common stock of a par value of $4, all paid up. The letters empowered the company to redeem the preferred shares at a premium of 1 per cent and converted it from a public to a private company. On June 18, 1938 a resolution providing for the redemption of the preferred shares was passed, and following the redemption application was made and letters patent issued for a further and corresponding reduction of 'capital.
Some time after the readjustment in 1938, the income authorities reviewing the accounts of the company found that on June 3, 1938 when the first supplementary letters issued there was $38,091.61 of undistributed income in the assets of the company; and treating the readjustment and conversion as effecting a capitalization of this income, which I take to mean profit, assessed a tax on the petitioner, a shareholder in the company, in respect of his share of that income received through the capitalization.
An increase of capital assets may be effected in several ways, but where the shares are of one class only with the same rights, I see no reason why the company by such action as was taken here, cannot appropriate profits to lost capital. Whether it does so is a question of intention, and it must appear that the appropriation was to be irrevocable.
The limited accounts before us indicate that there was no profit reserve and that all the assets were treated as a blended mass. The accumulated income was part of those assets and it represents the difference between the $140,000 of goodwill apparently written off and the debit balance in assets and liabilities of $101,908.39 shown as of June 30, 1938. Whether from these facts an actual intention to make a provisional or temporary appropriation to capital can be inferred is doubtful: certainly it was not specific and nothing binding on the company took place: and the power to revoke would remain until an act has made the appropriation definitive; Stanley v. Read 5. The admission of the appellant confirms that view. All we have up to this point is, therefore, the disappearance of the goodwill item and the absence of a profit reserve.
But the petition for reduction contained certain representations. It was represented as the ground for reduction that capital "had been lost or was no longer represented by available assets". The loss was stated to be $100,800 The original resolution to reduce was passed on May 6, 1938 and the debit balance on June 30, 1938 as mentioned was $101,108.39. No doubt the actual amount represented as loss was dictated by its being the amount that would permit the nearest approximation to the value of the actual assets by a reduced capital with a par value in whole dollars.
But the implication of the petition is that the remaining capital is intact, and that the new share capital of $79,200 is represented by that value of existing capital assets: that what was stated to be lost was all that was lost. Such a representation necessarily involves the final commitment of the undistributed profits, or, as the matters appeared to the shareholders at the time, of all the then existing assets of the company, to capital; and the company cannot now be heard to say the contrary.
That this was the result intended seems to be confirmed by what followed. Between June 18 and September 20, 1938 the preferred shares with premium, amounting in all to $72,720, were redeemed. By new supplementary letters patent the share capital on October 8, 1938 was further reduced to $7,200, consisting of the 1,800 shares of common stock. This amount again was the approximate value of the then total assets and the implied representation is again that they are capital assets. The question my be raised whether the effect of the petition was not merely to destroy a power to change an existing state of things, namely, a de facto capitalization indicated by the form of the balance sheet which must be taken as confirmed in time. But section 15 strikes at a final and conclusive appropriation which the readjustment brings about. Until the moment of the new letters that clearly did not take place; at that moment it did; and to treat the effect as suggested would, in my opinion, be to make too subtle a distinction as to the nature of the so-called power to revoke, which, in other situations involving special and conflicting interests in relation to profits, might prove embarrassing: to treat, in other words, the loss of the continuing right to deal with the profits as such, where there has been no specific application to capital, as effecting a piecemeal appropriation at the times of the various balance sheets over a period of many years.
In these circumstances the evidence is conclusive that the reduction of June 3rd involved the irrevocable appropriation of the undistributed profits to capital and was, therefore, a capitalization within the meaning of section 15.
I would, therefore, dismiss the appeal with costs.
Kellock, J. (dissenting):—The appellant, prior to the 3rd of June, 1938, was the owner of 518 shares of a par value of $100 each, of the capital stock of a Dominion company whose authorized capital was 2,000 shares, of which 1,800 had been issued.